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June 2013 Archive for Economic Sense

RSS By: Matt Bogard, AgWeb.com

Matt's primary interest is in the biotech industry and ag policy.

Should the Polluter Pay? The Coase Theorem and Cross Pollination

Jun 26, 2013

Since the recent finding of biotech wheat there has been a lot of discussion about the cross pollination of biotech and non-biotech varieties and the impacts. Some think we need a drastic regulatory overhaul. This reminded me of a post I did some time ago about biotech alfalfa. There is a lot we can learn about how markets can work to solve many of the concerns that anti-gmo advocates have with biotechnology. For the sake of this discussion, lets view biotech cross pollination of non-biotech crops as an 'externality.' (despite the evidence that the risks are slight take for instance biotech alfalfa.) An externality in the most simple terms is an unintended consequence that nobody is compensated for. 

Traditionally when it comes to environmental externalities, the general philosophy was that 'the polluter pays'. A factory polluting the air or water should pay for the damages that are caused. In a much simpler case, if you build a house next to me and you don't like the smell of livestock waste coming from my property, the traditional philosophy would hold that you could have the government stop my operation. (or in the case of biotechnology, the grower or biotech company pays for damges of cross pollination, or is prevented from growing such crops)

The economist Ronald Coase brought additional insight to this issue. 

1) yes it is true that my operation is harming you via air pollution. (odor)
2) however, in stopping me via government or legal intervention (or taxing my waste production) you are harming me.

 

The reciprocal nature of the ‘harms’ is probably the most profound insight we get from Coase. Who is harming who, and who is doing the most harm? Who’s responsible for dealing with it? How should the costs be shared?  This kind of information is very difficult for regulators or voters to grasp, because in economic terms, interpersonal comparisons of utility are not possible. We are all different with differing wants, needs, desires, tastes, preferences, goals etc. Determining the optimal level of pollution or ‘harm’ is one formulation of what economists refer to as the ‘knowledge problem’ which can only be solved by ‘local knowledge’ held by individuals, not bureaucrats or even voters.

Coase says that the issue is that no one owns the air that surrounds my livestock operation and your home. There then follows a dispute over how the air should be used- to absorb livestock odor, or to provide a scent free atmosphere in your back yard. Whenever the cost of one's behavior is not factored into a price by which a choice can be valued, I can harm you without compensating you for it. ( i.e. an externality exists) or in other words, if we don’t bear the full cost of our behavior, we might harm others without intention.

One way to ensure that we bear the full costs of our behavior is through well-defined property rights. If I own rights to the air, then I can choose to pollute the air, but you can bargain with me to pay me to pollute less.  If you own rights to the air, then you can prevent me from polluting it, or I can bargain with you about managing my pollution.  Regardless of who ‘owns’ the air, individuals can bargain to work out a solution that works for both parties and damages can be awarded if one person harms another.


The assignment of property rights and the potential for bargaining results in behavior that is changed or altered to account for the negative impact our choices have on others. This is the essence of what is known as the Coase Theorem. The bargaining process between individuals utilizes the local knowledge, preferences, and circumstances related to each individual in a way that voting or government regulation cannot.

How might this apply in the context of biotech cross pollination with non-biotech and organic crops?  Some favor a regulatory approach, limiting planting options for biotech producers. This is contrary to the Coase Theorem and  fails to allow for the bargaining that takes advantage of local knowledge to solve the knowledge problem.

The agriculture industry offers some of the greatest examples of how technological advances and market forces lead to self-correcting or internalization of externalities.  The adoption of biotechnology has led to reduced groundwater pollution, increased biodiversity, and reduced greenhouse gas emissions. All of which has occurred in absence of  and in spite of  taxes and government regulations. Of course, that takes the power and prestige away from regulators, and empowers property owners and market forces. In any case, what the Coase Theorem tells us is that there is no case for arbitrarily giving one party a regulatory trump card. The principle of ‘polluter pays’ is not always optimal nor does it take full advantage of all of the information available to solve society’s complicated problems related to the environment.


References:

Matt Bogard. 2012. "An Introduction to Game Theory: Applications in Environmental Economics and Public Choice with Mathematical Appendix"  http://works.bepress.com/matt_bogard/22

The Problem of Social Cost. R. H. Coase. Journal of Law and Economics, Vol. 3 (Oct., 1960), pp. 1-44

Towards a Theory of Property Rights.
Harold Demsetz .The American Economic Review. Volume 57, Issue 2. May, 1967

The Economics of Welfare
Arthur C. Pigou Macmillan and Co. London, Fourth edition, 1932. First published: 1920.

Modern Sustainable Agriculture.  Matt Bogard https://www.youtube.com/watch?v=D4ZL7w9q9Jc

Modern Sustainable Agriculture- Annotated Bibliography. Matt Bogard. http://ageconomist.blogspot.com/2011/02/modern-sustainable-agriculture.html

 

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