Coase, external costs, and lighthouses

Yes, Coase reformulated the problems of social cost and public goods. No, he did not make them go away.

Ronald Coase’s passing - at the ripe age of 102 - is an opportunity to recognize a substantial intellectual achievement. “The Problem of Social Cost” represents a major advance over Pigou in thinking about policy toward third-party effects. It does not deserve most of its “Coasean” followers (including Coase himself, in some moods) who want to act as if the problem had been eliminated rather than being reformulated as one of minimizing transactions costs and dealing with free-ridership. (Harold Demsetz makes the strong argument that the public-goods/free-ridership problem is more fundamental than transactions costs proper.

(A different critique, not often offered, is that the paper ignores the problem of extortion: it’s one thing for you to voluntarily pay to have me move my hog farm to improve the atmosphere around your mansion next door, and something else for me to buy the land next to your mansion and threaten to set up a hog farm unless you buy me out at a premium.)

“The Lighthouse in Economics,” by contrast, does not get within a million miles of proving what Coase and his followers think it proves. Yes, there were private-enterprise lighthouses in Britain. But there were never free-market lighthouses in Britain or anywhere else. Lighthouse construction and operation were supported by tolls - that is, taxes - collected at nearby ports. Of course a private enterprise can supply a public good if it has the power of the state to force someone to pay for it. So what?

In the end, the political economy of private lighthouses worked out so badly that it was decided to make them a public service after all, though still supported by shipping fees rather than out of general revenue.

How much of any given public good to provide (including the elimination of public bads such as air pollution), and how to pay for it, remain problems outside the reach of “free-market” dogmatizing. But that won’t, alas, prevent libertarians from pretending that waving their magic wands while shouting “Coase!” makes the problems go away.

P.s. Still waiting for some libertarian to notice the argument in Nozick’s Anarchy, State, and Utopia which demonstrates that Lockean principles cannot support the acquisition of private property in land, because the “enough-and-as-good” proviso unravels backwards.

Update John Cassidy expounds the differences between what Coase taught and what was taught in Coase’s name.

Author: Mark Kleiman

Professor of Public Policy at the NYU Marron Institute for Urban Management and editor of the Journal of Drug Policy Analysis. Teaches about the methods of policy analysis about drug abuse control and crime control policy, working out the implications of two principles: that swift and certain sanctions don't have to be severe to be effective, and that well-designed threats usually don't have to be carried out. Books: Drugs and Drug Policy: What Everyone Needs to Know (with Jonathan Caulkins and Angela Hawken) When Brute Force Fails: How to Have Less Crime and Less Punishment (Princeton, 2009; named one of the "books of the year" by The Economist Against Excess: Drug Policy for Results (Basic, 1993) Marijuana: Costs of Abuse, Costs of Control (Greenwood, 1989) UCLA Homepage Curriculum Vitae Contact: Markarkleiman-at-gmail.com

26 thoughts on “Coase, external costs, and lighthouses”

  1. Indeed.

    No one who reads the lighthouse paper with any degree of attention can believe that it supports the notion that lighthouses can be readily provided without government intervention. That so many do seem to believe it is what - interesting, astonishing, what?

  2. As a general matter, both the champions and detractors of the lighthouse paper miss the point. You are correct that the paper shows that “private enterprise lighthouses” existed in Britain, not “free market lighthouses.” But what the paper also illustrated is that lighthouses, like other “public goods,” could be provided through tying arrangements. The Coasean question, then, is not whether the “free market” can or will produce the optimal number of lighthouses. It can’t and won’t. Rather the question is whether direct provision of lighthouses by governments is more or less likely to come closer to providing the optimal number of lighthouses (or other public goods) than available alternatives given existing and reasonably likely institutional arrangements. The virtue of the paper is not that it settled the debate about lighthouses, let alone about public goods, but that it helped illustrate that economic theory is insufficient to predict what will actually come to pass in the real world, and that comparative analysis is necessary to determine whether, in any given instance, government intervention is preferable to the alternatives.

    1. What he said … times two!

      Consider health insurance in this country. An option is to let the “free market work its magic.” We know how well that worked out in our lifetime. A second option is to let the government take over insuring health. A “Medicare for everybody” system, with the added proviso that the “supplemental coverage” would no longer be required because the Medicare system would subsume that supplemental coverage, as well. That simply was not politically feasible in our country. Too few economists and accountants and actuaries casting votes, and too many who were taken in by the rants against Death Panels et al.

      The third option, which proved feasible, was Coasean lighthouses for health coverage. Government intervention in the marketplace, enforcing the requirements and the boundaries of the market, but ensuring that the light would be available for everybody, at a relatively stable price, while leaving it to “private enterprise” insurers to provide it while making a modicum of profit.

      1. The feasibility of the third option will be determined by how many shipwrecks, large and small, we end up with. In the mean time, rather than curse the darkness, a lot of people are making the ships lighter by not being the last rats off.

      2. What we really need is an individual lighthouse mandate, subsidies for lighthouses for the poor, and a requirement that lighthouses shine their lights for all comers.

      3. “Rather the question is whether direct provision of lighthouses by governments is more or less likely to come closer to providing the optimal number of lighthouses (or other public goods) than available alternatives given existing and reasonably likely institutional arrangements. ”

        And who does the accounting of which option will give better results? THAT is the question.
        The problem we have in the US is an ideology (for the rubes) and a parasitism (for the 1%) that is so pervasive that it’s very hard to get an honest accounting.

        Take prisons for example. Yes, we start off with “Acme Prison Corp can run prisons at 95% of the cost of the government” as measured by the cost of food, labor, construction. But this accounting does not include the MASSIVE pressure we have now built into the system to continually expand the prison system, the way in which we now have a powerful and organized special interest pushing in one direction.

        Take health, where we have the same sort of thing. Maybe a private hospital can deliver babies and set bones cheaper than the NHS, but once again we have a MASSIVE pressure in the system to change what is being done, to take more MRIs, insert more stents, prescribe more medicines.

    2. So you agree that it’s false to say that,

      “Coase shows that private entrepreneurs successfully established and operated an enterprise that most economists believed was the classic example of a public good that could only be provided by government.”

      1. What I agree is that Ilya Somin (whoever that is) attributes something to Coase’s Lighthouse paper that Coase did not claim for it.

        Mark wrote “…within a million miles of proving what Coase and his followers think it proves.” I can’t speak for his followers, but Mark (and Ilya Somin) are mistaken about Coase. He had no grandiose ambitions for that Lighthouse paper. We shouldn’t make more of it than Coase did.

        There is a good post about Ronald Coase today on Wonkblog:
        http://www.washingtonpost.com/blogs/wonkblog/wp/2013/09/03/ronald-coase-is-dead-here-are-five-of-his-papers-you-need-to-read/

        Here is Dylan Matthews’s synopsis of the importance of the Lighthouse paper, quoting Coase’s own words:

        Coase’s point isn’t that this system worked better than ones in which lighthouses are publicly owned, or, as was later the case in Britain, run by a private foundation for public benefit. His point is merely that economists should use better examples. “This paper is not intended to settle the question of how lighthouse service ought to be organized and financed. This must await more detailed studies,” Coase concludes. “In the meantime, economists wishing to point to a service which is best provided by the government should use an example which has a more solid backing.”

        In the Somin post on Volokh, there’s a good comment by Bernard:
        Before we get all carried away with private lighthouses, let’s note that, as Coase explains, the “private” system was created and run under duress from the British government. It’s really not the wonderful libertarian refutation of public goods that it is sometimes made out to be.

        Finally, in the Dylan Matthews post on Wonkblog, he points our that Coase was aware of the special place “public goods” have in the lexicon of economics. Coase pointed out that requiring anyone using ports to pay a fee to maintain the lighthouses makes them a “club good” rather than a public good.

        It appears to me that Coase had his head on straight, and some folks with agendas of their own have gotten carried with expanding Coase’s modest point.

    3. ¨… comparative analysis is necessary to determine whether, in any given instance, government intervention is preferable to the alternatives.¨
      Hamlet
      There’s ne’er a villain dwelling in all Denmark
      But he’s an arrant knave.
      Horatio
      There needs no ghost, my lord, come from the grave
      To tell us this.

    4. I wish what Jonathan describes is what Jonathan’s fellow libertarians learned from Coase’s lighthouse essay. I think, however, what they got out of the lighthouse essay is what Mark Kleiman says they did. Jonathan, however, is much less prone to ideological blinders. He does see utility in the idea of government public policy, and indeed a mixed economy. Coase appears to have recognized that too at least from time to time.

      The other commenters below hit precisely the allure of Obamacare in a nation such as ours where our elites are stuck in a mantra of “free markets” (money corruption is a big factor in staying in that mantra) and can’t politically work their way toward the obvious health insurance solution, which was Medicare for All. If one agrees with Jonathan’s analysis of Coase’s lighthouse essay, then Dilan is correct that the solution under this circumstance is “individual…mandate, subsidies…for the poor, and a requirement….(of coverage) for all comers.”

      Hey, who said Coase’s essays can’t solve any real world problems? 🙂

    5. Non-snarkily, I’m not sure what you mean by “tying arrangements.” I presume you mean something like a user fee. That some government-provided goods can be paid for out of user fees is interesting, but hardly a great insight or a killing argument against the notion of public goods. While lighthouses are public goods they are really a sort of special kind, in that their beneficiaries - shipowners - can readily be identified and charged. The average Briton is free to use the lighthouse, but has no real occasion to do so.

      So, besides the fact that the system described by Coase is dependent on government involvement, it is also the case that, whatever its merits, it does not generalize easily to all other public goods.

      1. What I mean by tying arrangements is that the owner of a port could finance a lighthouse through whatever fees are charged for using the port. Yes, there would be free riders as some would be able to use the lighthouse without paying — those who are sailing by — but if the value of the lighthouse in helping those ships bound for port (and the value to the port in helping ships arrive safely) are large enough, then we would expect some ports to build and operate lighthouses. Would they do so at the “optimal” level? Almost certainly not, but then it’s almost certainly the case that the government would not provide the optimal number of lighthouses either, so the question would become which set of arrangements is preferable. The former arrangement is no more “dependent upon government” than any other institutional arrangement based upon property rights and voluntary exchange.

        As for whether the point is generalizable, it is in this sense: The private sector is capable of providing many things that have public good characteristics, so the purported existence of such characteristics do not, in themselves, justify government involvement. Rather, we must consider the extent to which government involvement is likely to improve upon the situation. In effect, it’s Coase’s argument about “externalities” all over again.

        1. You don’t get this discussion of tying arrangements from Coase. Yes, the paper notes the existence of “local lights,” which guide ships landing at a particular port, and which are paid for out of port fees. But Coase doesn’t given any indication that these would be useful to ships just sailing by. If there is a “free rider” problem with local lights, it’s one that escaped Coase’s notice.

          Coase mentions “local lights” for completeness, but his topic is lighthouses for general navigation, where the type of tying you describe isn’t applicable.

  3. A couple more good links from Crooked Timber:
    - Daniel Davies on lighthouses, with a link to a real history of English lighthouses (refusal to pay lighthouse dues at the Cinque Ports was punishable after 1261 as treason, which did not mean a merciful death);
    - a funny as well as dense legal analysis by Brian Simpson, a law professor at the University of Michigan. He concludes that Coasian private negotiation trading over rights to harm, and a Coasian cost-benefit analysis, are infeasible in an actual common law system. And don´t miss page 93 on rats.

  4. PS: ¨But there were never free-market lighthouses in Britain or anywhere else.¨
    There were, of a sort. The inhabitants of the island of Sark used to light fires to lure unwary mariners on to the plentiful nearby rocks, so they could loot the wrecks and corpses. The last recorded British case of a successful wrecking was in Devon as late as 1842.

        2. It’s an excellent question. The name definitely predates both the lighthouse and the (alleged) lured groundings of ships.

    2. Speaking of Sark, check out Canadian prog-rock band Rush’s song titled The Wreckers from their latest album Clockwork Angels. That’s exactly what the song is about.

  6. Peter Klein, on your linked blog: ¨Trinity House was a private organisation …¨
    This is a misreading. Trinity House was a chartered corporation. Henry VIII, and Henry III for that matter, would not have recognised anything like modern boundaries here. Corporations were created by sovereigns: free cities, universities, colonial ventures. Mediaeval society had informal associations of course - bands of pilgrims, troupes of entertainers, guilds. Some of these had quite effective informal sanctions, but not formal ones. Corporate legal personality was in the King´s gift, and a privilege not a right. We wonder today at the mixture of ¨private¨ and ¨public¨ functions in the great merchant companies: the British East India Company had a much bigger army when the Raj was nationalised in 1858 than the British Crown. But that mixture was normal in the pre-modern world. If we apply modern standards, Trinity House is straightforwardly a public body, like Oxford University, the Royal Engineers and the Bank of England.

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