Coase's 100th Birthday: No More "Externalities"

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Today, the great economist and Nobel laureate Ronald Coase will celebrate his 100th birthday. Coase’s work has revolutionized the way economists view resource conflicts. His paper “The Problem of Social Cost” challenged the widely-accepted work of Arthur C. Pigou on externalities and inspired a whole new way of thinking about environmental issues.

Unlike the Pigouvian approach, which claimed that market failure could be corrected by taxes, subsidies, and regulations, Coase taught us to view these issues in light of property rights and markets. In short, Coase taught against the use of the word “externality.”

For several years, I have been on a campaign to expunge the term “externality” from the vocabulary of economists, policy makers, and environmentalists. My campaign is not motivated by a belief that markets perfectly account for all costs and benefits. Rather it is driven by the lessons learned from entrepreneurs—the people with a passion for solving problems by finding win-win solutions. Entrepreneurs thrive in the space where there are impacts not accounted for in market transactions. It is in that space that they create gains from trade.

Consider the example of irrigation water withdrawals reducing stream flows for fish habitat. Viewed through the externality lens, trout fishers might argue that farmers are imposing costs on them and that the government should regulate water use. An environmental entrepreneur, however, sees an opportunity to convince trout lovers to contribute to the cause and to contract with farmers to increase instream flows.

Or consider the desire for open space. Through the externality lens, demanders of open space might say developers are imposing costs on them by building houses and that land use regulations are necessary. Land trust "enviropreneurs," on the other hand, accept the landowner’s right to develop and obtain conservation easements to determine future land use.

There is a big difference between the externality approach and the entrepreneurial approach to improving environmental quality. Asserting the existence of an externality pits one user of a resource against another in a zero-sum game where property rights are not clear. California’s Mono Lake is a quintessential example. In the early 1980s, environmentalists filed suit to stop Los Angeles from diverting water out of the Owens Valley even though the city had purchased the water by buying farmland and its accompanying water rights. The environmentalists “won” the suit, but it was not until the late 1990s when the legal wrangling ended and some water started flowing back into Mono Lake.

In contrast, entrepreneurship encourages conflict resolution and results in positive outcomes for all parties involved. Chris Corbin, a PERC enviropreneur fellow, epitomizes entrepreneurship. His firm, Lotic LLC, increases cash flows by encouraging efficient water use, by protecting and maximizing the value of water rights, and by developing water projects with ecological benefits. Rather than promoting conflict like that in the Mono Lake case, Corbin utilizes cooperation to keep more water in streams.

A Coasean view of the environment focuses on who owns the environment. When property rights are well defined and enforced, markets can work their magic. When property rights are not so clear, environmental entrepreneurs who clarify them do good for the environment while doing well for themselves. In honor of Coase's 100th birthday, let'sreplace externalities with entrepreneurship. The more we do so, the more we will see conflict replaced with cooperation and environmental rhetoric replaced with environmental improvement.

Terry Anderson is president of PERC and the John and Jean De Nault Senior Fellow at the Hoover Institution, Stanford University. He believes that market approaches can be both economically sound and environmentally sensitive. His research helped launch the idea of free market environmentalism and has prompted public debate over the proper role of...
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