Lecture 5

Property Rights, the Coase Theorem, and the Environment

Byeong-Hak Choe
bchoe@geneseo.edu

SUNY Geneseo

September 15, 2025

Property Rights, the Coase Theorem, and the Environment

Pigovian Taxes and Rights

  • A Pigovian tax makes polluters pay for the external damages they impose on society.
  • Implicit assumption:
    • Society has a right to clean environment and to be compensated for damages.
    • Polluters do not have unlimited rights to emit.
  • Intuitively appealing, but raises a broader question:
    • Who owns the right in cases of environmental harm?
    • The polluter, or society at large?

A Wetland Example: Competing Rights

  • Farmer Alpha drains a wetland to grow crops → earns $5,000 profit.
  • Downstream neighbor Beta loses $8,000 in crop damage from flooding.
  • Question:
    • Does Alpha’s property ownership give him the right to drain?
    • Or does Beta (or society) have the right to protection from harm?

Negotiation with Alpha Holding Rights

  • Suppose Alpha has the legal right to drain.
    • Beta can offer to pay him to keep the wetland intact.
    • Beta’s willingness to pay: up to $8,000 (her avoided damages).
    • Alpha’s willingness to accept: at least $5,000 (his foregone profit).
    • This creates a bargaining range: $5,000–$8,000.
  • Example outcome: Beta pays Alpha $6,000.
    • Alpha gains $1,000 more than draining.
    • Beta avoids $8,000 damage, but still pays $6,000 → net $2,000 better off.
    • The actual payment depends on each side’s bargaining power.
  • Efficient result: wetland preserved.

Negotiation with Alpha Holding Rights

Why Beta Could Still Be “Unhappy”

  • Beta is better off than if Alpha drained ($2,000 net gain).
  • But she could still feels burdened because:
    • She pays a large sum to prevent harm.
    • She may believe she should not have to pay at all.
  • Lesson: Efficiency ≠ Equity.
    • Efficient outcomes can still feel unfair.

Negotiation with Beta Holding Rights

  • Suppose the law gives Beta the right to a wetland.
    • Alpha must buy permission to drain.
    • With current values:
      • Alpha can offer up to $5,000 (his potential profit).
      • Beta demands at least $8,000 (her avoided loss).
    • No agreement possible → wetland preserved (same efficient outcome)
  • Outcome is identical regardless of who holds the rights—Wetland stays intact.

Negotiation with Beta Holding Rights

A Change in Payoffs

  • Imagine a new crop grows well on drained wetlands.
    • Alpha’s profit rises to $12,000.
    • Beta still faces $8,000 in damages.
  • Now negotiation is possible:
    • Alpha can pay Beta between $8,000 and $12,000.
    • Example: $10,000 payment →
      • Alpha nets $2,000.
      • Beta nets $2,000.
  • Takeaway: Efficient outcome depends on relative benefits and costs, not on initial assignment of rights.

The Coase Theorem

  • Transaction costs: Expenses of making a deal or negotiation (e.g., legal fees, administrative costs, or costs of bringing parties together).
  • The Coase Theorem:
    • If property rights are well defined and transaction costs are negligible,
    • Then private bargaining will lead to efficient allocation of resources,
    • Even when externalities are present.
  • Rights determine who pays whom, but not the final efficient outcome.
  • Assumes: Perfect information; Few parties; No high legal or enforcement costs.

Welfare Analysis of Company vs. Community

  • Company emits 80 tons of effluent into a river.
    • Company gains profits (MB of pollution).
    • Community bears damages (MC of pollution).
  • Efficient solution: 50 tons, where MB = MC.
    • Beyond 50, extra damage > extra profit.
    • Below 50, extra profit > extra damage.

Negotiation with Community Holding Rights

  • Assume:
    • Pollution rights sell for $150 each.
    • The community owns the rights.
  • At 50 tons: MB = MC = $150.
    • Company’s payments = $7,500 (area B + C).
    • Company benefits = $13,750 (area A + B + C).
    • Total community damages = $3,750 (area C).
  • Net results:
    • Company’ Net Benefit: $6,250.
    • Community’s Net Benefit: $3,750.
    • Social Welfare = $10,000.

Negotiation with Company Holding Rights

  • Assume:
    • Pollution rights sell for $150 each.
    • The company owns the rights.
  • At 50 tons: MB = MC = $150.
    • Community’s payments = $4,500 (area D + E).
    • Company benefits = $13,750 (area A + B + C).
    • Total community damages = $3,750 (area C).
  • Net results:
    • Company’s Net Benefit: $18,250.
    • Community’ Net Benefit:
      -$8,250.
    • Social Welfare = $10,000.
  • Distribution of welfare differs.

Case Study: NYC Land Acquisition Program

  • NYC must provide clean drinking water for 8.4 million people.
    • Option 1: Build massive water filtration plants (very costly).
    • Option 2: Protect watersheds upstream by buying land & easements.
  • NYC purchased property rights voluntarily (no eminent domain used):
    • Acquire 355,000+ acres from willing sellers; Pay fair market value.
  • Cheaper than filtration; Clean water maintained; Example of Coasean bargaining on a large scale.

Property Rights and Takings

  • Eminent Domain: Gov’t may take land for public use but must pay compensation (Fifth Amendment).
  • Taking: Any gov’t action that deprives an owner of property rights.
    • Regulatory Takings: Laws that restrict land use and may reduce property value.
  • Supreme Court Ruling – Lucas v. South Carolina Coastal Council:
    • South Carolina Law barred building on Lucas’s beachfront lots.
    • Ruling: A regulation that removes all economic use of land is a taking → compensation required.
Type of Taking Definition Compensation? Frequency
Total Taking All economic use eliminated ✅ Yes Rare
Partial Taking Some economic use remains ❌ No Common
  • Q: What is the rationale for not requiring compensation in cases of partial takings?

Limits of the Coase Theorem

  • The Promise of Coase
    • In theory, if property rights are clearly assigned, parties can negotiate efficient outcomes without government intervention.
    • This idea underpins free market environmentalism—the belief that expanding property rights and market mechanisms can handle pollution control.
  • The Reality: Transaction Costs
    • Efficient bargaining assumes low transaction costs, but in practice these costs can be very high.
    • When only two parties negotiate (e.g., Alpha and Beta), costs are manageable.
    • With 50 downstream communities and multiple factories, negotiation becomes cumbersome, maybe impossible.

Limits of the Coase Theorem

  • Free-Rider Effect
    • Some communities may wait for others to pay off the polluter, hoping to enjoy benefits without contributing.
    • This leads to undersupply of pollution reduction.
    • Example: if one community refuses to contribute, others may hesitate too, and no deal is reached.
  • Holdout Effect
    • When many parties must agree, a single holdout can block progress by demanding more compensation.
    • Example: 49 communities agree, but the 50th demands excessive payment, threatening to veto the entire agreement.
    • Like free-riding, this prevents efficient negotiation.

Limits of the Coase Theorem

  • Nonhuman and Ecosystem Impacts
    • Many environmental damages harm ecosystems, plants, or animals rather than identifiable individuals.
    • Who bargains for the survival of birds, bees, or endangered species?
    • Groups like The Nature Conservancy buy land to preserve ecosystems, but their reach is limited.
    • In markets, ecological values often lose to economic ones.
  • Future Generations
    • Property rights usually apply to the current generation.
    • Climate change, fisheries depletion, and species extinction impose costs on future people with no voice in today’s negotiations.
    • Markets alone cannot ensure intergenerational fairness.

Limits of the Coase Theorem - Equity Concerns

  • Poor communities may lack the resources to “buy out” polluters, even when health damages are severe.
  • They might accept hazardous facilities out of desperation for compensation.
  • Meanwhile, wealthier communities can afford to preserve open space, while poorer ones cannot.
  • Example: Global plastic waste trade
    • High-income countries export waste to poorer nations that accept environmental risks for financial gain.
    • A large share of traded plastics is mismanaged.
    • For decades, China was the largest importer, receiving 72% of global plastic waste exports and mismanaging about 76% of it (EIA, 2021).

Global plastics trade hits record $1.2 trillion

Global plastics trade hits record $1.2 trillion

Environmental Justice

  • Defined by EPA: “Fair treatment and meaningful involvement of all people regardless of race, color, national origin, or income.”

  • Example: Flint, Michigan Water Crisis (2014–)
    • City switched to Flint River water, which was corrosive and not treated properly → lead contamination.
    • 6,000–12,000 children exposed.
    • Community largely low-income and African-American.
  • Lesson: Markets alone cannot ensure fairness in environmental outcomes.

Environmental Justice

Race, Poverty and Hazardous Waste Facilities

  • Do polluting industries choose to locate in poor and minority communities—where land is cheaper and political resistance is weaker?

  • Or do low-income households move in near toxic storage or disposal facility (TSDF) after they are built, attracted by lower housing costs?

  • Pastor et al. (2016), “Which Came First? Toxic Facilities, Minority Move-In, and Environmental Justice”:

    • A 10% point increase in minority population share was linked to ~34–39% higher odds of a TSDF siting.
    • The pace of increase in minority residents near TSDFs was similar to the pace elsewhere in the region.