McCloskey on the Coase Theorem

The Coase Theorem is an important part of economics research, agricultural or otherwise. The standard definition of the theorem is that in a world with zero or very low transactions costs, bargaining over a disputed right between two parties will lead to an efficient allocation of resources regardless of which party is legally awarded the property right. (If you are familiar with the Coase Theorem, you can skip the next paragraph.)

A classic example (which is found in Coase's paper "The Problem of Social Cost" is that of the railroad and the farmer. As trains traveled down the track in the 1900s, they emitted sparks that potentially could set fire to farmers' crops. If this were to happen, who should pay for the lost crop? In a world where transactions costs (that is, costs associated with acquiring information, monitoring the other party, or executing the trade) are zero, it doesn't matter who a court decides is responsible. If it's less costly for the railroad to put on a spark-catching device, the farmer will pay the railroad company to do so. If it's less costly for the farmer to plant his crops farther from the railroad, the railroad company will pay the farmer to do so.

Of course, we don't live in a world of zero transactions costs, so it does matter to whom the court grants the property right. Transactions costs also make it difficult for governments to figure out how to solve the problem. If the government decided it wanted to make farmers reduce their planting to solve the problem, there would be significant costs associated with determining just how far to restrict planting away from the tracks. In the opposite case, the government (that is, the taxpayer) would have to incur a cost to determine precisely which device the railroad should use to contain the sparks. These costs don't disappear in the cases of tradeable permits in fisheries or pollution. The government still has to determine the extent and details of these artificial markets.

It seems strange, but Coase himself maintains that the theorem (as described in the first two paragraphs of this post) is not about his work. He says that it's really George Stigler's theorem, but that Stigler was kind enough to name it after him. This is where McCloskey comes in. Her Summer 1998 column in the Eastern Economic Journal makes some bold claims about the Coase Theorem and, I think, provides some interesting insights, which I reproduce below.

Her interpretation is at odds with the way most interpret the Theorem. Her interpretation, which she says is Coase's (and I have reason to believe it is... Coase spent a lot of time arguing against what he called "blackboard economics"), is a caution to people who take the typical form of the theorem as an argument for "markets are always best" or "government solutions are always best."

PERC Weighs in on EPA's WOTUS Rule

Over the past year, I've explored several aspects of EPA regulation (here, here, here, and here). In a blog post last month at the Property and Environment Research Center (PERC), law professor Jonathan Adler discussed the conservation aspect of the EPA's contentious new definition of "waters of the United States" (WOTUS). In the post, he makes some good points about the ways in which an expansion of federal government conservation efforts could affect private or state government conservation.

Adler says that previous court restrictions on EPA's authority were the impetus behind the new definition of "waters of the United States":

The new definition was prompted by the failure of prior agency definitions to withstand judicial review. In 2001, and again in 2006, the U.S. Supreme Court rejected the agencies’ overly expansive notion of their own jurisdiction. Authority to regulate activities touching upon “waters of the United States” is broad, but not infinite, the Court ruled, and must ultimately connect to the nation’s navigable waters. Already multiple suits are pending in federal court challenging the new WOTUS definition for failing to heed this guidance.

He writes that the underlying theory behind the new definition is that conservation can be maximized if and only if federal regulatory authority is maximized. However, Adler claims that there are potential crowding-out effects associated with the new definition. He gives a couple of examples:

Consider the case of wetlands, which are subject to the Clean Water Act under the new WOTUS rule insofar as they are adjacent or otherwise connected to navigable waters and their tributaries. If federal regulation does not cover all wetlands—and it does not—other steps are necessary to maximize wetland conservation. Yet conservation groups and state and local governments cannot know where their efforts are most needed if they do not know where federal regulatory authority ends and the need for additional efforts begins. 

The expansion of federal regulatory jurisdiction also threatens to penalize and discourage conservation efforts more directly. Among other things, the Clean Water Act prohibits the discharge of pollutants, defined to include clean “fill material” such as dirt, in the nation’s waters without a permit, and the WOTUS rule defines waters to include many wetlands. This means that even the most well-intentioned conservationists may need a federal permit to undertake ecological restoration on private land. Why does this matter? Because obtaining such permits can be costly and time-consuming—and failure to comply can bring criminal penalties. And as has been shown in the context of endangered species, excessively punitive regulations can discourage voluntary conservation on private land.

Adler concludes:

There are more than 100 million acres of wetlands in the United States, and approximately three-fourths of these are on private land. This means that insofar as federal regulatory efforts discourage private conservation, they can have significant, unintended consequences. The unrestrained expansion of regulatory jurisdiction may be good for federal agencies, but it’s not always good for conservation.

What's clear is that this new definition, whatever form it takes, will have substantial effects on agriculture and conservation. We don't yet know whether those effects will be positive or negative on net.

Potpourri

Ag Econ Research & Extension
Jayson Lusk discusses an article on returns to publicly-funded agricultural research and extension. He also tackles the question: "Is ag econ academic research cited?" and answers in the affirmative.

Is Econ 101 Worthless?

David Henderson and Don Boudreaux respond to Noah Smith's contention that most of what we teach in Econ 101 is wrong.

Healthcare Reform
Two perspectives on recent developments related to Obamacare: one from Shikha Dalmia and another from Paul Krugman.

I, Pencil Revisited?
George Leef responds to a criticism of the famous essay "I, Pencil."

Regulatory Announcements
The Obama administration picks some interesting dates to announce new regulations.

A student gives a creative example of an externality.
David Henderson's student has a good understanding of Public Choice.

A new edition of Alchian and Allen's textbook.
Don Boudreaux lists some myths busted in a forthcoming edition of Alchian and Allen.

The Hockey Stick of Banking Regulation

Since the early days of the financial crisis, we've heard from many sources that it was caused by deregulation in the financial sector. Some economists and commentators blamed the crisis on general deregulation, while others pointed to the repeal of specific regulations over the last couple of decades as potential causes.

Recently, the Mercatus Center published RegData, which is a comprehensive measurement of regulatory restrictions by industry and by regulator. This index gives us a better picture of the regulatory environment at the industry level. I've referred to RegData in previous posts about EPA and USDA regulation of agriculture (here, here, here, here, and here).

In this post I provide some graphs and a brief discussion of banking regulation since 1970. This is an especially important issue in agriculture since ag lenders are likely to face liquidity issues due to low farm profits in coming years. 

Questioning the Credibility Revolution

If you follow the econonomics blogosphere, you've likely heard a lot about the "credibility revolution." The "credbility" part has to do with the supposed superiority of randomized control trials and quasi-experimental design over traditional models. The "revolution" part has to do with the suggestion that these models should replace, to some degree, theory in determining causality. One popular book, Angrist & Pischke's "Mostly Harmless Econometrics," discusses these methods quite clearly. I've used it a few times as a reference and found it quite helpful.

Of course, this revolution is very important for agricultural economists. We spend a lot of time using empirical methods to examine microeconomic problems. An open mind and critical eye are, I think, important for evaluating the usefulness of these newly-popular methods.

As the title suggests, I'm skeptical of the "revolution" part and somewhat skeptical of the "credibility" part. Experimental methods are nice as far as they go, but the use of experiments (broadly speaking) is more problematic in the social sciences than in the natural sciences. This is especially important if we are going to rely on the data to determine causality for us, rather than relying on sound theory. Further, some people seem to think these methods are the only way to do empirical microeconomics. In this post I'll draw from a few sources to make the arguments that 1) there are some important limitations to these quasi-experimental methods, 2) we shouldn't replace sound theory with data analysis, and 3) the "old" empirical models are just as useful as they always have been.

Roman Frydman on the New Rational Expectations Hypothesis

While reading a post at the Coordination Problem blog, I came across this interview of Roman Frydman (NYU economist) by Lynn Parramore at the Institute for New Economic Thinking. The interview was very interesting and I thought I'd share some of my favorite bits. The whole thing is worth reading.

LP: It seems obvious that both fundamentals and psychology matter. Why haven’t economists developed an approach to modeling stock-price movements that incorporates both?

RF: It took a while to realize that the reason is relatively straightforward. Economists have relied on models that assume away unforeseeable change. As different as they are, rational expectations and behavioral-finance models represent the market with what mathematicians call a probability distribution – a rule that specifies in advance the chances of absolutely everything that will ever happen.

In a world in which nothing unforeseen ever happened, rational individuals could compute precisely whatever they had to know about the future to make profit-maximizing decisions. Presuming that they do not fully rely on such computations and resort to psychology would mean that they forego profit opportunities.

Whither the Young Farmer?

Much is made about the average age of the American farmer. USDA Secretary Vilsack was once quoted as saying, "We have an aging farming population. If left unchecked, this could threaten our ability to produce the food we need – and also result in the loss of tens of thousands of acres of working lands that we rely on to clean our air and water." That's serious stuff, but a more careful analysis reveals that the situation isn't so dire after all.

Analysis by Carl Zulauf indicates that farmers are aging no faster than the general public. Additionally, we would expect, he says, that farmers would be older than the average business owner because modern agriculture is so capital intensive. Todd Kuethe breaks down farmer age by number of farms, acreage, and income, and notes that

The largest share of the income of the sector is captured managers between the age of 45 and 64. Just over half of Illinois' primary farm operators are between ages 45 and 64 (51.5%). This group, however, represents 60% of Illinois' agricultural land and 62.9% of the state's farm income.

Zulauf's observation that capital intensive industries are likely to have older sole proprietors on average is especially interesting given the current land price environment. As Brent Gloy and David Widmar note, land values are currently quite high, but a combination of low returns and rising interest rates could pave the way for a downward correction in land values. I made a similar argument about land values in Texas last October. The potential for a decline in land values may open up opportunities for younger farmers to buy in.

Another potential driver of the increasing age of the average farmer is increased regulation. As I've documented in the past, regulation by the EPA has increased almost continuously over the last 4 decades. Now more than ever farmers are burdened by the cost of regulation by the EPA. This increased regulatory cost creates economies of scale which might serve to hinder entry into the industry.


There are likely many causes of the increase in the average age of the American farmer, but it seems the worst thing that will happen is consolidation. If land values correct and young farmers are able to maintain access to credit, the trend of the aging farmer may at the very least slow down.