Is the Rma Sustainable?: the Politics Of the Coase Theorem.

Planning Quarterly June 1998, p.5-8, A revised version of a keynote address to the 1998 NZPI Annual Conference, Dunedin.

Keywords: Enjvironment & Resources; Regulation & Taxation

The Resource Management Act (RMA) is based upon numerous, often conflicting, notions. Among them was an economic analysis which derives from a theorem first proposed by Ronald Coase who received an economics prize in honour of Alfred Nobel, for this and other key insights which are the foundation of the modern subject of law and economics. The Coase theorem was important in many of the reforms of the 1980s, including the RMA. I will explain why this powerful theorem is important, how it relates to resource management and the RMA, and then I will reverse its use to obtain insights on recent attempts to reform the RMA and draw some conclusions about the role of planning.

A brief version of the Coase Theorem is
If property rights are properly allocated and transaction costs are zero, the utilization of the resources will be independent of the initial allocation of property rights.

The brief statement is a little dense, so let me give an illustration. Suppose one wants to build an airport. A consequence of the airport will be aircraft noise which will overflow the airport boundaries affecting neighbouring properties. The theorem says whether the airport goes ahead is not dependent upon whether the airport owner has the right to make as much noise as the owner likes or whether the neighbours are entitled to quiet. Instead the airport will go ahead if it the most efficient use of the resources involved (providing the costs of settling any dispute are zero). Assuming the airport has the right to make noise, the neighbouring property owners can buy the owner out to prevent the noise. Alternately if the neighbours have a right to silence, then the airport developer can buy them out, to go ahead with the runway. In either case the outcome is independent of who has the rights to the noise or silence.

Note how the proper allocation of the property rights (so they are well defined. fully allocated, and transparent) leads to a market resolution to allocate the use of the resource. It need not, but if a bureaucratic mechanism existed which did not interfere with the property right, the outcome would be the same as the market mechanism.

Designing Market Outcomes for Resource Decisions

The implication is that once property rights are allocated properly, all the subsequent decisions can be left to the market, where – and this involves a long held conclusion of economics – the outcome will be “efficient”, in the sense, say, of giving most output for the resources available. Further bureaucratic intervention is unnecessary.

Many people, including some members of the NZPI, have grave doubts about market outcomes. The Coase theorems attends to one of those sources of doubt, for it explains that by allocating fully property rights, externalities – that is where an market decisions did not take into full consideration all its impacts on the economy – could be internalised. One of the most fundamental justifications for traditional planning becomes eliminated if property rights are dealt with. This, of course, is a big “if”, for social and cultural externalities especially are difficult to convert into properties or property rights. Nevertheless where they can be, the Coase theorem suggests we may have greater confidence in market outcomes, of leaving decisions to the market.

So the design problem for the economic system is whether it could be possible to create a market environment which would give efficient outcomes of the use of resources. This vision drove many of the reforms of the 1980s. In the case of the individual transferrable quota for fishing and the (almost) freeholding of the radio licensing spectrum it was, with considerable success. The RMA may be seen as an attempt to leave decisions to the market, by properly allocating environmental property rights.

It follows that the cost benefit analysis (CBA) which was common before the RMA, is no longer needed as often as it use to be. A CBA gives exactly the same outcome as the market if there are no externalities and market prices reflect social prices. The provisions of section 32(1)b only really apply where those assumptions do not apply. The approach now is, that once the consent process has gone through, the market actors make the decisions. That is the big difference from the pre-1984 era.

(As an economist experienced in applying cost-benefit analysis, and a contributor to the economics literature, I regret in financial terms the extinction of a CBA in resource management decisions, even though supporting the development intellectual terms. I warn that limiting the RMA to natural resources only, and eliminate any reference to social resources, would leave the process to reintroducing CBAs, thwarting a central objective of the reform. Having made this commercial sacrifice, in the very rare circumstances in which a CBA is relevant to Section 32, I remain available for consultation.)

We can now see why the RMA is said to be about “effects”, rather than “outcomes”. Effects are the consequences on other’s property rights. Once they have been settled, the applicant may make market judgements for any use consistent with the consents. Because usually the applicant has in mind a particular outcome – say a supermarket – it appears the consent process is approving a supermarket, but in principle the application applies to any project which does not exceed the effects. The RMA is not so much about determining the use of a resource or resources, as ensuring the use does not infringe the property rights that others have in the resource.

Having made the case for market decisions using the Coase theorem, and suggesting that approached underpinned the economics of the RMA, I now want use the theorem to look at some of the difficulties, especially in the light of various proposals at the conference to reform the RMA.

The Property Right Problem

First note that the Coase theorem says nothing about to whom the property rights should be allocated. It concludes that once they are allocated, the use will be efficient, But suppose property rights worth a million dollars have to be allocated to either A or B. For each the issue of the efficient consequences is unimportant compared to whether they or the other person gets the million dollars.

An example was introduction of individual transferable quota for fish. I was involved in the deep seas allocation phase, and cannot recall a single reference to Maori fishing rights, as extraordinary as that seems a decade and a half later. (It was the exclusion of Maori from the inshore quota which precipitated the energy which led to the Maori fishing deal.)

Not only is there the important question of identifying who gets the property rights, but there is the problem of identifying which are the property rights. Fish and the radio frequency spectrum are simple in comparison to the myriads of rights implicit in the environment. Conceivably the government could have constructed a mammoth doomsday book of all the various rights. Instead it created a general law which wrote down principles of entitlement, and a process – set down in the RMA – by which the general principles could be applied in particular circumstances.

Perhaps the main economic function of the RMA is to identify the property rights of the participants. In principle once they are identified the owners could then directly negotiate with the developer/applicant in the way implicit in the Coase theorem (and which is allowed for in the RMA by developers purchasing property rights – agreements to consents – from property owners.

However for a couple of reasons a tribunal may also be involved in the exercising of the rights. First, some of the property right owners may not be able to exercise their rights, so a tribunal does it for them. These include future generations whose rights are embodied in the notion of sustainability,[1] and those non-human owners who have their rights derived from the intrinsic value provisions.

Second, a tribunal process may provide a cheaper way of exercising property rights by owners, than going through the normal market process. In effect it reduces the transaction costs, making the conditions for the Coase theorem to apply more closely.

(One thing the RMA does not do well is to enforce the property rights. This is the unresolved issue of the monitoring of consents.)

In summary then, the process provisions of the RMA have two major economic functions: the allocation of property rights and the exercise of the property rights. Both functions involve costs – the compliance costs of the RMA process. Many of the proposals for reform of the RMA amount to reducing these compliance costs.

Transaction Costs and Compliance Costs

The purity of the application of the Coase theorem is muddied, because in all economic activities there are transactions costs, so the theorem does not strictly apply. In practice the argument is made that transaction costs in market trades tend to be lower than bureaucratic ones, and so it is better to leave the economic decisions to the market. if there is adequate commercial law including the assignment of property rights. As a result a major objective in the design problem – how to design a successful economics mechanism – is to minimize transaction costs. (Such costs means the practical application of the pure theorem is an empirical matter, but typically the conclusion is reinforced by a political ideology which ranges from moderate liberalism to the extremity of the new right radicalism.)

The market is not always successful, particularly where the conflict is reasonably trivial. For instance, an element of the radio frequency spectrum may have its use interfered by another. Rather than have a massive court case so that someone whose TV reception can sue the neighbour with the wonky fridge, we have a simple bureaucratic operation to sort out the problem. (The small claims courts are another example designed to minimize the full – and expensive – force of standard judicial process.)

However the transaction costs of the Coase theory and market theory are not the same thing as the compliance costs of the RMA. Reducing compliance costs may not be the same as reducing transaction costs.

First, many of the RMA compliance costs are not transaction costs at all, most notably those which are involved in allocating property rights.

Second, some of the costs which appear to be compliance costs – notably developers’ planning and design costs – would have happened anyway. The RMA simply exposes them to public gaze.

Third, some of the compliance costs of the RMA actually reduce transaction costs. Consider the cost of a full court hearing to ensure that future generations have their property rights properly exercised. More insidious, consider the enormous costs to a neighbourhood which wanted to exercise its noise rights, but where there was no RMA, so they would have to form a neighbourhood consortium, fund it, and take part in a complicated legal transaction with the developer. Better, one might argue, the simplicity of the RMA procedure.

What do the Critics Want?

Why do the critics of the RMA focus, in effect, on compliance costs?

The first point is that of course it is economically beneficial to reduce compliance costs as far as possible, providing that does not undermine the integrity of the process. A particular problem is that there is considerable differences, among councils, between best practice and worst practice. Not only is this inefficient in the case of each inferior practice, but it creates an uncertainty in the consent process which in is inefficient itself. But a few anecdotes illustrating worst practice is not a good reason to junk the whole system. Far better to get worst practice nearer to best practice. That this is not the main recommendation of the critics, suggests they have some other concerns.

One is as to whom pays for the compliance costs? At least some of the proposals shift the costs from the applicant to the council or the other participants in the case. Covertly charging one’s costs to others is as old as the first property speculator, so here we simply observe it, and note that a review of who bears the compliance costs involved is appropriate, but needs to be tackled systematically and practically, rather than anecdotally and hysterically.

But there is a second major objective of, at least some, critics. Reducing the effectiveness of the RMA process would have the effect of either awarding the property rights to someone else, or reducing the effectiveness of those with rights to be able to exercise them – which is much the same thing. Recall my story of the A and B disputing over a million dollars, totally uninterested as to whether ultimately there will be an efficient outcome. Underneath much of the criticism of the RMA is the same dispute. The critics wanting to shift property rights from the future, from the public, from that which represents intrinsic environmental values. These rights would go to the developers.

Now there may be an inequity in the allocation of property rights, but it would be more honest to say so, rather than change the rules, neutering the current property allocation mechanism, in order to shift the rights to oneself and one’s friends or pressure group, or according to some ideological preference. The implication is that were the critics candid about their objectives, the debate would become more transparent, and self interest more evident. Perhaps the critics have a reason for not expressing themselves clearly.

Who Plans?

Underlying all this is the question of who plans. A decade ago I observed a Treasury official at an enquiry barely able to pronounce “plan” so ideologically antagonistic was he towards the notion. But if the government does not plan, it does not follow there is no planning. To the contrary, as J K Galbraith pointed out, in his Economics and the Public Purpose, corporations plan. The constant tension is not between planning and not-planning, but between planning by the public and planning in private.

We should not dismiss planning in private, for that is what happens in private homes as well as business corporations. The design problem is how to coordinate these private plans in the public interest. One of the most powerful coordinating mechanisms is the market. We should use it wherever it works effectively. But as the converse of the Coase theorem shows, if property rights cannot be properly allocated or if transactions costs are high, the market does not give very satisfactory outcomes. And we have also seen that the allocation of property rights is by no means simple, and may profoundly affect outcomes – the shape of society – even if the Coase conditions hold and the allocation does not affect the use of the resources.

So some bureaucratic intervention is required for a society to function properly. Not as much, I insist, as was occurring before 1984, but more than the extremists of the right would have it. And if that intervention is to be effective and efficient, there will have to be economic design which will involve effective planning.

Coming to this conclusion at a conference of the New Zealand Planning Institute may be comforting. Yet I would not want to leave members of the Institute complacent. The keynote speeches were not nostalgically recalling favourably the pre-1984 economic regime. As the conference organizers asked of me, I have challenged the Institute by asking where does the market fit into their planning. Over tea cups and the like, I gained the impression that many practising planners are so involved in the details of bureaucratic administration – properly concerned because getting the details right is important – that they have not an overview of the relationship between planning and the market – perhaps along the lines I have set down in this address.

I detect in public policy a swing back from the most extreme pursuit of the use of the market, because pure market principles have manifestly failed to give the public what it wants in a number of key areas. But any reversal will not be back to pre-1984 intervention. The principles of the RMA for all the defects of practice, are likely to be retained as far as public policy can foresee.

That leaves the NZPI with a challenge or, in terms of the conference theme, a preparedness to be changed. There is a need to articulate those principles so that a vast, complicated, and sometimes opaque law can be broadly understood by the public. In doing so, the Institute will find itself making a robust case for the market, and yet at the same time making an equally robust case for planning at the community level.

In the end the answer to “who plans” has to be the public desires to have broad control over its community’s social and physical environment. Nevertheless it is happy to leave much planning to be private. The more difficult question is “how to plan”, or more extensively, “how do we coordinate private plans to attain the broad control the public desires”. I hope this address, and the conference generally, has directed members of the NZPI towards this challenge, and given them some of the maps to progress on that way.

1. How the are future generations is covered in the “sustainability” provision is explained in the appendix to chapter 3 of The Commercialisation of New Zealand, thus resolving the tricky issue of what is the appropriate discount rate.