Friday, March 6, 2009

Coase Theorem & Indonesian Rain Forests

Last year Barnabas Suebu, the Papua Indonesian governor suggested that Papua Indonesia be paid not to cut down their rain forests. What a great idea!

This is a wonderful application of the Coase theorem. The Coase Theorem is that given that property rights are clearly assigned, and there are small numbers involved in the transaction and if transactions costs are small relative to the gains of trading that voluntary bargaining will lead to an efficient allocation of a negative externality. Let's see how this idea applies.

First, the property right is clearly assigned. Indonesia owns the land and trees in which the rain forest grows on, although the article states that different parts of the government have different views over who gets to make the decisions with regard to the rain forests.

Second, there are few groups involved. One is the government of Papua Indonesian, and the other would be the markets (Emission Trading Scheme) on which the rights to not cutting (or burning) the trees would be traded (see blog on carbon trading). While there are a lot of individuals involved, those sitting at the bargaining table would be few - but growing. Click here for some general information on carbon trading.

Third, the gains from bargaining (reduced carbon in the atmosphere and a cheap source to meet Kyoto carbon reduction agreements) have to be greater than the costs of bargaining.

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