Let me give you an example, a particular firm that is polluting the air will continue to do so because to the firm, the private cost of polluting is zero, and the social costs need not be considered. The external costs imposed on society (the social cost of the pollution) will not be factored into cost analysis of the firm. The result is the overproduction of pollution, to the nearby landowner the experience of production externalities, because there is no preventive law allocating the air to any individual or entity.
One method to prevent the overproduction of the 'bad' of pollution is to allocate air property rights to individuals. Now if the firm were to produce air pollution that was in excess to what particular land owners were comfortable with, these property owners would be provided a method to seek compensation for the pollution infringing on their land. The economic position of creating property rights for air is one which involves the prevention of the overproduction of air pollution by creating a deterrent effect with the establishment of the property right. Firms will be cognizant of the surrounding property owners, and will be more aware of the social costs of their pollution production.
Another effect of the property law is property value. Without the law, the particular value of land with considerable pollution will be lower, passing on the externality to the owner once again. If the courts allowed particular compensation for air pollution, this would permit the pareto efficient move, and prevent a pareto worsening move, the overproduction of the pollution. The establishment of the property rights is a method of externalising the costs of, in this case, pollution.
The economist responsible for the 'externalities' theory Dr. Coase suggested that the costs of the externalities could in fact be internalised to the cost-producer without external intervention, such as the courts. Rather than expending costs on creating new laws for pollution, Coase argued that the polluter and pollutee, if possible, could negotiate payments that would make each better off, thereby in the process choosing the Kaldor- Hicks (an economic measurement comparing total social costs to total social benefits) efficient combination of externality costs and subsequent reductions of these costs.Coase was attempting to incorporate criteria for his theory to hold. This included decisions that minimized the sum of harms for both parties involved.
If one firm is required to abate pollution, this in term is a pareto worsening move for the firm, yet beneficial to the particular land owner. A decision in the reverse would find the firm better off at the expense of the landowner. Therefore a solution must be reached that find the optimal amount of reduction for the firm that considers the maximum willingness to pay for abatement on behalf of the landowner.
Another criteria suggest that negotiations will only take place if the net result leads to an increase in the value of production. Essentially once negotiating costs have been considered, the increase in the value of production should still be positive.In a economic system that permits such negotiations, and if land owners have property laws in place to protect and facilitate both parties interested, than this alternate way of approaching the social costs of pollution and corresponding compensatory planning could expand and grow in popularity. Putting a cost to the amount of pollution based on a compensatory scale could make producers/private enterprises think twice about who is affected and how much pollution they are producing..DiscussEconomics is an online economic and financial dicussion forum that includes a number of topics including: foreign exchange discussions, interest rate indicators, economic indicators, economic analysis of property law, macroeconmic indicators, world oil econmoics, and personal finance questions.
By: Barry Flames