Quora Question: What are the strengths of Coasian Bargaining?

I recently answered the following question on Quora:

What are the strengths of Coasian Bargaining?

Coasian Bargaining says that agents can negotiate away the effects of externalities if transaction costs are sufficiently low. Ideally, this will lead to an efficient outcome.

wellwellwellSuppose you want to drill an oil well that will make you $100. Suppose it’ll make the lives of 20 neighbors $1 worse. How is this problem approached in different countries?

  • In Non-Coasian Anacapistan, you drill the well and create $100 of personal utility and $80 of total utility. The twenty neighbors are $1 worse off, but they all read Ayn Rand, flex their forearms, and carry on with their grim resolve to build the kind of buildings they want to build.
  • In Coastopia, the neighbors say you can drill the well iff you pay them $2 each. You drill the well and gain $60 of value. The neighbors gain $1 of value each.
  • In Coasistan, the neighbors demand $6 each. The well doesn’t get drilled. No one wins except for the lawyers who negotiated the failed deal.
  • In StatusQuoVille, the neighbors all vote on whether or not the well should be drilled. Depending on who shows up to the polls, it’s either drilled or not. The winner takes all, and everyone hates each other.

Coastopia is clearly an unrealistic fantasy, but it has some enviable features and real-world take-aways. In my experience, those who spend time thinking about Coasian Bargaining are more likely to be impartial when assessing real-world externalitites. While some are quick to say that fracking should be outlawed because it disturbs the locals, those from the Coasian school of thought will consider other possibilities. Maybe oil companies should pay money to the locals. Maybe locals should pay oil companies to not drill. Maybe oil companies should pay locals to move. Coasian bargainers are more likely to consider creative solutions rather than simply banning productive economic activity of which they disapprove. This leads to more economically efficient outcomes. In my toy example, the drilling clearly should happen. Any outcome that doesn’t result in a new well misses out on $80 of total utility.

All that said, I wouldn’t want to live in Coastopia. Incentives work both ways, and you wouldn’t want to live in a world where the prevalence of Coasian Bargaining encourages potential externalizers to seek out situations to threaten. “That’s an awfully nice stream you have there. It’d be a shame if someone were to dump runoff into it. Perhaps you should pay me to threaten someone from the next town instead.” On net, the average man’s distaste of naked Coasian Bargaining may be a good thing.

In DanielMorganTopia, all questions like these are solved through Pigovian Taxes, an approach which doesn’t require perfect bargaining and has decent efficiency if the government is reasonably competent. But I don’t rule the world. Not yet.