Academic journal article The Cato Journal

The Coasean Framework of the New York City Watershed Agreement

Academic journal article The Cato Journal

The Coasean Framework of the New York City Watershed Agreement

Article excerpt

Over 50 years ago, in "The Problem of Social Cost," Ronald Coase (1960) attempted to reorient the economics profession's treatment of externalities. He wanted to draw economists' attention away from the world of pure competition as a policy standard and investigate the consequences of transaction costs and property rights for the operation of markets. In 1991, he was awarded the Nobel prize in economics "for his discovery and clarification of the significance of transaction costs and property rights for the institutional structure and functioning of the economy" (Royal Swedish Academy of Sciences 1991). The Academy cited both his 1960 article and his 1937 article "The Nature of the Firm."

Still, critics question both the relevance and applicability of the Coasean framework for analyzing, explaining, and ameliorating harmful effects associated with economic activities, reflecting the degree to which the profession's treatment has remained unchanged. Nalebuff (1997: 35-37), for example, has argued that for environmental problems "as the scope of the externality affects more and more people, it becomes increasingly difficult to assign property rights." Moreover, "even when property rights have been assigned, exclusion is difficult if not impossible." In this article, we argue that the New York City Watershed Memorandum of Agreement (MOA) proves the usefulness of the Coasean framework--even when there are a large number of affected parties from nonpoint source pollution.

In 1997, nearly a decade after the Environmental Protection Agency ordered New York City to filter its water to remove contaminants originating in upper New York State watersheds, NYC entered into a MOA involving the State of New York, a number of local governments and environmental groups in the Catskills, and the EPA. In Coasean terms, the MOA is the consequence of the State of New York's assignment of property rights to the Catskill/Delaware Watershed communities to continue with regional development and current practices, although some of those activities degrade NYC's drinking water. This rights assignment positioned NYC as the responsible party for initiating negotiations and programs protecting the Watershed system. Once responsibility was established, NYC opted to buy lands contributing to water quality degradation (for example, farmlands on riparian corridors), instead of building a multibillion-dollar filtration system. Residents and landowners upstream were compensated for development restrictions incurred from the MOA. New York State's role as mediator eliminated bargaining barriers and effectively reduced the transaction costs of arranging negotiations, demonstrating potential economic benefits to all parties, and providing alternative options to unilateral regulatory decisionmaking.

Externalities and the Pigouvian Tradition

Externalities exist when the effects of a transaction between two parties spill over to nonparticipants. Effects can be either beneficial (positive externalities) or harmful (negative externalities) to non-participants. When externalities are unaccounted for in the decision-making of the participants, transactions will result in either "too much" or "too line" consumption or production. This very language, which economists use, derives from modern welfare economics founded on Pigou's extension of marginal analysis to the utilitarian market-failure analysis of J. S. Mill and Henry Sidgwick (Medema 2009).

In the history of welfare economics, the classical approach to solving negative externality problems, such as pollution, was through the use of regulation, or what Mill (1871) termed "authoritative" solutions, "in which certain types of conduct are prescribed or proscribed" (Medema 2009: 37). Sometimes referred to as "command and control" policies, authoritative solutions prohibit firms from producing a negative externality, require a certain standard of emissions of a negative externality be reached, or require firms to employ specific externality-reducing technologies, all backed by legal penalties. …

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