Coase's Curse: How the Coase Theorem Has Biased Ecological Policy Debate

Coase‘s Curse: How the Coase Theorem has Biased Ecological Policy Debate

Green Budget Reform

Fourth Annual Global Conference on Environmental Taxation Issues - Sydney, June 5-7, 2003

© Dr. Görres – www.foes-ev.de Oktober 03 G.B.R. 1 Coase‘s Curse: How the Coase Theorem has Biased Ecological Policy Debate 1.Introducing Ronald Coase and his famous Theorem 2.A Victory of the Chicago School? 3.Comparing Coase‘s world and the Real World 4.Back to Adam Smith and the Necessary Combination of Visibile and Invisible Hand 5.Why Coase‘s Theorem Really Laid a Curse over the Debate

• Born 1910 in Willeden, U.K. • 1951 Doctorate at University of London, emigration to U.S. • 1937 “The Nature of the Firm” • 1964 University of Chicago • 1966 “The Problem of Social Cost” • 1974 “The Lighthouse in Economics” • 1991 Nobel Prize

Source: A Regulatory Framework for the 21st Century, Dr. Elisabeth Bailey. www.princeton.edu/centennial/ bailey © Dr. Görres – www.foes-ev.de Oktober 03 G.B.R. 4 … that served as a justification for deregulation…

Visible Visible and Invisible Hand Invisible Hand Hand Only

Feudalism Adam Smith Walras/ Classics State Pigou/ Socialism Keynes Coase/ Chicago

Green Budget

Unsustainable Coase (Sustainable behaviour World behaviour – but taking place not taking place)

© Dr. Görres – www.foes-ev.de Oktober 03 G.B.R. 8 (To be sung like “Yellow Submarine”) “We all live in a tiny Edgeworth Box, tiny Edgeworth Box…” – But do we? Coase World Real Word Examples § Constructed cases of § Multitude of external birds and bees…. effects

Number of Players § “Robinson and Friday” § Millions of people or § Living in a rather small firms Edgeworth Box § Different countries Scope of problems § Mainly local § Typically global

Fiscal Effects § Irrelevant § Major source of state revenue View of Externalities § Rare exception to § Rule, not exception otherwise perfect § Majority of activities market world

© Dr. Görres – www.foes-ev.de Oktober 03 G.B.R. 10 Given the obvious irrelevance of the Coase world, we must ask ourselves: What did he really want to tell us? 1. A general reminder about the importance of transaction costs? 2. A revelation, that small groups, as long as they are behaving sensibly, can find solutions to most problems? 3. A scientific proof, that Pigou was wrong, and the Chicago school was right, in rejecting government interventions? 4. A far-sighted plead to favor ecotaxes and emission-trading over command and control?

© Dr. Görres – www.foes-ev.de Oktober 03 G.B.R. 11 If Economics where a science about Edgeworth Boxes, it would not be called a social science! 1. A reminder about the importance of transaction costs? 2. A revelation, that small groups, as long as they are behaving sensibly, can find solutions to most problems? Ad 1 and 2: • Both is certainly true – but also most trivial. • Without transaction cost, and within only small groups, we would need no firms, no governments, perhaps not even markets… • If we are talking about social costs in the sense of costs to society, cases that involve only small groups seem to miss the mark

“In the absence of transaction costs, people can solve the problem without the government” -- doesn’t that sound a lot like saying:

• In the absence of gravity, we all could fly? • In the absence of poverty, there would be no poor people? • In the absence of Coase, there would be no Coase Theorem?

© Dr. Görres – www.foes-ev.de Oktober 03 G.B.R. 13 Perhaps the Coase Theorem was a secret plea for market- based instruments of ecological policy? 3. A scientific proof, that Pigou was wrong, and the Chicago school was right, in calling for the government’s intervention? Ad 3: This is where the case becomes ideological. In my view, it’s perhaps not what Coase meant, but what others made of it. 4. A far-sighted plead to to favor ecotaxes and emission-trading over command and control? Ad 4: Why not? • The best interpretation of Coase seems to be a call for property rights that maximize efficiency • But creation of such rights clearly is a political process, not an outcome of market dynamics • If we create new rules and new tools through the visible hand of the state, the invisible hand can do the job again © Dr. Görres – www.foes-ev.de Oktober 03 G.B.R. 14 Why did the Coase Theorem create so much harm? 1. By choosing trivial and irrelevant examples (but of the kind all economists love), Coase lead an entire generation of researchers into a Peter Pan World: i.e. into overlooking the fact that most eco- problems are macro, not micro! 2. By proclaiming the self-healing potential of those situations, research was led into a “laissez-faire-laissez-aller-dream” and kept away from the necessary return to Adam Smith and to the historical middle-of- the-road (i.e. combination of visible and invisible hand) 3. By claiming that different instruments can provide equally efficient solutions, Coase became something like the Paul Feyerabend of the Eco-Instrument debate (“anything goes”). 4. By treating state intervention as the least desirable path, potential innovation gains from intelligent regulation are constantly overlooked 5. Even today, many economists and politicians have not realized the necessary transition from local/ national pollution control to global resource productivity – perhaps also an effect of “Coase’s Curse”?

© Dr. Görres – www.foes-ev.de Oktober 03 G.B.R. 15 Adam Smith discovered the invisible hand – but he never believed we can do without the visible hand of the state Visible Visible and Invisible Hand invisible Hand Hand

Feudalism Adam Smith Walras/ Classics State Pigou/ Socialism Keynes Coase/ Chicago

Moral Suasion Highly efficient

Works always Subsidies

Command/Control Not for big groups

Emission Trading Too costly!

Ecotaxes Only alibi-function

Scope/ No. of Players Small Medium Large

Political Priorities

© Dr. Görres – www.foes-ev.de Oktober 03 G.B.R. 17 TWO DISTINCT PHASES OF ECOLOGICAL POLICY Both nationally and globally, we must progress from Pollution Control to Resource Productivity 1975 - 2000 2000 - 2100? Pollution Control Resource Productivity Problem Toxics, Waste, SOx, Fluorides… CO2, Energy, land use, other Substances primary resources… Regional Focus/ Mainly local / Mainly global /mainly Process Stage Mainly outputs/emissions inputs/resources Predominating End of pipe/ As upstream as possible – philosophy Command and control mostly market incentives

Affected eco- About 5 Percent About 95 percent nomic activities Most efficient Policy mix– anything goes Not possible w/o market forces/ tools (Coase Theorem) allocative power of tax system

Difficulty of task Prevent harmful activities – Change entire way of life – clean up our mess find new prosperity model

Source: Ernst von Weizsäcker © Dr. Görres – www.foes-ev.de Oktober 03 G.B.R. 18 To overcome the curse left by the Coase Theorem, we must change our perceptions in more than one way 1. We must acknowledge the real magnitude of the ecological problem. For most of our economic activities, negative external effects are the rule, not the exception! 2. We must assign clear priorities within in our tool box. We do need a combination a tools (policy mix) – but some instruments are clearly more powerful and more sustainable than others. Moral suasion and subsidies can serve as starters and appetizers – but not as main dish of our menu! 3. Without ecotaxes, we were foregoing the most powerful weapon that we have. We will not solve global problems like the clima threat, if we do not put the allocative power of the fiscal system at the service of the environment. 4. We should not overlook the enourmous innovation potential of clear signals for new price relations.

Green Budget Germany (Förderverein Ökologische Steuerreform e.V./ FÖS) is a nonprofit organisation, founded in 1994. Our principal goal is to participate in the development of the German and European Ecotax Reform with own contributions, but mainly through communicating the basic principles and arguments in the business, scientific and political communities. Among other publications, we publish a monthly Newsletter (“ÖkoSteuerNews”) in German and the bimonthly “GreenBudgetNews” in English. Dr. Anselm Görres, born in 1952, economist and former McKinsey Consultant, is manager and entrepreneur in Munich Germany (www.zmm.de). He is co- founder and President of FÖS. He has written books and many articles about ecotaxes in Germany.

Förderverein Ökologische Steuerreform e.V. Brienner Str. 44 – D 80333 München Fon +49-89-520-113-13, Fax -14 [email protected]; www.foes-ev.de