Academic journal article The Town Planning Review

'The Problem of Social Cost': The Coase Theorem and Externality Explained: Using Simple Diagrams and Examples to Illustrate the Role of Land Use Planning in Tackling Externalities1

Academic journal article The Town Planning Review

'The Problem of Social Cost': The Coase Theorem and Externality Explained: Using Simple Diagrams and Examples to Illustrate the Role of Land Use Planning in Tackling Externalities1

Article excerpt

This paper seeks, with the help of simple conceptual drawings common in the fields of economics and planning, to (a) survey the evolution of the Coase theorem; (b) offer a logical account of the relationship between the farming examples in Coase's 'The Problem of Social Cost', the Coase theorem, and Pigou's concept of externality in The Economics of Welfare; and (c) to examine the relevance or otherwise of the Coase theorem and classic examples, hypothetical and real, used by economic and planning researchers for land use planning to deal with externalities. The paper concludes with a discussion on the relevance of Pigou's air pollution example in light of its treatment by key libertarian economists and the role of examples as a means of articulation in research and policy formulation.

This paper is concerned with those actions of business firms which have harmful effects on others. (Coase 1960, 1; 1988, 95)

The proposition must, to be sure, be qualified by an important fact. When a factory spews smoke on a thousand homes, the ideal solution is to arrange a compensation system whereby the home owners pay the factory to install smoke reduction devices up to the point where the marginal cost of smoke reduction equals the sum of the marginal gains to the homeowners. But the costs of this transaction may be prohibitive - of getting people together. Of assessing damages, and so on - only a statutory intervention may be feasible. (Stigler, 1966, 120; 1987, 114-15)

Prelude: a personal testimony

Following in the footsteps of Willis (1980), Fischel (1985), and Heikkila (1989; 1994; 2000), who expounded the usefulness of diagrams to explain the economics of land use zoning, this paper aims to apply simple diagrammatic tools2 to clarify the complicated relationship between (a) the Pigovian concept of externality; (b) the land use conflict example in 1991 Noble Prize winner Ronald Coase's 'The Problem of Social Cost'; and (c) 1982 Nobel laureate George Stigler's 'Coase theorem'. Such clarification should pave the way for a better understanding of the question of pollution and the use of examples as a means of persuasion in science.

Stigler's theorisation about Coase's farming example was developed further by such economists as Cheung and Barzel as a theory relevant to land use planning, and illuminates the nature of several famous examples offered by authorities in these fields. Sophisticated mathematical equations and obscure citations have displaced these tools as good visual aids in modern textbooks and academic writings. However, there is in the literature a host of relevant and interesting examples that can be invoked to help us better understand this versatile theorem. Based on the author's reading of the relevant literature and his teaching experience, this endeavour should be useful as a contribution to the teaching and critical understanding of planning theory.

The theorem discussed here, which is 'well received' in the economics and planning field, should be no more a nightmare in the classroom for planning students than it is for economics students. They often cannot figure out how Coase's 1960 paper really articulates the Pigovian welfare economic concept of externality, which is usually taught separately in economics schools, not to mention how the land use conflict example in the 1960 paper actually became constellated into the Coase theorem. When questions are raised in class, the typical response is, 'Please read the original works of Coase and Stigler carefully and let's discuss them afterwards.' Such a reading of a Nobel standard work, the summit of many years of thinking since the 1930s, is usually never commenced, and hence no discussion is deemed meaningful. When a student becomes a teacher in planning, he or she would naturally try to avoid the topic as much as they can! This author was one of those who was initiated into the reading of the 1960 paper by his planning law teacher, a scholar and practising barrister who advised that all students had to read it, although they were left alone to do the job in the law library offcampus. …

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