Friday, December 28, 2012

A Coasian View of Matt Damon's Fracking Movie called "Promised Land"

An "intellectual" can write a review without having read the book or seen the movie.  While I am not an intellectual, I have read this review of Matt Damon's Promised Land and I have a few thoughts to share.  Now, I'm not a big city lawyer but I can tell that this Hollywood star believes that domestic drilling has significant localized environmental costs that those who are leasing their land to energy companies are ignoring.

So, let's sketch a simple rural social cost story and see if the Coase Theorem applies.   Matt and Mike own adjacent properties.  Matt grows cows while Mike doesn't do much with his land.  A gas company offers Mike serious $ per acre for the right to drill for gas.  Mike accepts.  An unintended consequence of drilling for gas on Mike's property is that there is extra water pollution on Matt's land and Matt's cows get sick from this water pollution.  

There is a basic property rights question here.  If Matt has the property rights to healthy cattle and if it is low cost to establish that any cattle disease is traceable to Mike, then Mike will compensate Matt for any damage done to his cattle.   If transaction costs and issues of accountability (perhaps there are several fracking sites within the area) make it cloudy and difficult to establish who caused Matt's cows to suffer, then Matt may be a victim of fracking.  Does this mean that fracking should be banned in this town?  An economist would ask;

1.  what is the value of the land per year when used for fracking  , call this $A
2.  What is the value of the land per year when it is used for its next best alternative,  call this $B
3.  what is the total environmental damage caused per year to the town, call this $C

A Coasian would say that if  A - B - C >  0 , then fracking should continue and Matt Damon has made a silly movie.

If A <  B +  C  then fracking should not have been allowed in this town.    If the land in the town were owned by one big "corporation" then no fracking would occur because the big capitalist would internalize the social costs caused by fracking.

The irony here is that the division of land into many smaller plots makes each small land owner have little incentive to internalize the externality.  So, Matt Damon is implicitly a friend of the 1%!     If there had been a single land owner and A < B+C, the frackers would never have been invited in and there would be no issue.  UPDATE ---- To see this point, consider an owner of a suburban shopping mall.  If Mr. Taubman believes that a new entrant (such as a dirty book store) will cause damage to the sales of other mall tenants then he won't let the entrant enter even if that book store would be profitable.  The residual claimant, Mr. Taubman, internalizes the total profit effect of the entry.

Now, the dispersed small land owners could still reach the efficient allocation of resources if transaction costs are low and they can bargain with each other.    If the dispersed land owners joined an association where they had to make group decisions, then this would nudge them toward the Coasian solution (i.e only invite fracking if A-B-C > 0).  If they are decentralized folks who do not speak to each other, then the town's individually rational choices (i.e Mike leasing to the frackers) may lower the entire community's well being.

 My office is 3 miles from Hollywood. I would be happy to meet with folks to go over the econ 101 of their plot lines before they make an irreversible investment of $25 million or more in a movie.  My fee would only be 3 free tickets to a Westwood Village premier.

UPDATE:  My mom has emailed me two comments about this blog post. She noted that the impact of fracking on neighbor's health and cows may be uncertain and take time to manifest itself.  In this case, the "C" mentioned above becomes an expected present discounted value of social costs.  If the land owners "know that they do not know" how to estimate this (because they have no previous experience with fracking) then a rational decision maker would run a field experiment and set aside perhaps 10% of the total land area and lease this to the frackers to see if fracking causes significant social damage.   If the land owners do not know that they do not know the consequences of inviting the gas companies to frack, then this is the start of benevolent paternalism as we don't allow adults to make their own choices.  Once we start down that path where do we stop?

Now, in this second case there is a role for well meaning, well trained environmental consultants to step in.   If well meaning people foresee that the rural land owners "don't know that they don't know" the potential negative consequences of fracking then the consultants can play a positive social role as "free consultants" educating the people about the unintended health consequences before the land owners make their choices over inviting in the gas companies.