Matt Damon’s “Promised Land” Meets the Coase Theorem

Below the fold, I offer an economic analysis of Matt Damon’s new movie.  I admit that I haven’t seen it but that won’t slow me down.  I wish the RBC a very happy new year.   For folks who need some good news, I point you to the new FEMA financed domes that can withstand 200 MPH gusts of wind.  During a hurricane, the lucky folks who are admitted can enjoy a game of indoor football.  This is distinctive adaptation.

An “intellectual” can write a review without having read the book or seen the movie.  While I am not an intellectual, I have read this review of Matt Damon’s Promised Land and I have a few thoughts to share.  Now, I’m not a big city lawyer but I can tell that this Hollywood star believes that domestic drilling has significant localized environmental costs that those who are leasing their land to energy companies are ignoring.

 

So, let’s sketch a simple rural social cost story and see if the Coase Theorem applies.   Matt and Mike own adjacent properties.  Matt grows cows while Mike doesn’t do much with his land.  A gas company offers Mike serious $ per acre for the right to drill for gas.  Mike accepts.  An unintended consequence of drilling for gas on Mike’s property is that there is extra water pollution on Matt’s land and Matt’s cows get sick from this water pollution.

 

There is a basic property rights question here.  If Matt has the property rights to healthy cattle and if it is low cost to establish that any cattle disease is traceable to Mike, then Mike will compensate Matt for any damage done to his cattle.   If transaction costs and issues of accountability (perhaps there are several fracking sites within the area) make it cloudy and difficult to establish who caused Matt’s cows to suffer, then Matt may be a victim of fracking.  Does this mean that fracking should be banned in this town?  An economist would ask;

 

1.  what is the value of the land per year when used for fracking  , call this $A

2.  What is the value of the land per year when it is used for its next best alternative,  call this $B

3.  what is the total environmental damage caused per year to the town, call this $C

 

A Coasian would say that if  A - B – C  is greater than  0 , then fracking should continue and Matt Damon has made a silly movie.

 

If A is less than ( B +  C)  then fracking should not have been allowed in this town.    If the land in the town were owned by one big “corporation” then no fracking would occur because the big capitalist would internalize the social costs caused by fracking.

 

The irony here is that the division of land into many smaller plots makes each small land owner have little incentive to internalize the externality.  So, Matt Damon is implicitly a friend of the 1%!     If there had been a single land owner and A < B+C, the frackers would never have been invited in and there would be no issue.  UPDATE —- To see this point, consider an owner of a suburban shopping mall.  If Mr. Taubman believes that a new entrant (such as a dirty book store) will cause damage to the sales of other mall tenants then he won’t let the entrant enter even if that book store would be profitable.  The residual claimant, Mr. Taubman, internalizes the total profit effect of the entry.

 

Now, the dispersed small land owners could still reach the efficient allocation of resources if transaction costs are low and they can bargain with each other.    If the dispersed land owners joined an association where they had to make group decisions, then this would nudge them toward the Coasian solution (i.e only invite fracking if (A-B-C) is greater than 0).  If they are decentralized folks who do not speak to each other, then the town’s individually rational choices (i.e Mike leasing to the frackers) may lower the entire community’s well being.

 

My office is 3 miles from Hollywood. I would be happy to meet with folks to go over the econ 101 of their plot lines before they make an irreversible investment of $25 million or more in a movie.  My fee would only be 3 free tickets to a Westwood Village premier.

 

UPDATE:  My mom has emailed me two comments about this blog post. She noted that the impact of fracking on neighbor’s health and cows may be uncertain and take time to manifest itself.  In this case, the “C” mentioned above becomes an expected present discounted value of social costs.  If the land owners “know that they do not know” how to estimate this (because they have no previous experience with fracking) then a rational decision maker would run a field experiment and set aside perhaps 10% of the total land area and lease this to the frackers to see if fracking causes significant social damage.   If the land owners do not know that they do not know the consequences of inviting the gas companies to frack, then this is the start of benevolent paternalism as we don’t allow adults to make their own choices.  Once we start down that path where do we stop?

 

Now, in this second case there is a role for well meaning, well trained environmental consultants to step in.   If well meaning people foresee that the rural land owners “don’t know that they don’t know” the potential negative consequences of fracking then the consultants can play a positive social role as “free consultants” educating the people about the unintended health consequences before the land owners make their choices over inviting in the gas companies.

Comments

  1. Lars says

    There is so much that is stupid and morally wrong about this post, but let me single this out: Kahn is endorsing the idea that if an individual can make a profit by hurting his neighbor then he should do so as long as he makes more than the whatever his neighbor’s losses are valued at, even if his neighbor has no way to extract compensation. What an asshole.

    • Ken Rhodes says

      Interestingly, Lars, I agree that there is much that is wrong (incrrect) and wrong (ethically) in the post, but the one thing that Kahn did NOT do is suggest, as you stated, that an individual ought to do what you said. What he wrote is that an individual will have little incentive to internalize the externality, which means that individual small owners will tend to optimize their own return, irrespective of community best interests.

      This statement is certainly true statistically in most cases. Because of that tendency of individuals for personal optimization, we have an institution called “government” which is supposed to represent the combined best interest of the community as a whole. When a large minority, or perhaps even a majority, of individuals don’t trust their “government,” which means they don’t trust themselves acting as a collective, then we have (a) a breakdown in governance and (b) a bunch of individuals acting for personal optimization at a significant cost to the group.

      • Lars says

        “A Coasian would say that if A – B – C is greater than 0 , then fracking should continue and Matt Damon has made a silly movie.”

      • Lars says

        In fact, he specifically warns us that government intervention will lead us down the slippery slope of paternalism. What post did you read?

  2. Byomtov says

    The one-owner analysis only works if the relevant land is completely isolated – surrounded by large useless desert for example – or if the fracker owns, and does not frack on, all surrounding property that might be affected. Otherwise, you are talking about owning “my land and all adjacent land.” There will always be a problem at the boundary.

    Backing up a bit,

    If Matt has the property rights to healthy cattle and if it is low cost to establish that any cattle disease is traceable to Mike, then Mike will compensate Matt for any damage done to his cattle.

    Will he now? Presumably Mike is not going to get out his checkbook out of general good will. Someone will have to make him. And who is going to do that? And low cost? Let’s see. Hire a lawyer. Hire a veterinarian or two with expertise on this subject to testify. Wait around for a few years for a resolution. Oh, and one more thing. It’s not going to be Mike at all. If Mike has a lick of brains he will have insisted that the gas company indemnify him against lawsuits and the like. So Matt is now fighting the gas company, which has all the time in the world, and plenty of lawyers (and possibly even a judge or two) of its own.

    It all sounds lovely, but maybe Damon was making a movie about real life, and not about the abstract ideas in Coase’s article.

    • Lars says

      Yes, one wonders why a blog that styles itself as reality-based is publishing someone whose thinking is so completely dominated by toy economic models.

      • J says

        Matthew Kahn’s profession (economics) is currently in a self-inflicted moral crisis of over four years’ duration. One would think he might have something more significant and serious and urgent to write about. But as far as I can tell, relatively few economists are capable of self-reflection or even self-awareness. Economics is the Marie Antoinette of academia.

      • Dan Staley says

        This ecologist who has had his share of econ sees this thought process as painfully limiting and blinkered, fraught with questionable premises. And these types advise on policy too often for my blood. This is reality.

  3. BobD says

    Life is certainly about more than an economic equation. Doing anything for a profit that would damage your neighbor is morally and ethically bankrupt.

    • Karlr says

      Really? Just what do you mean by “profit” – If you mean “A valuable return” then doesn’t that mean “damaging your neighbor” includes disallowing him the profit and seeking to better your own position would be morally and ethically bankrupt? Particularly if you are disallowing him the profit because of fear rather than facts.

  4. says

    There are more problems with fracking than the local pollution more or less addressed by Coase and Matt. BTW, the risks are a bit more serious than just “sick cows”. Several fracking chemicals like benzene are cancer risks in humans. Since the formulations are trade secrets, it’s a rather hard to evaluate these risks accurately, a precondition for a Coase equilibrium.

    One: fracked wells are incredibly short-lived: half the lifetime production comes in the first year. Their returns have been hyped by an industry protected by Cheney from releasing key information to the public. To keep producing, wells have to be re-fracked; the industry has to keep drilling more wells at a frantic pace. The pollution damage – including to groundwater – is long-term.

    Second, gas does not pay its CO2 externalities. These come from combustion and leaks: methane is a much worse greenhouse gas than carbon dioxide.

    Shale gas is a nasty bubble. If the law imposed a strict liability without time-limit on the industry for environmental and health damage, would any wells be drilled?

    • J says

      Sorry, but as any economist will tell you, you need to ignore all those messy complications and simplify the world down to the point where everything can be expressed in higher math (like “Is A minus B minus C greater than 0?”). As long as you assume that none of the stuff you simplified away matters, it’s all very nice and quantitative and satisfying.

      OK, that was a bit harsh. There probably are econ profs out there who could accurately be described as belonging to the “Reality Based Community”. It would be nice to have one of them blogging here.

      • Ken Rhodes says

        You’re right, J, you were a little harsh. And yes, there are some pretty smart progressive economists. Fellow named Krugman won the Nobel, y’know, and his sidelight is his blog titled “Conscience of a Liberal.”

        But even though your comment was a little harsh, it was based on an intuition that was absolutely correct. The funny thing about that Coase Theorem stuff is that it’s analytically sound. It’s the measurements that are hard, not the math. Most particularly, if you go back and read Kahn’s simple formulation, focus for a moment on the C term–”What is the total environmental damage caused per year to the town, call this $C.”

        Kahn has made a leap in terminology that obscures the measurement difficulty. The A term (value of the fracking per year) and the B term (value of alternative use per year) are annual data; they are like the returns on one-year bonds. But the C term (environmental costs) keeps sending bills for MANY years after the payoff is done. Therefore, to get the accurate cost “per year” you have to amortize the TOTAL costs over the limited payoff period. IOW, you have to take the integral of the cost function from now to infinity and divide it by the number of years you can get the payoff.

        If you fail to do that, and instead simply measure this year’s payoff against this year’s apparent cost, you have failed the measurement test.

    • Dan Staley says

      Here on the Front Range, you can’t swing a dead cat without hitting a new rig or existing pad. The local astronomy club lost a dark sky site due to the rig-pad lights. One place where I volunteer I drive past maybe 30 pads – many by Koch – and if the wind is right you can smell them too.

    • Mitch Guthman says

      I think you are right in general but the key point here is the ability of various actors in our society to shift the costs of their activities to the larger society while retaining the bulk of the benefits of the activity for themselves. That’s the role of the bean-counters. In the case of fracking, for example, the profits from this short term activity are large and immediate while the costs are distant and widely distributed. Some people who get cancer will die without suing the polluters. Most who become sick will be unable to afford any justice even if it’s possible to identify the source of the illness. They will simply crawl away and die.

      This is generally the problem with the way our society has been going. If one has the money to buy the lawyers, the judges and the politicians then all manner of evil can be justified as being “economically rational”. It’s simply good business

    • Barry says

      “Their returns have been hyped by an industry protected by Cheney from releasing key information to the public.”

      Sound like the Coase Theorem doesn’t apply, then. And didn’t anyway, given the massive transaction costs involved.

    • says

      Not really. The Coase theorem that with perfect information and complete markets you will end up at the same amount of pollution and compensation, whether polluters or victims have the rights, is interesting. The mistake lies in treating the two positions as ethically symmetrical as well. The person causing direct damage to others should pay for it, not the victims pay the tortfeasor to stop.

      • Byomtov says

        Yes. But there is a further problem, I think. Coase, so far as I can tell, largely ignores the cost of enforcing property rights. He talks a good bit about transaction costs, but it’s not clear to me that that includes enforcement costs. When those are substantial, it seems that we do not in fact have the well-delineated property rights he takes as an assumption.

        Take the movie case. Under Coase, Mike says to Matt, “Fracking is much more valuable than your dairy operation. Therefore I will pay you the value of your dairy operation (plus a dollar if you like) to shut down and let me frack.” This magically happens because Matt has a property right to keep cows, which the fracking destroys. One practical problem arises when Mike says, instead, “Sue me,” as the Mikes of the world, or their lessees, often do. Another arises when Mike determines that he much prefers dairy farming to whatever other job he could get, a preference that may be based in part on non-financial considerations.

      • Barry says

        IIRC, no. The Coase Theorem states thatthe level of economic output would be the same. Who gets what can change a lot (for example, if there is no public rights over the ground waterr, the fracking companies would pollute happily, and pocket their profits while everybody else lost.

      • paul says

        The thing is, this particular theorem of Coase has been known to be a dead letter in fact for at least 30 years, because the definition of “perfect information” (much less “efficient and complete markets”) turns out to be a political rather than an objective factor. Sure, you can claim that when a buyer and a seller can’t agree on a price one of them is wrong (or both are), but that doesn’t give you any guidance in deciding which one’s valuation is right. And in every other kind of market, the whole notion of ownership depends on the right to eschew transactions at a price that doesn’t meet your valuation. All you need is for one of the putative rights-owners to be resource-constrained, and the theorem turns to crap. (Either because the owner of a right won’t sell at any price, or because a person desiring to buy hasn’t got enough money.)

        Short-sighted application of the theorem does, however, explain pretty well by obviously-polluting facilities get located in poor areas.

  5. Mitch Guthman says

    Two points:

    First, as Byomtov points outs, it needs constant repeating that no man is an island. In this case the individual isn’t making choices solely for himself. He is choosing for everyone in the surrounding community and, perhaps, beyond. If there are any adverse consequences they are most likely to be borne mainly by the neighbors and the community at large. Why shouldn’t the rest of the community be able to protect itself by regulating activities that are likely to injure them and their families?

    Indeed, your mom is right to bring up the issue of uncertainty but you don’t seem to be taking the hint. Your political-economic model seems to assume that landowners ought presumptively to be to externalize their costs (such as pollution) while keeping the profits from the uses of their land. If there’s significant uncertainty about the future harm from fracking, wouldn’t it be more sensible to prohibit it altogether until the potential for future harm is quantifiable? (Particularly since there’s no guarantee either that the ten percent reserve fund will be adequate or that the polluters won’t simply take the profits from the fracking and place them outside the reach of the legal system?).

    Second, not everyone is willing to agree that the losses of all kinds can or should simply be reduced to money. The fact that the landowner’s profit from his polluting activity may be “greater” than the “value” of my or my child’s life doesn’t mean that he ought to be able to kill us if there’s a net economic gain. And why is everything reduced to its economic value?

    Why can’t the “reserve fund” for future harms of fracking be measure in a non-economic way—if the farmer’s poor choice results in economic loss to me, I should get money. But why, if the harm from fracking results in the death of my cows shouldn’t I be allowed to burn down his farm and salt his fields? If my child dies, why shouldn’t I be able to kill the farmer’s child or a child from each of the energy company’s executives? I believe that the application “Guthman’s theorem” would result in better decision making and significantly less pollution.

    • Lewis Carroll says

      Why not just cut out the middle step, and require that the children and grandchildren of the selling farmer, as well as the children and grandchildren of the controlling shareholders of the gas company, drink the groundwater from around the fracking sites?

  6. Kevin E says

    Long term damage to the land and its ecological services, alluded to by James Wimberley above, is an under appreciated cost here.

    How do we calculate the cost of making the land permanently unable to support the activities after drilling, like raising cows, that were economically dominant before? The orthodox answer is one about the winners compensating the losers. But this seems unworkable and even conceptually confused when dealing with lasting ecological damage whose losers may have yet to be born. Political philosophy has yet to get anything approximating a good hold of how to do inter generational distribution and justice, so it’s hard to imagine economists can have a simple, workable solution in their back pocket.

    All of this leaves aside the fact that we don’t actually know what the long term costs are going to be, barring a limited but controlled multi-decadal trial mentioned by Kahn. He expresses concern that such a trial will constitute benevolent paternalism toward anyone who doesn’t realize they don’t know the costs. Thing is, we have a way of making these sorts of coordinated, authoritative decisions: it’s called government. Specifically democratic government can make decisions like this legitimately; it’s kinda what it’s for.

    • PW says

      Of course, we have a decreasingly democratic government. That shows itself at ground level zero in fracking territory. Pruningsheers.us is a blog that follows, up close and personal, the balance of power between citizen and corporate interests in fracking territory in Ohio. It shows us that local elected officials are not always representing their constituents in the process, that the weight of pressure (political, financial) in on the corporate side of the deal.

      http://www.pruningshears.us/pruning-shears/2012/10/25/home-rule-on-that-ballot-this-election-season-activists-vers.html

      Leaving theorems out of this, I think we’d find that if we were to begin with adjusting our attitudes about energy and the amount we need, we might also find ourselves returning to a kind of democratic balance. Never perfect, democracy is nonetheless worth saving, probably worth a lot more in the long run than the notion that if it’s there, we can use it — even use it up — regardless of consequences.

    • BobD says

      Yes they are underestimating the damage Fracking produces. Ask Butler County, Pa residents what the cost of Fracking is. I would think that like the Super Fund pollution sites that if the land used for fracking is damaged the owners, and Gas producing companies would be responsible for paying for restoration. The E.P.A. doesn’t mess around with those Super Fund sites years later they can be told to pay for cleanup.

      • Pamela Dritt says

        Sometimes the EPA tells the companies that caused Super Fund pollution sites to pay for cleanup. But the EPA doesn’t force them to pay for cleanup. Usually, the companies just go bankrupt, often after divesting the polluting division from the profitable company.

        I know: I lived next to the Nuclear Metals/Starmet site in Concord MA. They not only didn’t pay to clean the place up, they refused to shut down (after their bankruptcy)to allow government cleanup to occur. And that’s after they trucked their other nuclear waste (from their other plants)up to MA in the dead of night and dumped it.

  7. Dan Staley says

    How do we calculate the cost of [Long term damage to the land and its ecological services]…All of this leaves aside the fact that we don’t actually know what the long term costs are going to be,

    First, what gets measured gets managed. It is not in corporate interests to have these measurements performed. Second, I do a bit of applied ecological policy work. Once a year I choose an ecological conference to share. Invariably after attending such a conference, I’m discouraged that the rate of human impacts is far steeper than the rate of our understanding of ecology. And I’d say our rate of planning and action is a negative slope. Jus’ sayin’.

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