COASE, WAR, AND THE PROBLEM OF EVIL SPIRITS

The economics of war (Micha Ghertner, Jewsweek, 8/8/2003)

Coase, now a professor of economics at the University of Chicago Law School, published a groundbreaking paper in 1960, titled, "The Problem of Social Cost." Prior to this paper, virtually all economists accepted the idea of Pigouvian taxes and subsidies, named after another British economist, Arthur Pigou. Roughly, Pigou believed that any activities which create either positive or negative side-effects should be subsidized or taxed accordingly. These side-effects, which economists call "externalities," (as they are external to the intentions of the actor who created them) were thought to require either encouragement or discouragement from the government to reach their socially optimal levels....

What Coase discovered was that the Pigouvian view, although intuitively plausible, was in fact wrong, or at best, incomplete. If the people living near the paper mill could easily get together and bargain with the paper mill's owners, and if the owner of the outdoor cafe could easily get together and bargain with the owner of the baker, no taxes or subsidies would be necessary. Essentially, Coase's insight -- the Coase theorem -- was that externalities themselves are not so important; rather, transaction costs -- the costs of getting together to bargain -- are central to whether or not a situation will result in a socially optimal outcome. If transaction costs are zero, it does not matter if the owner of the paper mill is liable for damages, nor does the baker need to be rewarded through government subsidy to produce enough pleasing smells; in both cases, the result will be the same. The relevant parties will bargain with each other and achieve the best result....

So what does any of this have to do with war? Well, war is essentially a form of conflict, and the Coase theorem, at its most basic level, is a theory of conflict resolution. We would expect, according to the Coase theorem, that if transaction costs between the conflicted parties were low or non-existent, a mutually beneficial agreement could be reached. War is a negative-sum game -- a losing proposition for all parties involved -- and almost any conceivable resolution would leave everyone better off than the inevitable death and destruction that violent conflict brings. But as the Israeli-Palestinian conflict sadly demonstrates, this theory does not seem to hold true. Why?

To answer this question, George Mason University economist Tyler Cowen, in an upcoming academic article for the journal Public Choice, "A Road Map to Middle Eastern Peace? -- A Public Choice Perspective," examines the conflict from a game theoretic perspective. ...

Cowen concludes that, unfortunately, the Coase theorem doesn't help us much in solving the Israeli-Palestinian conflict, other than explaining why an amicable agreement is so difficult to achieve. Rather than try to sculpt the facts to fit the theory, as many academics are known to do, Cowen humbly concedes that the Coase theorem does not seem to be "a good description of the real world."

The Coase Theorem is valid within its domain, but one must always be sensitive to what a theory's domain is -- sensitive to the range of circumstances in which its assumptions are realistic. The Coase Theorem is usually presented as a theorem within neoclassical economics (though it can also be derived in a broader economic perspective, as Coase himself preferred) that relies on the neoclassical assumption that people's utilities are based solely on effects on themselves personally -- that decision-makers are indifferent to effects on other people, except insofar as those other people communicate preferences to them through transactions. In this form, the theorem assumes that Palestinians neither want to help Israelis nor hurt them; it assumes Palestinians are indifferent to Israelis; and thus that Israeli preferences will reach Palestinians either in the form of punishments inflicted for behavior Israelis don't like or rewards offered for behavior Israelis like.

Once you admit the possibility of evil -- the possibility that some people gain utility from others' pain -- then there is no reason why violence should be bargained away. It seems plain that Palestinian suicide-bombers are evil-spirited -- that they derive enough utility from dead and wounded Israelis to counterbalance the utility loss from their own deaths. So to accurately analyze the Israeli-Palestinian conflict one would need a generalized Coase Theorem, in which evil-spiritedness is allowed. And this generalized Coase Theorem would show that in the presence of evil, the result of bargaining (an equilibrium, in game-theory terms) may well be continued murder. The reason is that continued murder enhances the utility of the evil-spirited, and the victims may not have enough to offer the evil-spirited to make up for the lost utility they would suffer by not murdering.

It is curious that Cowen does not offer the existence of evil as a possible resolution to the puzzle he has tangled with. Rather than acknowledge evil and generalize the Coase Theorem, he concludes, "The Chicago school is overly optimistic when it applies the Coase theorem to politics. The Coase theorem is a useful foil for figuring out why efficient political bargains are so problematic, but it is not a good description of the real world.... [T]he Coase theorem does not describe the world we live in." This would seem to be a message of analytical despair. Is it easier for academics to abandon hope in scientific fruitfulness than to acknowledge the existence of evil?

What we need is help understanding how people can be turned from evil toward good -- from a desire to inflict pain to at least indifference or, better yet, a desire to see good come to others. A generalized Coase Theorem would be a step torward analyzing ethical and spiritual decisions -- toward an economics of good and evil. To start such a field would be a contribution worthy of a great economist.

Posted by Paul Jaminet at August 8, 2003 11:40 AM