Coase and Fireworks

In my continuing effort to demonstrate what the mundane world looks like through the eyes of a nerdy law professor, today we will talk about Ronald Coase, recipient of the Nobel Prize in economics, and fireworks.

Before we had dogs, I liked fireworks, at least the professionally staged kind.  Up here in Charlevoix, Michigan, every year in late July the town has a week-long event called Venetian Festival.  The highlight on Friday night is a spectacular fireworks show out over the lake for which our deck is effectively a front row seat.  For the last seventeen years or so, however, I have not been out on the deck nor have I seen the fireworks.  No, I am back in a closet with the door closed, comforting our dog(s) who is/are going batshit crazy.

With the professionally staged fireworks, at least I know when to go into the closet and when I can come out.  It's the private ones that really drive me crazy.  In Massachusetts, where we live nine months of the year, I don't have worry.  Private fireworks are illegal, end of story.  

Here in Michigan, however, we have to deal with one aspect of the state legislature's Year of Living Stupidly.  In 2011, the same year it passed the law eliminating the requirement that motorcyclists wear helmets, Michigan first permitted the sale of fireworks in the state.  In 2013, it amended the law to permit local units of government to ban the use of consumer fireworks, but not on national holidays, the day before or the day after a national holiday.  (It also allows any city in the state with a population greater than 750,000 - there is only one - to ban them between midnight and 8 a.m. on such holidays, and only between 1 a.m. and 8 a.m. on New Year's Day.)

The reasons for my sitting on the beach and, like a complete dork, reading Ronald Coase's The Problem of Social Cost follow the break. If he had the house next door, and had the same issues I do, what might he say about it?

Our local unit of government, the City of Charlevoix, and the surrounding Charlevoix Township each enacted ordinances banning the private use of consumer fireworks to the extent permitted by the Michigan statute.  Thus, for three of the days we are here during the summer (July 3-5), we have to deal with the possibility that some *)&(*^*^&$ is going to be responsible for random and unexpected fireworks activity that turns our dogs' brains into petroleum jelly and causes them to (a) howl madly, and (b) scurry around the house wildly under beds, couches, and other areas of perceived safety.  

The rest of the summer we can be fairly sure that our nearby neighbors won't be using consumer fireworks because of the local ordinance.  If they did out of a misunderstanding of the law, and they were to ignore our friendly suggestion that they obey the law, we would be within our rights to call out Charlevoix's Finest.

Here's the problem.  If you happened by my earlier discussion of riparian rights, you saw this Google Earth picture. It so happens that I took the above picture just about at the tip of the red arrow.  The city proper is largely to the left (west) of the tip of the arrow.  The township pretty much ends at the other end of the arrow.  Every thing else to the right, including that peninsula (known as Pine Point) that looks sort of like India, is in Hayes Township.  Hayes Township has never passed an ordinance banning fireworks.  So just after it gets dark, for much of the summer, we are treated to a fireworks display that carries very nicely, sound and otherwise, across the mile or so to our house.

Where our dogs, having dog-like senses of hearing and smell, proceed to have their brains turned into petroleum jelly and thereupon to (a) howl madly, and (b) scurry around the house wildly under beds, couches, and other areas of perceived safety.

Now, I know that the reason for all of this fireworks activity under the current legal regime is the result not of, as Coase might hypothesize, a railroad needing to run a railroad even if sparks cause crops to catch fire, or industries needing to burn fuel even if it causes air pollution nearby.  It is the product of market activity in which the total value of production exceeds the cost of such production, and consumer activity in which the utility engendered by playing with toys that make loud booms and bright flashes exceeds the cost of such activity, at least for those engaged in it.

The social cost occurs across the lake at my house, where I am contemplating the purchase of doggy Xanax.

The popular takeaway - the "Coase Theorem" - applied to my situation is this.  In a world of zero transaction costs, the total net social welfare of setting off fireworks, on one hand, and my distress in dealing with the dogs does not depend upon the initial allocation of rights.  Assuming that we valued noise and peace in the appropriate ranges, either the celebrants would pay me for the right to have the rockets' red glare or I would pay them to cease and desist. 

It works like this. Let's assume that the pricing system works costlessly and the only actors are A across the lake who wants to use fireworks and me.  The cost to me of insulating my house against fireworks noise is $100.  If the default rule is that the fireworks can't be used without my consent, and the value to A of his (and it's always a "he") activity is more than $100, then A ought to be willing to pay me up to $100 to shoot off fireworks (the cap being $100 because for that amount he can pay for the insulation of my house).  If there is no regulation against fireworks, and I value silence at more than $100, I ought to be willing to pay A up to $100 to have him stop.  In short, with a smooth and costless pricing system, you get the same result regardless of the initial legal entitlement. But, of course, the idealized world of zero transaction costs doesn't exist, and so even if the world only consisted of A and me, and the transaction costs of paying off A creates a total cost to me that exceeds the value of silence, I won't do it, even if without transaction costs it would have been the more efficient result.  And it's not just A and me.  It's many of the good citizens of Hayes Township and many of the good citizens of Charlevoix.

Is there a market solution to my problem?!!?  It turns out that Coase didn't articulate a theorem (or at least that wasn't his object in the article).  There were no helpful hints on how to articulate a default rule so as to minimize transaction costs with the aim of an optimal allocation of resources.  In fact, he never used the word "theorem" or the term "transaction costs."

I recommend Pierre Schlag's critique of the morphing of what Coase said in Social Cost into neo-classical law and economics.  At the beach the other day, I confirmed Pierre's statement that you can get the entire basis for what others now call the Coase Theorem by page 8 of Coase's original 1960 article and skip the remaining 36 pages (actually there's a piece of it at pages 15-16 as well).  Pierre's critique is not of Coase's article. His point was that the popular takeaways - mainly Chicago Law and Economics - have transformed Coase's point into something else entirely. It wasn't Coase who developed the L&E focus on using neo-classical economics to justify legal rules, or to focus on the reduction of transaction costs in pursuit of an idealized efficient solution.  Moreover, in a different piece, Pierre observed that the L&E approach to transaction costs itself is neither theoretically intelligible nor operationally applicable.

To the contrary, according to Schlag (and, by my reading of Coase, he is right), Coase had a far different goal in Social Cost. Coase wanted neo-classical economics to take account of the real world, in particular the effect of law and legal institutions on resource allocation.  Coase's main object was to criticize the prevailing acceptance among neo-classical economists of the idea of Pigouvian taxes.  He wanted to demonstrate the problem with Pigou's approach to externalities - namely, to impose taxes or bounties to the extent that the social cost of an activity exceeded the private cost to the actor.  

Coase was skeptical of Pigou's entire approach.  The bounties or taxes were likely to be overbroad.  Indeed, the focus on making an actor's private costs equal to the total social cost of the activity was misplaced.  In the foregoing example, suppose the social cost of fireworks noise is $200 to me.  Coase criticized the knee-jerk remedy merely of taxing the activity in the amount of $200, because it is possible, in an appropriately free market, that it would only cost $100 to achieve an optimal allocation of resources. In short, the appropriate way to judge externalities (Coase didn't use that term either) was to assess the total effect on social costs both for the actors and those affected by the actors and not simply to add costs to deter the unwanted activity.

But, wait. If the market is not going to work, am I out of luck?  I don't think so.

If Professor Coase lived next door and I were to walk over there and find him, like me, huddled in a closet with his batshit crazy dogs, I don't think, based at least on what he said in The Problem of Social Cost, that he'd rule out the idea of having government rather than the market decide how resources are to be allocated. Firms get organized when there are opportunities for value-enhancing transactions, but only under a scheme where less expensive intra-firm administrative costs substitute for higher costs of market transactions. And then there is the case of something like fireworks noise, "which may affect a vast number of people engaged in a wide variety of activities" and so "the administrative costs might well be so high as to make any attempt to deal with the problem within the confines of a single firm impossible.  An alternative solution is direct Government regulation."  Here, Coase observed that "[t]he government is, in a sense, a super-firm (but of a very special kind) since it is able to influence the use of factors of production by administrative decision."  Coase pointed out that the "government is able, if it wishes, to avoid the market altogether, which a firm can never do."

That is an interesting point up here along the lake. Yes, government regulation can be overbroad and inefficient. 

But equally there is no reason why, on occasion, such governmental administrative regulation should not lead to an improvement in economic efficiency. This would seem particularly likely when, as is normally the case with the smoke nuisance, a large number of people are involved and in which therefore the costs of handling the problem through the market or the firm may be high.

But you have to get down to cases and not deal in abstractions. Coase thought economists and policy-makers over-estimate the advantages of government regulation, but all that does is suggest that government regulation should be curtailed. "It does not tell us where the boundary line should be drawn. This, it seems to me, has to come from a detailed investigation of the actual results of handling the problem in different ways."  The problem even with local government regulation is that it doesn't fully account for all of the social costs, because the board of supervisors in Hayes Township has not enacted the same ordinances as Charlevoix and Charlevoix Township, and parts of Hayes Township are closer to my living room than parts of my own city.

So, here I am, 1,778 words into this blog post, and discovering that, if Ronald Coase were my neighbor, I might well get him to join me in an effort to get the county or maybe the state government to understand there is a social cost to fireworks.  Not everything needs to be dealt with in terms of markets.

In this article, the analysis has been confined, as is usual in this part of economics, to comparisons of the value of production, as measured by the market. But it is, of course, desirable that the choice between different social arrangements for the solution of economic problems should be carried out in broader terms than this and that the total effect of these arrangements in all spheres of life should be taken into account. As Frank H. Knight has so often emphasized, problems of welfare economics must ultimately dissolve into a study of aesthetics and morals.

I suspect he'd agreed with me that, for fireworks, as elsewhere, "[in] devising and choosing between social arrangements we should have regard for the total effect." We could gather up the dogs and all those suffering from PTSD and march on township hall to tell them just that.

Or maybe he would tell me that I had over-thought the issue and suggest reading more appropriate for the beach.