The Road to Externalities

Several years back, many Charlottesville citizens grew increasingly worried or excited over the prospect of a new Western Bypass.  Those in favor saw a positive externality: this road would make travel easier for many people.  However, those opposed- particularly those living close to the possible site of the road- viewed the negative externalities: the road would lower their home values and increase the noise level, disrupting their daily lives.

After taking economics classes, my views on this project have shifted.  Looking at roads in general, if a proposed road were built by a private company, which Friedman suggests is an option if the road were excludable, then the residents around the road could work out a Coasian solution.  Depending on the property rights, the road builder could either pay the residents for the right to build the road near them and cause them discomfort, or the residents could pay the builders to reduce the size of the road or simply not build it.  Under Coase's assumptions, either way would lead to the same outcome. However, in a real world situation such as this, there are not two clear sides.  Instead, some citizens will support the road, and some will not, while other free riders will remain uninvolved and hope that their side wins. Therefore, the transaction costs would be extremely high.

In the case of the Western Bypass, the government ultimately decided the fate of the road.  Although the government's decision is almost certainly not allocatively efficient, nor is it proportionately representative, it provides a solution to the confusion and chaos caused by the real world negotiations a private market Coasian solution would cause.

Water Must Cost More

A growing American population coupled with climate change has begun to constrain the water supply. The Rio Grande is running dry before it even reaches the Gulf, and cities and states throughout the West are experiencing droughts. This isn’t to say that there is a shortage of water and that all global citizens must reduce their consumption before we drink the Earth dry. We have plenty of water on Earth. It simply isn’t allocated very efficiently.

Market principles just haven’t applied to water. For too long we have thought of water as a purely public good but now we are realizing that water is excluded on a first-come first-served basis and, due to our very developed infrastructure, the only limit on consumption is it’s very, very low price.  

In order to more efficiently allocate our limited amount of water we must ensure that water is going to its most valuable uses. Normally, a Coasian solution could determine an efficient allocation. There are well-defined property rights with water municipal companies owning the right to water, but there are approximately 300 million bargainers (population of the US) and transaction costs won’t be cheap.

Alternatively, regulators may choose treat water like air pollution and enact a cap and trade policy to provide those who value it most a means to acquire it. However, right now “the allocation of water is certainly arbitrary” and implementing a new market takes time especially through bureaucracy. Therefore it may be simpler to employ a progressive price scheme on water usage as many municipals charge a flat or a regressive rate that encourages overuse.

Can Property Rights Protect Nature?

In this article, John Stossel claims assigning property rights to nature will do more to protect the environment than allowing the government to protect it. He claims that when people own things and there is a simple, honest court system, the environment would be less subject to depletion. This is similar to the Coasian solution to externalities (people would act to keep their property from being harmed, while also protecting society's interests), suggesting private property rights can limit negative effects upon society, although Coase would go further in suggesting that court systems would not even be needed. Stossel does not only claim a Coasian-like solution would work; he also claims that private property rights can actually protect the environment more than government can. When the government attempts to protect the environment by making it public, you have what Stossel calls 'tragedy of the commons," which is when people treat/value public property worse than they would treat/value there own. However, I do not think Stossel takes into account the assignment problem very well.

Argentina's Holdout Problem

A little background to the issue: in the end of the 1990s and early 2000s, Argentina’s economy was facing severe difficulties and the government was unable to make interest payments on sovereign debt issued in 1994. In 2005 and 2010 Argentina restructured its debt, ultimately negotiating the value of their bonds down 70%. Approximately 93% on bondholders accepted the Argentinean offer. 7% of bonds were not renegotiated, however. Most of these bonds were owned by hedge funds that purchased the debt while it was very distressed i.e. following the default but before the restructuring. These same hedge funds have been fighting Argentina for full payment since then and have gained a lot of press lately as "holdout creditors" or Vulture Funds (as Argentina prefers).

The holdout problem is one of the main critiques with Coasian solutions. The idea behind it is that if one party must negotiate with many actors in the opposite side in order to gain some right or benefit, the last actor to participate in negotiations (the holdout) gains tremendous leverage over the other party because he single handedly controls the overall success or failure of the negotiation. However, it may be difficult to understand how Argentina's holdout creditors have so much leverage, given that for well over 10 years they didn't receive any payments. The catalyst for this holdout problem was not the initial debt renegotiation, since that went on despite the holdouts' objections. Instead, holdouts gained their leverage in 2013 with a ruling over pari passu clauses on the bond offering, in which US Judge Grieza declared that Argentina could not pay its restructured bond holders unless it also paid its non-restructured (holdout) bonds as well. As a consequence, the hedge funds were able to setup a scenario where either Argentina paid them, or it would default in its restructured debt - that incredible leverage is what created a de facto holdout problem, something very different from the de jure issue that had been going on for more than a decade.

Interestingly, however, the fact that Argentina has a) defaulted, b) remained a "stable" society and c) continuously tried financial maneuvers to skirt US rulings, show the difficulty of actually using leverage as a holdout if there is no strong entity that can enforce the consequences of non-negotiation. Ultimately a holdout's leverage becomes meaningless if the costs associated with its demands are higher than the cost of non-negotiation, and when it comes to international law, those costs are rarely materialized, unfortunately.

Children Prove to be Irrational and Altruistic at a Younger Age

When economists analyze what they believe to be rational, they often weigh the costs and the benefits to decide if it would be rational to participate or contribute to an activity. Sometimes individuals contribute or participate in an activity because they are altruistic, even though it is not rational for them to do so. This article in the Wall Street Journal analyzes if altruism begins when children are young, in this case three to four years old, and how this affects the decisions they make. Typical research has said that younger children are not altruistic and only become so when they become older and have “stronger notions of morality.” However, this study found that the majority of the three and four years olds expressed altruistic tendencies when they chose to give up some of the stickers they were given to an unknown child who they were told did not have any stickers. There are two topics from class that seem to be relevant to this study. The first is Coase and his work on the “Coasian Solution” where beneficiaries of a public good pool together their resources depending on their willingness to pay in order to provide the good. The issues that arise from this theorem are the holdout problem and the free rider problem, where it is more rational for some individuals to abstain from contributing to the provision of the good if enough other people pay and get the good provided without them having to contribute. As mentioned in the article, the only way to prevent the free rider and holdout problem is to make sure the people that benefit from the good are altruistic, so even if it is not rational for them to contribute to the provision of the good because it will be provided anyway, it is morally right for them to contribute so they do so anyway. Another instance where abstaining from contributing is rational is Johnson’s article on voting where it is irrational for people to vote when weighing the costs and benefits, but people do so anyway because people see it altruistically as their duty. Therefore, if the study holds true and children are showing altruistic tendencies at a younger age than previously thought, maybe we can expect a lot less free riders and a lot more voters in the future.