Why Teach the Solow Model? Why Teach The Coase Theorem?
Thursday April 3, 2008
A great three-way debate on the value of the Solow model. EclectEcon starts by simply asking:
The basic takeaway from the Coase theorem is that there are conflicts between property rights and efficiency, but that's okay, because private bargaining can lead us away from the property rights outcome to the "efficient" outcome. The normative lesson of the Coase theorem is that efficiency should trump property rights.
Here is an example: One household uses harsh herbicides on their lawn. After it rains, the herbicides run into their neighbour's yard and kills their organic tomato plants. Household 1 values their lawn at $800 and Household 2 values their tomato plants at $1000. So before this happens again, Household 2 should make a payment to Household 1 for an amount between $800-$1000 to get him to stop using the herbicide. This is the "efficient" outcome.
But shouldn't Household 2 have a right not to have his property destroyed? Why should they have to pay their neighbour "protection money" to ensure the safety of their tomatoes? If we truly believe in property rights, why should we allow efficiency to trump them?
Why teach the Solow growth model?To which William J. Polley gives a spirited defense, including the following:
Same reason we teach the Ricardian model of comparative advantage.Whereas Gabriel Mihalache believes the Solow model is useful as a stepping-stone to more robust models:
Even though it oversimplifies reality to nearly the point of absurdity, it contains many useful insights that are vital to understanding more sophisticated models and policy discussions.
The short answer is this: Solow is a good stepping-stone to Ramsey-Cass-Koopmans which is a good stepping-stone to the stochastic growth model of Brock and Mirman which is a good stepping-stone to Real Business Cycle, the baseline model for much of contemporary macroeconomics.EclectEcon believes intro macroeconomics courses should have a different focus:
But when I look at countries that have grown rapidly and countries that haven't grown rapidly, it seems to me that things like prices and interest rates, along with institutions, property rights, transaction costs, and entrepreneurship are much more important than exogenous technical change.I was nodding my head in agreement, until he said the following:
I replied that I teach nothing explicit about growth theories, but I do teach the Coase theorem and the importance of property rights and transaction costs in understanding exchange and growth.If you believe in the importance of property rights, why on earth would you teach the Coase theorem?
The basic takeaway from the Coase theorem is that there are conflicts between property rights and efficiency, but that's okay, because private bargaining can lead us away from the property rights outcome to the "efficient" outcome. The normative lesson of the Coase theorem is that efficiency should trump property rights.
Here is an example: One household uses harsh herbicides on their lawn. After it rains, the herbicides run into their neighbour's yard and kills their organic tomato plants. Household 1 values their lawn at $800 and Household 2 values their tomato plants at $1000. So before this happens again, Household 2 should make a payment to Household 1 for an amount between $800-$1000 to get him to stop using the herbicide. This is the "efficient" outcome.
But shouldn't Household 2 have a right not to have his property destroyed? Why should they have to pay their neighbour "protection money" to ensure the safety of their tomatoes? If we truly believe in property rights, why should we allow efficiency to trump them?
Comments
Er… no?
Coase says that property rights are not am impediment to efficiency.
If household 2 has property rights, household 1 will buy those rights and pollute only if its valuation is higher than the willingless-to-sell of household 2.
In either case, the outcome is efficient.
I take three lessons away from Coase:
1) Any given property rights distribution is not, primae facie, an impediment to efficiency;
2) Efficiency is not a valid criteria by which to decide who should own what (follows from 1);
3) When transaction costs are large, initial assignment of property rights matters.
Economics has nothing to say about who should own what, it can only says that, regardless of whom owns what, if transaction costs are low, efficiency will prevail.
“But shouldn’t Household 2 have a right not to have his property destroyed? Why should they have to pay their neighbour “protection money” to ensure the safety of their tomatoes?”
Because in reality there is almost always more than one neighbor, so “protection money” contracts tend not to be efficient. If you consider a situation where there are just 10 neighbors, it’s obviously going to be extremely difficult to get all 10 neighbors to agree to the same terms, especially since they all are going to value their lawns differently, and it is in each of their best interests not to let the others know what that value is. Increase the players to the entire world population, and you have a tragedy of the commons, unless government steps in to act as a broker and binding arbiter (OK, each of you pay $X in property taxes each year and we’ll act as the protector of your “rights”). Why is it called “protection money” if it goes to Household 1 but not if it goes to the government?
If the world consisted solely of instances of your simplified scenario, I don’t think Household 2 *does* have a right not to have “his property” destroyed. Property rights only exist because they tend to be efficient. Private ownership of land (subject to property taxes) with the right not to have others pollute on it is more efficient than the tragedy of the commons. In your simplified case, it probably doesn’t matter (there still is the inefficiency of discovering the parties’ values), but in most cases it does matter.
Gabriel’s right. You have a twisted idea of the Coase theorem.
However, what happens when Household 2 doesn’t have the right to be free of pollution? It seems as if few of us have the right to be free from pollution in this country and across this world, and thus externalities are tolerated or even encouraged in the case of agriculture, which imposes massive externalities. When a large mass of disorganized people are being hit with a small amount of externalities, but the sum is huge, you get a very inefficient outcome — sort of like trade. The benefits are diffuse and the restrictions are concentrated.
The Coase Theorem is positive, not normative. It says that if transaction costs are low and if property rights are well-defined, then regardless of the initial assignment of the property rights, they will eventually end up being owned by those who value them the most.
In your example, if the organic tomato farmer values the right to be pesticide free more than the evil lawn guy values a nice lawn, then the tomato farmer will not sell that right to the lawn guy if it is initially given to the farmer.
You want to argue about who SHOULD have the property right? that has nothing to do with efficiency IF property rights are well-defined (and easily enforced) and if transaction costs are low.
All of these models have missed some of the big picture of macroeconomics because they neglect the important part played by the landowner and the speculation in its value by him and by his partners the banks. This omission is not by chance but because such knowledge has been supressed by the funders of the economics departments at universities who are monopolists. They don’t want the knowledge to get out about how much their manipulations affect and control the rest of the country’s business.
Land-value is a natural resource created by nature and the infrastructure of tax-payers investments via the government. This value belongs to the people of the whole nation and not to a few fat cats who choose to exploit their advantage of land holdings. So what we need is a new model of the macroeconomy which includes all 7 participants in the macroeconomics system namely: landlords, householders, government, producers, capitalists, banks and the rest of the world. Each of these entities requires careful definition of the role that it plays and the connection between them. Then we will be on the way to ujnderstanding the true cause of business cycles.
RIGHT TO PEACEFUL OWNERSHIP OF PROPERTY IS GUARANTIED