Appreciation of Ronald Coase

Ronald Coase passed away yesterday, four months shy of his 103rd birthday and working right up to the end. An archive search here shows how deeply Coase’s work influences Mike’s and mine, and we are not alone — Coase was one of the most influential economists of the 20th century, an influence made even more striking by the fact that it derives from relatively few publications. Few, but subtle and nuanced, and blockbuster. I cannot think of any aspects of my research that his work has touched, and his method of analyzing and thinking through problems also informs most of my teaching and research, and writing more generally.

Some appreciations of Coase come from Peter Klein, Geoff Manne, Jonathan Adler (on Coase and Ellickson and on Coase and externalities, the second being a must read), Todd Zywicki (making the essential point about the subtlety of Coase’s argument that costs are reciprocal), and Northwestern’s own Kevin Bryan. David Henderson also excerpts a quote of Coase’s that I find particularly inspiring in suggesting how we should engage in economic analysis:

Testable predictions are not all that matters. And realism in our assumptions is needed if our theories are ever to help us understand why the system works the way it does. Realism in assumptions forces us to analyze the world that exists, not some imaginary world that does not.

Given the recent debate around “economath” and the Rosenberg/Curtain NYT commentary about economics not being a science because it fails to generate testable predictions (which is a very narrow and not widely-held definition of science, I think), Coase’s observation is apt — strong assumptions to enable excessive formalism in our theory formation reduce our ability to use our models to understand how the world works, and that’s a tradeoff that we confront constantly.

I honor Coase’s long, richly-lived life, and the important new ways of thinking about and understanding the world that his work has enabled.

UPDATE: Pete Boettke and I were clearly working in parallel, and he posted this excellent observation about Coase’s contributions to new institutional economics and robust political economy at the same time I did. Pete also points to the 1959 FCC paper, which I think is one of Coase’s best and is quite underappreciated for many reasons (and I’ve written about a lot here before, particularly regarding modern spectrum policy).

Are property rights now more clearly defined for organic farmers in Minnesota?

Michael Giberson

The United States Supreme Court chose to let stand a Minnesota Supreme Court decision concerning the rights of organic farmers exposed to pesticide drift from neighboring conventional farms. In the case Johnson v. Paynesville Farmers Union Cooperative Oil Co., the organic-farming Johnsons had sued conventional-farming Paynesville for damages after pesticide drift from Paynesville’s farm damaged the Johnson’s organic crops and required some of Johnson’s fields to be held out from organic production for up to three years. The U.S. Supreme Court action left in place Minnesota’s decision which held Paynesville was not responsible for harm to the Johnsons’ organic crops.

The case provides a good background for exploring questions of externality and property rights (i.e., a real live case for contemplating Coasian reasoning):

  • At one time both the Johnsons and Paynesville engaged in conventional farming, including the application of pesticides. Pesticide drift was a non-issue.
  • In the 1990s Johnsons decided to switch to organic farming. They posted signs declaring the property was to be used for organic farms, established a buffer zone between their organic fields and adjacent properties, and asked Paynesville to take actions to avoid overspraying Johnsons’ fields. Then they operated without pesticides for three years in order to qualify to market their product as organic.
  • Subsequently, pesticide drift from the Paynesville farm has resulted in damages to the Johnsons on at least five occasions: crops have had to be sold at lower non-organic prices, crops had to be destroyed, and fields had to be held out of organic production for three years after the pesticide overspray.

The story may be framed as a simple case of negative externality: Paynesville’s operation are imposing an external cost (i.e. “polluting”) the Johnsons’ operations. The beginning economist will jump to the conclusion that efficiency requires a tax on Paynesville, or, in the case of a more thoughtful student, liability for damages.

But the question of who is creating the externality is a bit more complicated, observes the more advanced economics student. After all, pesticide drift is only a problem because of the Johnsons’ choice to go organic. You might say that the Johnsons caused the problem by starting up an organic farm in an area they knew was subject to occasional pesticide drift. If you build your house adjacent to an airport, you don’t really have much ground to subsequently complain about the related noise and traffic.

In class discussions when I’ve talked about this case, most students will side with the Johnsons at first. The question that moves many of them back to Paynesville’s side is this: “If Paynesville had the right to its manner of operations before the Johnsons switched, how did the Johnsons acquire the right to force Paynesville to change its operations?” Or sometimes, this question: “No one is too worried if Johnsons’ choice results in a higher cost of operation for the Johnsons, but on what grounds do the Johnsons get to impose a higher cost of operation on Paynesville?”

(Note that you can move students to the Paynesville side by asking, “What right does Paynesville have to limit the Johnsons ability to farm the way they please on their own farm?” Also relevant, Minnesota farming regulations prohibits the application of pesticide in a manner that damages neighboring property, and the State has cited Paynesville for violating this rule in the past.)

Now that it appears that the legal matters are settled–the Johnsons’ choice to go organic does not impose restrictions on how Paynesville operates–Coasian thinking would have us expect the least-cost avoider to take steps to minimized the costs associated with pesticide drift. I can imagine several possibilities, but have no idea which would be least cost:

  • Johnsons pay Paynesville to exercise greater caution to avoid pesticide drift.
  • Johnsons expand their buffer zone between the organic crops and the Paynesville property.
  • Johnsons simply suffer occasional pesticide drift and attendant costs.
  • Johnsons return to conventional farming on their property.
  • Johnsons sell and relocate their organic farm elsewhere.
  • Johnsons buy out Paynesville (i.e. Paynesville relocates its conventional farm elsewhere).

Because this is a case in which the number of parties is small on each side of the externality, the costs of negotiation should be small and so ‘transactions costs’ ought not be a barrier to obtaining the least cost solution. Of course if the least cost adjustment is fully in the Johnsons’ control then it will not require negotiation at all.

NOTES: The first link above includes a summary of the case and links to related documents including the Johnsons’ appeal to the U.S. Supreme Court. The Johnsons’ appeal includes a lengthy appendix with the text of the Minnesota court decisions.

Lynne and I have each written about this case before: Lynne here, and me here and here.]

Minnesota Supreme Court rules pesticide drift is not a trespass, but might be a nuisance

Michael Giberson

The Minnesota Supreme Court ruled today that pesticide drifting across property lines onto an organic farmer’s crop does not constitute a trespass under state law. The court dismissed the trespass claim as well as accompanying claims asserting nuisance and negligence under laws that govern organic farming. The organic farming laws regulate what a producer can apply to his own crop, but not what may drift onto the crop from elsewhere. However, the court ruled that additional nuisance and negligence claims not grounded in the organic farming laws could advance, and that portion of the suit was remanded to a lower court for further action. The case is Johnson v. Paynesville Farmers Union Cooperative Oil Company.

The case has become somewhat noteworthy within the organic farming community as an effort in which a small organic family farmer is battling against big, conventional agriculture. (Example.)

We’ve been following it more for its potential as an example of Coasian-style clarification of property rights, which done well can promote efficient resolution of such conflicts. The case might, eventually, bring clarity to the property rights held by neighboring farmers with respect to unwanted pesticide drift in Minnesota. Whether it does bring clarity will depend on what the lower court now does with the Minnesota Supreme Court’s ruling.

NOTES: We have discussed the case here before, Lynne with Coase, legal liability, and pesticide drift) and me with A Coasian look at pesticide and genetic drift). Additional background information available at those links. You can view the supreme court hearing in the case, from February 2012, at this link.

Praise for a New York Times article on natural gas fracking (Or, How property rights help mitigate potential environmental harms)

Michael Giberson

I’m writing in praise of a New York Times article on natural gas fracking. Yes, really! Even more surprising, I’m writing in praise of a New York Times on fracking written by Ian Urbina. Yes, really!

What is this marvel, you ask? I answer, “Rush to Drill for Natural Gas Creates Conflicts With Mortgages.”

What is so marvelous about this article? I answer, the way it highlights how property and contract laws can serve to regulate potential environmental harms from gas drilling and hydraulic fracturing.

Of course, as the headline suggests, the focus of the article concerns mortgage restrictions which may be violated if a property owner leases part or all of the property for oil or gas development. Mortgage lenders usually include such limiting provisions in loan contracts to help ensure protection of the property, which typically serves as collateral for the loan. Obviously mortgage contracts differ and the article notes that only sometimes will leasing violate a mortgage. The article further notes that lenders who don’t secure such restrictions in their mortgages, or who fail to closely police compliance with such restrictions, may find it difficult to resell their mortgages in the secondary market.

But here is the deal: almost all of the well-documented environmental harms from natural gas drilling and hydraulic fracturing happen within a few hundred feet of an active well: cases of methane in groundwater, spills from holding ponds filled with produced water from fracking, and so on. If the landowner owns the surface and mineral rights free and clear, and owns a large enough piece of property that effects on neighbors are unlikely, then most of the potential hazards from drilling and fracking are faced by the property owner who can weigh the trade-offs between the costs and benefits and negotiate reasonable protections within the lease with a developer. Actions taken by the developer in response to such a contract to mitigate the likely harm to the property-owner will also almost inherently serve to mitigate any possible harm to neighboring properties. If methane doesn’t migrate from the well into the groundwater immediately around the well, it can’t subsequently migrate across a property line some tens or hundreds of feet distant.

When a landowner borrows against the land, the lender naturally gains an interest in protecting the land’s valueas a tool to help ensure the loan’s repayment. In may be the case, as the article mentions, that the a lease enhances the value of a property and the resulting income makes loan repayment more likely. On the other hand, gas drilling and fracking may reduce the value of the surface property. The point is that – working in the context of contracts and property law –  landowners, lenders, and gas development companies have a natural interest in trying to work out these issues in an way that should naturally reflect most of the potential costs and benefits from exploitation of the shale resource.

Not every potential hazard will be well contained within a mortgage contract and a mineral lease. For example, the landowner may not care too much what the developer does with produced water from fracking operations so long as it is safely removed from her property. Other issues may depend on rights to surface water crossing a property or the contribution to any local air pollution hazards. In such cases liability rules and potential litigation by neighbors might be the efficient regulator, but government-provided regulation is also sometimes the efficient response.

I praise the New York Times article for highlighting (even if only indirectly) the way that decentralized decision making in the context of the rights and responsibilities attendant to property and contract law can serve to regulate environmental harm. The next step, from the view of government policy, is to refocus the efforts of government regulators on just those harms that are not well addressed within the scope of voluntary decentralized decisions.

[NOTE: For additional commentary on Urbina's NYT reporting on natural gas fracking, none of it laudatory, see this search of the KP archives.]

A Coasian look at pesticide and genetic drift

Michael Giberson

A few weeks back Lynne drew attention to an interesting property dispute between neighboring farmers in Minnesota, currently the subject of legal action (see news summary here, related court decision here). In brief, the issue is pesticide drift from conventionally farmed crops onto a neighboring organic farm, and whether the organic farm can sue the conventional farm for pesticide-drift trespassing. Appeals court says yes.

David Conner wrote about a very similar hypothetical case a few years back in “Pesticides and Genetic Drift: Alternative Property Rights Scenarios,” when considering a Coasian approach to resolving such issues:

Imagine the following hypothetical dispute between Cameron Conventional and Olivia Organic, two farmers with adjacent fields. Cam­eron is a cutting-edge, high-tech farmer, an early adopter of new technologies, making him a low­ cost producer of grains and legumes. “Back to the land” Olivia grows organic specialty orops for sale at a local farmers’ marker.

Someone tests an ear of Olivia’s sweet corn and determines that it is contaminated by pesticides and pollen from GE corn. Her upset consumers begin to boycott her. The belief that she is an organic producer is stripped away. She must now sell her produce conventionally at a much lower price. What are her options?

Conner then explores the case in “Coasian” fashion, considering various scenarios depending upon who would be the least-cost avoider of the conflict and who held what rights.

Coase, legal liability, and pesticide drift

Lynne Kiesling

A ruling last week from Minnesota’s Court of Appeals provides an interesting case study in using common law and legal liability (a la Coase) in an environmental case. As summarized in the St. Cloud Times, the issue at hand is pesticide drift — when pesticide spray on one field is carried over to another field by wind. In the case of an organic farm, such pesticide drift has a significant economic cost, because the organic farmer cannot sell the affected produce, and may even have to take affected acreage out of rotation for several years to clear the pesticide and retain the foundation of the organic attribution (usually defined by law).

Here’s a bit more about the fact pattern:

The Johnsons turned their farm into an organic one in the 1990s to take advantage of the higher prices organic crops and seeds bring at market. They posted signs noting that the farm was organic, created a buffer between their property and neighboring farms and asked the co-op to take precautions to avoid overspraying, according to the Court of Appeals opinion.

But the co-op violated state law four times from 1998-2008 by spraying chemicals that landed on the Johnson’s organic farm, the opinion said. The opinion said that the co-op was cited four times by the Minnesota Department of Agriculture for violating pesticide laws that make it illegal to “apply a pesticide resulting in damage to adjacent property.”

A 2002 overspray led to the Johnsons selling their crops at lower, nonorganic prices and taking the tainted field out of production for three years. In 2005, 2007 and 2008, the overspray led the Johnsons to destroy alfalfa and soybeans and plow under and take out of production for three years parts of their fields, according to the Court of Appeals opinion.

What’s interesting to me about this case is the Johnsons’ use of the common law — they filed a lawsuit claiming nuisance and trespass. The district court found against them, but this appeals ruling negates that and sends it back to the district court:

The Court of Appeals opinion Monday decided that what the co-op did could be considered a trespass because it met the two elements necessary — that the Johnsons had rightful possession of their fields and that the cooperative’s unlawful spraying of the pesticide, causing it to drift onto the Johnsons’ otherwise chemical-free fields, constitutes an unlawful entry.

Looks to me like an application of Coase to the pesticide drift question — clarifying who has legal liability for the consequences of actions when those actions affect others, use of the common law concept of nuisance — with the result that the pesticide sprayer is liable for the costs of the consequences.

In a case like this, with two adjoining plots of land, the identification of the actors and the actions is pretty straightforward, so it’s a textbook low transaction cost case. But what happens if, say, the organic farm is adjacent to three other farms, and the issue is not pesticide drift, but is rather GMO propagation drift? If all four farms plant corn, but three of them plant the same strain of drought-resistant GMO corn, some seed propagation across property boundaries is likely. How do you assign liability with multiple potential actors? Is there a way to avoid such a cost, and if so, who is likely to be the least-cost avoider? Or more interestingly, since the GMO corn is drought resistant, how do you net out the beneficial effects of the need for less irrigation against the cost of the corn not being able to be sold as GMO-free any more?

I think I may have just identified a new case study for my fall environmental class …

Reversing the Seaway Pipeline

Michael Giberson

The Seaway Pipeline is built to carry crude oil from the Gulf Coast to Cushing, Oklahoma, but with the current price differential between crude oil at the coast and crude oil at Cushing, each barrel delivered on the pipeline loses about $10-15 of value. The Streetwise Professor does a little back of the envelope calculation to conclude reversing the flow of the pipeline would create substantial economic gains. The (part) owner of the pipeline has substantial refinery assets in the Mid-Continent region, so it benefits from the low crude oil price at Cushing and is not interested in reversing the flow. The only way to reverse the flow may be for someone to buy the current owners out. Can somebody make this deal happen?

Demsetz discusses Coase’s mistake on Pigou and social costs

Michael Giberson

Last summer, Harold Demsetz spoke at the Property and Environment Research Center on Ronald Coase’s big mistake in “The Problem of Social Cost.” PERC has just posted the video.

Demsetz_at_PERC_video

Harold Demsetz lecturing on Coase's mistake in "The Problem of Social Cost."

The article he is presenting is, “Fallacies in the Economic Doctrine of Externalities,” but I bet in the written article he doesn’t say, “what the hell is a court doing in this model?” (at least not in those words).

Demsetz notes that his title is a nod toward Frank Knight’s 1924 response to Pigou, “Some Fallacies in the Interpretation of Social Cost.”

Ronald Coase interview

Michael Giberson

Interview with Ronald Coase, on the occasion of the establishment of the Coase China Society, an effort to stimulate study and application of Coase’s ideas in China. Interview conducted by Wang Ning, a student of Coase’s now teaching at Arizona State University and co-author with Coase of the book How China Became Capitalist.

HT to Paul Walker of Anti-Dismal.

A few selections illustrating Coase’s views on Coasean economics, experimentation and institutional reform, and where Hayek had a good point:

WN: You mentioned many times that you do not like the term, “Coasean economics”, and prefer to call it simply the “right economics” or “good economics”.  What separates the good from bad, the right from wrong?

RC: The bad or wrong economics is what I called the “blackboard economics”. It does not study the real world economy. Instead, its efforts are on an imaginary world that exists only in the mind of economists, for example, the zero-transaction cost world.

Ideas and imaginations are terribly important in economic research or any pursuit of science. But the subject of study has to be real.

[...]

WN: The second question many Chinese have in mind for you is, what you think other countries can learn from the Chinese experience of market transformation? Is there any general lesson to be learned from the China model?

RC: I don’t know. You don’t know what you can learn until you try to learn.

WN: I think this point is critically important. If I understood correctly, you are saying that learning from China or any other example is not like learning from a book or cooking recipe, but more like learning by doing. If the Chinese economic reform is an experiment, learning from China remains an experiment. Different countries will learn different things even if they learn from the same model.

RC: Exactly. What we do is all experiment.

[...]

RC: Nothing guarantees success. Given human fallibility, we are bound to make mistakes all the time.

WN: So the question is how we can learn from experiments at minimal cost. Or, how could we structure our economy and society in such a way that collective learning can be facilitated at a bearable price?

RC: That’s right. Hayek made a good point that knowledge was diffused in society and that made central planning impossible.

WN: The diffusion of knowledge creates another social problem: conflict between competing ideas. To my knowledge, only people fight for ideas (religious or ideological), only people are willing to die for their ideas. The animal world might be bloody and uncivilized. But animals, as far as we know, do not fight over ideas.

RC:  That’s probably right. That’s why we need a market for ideas. Ideas can compete; people with different ideas do not need to slaughter each other.

Cole on Coase and cattle

Michael Giberson

Arizona is re-thinking its open range law. Dan Cole, blogging at Law, Economics & Cycling, is reminded of Ronald Coase (and specifically Robert Ellickson’s law review article “Of Coase and Catttle“). Cole summarizes the situation:

Arizona is an “open range” state, which means that cattle can roam at will. Ranchers do not have to fence them in (but they are responsible for collecting wandering cattle) neighbors must fence them out. From a Coasean point of view, roaming cattle and the harm they cause constitutes a joint-cost problem created by both cattle ranchers and neighbors. The chief solution to the problem is for someone to build a fence. The chief question is: who should have to bear the costs of building and maintaining fences. Ultimately, what “open range” laws do, by insulating cattle ranchers from liability (though not as much as the ranchers might believe) for trespassing cattle, is to allocate the costs of fencing out to the neighbors. The fight going on now in Arizona is about changing the law from “fencing out” to “fencing in,” which would basically just reallocate the costs to the cattle ranchers.

The issue is more complicated than who pays for damages to vegetable gardens inflicted by wandering cows.  An important current issue in Arizona is car-cattle collisions. Under “open range” rules, the driver may be liable to damage to the cow, whereas with a “closed range” rule the rancher may be liable to damage to the vehicle.

Cole offers some additional detail and nuance, so go read his post.