Hi everybody, welcome back. Last time, I argued that the transactions
between the owners of good health, our steel plants neighbors and the steel
plant itself over the transfer of that good help from the neighbors to the steel
plant to be used to produce steel, that those transactions will typically not
take place because they're blocked by a combination of transactions costs.
Primarily the transactions costs created by involuntariness.
The technical ability of the steel plant to simply take the, the property right to
good health. And to use it to produce steel without
bargaining with the, with the owners of the good health themselves.
In this lecture, I'd like to talk about solutions to this particular problem, to
the problem of the failure of markets in good health to exist.
And thus, will persistence of externality relationships between the steel plant and
the owners of the good health, the, the plant's neighbors.
I'll talk about four such solutions, two of them in this lecture and two of them
in the next lecture. These four are what I'll call absolute
deterrents, tort liability, a tax, which I'll call the Pigovian tax and finally,
social norms. Let's talk about each of these in turn.
Absolute deterrence means that there won't be any crud at all.
We could attempt to deter the production of crud absolutely by simply passing a
law that says that no crud may be tossed in the in the air, end of story.
But of course if we do that and ban the production of crud, under our hypothesis,
we'll also ban the production of steel. Because as we've assumed steel can't be
made without the production of some irreducible amount of crud.
If the crud is banned, then no cost to good health are imposed it all.
That is the property right to good health stays with the plants neighbors because
the plant doesn't use it to make steel because no steel is being made.
Thus, the cost to to good health, or put another way, the taking of the property
right to good health, which is initially placed in the plant's neighbors, are
deterred absolutely. At least ideally.
If the law works well, no steel will be produced, and no crud would be produced
as well. This may well be the efficient outcome if
the neighbors are the higher valuing owners of the right to good health.
So indeed, if transactions between the neighbors and the steel plant were easy,
and the steel plant was not the highest valuing owner of the rights to good
health. That is, if the sum of the costs that the
owners of good health would have to contribute to the production of steel is
greater than the value of that good health to the steel plant for the
production of steel, then the efficient outcome is that the property rights
remain in the hands of the plant's neighbors, that the steel plant not have
them and that therefore, steel will not be made.
But, it may be the other way around. It may be that the production of steel
does produce enough value to cover all the costs of production, including the
cost of good health. And if that is the case, than banning
crud is inefficient. That is to say, it stops the production
of steel such that the steel would be more valuable than all of the resources
that had to be contributed in order to produce that steel including the
contribution of the good health. Without exchanges, it's very very hard to
know who the highest valuing owner of a property right might be.
So, if we simply ban the crud altogether, we take a chance by presuming that
relationship to lie in one direction or another.
If we ban the crud that is, we might argue or interpret that as a statement
and a presumption if you will, that the plant is the lower valuing owner of the
property rights in question. And thus that the property rights for
efficiency sake ought to stay with the the owners that is with the plant's
neighbors. But of course that presupposition may be
wrong. It may well be that free transactions
would have transferred the property rights from the original owners to the
plant. And without free exchange, it is very
difficult to know. A second possible solution to the market
failure problem is torque liability. This means bringing the law and the
courts into the solution of the externality problem that we've been
describing. In a tort liability solution, we allow
the neighbors, the owners of the property the right to good health, to sue the
steel plant for the plant's uncompensated taking of their rights.
And if a jury founds, finds first that the neighbors are the original owners of
the property right and that the steel plant is unlawfully taken that property
right from them without consent or compensation, then the jury fixes an
amount of compensation to be paid by the steel plant for the deprivation of the
property rights that the plant's neighbors have suffered.
So, tort liability means a tort. What's a tort?
A tort is an unlawful act that does not rise to the level of a crime and for
which compensation is due from the person who has committed the tort, called the
tortfeasor, to the victim or the bearer of the costs of the tort.
Torts are unlawful acts, which means that the law can take action against the
people who take them. Torts are, in themselves, not crimes.
Crimes typically include torts, but torts typically don't include crimes.
Later in the course, we'll spend a good deal of time distinguishing between tort
and crime. But for now, all we need to know is that
torts are unlawful takings of property rights by individuals for which
compensation in the form of damages are due.
And in a tort suit the job of the jury, as I've said, first is to decide whether
the plaintiff's property right was in fact taken by the defendant unlawfully.
And if so, what amount the defendant must pay the plaintiff in compensation for the
value of the loss. Talking about tort liability in this way,
introduces a crucial concept that we'll be using many times later on in the
course. And that's the notion of liability.
So I'd like to take a digression and talk for a little bit about the problem of
property and liability. And in doing so, I will draw on the
groundbreaking work of two legal scholars, Guido Calabresi, a professor of
law at Yale law school and later a judge, like Judge Posner in the Federal Appeals
Court. In Judge Calabresi's case for the second
federal circuit and in an article that Judge Calabresi wrote in 1972 with his
co-author A. Douglas Melamed who is shown on the
right. In this article Calabresi and Melamed
define and distinguish between property rules and liability rules as ways of
governing legal regimes, as it were, for the distribution and allocation of
particular kinds of property rights. So let me talk just a little bit about
what Calabresi and Melamed have to say about the concepts of property and
liability. The first thing that Calabresi and
Melamed do, is to expand the notion of property rights, as we've been talking
about them, into a slightly larger category, which they identify as
entitlements. For Calabresi and Melamed, an entitlement
is a legally backed right, held by an individual either to be able to impose
specific costs without compensation on other people.
Or contrarily, to be free of such uncompensated cost imposition.
In our steel plant example, we've assumed that the plant's neighbors have an
entitlement to their good health. And if the plant takes that entitlement
to their good health by tossing crud into the air and forcing the neighbors to
breathe that crud to the detriment of their good health, then that entitlement
has been taken from the original owners by the steel plant.
Alternatively, in principle, the steel plant may have been given a cognate
entitlement to impose the cost on the health of its neighbors by throwing crud
into the air and to do so without having to pay any compensation to the plants
neighbors or to win their consent to the detriment of good health.
So generally speaking, any particular entitlement could be expressed into
alternative ways. It could be an entitlement on the part of
some individual to be able to impose costs upon others in a certain way
without their consent and without having to pay them compensation.
Or a cognate entitlement could be placed in the victims, as it were, of that
relationship and then, they would have an entitlement to be free of the specific
kinds of costs that are being imposed without their consent and or without
they're being paid compensation for it. Entitlements, Calabresi and Melamed
argue, may be protected in two different ways.
By this they mean, that the law can throw its weight behind the claims of
entitlement owners and, and protect their ability to enjoy their entitlements, in
two different ways. One of them is to protect entitlement by
property rule, which means that the, the entitlement can only be transferred from
its original owner to another owner if, if the original owner agrees to the
transfer. So in a property rule situation, no
entitlements are forcibly or involuntarily extracted from anybody.
All entitlements that are successfully protected by property rule, all these
entitlements can only be moved from one person to another with the consent of the
original owner. Which means that the original owner gets
to set the price at which the entitlement would be transferred.
If I have a property right to my watch, and it is protected by the property rule,
I don't have to give the watch to anybody if I don't want to, and nobody may take
the watch without my consent. But I may sell the watch, and agree to
transfer it to another person if I'm paid what seems to me, by my own likes, to be
adequate compensation for what I've lost. Or, entitlements may be protected, by
what Calabresi and Melamed call a liability rule.
In this case, as in our steel plant example, the entitlement is initially
taken from its previous owner without that owner's consent or compensation.
But at some later moment in time, the one who has taken that entitlement unlawfully
is then required by the law to pay the owner compensation for the loss.
And that compensation is determined not by the person who has lost the
entitlement, but by a third party. In the case of tort suits, typically that
third party is an impartial jury. Thus, liability judgements complete a
transaction whose two parts have been broken in time.
So we can think about the steel plant and its dealings with the owners of good
health as a two sided transaction in which when we raise the curtain on the
problem, only one part of the transaction has been undertaken and the second part
of the transaction has not yet been completed.
The two parts of the transaction are this.
First, the cost imposer initiates the transaction by taking the owner's
entitlement without that person's consent.
In our example, the first half of the transaction would occur when the steel
plant starts to produce steel. It tosses the crud in the air, people
breath the crud and they begin to suffer deleterious effects to their good health
and the costs that are intended to that. That's the first part of the transaction.
And in this part of the transaction, the cost imposer has reached over to the
neighbor, to the original entitlement owner and seize that entitlement from the
original owner without paying the owner compensation or without gaining the
consent of that particular individual. Where property rules are sufficient to
protect entitlements, that is where people don't steal, and where people
don't have the ability to simply seize property rights from other people without
their consent. In such circumstances, property
entitlements may be transferred only by free exchange or by a gift.
And when they're transferred by free exchange, as I've noted before, they're
transferred at prices that sellers are free to accept or refuse.
So that indeed sellers can set their own price.
And if they choose not to sell at any given price, then the entitlement will
stay with them. This means that the sellers of
entitlements can include what might be called, subjective values, in the price
that they demand for the entitlements that they sell.
Again, consider my watch. Suppose I'm selling a property
entitlement to my watch, and suppose the market value of the watch is $50.
That means that I could purchase an identical watch to the one that I have
simply by going to the store and paying $50 for it.
Now, suppose somebody unlawfully takes my watch.
Perhaps as a part of an accident, my watch is destroyed and it's determined
that the accident was the fault of someone else.
So, in terms of tort liability, that's someone else will be said to have
unlawfully taken my entitlement to my wrist watch.
We might say that the appropriate amount of compensation for me is just the amount
that I need to purchase another wrist watch that would exactly replace the one
that I had. And by hypothesis I've said, I could go
to the jeweler and buy another wrist watch for $50.
But suppose this wrist watch was given to me by my favorite aunt Sally, whom I love
dearly, and therefore I place a great deal of sentimental value on this watch.
In this case, my watch is not the same as the one that I could replace it with for
$50. Because that replacement watch didn't
come from my aunt Sally. My watch, the one that I did get from
aunt Sally, has sentimental value to me. Suppose that sentimental value is $100,
then I might be willing to sell the watch for $200.
Because then I received $200, I've suffered the loss of the $50 watch that I
could replace and I've suffered the loss of the $100 worth of sentimental value
because I no longer have the watch given to me by my aunt Sally.
But that cost, 50 plus 100, is 150, which is smaller than the 200.
Alternatively, if I were only offered $50 or $60 for the watch, even though I could
get another watch for $50, I'd refuse the bargain because of the subjective $100
value that I attached to the watch. When property rules are sufficient to
protect entitlements, I'm free to include these subjective values in the price that
I demand in exchange for my consent to surrender my entitlement.
But where markets fail, as they did in the case of the steel plant, and
entitlements are taken without consent as the steel plant by hypothesis takes the
right to good health, the entitlement to good health of its neighbors.
Then the taker, in this case the steel plant, extinguishes the entitlement.
Once those people breath the smoke, they no longer have their good health, and
their entitlement to good health has been taken from them, and effectively
destroyed by the steel plants action of tossing the crud into the river.