1 Cheung, Steven N. S., “The Structure of a Contract and the Theory of a Non-Exclusive Resource,” Journal of Law and Economics 13 (1970): 49–70.
2 Prominent among the institutionalists are Ronald H. Coase, Terry L. Anderson, Donald R. Leal, Steven N. S. Cheung, Fred S. McChesney, and Elinor Ostrom. For related literature, see Coase, Ronald H., “The Problem of Social Cost,” Journal of Law and Economics 3 (1960): 1–44; Anderson, Terry L. and Leal, Donald R., Free Market Environmentalism (New York: Palgrave, 2001); Cheung, “The Structure of a Contract”; Anderson, Terry L. and McChesney, Fred S., eds., Property Rights: Cooperation, Conflict, and Law (Princeton, NJ: Princeton University Press, 2003); and Ostrom, Elinor, Governing the Commons (New York: Cambridge University Press, 1990).
3 See Coase, “The Problem of Social Cost”; Buchanan, James M. and Tullock, Gordon, The Calculus of Consent (Ann Arbor: University of Michigan Press, 1965); and Buchanan, James M. and Stubblebine, William C., “Externality,” Economica 29 (1962): 371–84.
4 Pigou, A. C., The Economics of Welfare, 1st ed. (London: Macmillan Publishing, 1920).
6 Coase, “The Problem of Social Cost.”
7 On this, see Raymond, Leigh, Private Rights in Public Resources (Washington, DC: Resources for the Future, 2003).
8 In spite of his recognizing the possibility of legislative anti-efficiency effects, Pigou apparently gave no consideration to the operation of private law in imposing cost on negligent producers of externalities. Pigou, it seems, embraced the system of property rights described by David Hume. (On this, see Raymond, Private Rights in Public Resources.) For Hume, property rights and their articulation were created and modified by government, not by market forces and private law. To Pigou, property rights are endogenous to the political process. We note that when politicians and government become endogenous to the story, the simple analytics of welfare economics get complicated.
9 Buchanan and Tullock, The Calculus of Consent.
10 See Marshall, Alfred, Principles of Economics (London: Macmillan and Co., 1920); Pigou, The Economics of Welfare; Knight, Frank H., “Some Fallacies in the Interpretation of Social Cost,” Quarterly Journal of Economics 37 (1924): 582–606; Young, Allyn A., “Increasing Returns and Economic Progress,” Economic Journal 38 (1928): 527–42; Sraffa, Piero, “The Laws of Returns under Competitive Conditions,” Economic Journal 36 (1926): 535–50; Clapham, J. H., “Of Empty Economic Boxes,” Economic Journal 32 (1922): 305–14; Graham, Frank D., “Some Fallacies in the Interpretation of Social Costs,” Quarterly Journal of Economics 39 (1925): 324–30; Robertson, D. H., “Those Empty Boxes,” Economic Journal 34 (1924): 16–30; Shove, G. F., “Varying Costs and Marginal Net Product,” Economic Journal 38 (1928): 258–66; Robbins, Lionel, “The Representative Firm,” Economic Journal 38 (1928): 387–404; Harrod, R. F., “Notes on Supply,” Economic Journal 40 (1930): 232–41; and Viner, Jacob, “Cost Curves and Supply Curves,” Zietschrift fur Nationalokonomic 3 (1931): 23–46.
11 Buchanan and Stubblebine, “Externality.”
12 Ibid., 371. We note that the concept of Pareto-optimality is used by most neoclassical economists to address the issue of efficient use of resources. In brief, a state of the world, with its associated allocation of resources, is considered efficient if there is no reallocation of resources that could make at least one person better off (relative to the initial allocation) while leaving no one worse off. When a reallocation could make at least one person better off, while leaving all others no worse off, an inefficiency exists and a so-called Pareto-improvement is possible. A Pareto-relevant externality is an externality that produces an allocation of resources that is inefficient, so that a Pareto-improvement is possible. A Pareto-irrelevant externality is an externality that does not yield a potential Pareto-improvement. In other words, Pareto-irrelevant externalities do not cause inefficiency; thus, no policy for improvement is appropriate.
13 Kapp, William, “On the Nature and Significance of Social Costs,” Kyklos 32 (1969): 334–47.
14 Ibid., 335.
15 The “empty boxes” debate takes its name from a 1922 article by J. H. Clapham (see note 10 above). The debate revolved around whether inefficiencies (Pareto-relevant externalities) existed with increasing-cost and decreasing-cost competitive industries. Assuming that inefficiencies existed, it would then seem appropriate for analysts to identify industries that are characterized by increasing or decreasing costs. Clapham, using an analogy of a shop with boxes on the shelf, suggested that analysts place industries in conceptual boxes labeled increasing-, decreasing-, or constant-cost industries. Clapham argued that the distinction was not useful—that the conceptual boxes were, in effect, empty. The subsequent debate, with its related spin-off issues, is referred to as the “empty boxes” debate.
16 Pigou, The Economics of Welfare, 223.
17 Clapham, “Of Empty Economic Boxes.”
18 Ibid., 312 (emphasis added).
19 See Young, “Increasing Returns and Economic Progress”; and Knight, “Some Fallacies in the Interpretation of Social Cost.”
20 The only thing of conceptual value that survives from the empty boxes debate is the distinction that is drawn between pecuniary and nonpecuniary externalities. See Ellis, Howard and Fellner, William, “External Economies and Diseconomies,” American Economic Review 33 (1943): 493–511.
21 Marshall, Alfred, Principles of Economics (London: Macmillan and Co., 1920), 225.
22 Interestingly, given the Pigouvian tax tradition, Pigou did not limit acceptable government interventions for equating social and private net product to taxes and subsidies. He also speaks very favorably of a wide variety of regulations and legal constraints.
23 We take some liberties in characterizing this as a debate, for there were few protagonists before Coase, chiefly Pigou and Knight, and Pigou appears either to have conceded (though not explicitly) the point without much debate or to have simply ignored the issue raised by Knight.
24 Knight, “Some Fallacies in the Interpretation of Social Cost.”
25 Pigou, A. C., The Economics of Welfare, 4th ed. (London: Macmillan and Co., 1932), 182–203.
26 Pigou attributes this example to Henry Sidgwick.
27 Ibid., 183–85.
28 On this point, Pigou laments in a footnote: “In Germany the town-planning schemes of most cities render anti-social action of this kind impossible; but in America individual site-owners appear to be entirely free, and in England to be largely free, to do what they will with their land.” Pigou's view that the freedom of site-owners is the source of “anti-social action” may offer some insight into his mind-set regarding external effects. (See ibid., 186.)
29 See ibid., 134, 186–87, and 196–203.
30 Ibid., 129–30.
31 Ibid., 192 (emphasis added).
32 Coase, “The Problem of Social Cost,” 35.
33 See Meade, James E., “External Economies and Diseconomies in a Competitive Situation,” Economic Journal 62 (1952): 54–67. It is telling that Meade's essay is remembered almost exclusively for one of his examples, the famous beekeeper and apple farmer example, rather than for a basic insight contained in the distinction he makes.
34 See Baumol, William J., “On Taxation and the Control of Externalities,” American Economic Review 62 (1972): 307–22; and Baumol, William J. and Oates, Wallace, The Theory of Environmental Policy (Englewood Cliffs, NJ: Prentice Hall, 1975). Meade's discussion, however, had one advantage over the later discussion by Baumol and Oates. Specifically, Meade implies that it is the depletability of the asset whose use gives rise to external effects, not the depletability of the externality itself, which is significant. This is a subtle but potentially important distinction.
35 See Yandle, Bruce, “Environmental Turning Points,” Independent Review 9 (2004): 211–26.
36 See Anderson and Leal, Free Market Environmentalism; and Yandle, Bruce, “Coase, Pigou, and Environmental Rights,” in Hill, Peter J. and Meiners, Roger E., eds., Who Owns the Environment? (Lanham, MD: Rowman and Littlefield, 1998), 119–52.
37 Central to this point are Coase, “The Problem of Social Cost”; Buchanan and Stubblebine, “Externality”; Ralph Turvey, “On Divergences between Social Cost and Private Cost,” Economica 30, no. 119 (1963): 309–13; and Baumol, “On Taxation and the Control of Externalities.”
38 For example, see Meiners, Roger E. and Yandle, Bruce, “Common Law and the Conceit of Modern Environmental Policy,” George Mason University Law Review 7 (1999): 923–63.
39 On this, see Coase, “The Problem of Social Cost”; and Browning, Edgar L., “External Diseconomies, Compensation, and the Measure of Damage,” Southern Economic Journal 43 (1977): 1279–87.
40 See Buchanan and Stubblebine, “Externality.”
41 Baumol and Oates, The Theory of Environmental Policy.
43 Pigou, The Economics of Welfare, 4th ed., 195.
44 Ibid., 332.
45 Buchanan, James M., “Public Choice: The Origins and Development of a Research Program,” in Eberling, Richard M., ed., Champions of Freedom, vol. 31 (Hillsdale, MI: Hillsdale College, 2004), 25 (emphasis in the original).
46 Buchanan and Tullock, The Calculus of Consent.
47 Ibid., 189–90.
The authors express appreciation to David Gordon and Ellen Frankel Paul for insightful comments and thought-provoking criticism.
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