what is collective action?

What is Collective Action?

Whenever individuals act together they engage in collective action.

In conventional economic theory, all necessary collective action to produce the goods and services required for a good society can be organized spontaneously through a “market economy”.

But in fact this conventional theory is inadequate:

i) For the market to work, a number of institutions and organizations have to exist in advance, and these require prior collective action.

These include things like a state to enforce rules, rules and institutions that ensure that individual actions add to social welfare.

ii) Even when a market is working, there are market failures that require ex post collective action to resolve

Theories of collective action address a number of related questions

i) When is it in the interest of individuals to act collectively and when is it not?

ii) Why do individuals often fail to act collectively even when they would collectively gain by doing so?

iii) When does collective action by some group of individuals result in social benefit and when does it result in benefit for the group at the expense of society?

i) When is it in the interest of individuals to act collectively and when is it not?

If individuals refuse to contribute or participate in collective action when it is against their interest, then this is not a failure of collective action.

However, we have to be careful in defining when something is against an individual’s interest. For example, if an individual is taxed, it may appear that the individual is made worse off, but if the tax is used to provide a collective or public good, then the individual may be better off as a result.

In conventional economic theory if individuals are free to decide, they always act rationally. If it was in their own interest to act collectively, they would do so.

ii) Why do individuals often fail to act collectively even when they may gain?

Collective action theory has identified a series of problems:i) Coordination problems (There are socially desirable outcomes which

all individuals would prefer but they miss either because of multiple equilibria, or assurance problems)

ii) Free-rider problems (Attempts to get benefits without contributing to the collective action)

iii) Distributive Conflicts (Collective action breaks down into open conflict because there are multiple equilibria with different distributions of benefits)

v) Deeper problems for the Chicken Game include the Distribution of Power that determines how long it takes to resolve Conflicts

vi) Leadership Problems affect all types of collective action (Failures to persuade, but does not explain where good leadership comes from)

iv) Deeper problems for the prisoner’s dilemma include the transaction costs of enforcement, the absence of trust, high discount rates

iii) When does collective action by some group result in social benefit?

Potentially Beneficial for the Individual

Potentially Harmful for the Individual

Beneficial for Society

Harmful for Society

Some individuals have no prospect of gaining from the collective action but it is still good for society. Some types of distributive conflict are like this, if one group has no prospect of winning. However, if society still gains it should be possible to compensate losers so this is a failure of the political system (which is a collective action failure at some level).

Collective Action good for everyone. Environmental protection, provision of public goods etc. Failure of collective action can be due to free-rider problems, distributive conflicts etc.

Failure of collective action good for society. Examples: value-reducing rent-seeking, the creation of cartels, monopolies, corruption, environmental depletion by big business or criminals.

Perverse behaviour by individuals. Not the subject of economic theory. Alchoholism, gambling etc.

Conventional Economic Theory and Collective action

• Conventional economics has a bias towards the study of individual action rather than collective action because for a long time free market economists assumed that any collective action would be against the public interest.

• Thus conventional economics was primarily concerned with the lower left hand box in our diagram above, where the failure of collective action is socially desirable.

Thus collective action is normally seen as part of rent-seeking theory: small groups engage in collective action to capture rents that enrich them at the expense of society (monopolies, transfers, extortion)

But there is a contradiction in conventional theory: to stop collective action by small groups requires collective action by bigger groups (the whole of society). So all collective action cannot be bad!

How Social Efficiency is Achieved in Conventional Economic Theory 1

• The achievement of Pareto efficiency in a single market: Buyers and sellers achieve the equilibrium price and quantity: this also achieves Pareto efficiency and maximizes net social benefit.

If we simply concentrate on Pareto efficiency, we are implicitly making a number of value judgements:

a) Individualism: Only the welfare of individuals is of relevance. The welfare of groups, classes, firms, nations etc is not

b) Non-Paternalism: The preferences of individuals are sacrosanct, even if they desire the consumption of goods which are harmful for themselves.

c) No one's welfare can be reduced whatever the gains to others. This is another way of saying that distribution does not matter. A pareto improvement can occur through a very rich man becoming richer as long as no one gets poorer. Equally, the improvement of very poor people is ruled out if even one very rich person suffers slightly.

An Alternative Conception of Social Welfare

Net Social Benefit: Weaker conception of social welfare that maintains a) and b) but drops c) to allow interpersonal comparisons and to reach an assessment of social welfare that takes into account gains and losses of different individuals.

This is the basis of cost-benefit analysis, and is the underlying concept in any assessment of the costs and benefits of collective action.

Net social benefit is increased if the gain of gainers is more than the loss of losers.

How Social Efficiency is Achieved in Conventional Economic Theory 2

The First Theorem of Welfare Economics: A perfectly competitive market economy will reach a general equilibrium (all markets will clear) and when this happens, we will achieve Pareto efficiency.

Implication: Any other form of collective action is not necessary: self-seeking individuals in a competitive market will collectively achieve Pareto efficiency by acting as individuals

Limitations: i) Markets are not ‘natural’: they have to be set up and regulated and this requires prior collective action

ii) There are many market failures that need to be corrected through subsequent collective action

iii) When states intervene to correct market failures this may cause further problems of state/government failures that require collective action to reduce.

All of these are collective action problems.

Market failures

Market failures describe situations where self-seeking behaviour by individuals does not result in the best allocation of resources.

Externalities: Actions of one individual have a direct effect on the cost or utility of another individual. Too much or too little of a good or service may be provided and as a result net social benefit is not maximized.

The collective action problem here is to devise solutions that maximize net social benefit.

Public Goods: When a good is non-rival and non-excludable, not enough of it will be provided because of a free-rider problem.

This is directly a collective action problem.

Government/State Failures

Government failure is defined as the loss of welfare due to the activity of states acting inappropriately, or

due to the inactivity of states when they fail to act to correct market failure (Krueger 1990).

With no state action: State Failure = Market Failure.

With state action: State Failure = 0 if state intervention totally removed market failure. But

State Failure can be much more than Market Failure if state intervention makes matters worse.

Causes of / Contributors to State Failure 1.

i) Fundamental Constraints: Information. The Insights of Hayek. States do not have information about individual costs and benefits to make the right decisions about the allocation of resources. However Hayek is too extreme: clearly there are conditions under which states have better information than markets, and in other situations markets perform better than states.

So the real question for improving state performance in organizing collective action is how to improve the information capacity of the state. Both institutions and politics can affect this capacity

Issues: Democracy vs. Authoritarianism. It is argued that democracy improves the information available to the state. But this is only true in an ideal democracy. Many real world democracies may only increase the access to power of special interest groups, powerful factions and client groups.

Centralization vs. Decentralization. It is argued that decentralization improves the information available to the state. But similar issues arise here

Moreover, information can work both ways: it can help parties negotiate win-win solutions more easily, but it can also enable all relative and absolute losers to block change more effectively

Causes of / Contributors to State Failure 2

ii) Institutional and bureaucratic Capacity: States may lack the capacity in terms of the quality of its personnel or the design of its institutional structure to carry out necessary functions or provide the desired services.

Issues. Improving Bureaucratic Capacity and Quality. Improving training and incentives of bureaucrats: higher salaries, better internal monitoring and promotions linked to performance, etc. This is a variant of the knowledge/learning failure argument to create a state leadership that is rational and able to learn

Changing Institutional Structure – Enabling internalization of externalities An institutionally fragmented state structure may fail to assess all the effects of intervention in different sectors.


iii) Rent seeking: Bureaucrats and Politicians Have Their Own Objectives. To maximize their wealth bureaucrats can subvert the goals of the state and of the public. Damaging interventions are essentially those that create damaging rents because they give large payoffs to bureaucrats or politicians

We have seen that the argument here is very complex: there is no reason why self-seeking bureaucrats and politicians should create damaging rents. The reasons why rent seeking can result in damaging rents take us back to institutional structure and political power

Conventional Policy focuses on reducing rent seeking and corruption:

a) Higher Salaries for Bureaucrats (making it more expensive for them to lose their jobs if they are caught for corruption),

b) Better Monitoring (through civil society, democracy),

c) Less Discretion for Bureaucrats (through Liberalization and Privatization).

None of these measures work too well and we will discuss why later.


iv) The disposition of political power. Small but powerful groups can use politics to capture or constrain the state. The state caters to specific interests and not to the general interest.

Political power and institutions can interact in non-linear ways. Institutions that work well with one distribution of power can be value reducing with a different distribution of power: the case of some types of industrial policy in the presence of clientelism

The organization of patron-client politics in developing countries is important because critical elites are organized through patron-client networks. The distribution of power and the fragmentation of patron-client networks is an important variable determining the efficiency of different institutional solutions to market failure and catching up

Issues. It is argued that deepening democracy will reduce clientelist politics but the evidence does not support such a simplistic proposition. Examples such as India shows that clientelist politics can survive in mature developing country democracies.

Causes of Collective Action Failures 1

i) Large Numbers of Potential Members in Group. Mancur Olson first pointed out that collective action may be more difficult to organize if the number of members in the potential group is large. Equally, he argues small groups are therefore easier to form.

Olson’s basic argument was that small groups were more likely to be Privileged in having at least one individual who will privately provide the required good. The individual advantage Ai of the good is the Individual Value Vi minus

the total cost C:

Ai = Vi - C.

If Ai > 0, some i will provide the good and the group is a “privileged

group”: its collective action problem disappears because a private individual will provide the public good.Note that in Olson’s original model C could not be split between the individuals. This is not necessarily always or even usually the case

Causes of Collective Action Failures 1 continued

Olson goes on to argue that if the number of individuals is large, it will be less likely that there will be a privileged individual.

Olson gives three arguments for his small number theory:

Olson’s argument is that even if the good is collectively desirable, ie Vi - C > 0, if Vi - C < 0 for all i, the good may nevertheless not be provided.

This is simply the public good problem: the good is collectively desirable but no individual wants to provide it by himself or herself. If everyone contributed, everyone would be better off, but if others try to free-ride and only one person ends up paying, then that person is worse off.Clearly a privileged group is one where there is a single individual who values the good so highly that that individual provides the good single-handedly.

Causes of Collective Action Failures 1 continued

iii) As n , the coordination costs per person . This is a much more sophisticated argument which though contingent may be more systematically relevant.

i) Individual incentives to contribute fall with group size that isAi as n .

This is clearly a contingent argument which depends on how Vi and C change with n. The claim is that either C increases or V decreases as numbers increase. This may not happen in every case. The reverse could be true if there are economies of scale in the provision of public goods.

ii) Olson’s main conclusion: Larger groups are less likely to be privileged. This says it is less likely that for some i, Ai >0, when n .

This is clearly a contingent result. We know millionaires can contribute to build parks and libraries or contribute to university endowments or charities from which large numbers benefit.

Numerical Examples of how C and V can change with n

Case III. Total value of good nVi constant, so implicitly Vi falls. Here

the good is strictly rival like a private good but C is fixed. This result would still hold to a weaker extent if the good was an impure public good, that is subject to congestion.In this case too, C/Vi goes up. (Buchanan).

Case I. Vi stays constant so nVi as n . C stays constant. (Radio, to some extent infrastructure). In this case, which is that of a pure public good, n going up has no effect on group succeeding. The minimum contributing group C/Vi is unchanged. (Frohlich and Oppenheimer).Case II. Vi stays constant but C in proportion to n. Here the problem is similar to that of a tragedy of the commons, as the number of users increase, the cost of maintaining the asset increases. (Some types of infrastructure, Tragedy of the Commons: Hardin).In this case C/Vi goes up with n.

The core of Olson’s argument can be examined by going beyond a single privileged individual and looking for the minimum contributing group

Numerical Example Continued

n Vi nVi C Smallest Integer > C/Vi

Base 5 4 20 5 2

Case I 100 4 400 5 2

Case II 100 4 400 100 26

Case III 100 0.2 20 5 26

Olson’s Key Collective Action Conclusions

Thus Olson’s main conclusion is a) Smaller Groups are Easier to Form, BUT

b) The more inclusive and therefore the larger the group, the more likely it would be to reflect interests that increase social welfare.

Thus, a weak result is that as the potential number of cooperators increase, the critical minimum number required to achieve minimal cooperation also increases

We will see that if we use a game theoretic approach that looks at the difficulty of sustaining sub-game perfect Nash equilibria in indefinitely played n-person games, we get a richer explanation of why cooperation is less likely as n increases

Olson’s conclusion in his second book The Rise and Decline of Nations is that societies tend to go into sclerosis over time and need a big shock (war or political crisis) to shake out all the small rent seeking organizations and return to a growth path

Olson’s Key Collective Action Conclusions

However, it is true that the bigger the group becomes, the less likely that it can become richer through redistribution, and the more likely that it has to become richer by trying to produce more. But even this result assumes that when a big group acts collectively it does not attempt any internal redistribution to benefit some at the expense of others.

However if Olson’s two propositions are true, we would expect to see greater social fragmentation and declining performance over time in stable societies, and high growth in post-shock societies.

These results only hold if small groups go for redistributive rents, in other words they can only become rich at the expense of others.

However, many small groups can be organizing in ways which not only make them richer, but in the process, make society richer as well. Olson’s theory does not allow for this.


ii) Transaction Costs. Transaction costs are the costs of organizing transactions, both in the market and within groups in the context of collective action. Transaction costs include: a) The cost of finding other people to transact with, both in the market and in the context of collective actionb) The cost of negotiating the terms of the transaction, whether it is the price at which goods are to be bought and sold in the market or the contributions and benefits of different members participating in collective action.

c) Writing the contract covering all contingencies which can arise from the transaction and the rights and responsibilities of the different parties.

d) Monitoring the contract or the terms of the transaction to see if all parties are delivering what they promised to deliver

e) Enforcing the contract through credible punishments which can include litigation and other costs of adjudication.


iii) Leadership. The importance of leadership cannot be denied and in the popular understanding, all collective action is due to the presence of good leadership.

While leadership is clearly important, theory suggests that it is only one of a number of factors which matter, so focussing on leadership alone is unlikely to work miracles if the other factors are not favourable.

iv) Free-riding. One of the major contributors to collective action failure. The attempt of each individual to participate in the benefits of collective action without contributing. Free-riding is only possible if the benefit of collective action is at least partly like a public good. The free-riding problem can be studied using the Prisoner’s dilemma game.


v) Distributive Conflicts. These are conflicts over the distribution of the costs and benefits of collective action. Distributive conflicts are likely to last longer if the parties to the conflict are evenly matched. The distributive conflict problem can be studied using the Chicken game.vi) Political Costs. These are the costs of solving the distributive conflicts over the distribution of the costs and benefits of collective action. Not everyone benefits the same amount or pays the same cost from any proposed collective action. Each person wants a type of collective action that maximizes their benefit and minimizes their cost. This means that it is likely that there will be conflicts over which collective action solution should be chosen. How large these political costs are depends on the distribution of political power in society.

vii) Trust, Culture and Morality. Are some cultures more conducive for collective action than others? Weber and the argument for the Protestant Ethic. The new interest in the Confucian Ethic. Limitations of these approaches.

Externalities

An externality exists whenever the utility of a consumer or the production possibility of a producer is directly affected by the actions of another agent in the economy.

Externalities can be consumption externalities when they affect utility functions or production externalities when they affect production functions. They can be bilateral if they affect two people or multilateral if they affect many. They may be positive if they increase utility or production, negative otherwise.

By definition, externalities exist because of missing markets, but missing markets in turn exist because of transaction costs of transacting in particular markets

Transaction costs are the costs of discovering trade opportunities, reaching agreements on price, monitoring the transactions to prevent free riding and fraud, and if necessarily enforcing contracts if default is detected

Externalities 2

A technological externality exists where a utility or production function has the form (shown in the case of a utility function):

Ui = Ui (x1i, x2i,..... xni, h), where xni is the level of each xn consumed by i and h is an activity whose level is directly chosen by another agent. For instance, h could be the level of smoke in the air agent i breathes.

The derived utility function is more useful for our purposes and is given by:

Vi = Vi (p, wi, h) since each xni in the utility function is a function of p and wi, the price vector and the initial endowments of agent i

Most externality analysis is based on an important and implicit assumption: that of zero wealth effects. We will first follow this tradition and then examine the consequences of dropping this assumption later.

Externalities 3

If there are no wealth effects, the derived utility function can be written as: Vi (p, wi, h) = Фi (p, h) + wi.

This means that greater or lesser wealth has an effect on utility but no effect on the precise quantities of each good consumed.

Smoke

Wealth

If utility functions were in fact like this, the optimal level of any activity, including externality-generating activities, would not depend on the wealth of the participants.

The Efficient Level of Externalities

1'(h) (=MB1)

- 2'(h) (=MC2)

h*ho

A

B

In the absence of any collective action to solve the externality, the emittor maximizes his personal utility and produces h* where Ф1'(h*) =

0 (MB=zero). Efficiency and social optimality requires the maximization of social (joint) utility which requires output of ho where Ф1'(h) + Ф2' (h)

= 0 (MB=MC).

The Efficient Level of Externalities 2

1'(h) (=MB1)

- 2'(h) (=MC2)

h*ho

A

B

By moving from h* to ho, the loss for the emittor (agent or group 1) is A, the gain for the recipient (agent or group 2) is A+B.

Society’s gain is A+B - A = B.

Illustration of Wealth Effects

Marginal CostRich Country

Marginal CostPoor Country

Marginal Benefit:Rich Country

Marginal Benefit:Poor Country

Efficient h: RichEmitter, Poor

Recipient

Efficient h: PoorEmitter, Rich

Recipient

What is the efficient level of emissions? With wealth effects, the answer depends on who is the emittor and who is the recipient.

Policy Responses to Externalities: Regulation

The simplest solution would be to regulate the level of activity to ho. The problem is that the functions Ф for each agent would have to be precisely known by the state to calculate this level of h.

This is because at the optimal level of externality production, each firm has to face exactly the same marginal cost: it must cost the same to get rid of a unit of pollution for every firm.

If firm A had a lower marginal cost of reducing pollution (its marginal benefit from pollution was lower) compared to firm B, then society will be better off by allowing firm B to produce more pollution and getting firm A to compensate by reducing pollution

In other words, a situation where the marginal costs of removing pollution (the marginal benefit of continuing to pollute) are unequal cannot be an optimal equilibrium

This is the problem for the regulator: we have to know each firm’s MB curve to determine the optimal amount pollution target to set for each


MC/MB

£15

MB ofFirm A

MB ofFirm B

Collective Output at each level Of MB

PollutionA’spollution

B’s Total

In this diagram, if each firm had to pay £15 to for each unit of pollution produced, firm A would produce A, firm B would produce more pollution at B (because it has a higher abatement cost/older technology), and the total pollution produced at this marginal cost would be the horizontal sum, shown as ‘Total’ pollution

The horizontal sum of the two MB curves shows the total output of pollution when each firm faces any given price at the margin for the pollution it produces


MC/MB

Firm A

Firm B

PollutionA’s

RegulatoryTarget

B’sRegulatory

Target

Social Optimum

The collective output line allows us to determine the optimal social amount of pollution when we can identify the social marginal cost curve and the distribution of this between the two firms can be read off along the horizontal line from that equilibrium

Social Marginal Cost



MC/MB

Firm A

Firm B

PollutionAverageRegulatory

Target

If instead the regulator divided the total pollution at the social optimum equally between the two firms, the result would not be a social optimum

Social Marginal Cost


ab

Firm A would be allowed to produce too much pollution given its marginal benefit, with a social loss shown by triangle a, and Firm B would be forced to reduce pollution so much that its marginal benefit would be higher than the social marginal cost, with a loss shown by triangle b

Transaction Costs Associated with Regulation

i) Costs of collecting firm level information about production possibilities and costs of abatement.

ii) Costs of monitoring accurately the emissions at the firm level. Note that government failure which allows corrupt officials to be bribed would significantly increase the transaction costs of collecting accurate information.

iii) Costs of enforcement when rules are broken. This includes legal costs and bureaucracies to collect the fines etc.

iv) If the regulatory solution is to be made acceptable, firms who are regulated should be compensated to the extent of their loss. But organizing this compensation also raises transaction costs of collecting taxes and distributing the subsidy.

Policy Responses to Externalities: Taxes and Subsidies

If the state knew the optimal level of ho, it would be able to induce this by imposing a tax on the emitter of th= - Ф2'(h

o), the marginal cost to the

recipient at the optimal level ho.

1'(h) (=MB1)

h*ho

TaxSubsidy

th = - 2'(ho)

- 2'(h) (=MC2)

A

B

C

D

E

The loss for 1 = A+Tax = A+C+D. The gain for 2 = A+B+E. The gain for G (government) is the Tax collected which is C+D. The net social benefit gained = (A+B+E)+(C+D)-(A+C+D)=B+E as before. This holds even if those taxed are otherwise compensated to the extent of A+C+D.

Policy Responses to Externalities: Taxes and Subsidies 2

Paradoxically, a subsidy to the producer, 1, at the same per unit level, not to produce beyond ho will theoretically have the same effect. A tax creates a disincentive to produce more than ho. A subsidy creates an incentive to cut production from h* to ho.

1'(h) (=MB1)

h*ho

TaxSubsidy

th = - 2'(ho)

- 2'(h) (=MC2)

A

B

C

D

E

In the case of the subsidy, the gain for 1 = Subsidy - Lost production = A+B-A=B. Gain for 2 = A+B+E. Loss for G = A+B (the subsidy).Net social benefit gained = B + (A+B+E) - (A+B) = B+E.

Transaction costs of Tax-Subsidy Solutions

i) Collecting information about marginal costs and benefits in the sector. Here firm level information is not required so the information requirement is less than in the case of regulation.

ii) Monitoring the amount of emission in the case of a tax and the amount of non-emission in the case of a subsidy. The second is more difficult to observe since each producer has the incentive to lie and exaggerate how much he would have produced in the absence of a subsidy. On the other hand, if the emittor is poorer, enforcing a tax on the emittor is likely to be politically very costly, particularly in international negotiations. iii) Administering the collection of the tax or delivery of the subsidy. This includes bureaucratic costs.

iv) In the case of the tax, in the long run compliance may require the emittor to be compensated to the extent of A+C+D. This has to be organized through subsidies unrelated to emission control and involve further transaction costs for the government.

Policy Responses to Externalities: Enforceable Rights

An alternative solution which saves on the information requirement of the state was proposed by Coase. This is based on creating the conditions for individual bargaining between emitters and recipients. The problem here is of potentially very high transaction costs of private exchange.

The theory is that if enforceable rights can be created on the external effects (essentially enforceable liability for damage in the case of negative externalities), then provided transaction costs of private bargaining are low, private bargaining between individuals will result in the optimal output of the activity, irrespective of the initial allocation of liability and the bargaining power of the agents.

This result is also known as Coase Theorem.

Policy Responses to Externalities: Enforceable Rights 2

1'(h) (=MB1)

- 2'(h) (=MC2)

h*ho

a

b

c

d

1) Suppose the right to pollute is given to the polluter. We then start off at h*. There are two possibilities in terms of bargaining power (ε represents a very small number):

a) Polluter is more powerful and can demand compensation of a+b-ε, making a net gain of (a+b- ε)-a = b- εThe Recipient makes a net gain of a+b - (a+b- ε) = εSocial gain = b- ε + ε = b

b) Recipient is more powerful and can offer compensation of a+ ε, making a net gain of (a+b)-(a+ε) = b- εThe Polluter makes a net gain of a+ ε - a = εSocial gain = b- ε + ε = b (the same as before)

Policy Responses to Externalities: Enforceable Rights 3

1'(h) (=MB1)

- 2'(h) (=MC2)

h*ho

a

b

c

d

2) Suppose the right to pollute is given to the recipient. We then start off at O. There are two possibilities in terms of bargaining power:

a) Polluter is more powerful and can offer compensation of c+ ε, making a net gain of c+d- (c+ ε) = d- εThe Recipient makes a net gain of (c+ ε) - c = εSocial gain = d- ε + ε = d

b) Recipient is more powerful and can demand compensation of c+d- ε, making a net gain of (c+d- ε) - c = d- εThe Polluter makes a net gain of (c+d) - (c+d- ε) = εSocial gain = d- ε + ε = d (the same as before)

Coase Theorem in the Presence of Wealth Effects

1 g e ts p o o re r

2 g e ts r ic h e r

M B 1

M C 2

h oh ^ ^ h *

1 g e ts r ic h e r

2 g e ts p o o re r

M B 1

M C 2

h o h ^ h *

C a s e II

C a s e I

If rights are initially given to the polluter and the starting point is h*, wealth effects can mean that the bargaining solution leads to h^ rather than ho.

If rights are initially given to the recipient and the starting point is O, wealth effects can mean that the bargaining solution leads to h^^ rather than ho.

Coase Theorem in the Presence of Transaction Costs

Case I2 pays TC

MC2

Case II

1 pays TC

MB1

h*h^h^^ ho

Case I: Rights given to Polluter and as a result, assume TC has to be paid by recipients.

Their willingness to pay declines and bargaining leads to h^ instead of ho.

Case II: Rights given to Recipient and as a result, assume TC has to be paid by polluters.

Their willingness to pay declines and bargaining leads to h^^ instead of ho.

Coase is often misrepresented as saying that transaction costs are low: in fact he was saying that transaction costs are typically not low, and therefore the allocation of rights does matter


Clearly these costs can be very high and will also be very high if emittors had to discover and pay off recipients. However, the aggregate costs of emittors and recipients can be very different

For instance, for recipients, these include: i) the costs of discovering other potential recipients, ii) organizing collective action with them by agreeing the contributions that each will make, iii) discovering the emittors and the individual or collective payoffs that will induce them to reduce their emission, iv) monitoring subsequent emissions to ensure that contracts have been adhered to, v) enforcing contract through courts or other means when contract violation happens

The transaction costs relevant here are the costs of either recipients of the externality, or the emittors or both to organize and enforce the transaction that would reduce the externality to the optimal level


However, transaction costs have a different and more practical implication for policy: if the transaction costs associated with the property rights (or any other) approach are too high, regulatory or other direct interventions may be better (provided their transaction costs are lower)

If the allocation of property rights can determine the ‘optimal’ level of pollution, the policy solution will be driven by the political preferences of the policy-makers: if policy-makers have a strong dislike for this externality they can achieve their outcome by choosing a particular policy approach

In this case, the presence of transaction costs and their differential impact means that who gets the initial rights DOES matter, not just for distribution, but also for determining the ‘optimal’ amount of pollution

Actually this makes policy towards externalities very difficult to ‘sell’ because many constituencies will always rightly think that the policy has been designed against their interests

Implications of Transaction Costs

In principle, the transaction cost associated with some solutions may be so great that it is not feasible to solve the externality: there will be no net social benefit to capture

The solution of any external problem has a potential gain in net social benefit (but we have seen that this net social benefit can depend on the transaction costs involved in solving the externality problem)

External effect

MC

MB

MC/MB

Potential NetSocial Benefit

WillingnessTo pay afterTransaction Costs

Why Do Externalities Exist?

If the transaction costs of solving an externality are too large, it is clearly more efficient to let the externality persist! Perhaps this is why many externalities exist in the first place

So if an externality persists there are two immediate possibilities, neither of which are very satisfactory :a) The gain in net social benefit is more than the potential transaction cost involved in solving the problem, ΔNSB>TC, but a failure of knowledge on the part of individuals or the state prevents a solution.

b) The gain in net social benefit is less than the potential transaction cost,

ΔNSB<TC, so the externalities are not Pareto relevant.

Neither is satisfactory in terms of being able to explain the vast range of externalities that are perceived to exist. If these are the only two possibilities, either most of these externalities can be rapidly solved once economists have pointed out the possibility, or they are irrelevant since they cannot actually be solved.

Why Do Externalities Exist? 2

A third possibility that is often not recognized is that the problem may be fundamentally political:

a) There may be differences in the valuation of costs and benefits because of different income levels of the groups involved, and the rich or the poor may not accept the willingness to pay criteria based on existing incomes as a true measure of social cost or benefit.

b) The distribution of costs and benefits may be different under different solutions and different groups may hold out till their preferred solutions are adopted.

In both cases solutions may be difficult to find even though the externality was “Pareto relevant” and there was no “knowledge failure”.

A further caveat: the non-convexity problem

The marginal approach to optimization can also be misleading in some circumstances where the effects of an externality can be ‘non-convex’

Non-convexity is particularly a problem where the recipients of an externally can take evasive action, that is the problem is not purely a technical one (though economies of scale can also cause technical non-convexities)

In this diagram the recipient’s total profits decline with emission but after a point the firm starts to cut back its own production or moving activities elsewhere so that its profits decline at a slower rate

Downstream Firm’sProfits

Emission

A

B

A further caveat: the non-convexity problem

Looking at the marginal cost of the recipient in this case shows that marginal costs initially increase as in the usual way, but as the rate of decline of total profits slows down, the marginal cost actually starts to fall at the point A, the point of inflexion in the previous diagram

MarginalProfit ofEmitter

MarginalLoss ofDown-stream

Firm

Emission

A

B

C

D

E

Emission

Total Net Profitof Firms

C

D

E

Clearly in this case we have to be careful: equating marginal costs and benefits can give us the global maximum C, but it could also give us the global minimum D. Compared to that, the point E where the externality is not tackled at all gives a higher net social benefit (in this case profit)

what is collective action?

Documents

collective action theory

failure of collective

necessary collective

theories of collective

prior collective action

group of individuals

group result

good society