Introduction to Coase Theorem
The Coase Theorem asserts that the issue of externalities can be resolved without government intervention if we clearly define property rights and keep transaction costs low.In his work on the Coase Theorem, Ronald Coase spoke about transactions costs which essentially refer to the costs accruing from activities like looking for partners, negotiating contracts, etc. In order to minimise these costs, economist often seek the intervention of political and legal institutions.[1]
In his treatise onProblem of Social Cost, Coase studies the externalities arising from economic transactions. He argues that when there are no transaction costs, and the economic exchange manifests in harmful consequences, then those involved can negotiate an agreement to resolve the problem. This will not only maximise the social product but it will also be independent of any political and legal institutions wherein the initial allocation of property will be unimportant vis-a-vis the result of the agreement.[2] Hence, Coase was in favour of assessing transaction costs for determining what is the optimal solution.
Description of the hypothetical case
The hypotheticalcase visualises a person paying a chargeof $100 to the airline toprevent the passenger seated in front of him from reclining. Here, since there is intervention by the airline and the money is not being paid to the passenger from whom the right to recline is bought off, it is not a case of strict application of the Coase Theorem since The Theorem requires the parties to negotiate and not other institutions to act as intemediaries. However, this charge of $100 depicts the initial allocation of property right to the person in the rear seat since he has bought the right to the space before him from the airline.
Hypothesis
I will argue in support of the aforementioned hypothetical case, i.e., theCoase Theorem does not find its way in the current fact situation. Through the course of this discussion, I will show that the Coase Theorem doesn’t apply in the situation since out of all conditions laid down in the Coase Theorem, it is only the condition of clearly defined property rights that is met. The problem of transaction costs will make the outcome inefficient and hence the Theorem should not be applied here.
Critical Analysis
Those in favour of applying this theorem in the given factual matrixargue that applying the Theorem is very simple since the negotiating parties are not only less in number but also that they are placed in close proximity. A number of complaints arise from passengers who recline their seats and hence encroach on the knee room of the passengers behind them.Applying the Coase Theorem to this fact situation gives rise to a simple solution- the passenger should pay the seated in front of him not to recline. The rationale is that if one values his or her knee space and does so more than he values his choice to lean back, then he can pay to ensure the seat stays upright and neither the government nor the airline will need to intervene to protect their knees. To sum it up, on buying an airline ticket, the passenger also buys the right to recline but if he so badly desired that the passenger seated before him does not recline then he must pay him/her to give away this right.[3] Thus, in the context of Coase Theorem, the initial allocation of property rights is irrelevant since the passengers have the right to decide to recline or not. When this right is contingent on the permission of the person seated behind, then one can purchase the right to recline from him.
The condition created by Coase for effective outcomes, such as well defined property rights and zero transaction costs are absent in the given scenario. Coase acknowledges that the world is full of transaction costs and hence there will be disputes with respect to this issue. Coase may not favour the possibility of this being overcome by buying off the right from another through an informal arrangement, since that can be done only when transaction costs are zero.[4]
Coase suggested that when it’s easier to make private contracts to allocate scare resources, then the initial allocation of the right is irrelevant since whoever values it more can purchase it from the other. Hence this is true only in the absence of hurdles preventing negotiation between parties. The barriers, or “transaction costs” take the form of time, difficulty in negotiation, etc. [5]
The greatest transaction cost will be for the person who wants to buythe property right as negotiation would not be costless in Coasean terms – people may feel shy in paying money to a stranger and so. Hence everything that impeded an easy transaction is a cost which hinders negotiations.[6]Interestingly, face to face interactions are presumed to have low transaction costs but they prevent smooth negotiations. There may be resistant to interact due to social or moral reasons and people may be unwilling to create a market of goods which are not usually exchanged.[7]Usually,it is also seen that people are unwilling to negotiate in an impromptu situation, like this one. The fact that reclining interferes with access to the space below the seat in front and hinders free use of the tray table may also create inhibitions in the party seeking the right to recline. Bargaining may be costly if the passenger is stubborn aboutdenying the right to recline and if it appears disrespectful to bargain about a seat. Moreover the negotiations will not be smooth since there may be differences of opinion over various issues like the duration of the agreement,assurance of performance and so. Also, in this case, there is a problem of multiple correlated externalities which make transaction costs and negotiations even more difficult. Also, the posture of a seat will influence the seating of a passenger in a much later row and consequently, more rows will mean higher need for negotiation and costs. Though the issues outlined above are viewed by supporters of Coase as beinga bunch of unnecessary complaints from those who had not valued their knee room and paid for it, but looking at it from a broader perspective shows that externalities are not always resolved by the market since transaction costs are high.[8]
A recliner creates a negative externality for the rear seat passenger. Coase believed that externality problems can be fixed when numbers are low and the benefit makes it a feasible option. However, as demonstrated above, the existing transaction costs, though assumed, make private negotiations an ineffective course of action. Thus once the passenger has paid the airline for more space, it is unlikely he would be keen to negotiate to give that right away. Assuming that there are no transaction costs as in an ideal situation, and people are keen to bargain, then the rear passenger may charge money from the passenger seated in front of him a price higher than that he paid to the airline to permit him to recline. As per the endowment effect, when someone is given a resource by default then they are unwilling to let go of it and consequently, the minimum sum they accept to let go is much more than the sum they purchased it for. As per Marron, evidence suggests that the resource must be allocated to the passenger in the rear seat since people are open to paying for more legroom. Hence in our case, when the rear passenger had bought the right from the airline, he had an endowed right to the legroom in front of him, hence he would be unwilling to negotiate with the passenger in front unless he was offered a very good price. Thus the transaction cost will be high and make the circumstances inefficient for application of the CoaseTheorem. We can hence say that the party who is assigned the right initially will value it more. [9]
Hence, both conditions for applicability of CoaseTheorem – Initial allocation of property rights and negotiation for the rights later – are not fulfilled, and the Theorem cannot be successfully applied.
This article has been authored by Pallavi Khanna.
[1] J. Johnson, The Economics of Reclining Your Airplane Seat Aren’t So Simple, The Washington Post, available at https://www.washingtonpost.com/news/monkey-cage/wp/2014/09/08/the-economics-of-reclining-your-airplane-seat-arent-so-simple/?utm_term=.cd43ba0176d1
[2] Menard & Bertrand, The Elgar Companion to Ronald H. Coase (2016) available athttps://books.google.co.in/books?hl=en&lr=&id=SnKNCwAAQBAJ&oi=fnd&pg=PA346&dq=%22airline%22+%22coase+theorem%22+%22seat%22+&ots=VJOPeFDGO4&sig=batZ0-90r2WKH2M9FbSQlChmNLM#v=onepage&q=%22airline%22%20%22coase%20theorem%22%20%22seat%22&f=false
[3]J. Barro, Don’t Want Me To Recline My Airline Seat, You Can Pay Me,The New York Times, available athttps://www.nytimes.com/2014/08/28/upshot/dont-want-me-to-recline-my-airline-seat-you-can-pay-me.html?_r=0
[4]Supra note 1.
[5] Buccafusco & Sprigman, Who Deserves Those Four Inches of Airplane Seat Space, The Slate, available athttp://www.slate.com/articles/health_and_science/science/2014/09/airplane_seat_reclining_can_economics_reveal_who_deserves_the_space.html
[6]Buchanan, Airplane Seatbacks, The Coase Theorem and Simplistic Solutions to Difficult Questions,Verdict Justia, available athttps://verdict.justia.com/2014/09/11/airplane-seatbacks-coase-theorem-simplistic-solutions-difficult-questions
[7]Supra note 5.
[8]J. Barro, Here’s The Key Thing You Should Know About Ronald Coase, The Great Economist Who Died Yesterday At 102, The Business Insider,available athttp://www.businessinsider.in/Heres-The-Key-Thing-You-Should-Know-About-Ronald-Coase-The-Great-Economist-Who-Died-Yesterday-At-102/articleshow/22253911.cms
[9]Supra note 5.
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