Why Voluntary Market Solutions Make Sense

Brad Matthews economics category

A voluntary solution is proactive:

Two parties that recognise a potential problem can come to a solution before it becomes a issue. Government on the other hand, arbitrates who is at fault after the fact. They decide how much the infringing party owes the other.

Finding a voluntary solution avoids that mess by creating agreements at the first sign of potential trouble. Agreements which benefit both parties.

Both parties can profit

When a government court decides who wins and who loses  (who is owed and who owes compensation), one party wins at the expense of the other. When two (or more) parties contract on their own terms however, each is self-interested. They want the best outcome for themselves.

Consider this in practice, in the following scenario from Ronald Coase’s paper The Problems of Social Cost.

A crop farmer’s land borders a cattle farmer’s. The fence bordering the properties has aged and is not as durable as it once was. Cattle could potentially destroy the fence simply by leaning against it — giving them access to feast or trample on the crop farmer’s product.

This is not good for the crop farmer. His crops are destroyed and he will likely initiate legal action.

This is not good for the cattle farmer. He has to also defend himself and likely pay restitution for the damaged product.

So how could they solve the problem outside of the courts?

  1. The crop farmer could pay the cattle farmer for a better fence to keep his crops safe.
  2. The crop farmer could pay the cattle farmer $X to maintain fewer cows. That limits their impact on the existing fence and the chance they might come onto his property.
  3. The cattle farmer could pay the crop farmer for a better fence to keep the cattle in. That avoids court fees and paying restitution.
  4. The cattle farmer could pay the crop farmer not to plant in the area closest to the fence. That limits the potential damage his herd could do if they got onto the crop farmer’s land.

Of course they could share the burden and both contribute a share toward a particular solution as well. Such as going halvies for a new fence.

Things get more interesting when you consider values and costs:

  • The marginal value of each cow to the cattle farmer. Let’s say the first one is worth $15 to him, a second is $13, a third might be $10, the 4th $6, and a 5th $1.
  • The value of the crop farmers produce — the average amount that the cows could destroy. $20 on average.
  • The cost the cattle farmer would incur in legal fees, lost time and paying restitution to the crop farmer. $30 on average.
  • The cost of repairing or installing a new fence ($20).
  • The crop farmer’s cost of initiating legal action and lost time ($5).

So if the fence goes down, the cropper’s out ~$25 (produce lost + legal costs). Although there’s the potential to get $30 in restitution. The cattle farmer is out ~$35 in restitution and legal expenses.

Solutions

Fixing that fence is starting to look like a pretty good option. In fact, if the crop farmer contributes anything less than $25, and the cattle farmer less than $35 they’re better off than waiting for courts to settle the matter after the fact(except in the alternate universe where the fence managed to remain intact indefinitely). That fence could cost $49 and it would still be better than going to court. Of course this presupposes parties are aware of court costs and compensation. Clearly that isn’t always the case. Though it wouldn’t be hard to arrive at a rough estimate as it’s based on the value of crop destroyed.

Another solution might be for the cattle farmer to keep two cows (worth $28 to him). The crop farmer decides to pay him $17 (the value of the third, fourth and fifth cows combined) to get rid of them. This relieves potential pressure on the fence and results in more value for everyone. No crops are destroyed and no legal action taken.

Essentially, both parties benefit from taking action proactively, be it avoiding destruction of property or having to pay restitution expenses. Often times a range exists where both parties benefit in terms of the marginal costs of relevant factors vs state alternatives.

Objections

That said, there are plenty of comparable problems where the fence is hidden from plain view. We don’t see the potential problems until they’re upon us.

If that sounds like a solid objection consider the fence — it wasn’t accounted for in the restitution. Likely the court would order the cattle farmer to pay for it or (much less likely), both contribute. That makes sense, right?

Of course.

What doesn’t make sense is wasting money on the courts instructing them to do so. Both farmers could have handled compensation and fence repair (or cattle reduction) between themselves.

That might not be possible for all comparable situations and individual personality types. However, the incentive of saving money tends to help to make the otherwise boorish more cooperative and willing to talk.

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