The Identity of the Generator in the Problem of Social Cost

Abstract:     
One of Coase's central insights is that distinguishing between the generator and recipient of an externality is of limited value because externality problems are reciprocal. We reconsider the relevance of the identity of the generator in a model with non-contractible investment ex ante but frictionless bargaining over the externality ex post. In this framework, a party may distort its investment to worsen the other's threat point in bargaining. We demonstrate that the presence of this distortion depends, among other factors, on whether the investing party is a generator. Social efficiency can sometimes be improved by conditioning property rights on the identity of the generator: for example, assigning damage rights if the rights holder is a generator and injunction rights if the rights holder is a recipient can be more efficient than either unconditional damage or injunction rights.

Keywords: externality, polluter, transactions cost, reciprocal harm

JEL Classifications: K11, D23, C78, H23

Working Paper Series