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Litigation and Regulation

On January 30, 2017, President Trump issued an executive order entitled: “Reducing Regulation and Controlling Regulatory Costs.”1 Known as the “One-In, Two-Out” rule, it calls for dramatically reducing the regulatory burden upon the US economy. This executive order may do more for the US economy than any other economic proposal by the Trump administration, perhaps even far more than any enacted tax cuts.

There is no doubt regulatory reform is needed. From anecdotally looking at the effects upon particular industries (e.g., Dodd-Frank’s impact on preventing new community banks from opening), to the number of pages in the Federal Register, to estimates of lost man hours and direct expenditures from the Congressional Budget Office: the degree of the regulatory burden is clear. The US economy has never suffered to this extent.

How did it get this bad? Three primary reasons exist. First, unlike fiscal or even monetary policy, the burden imposed by regulations is more difficult to quantify and assign causality. Second, regulations exist and have increased in number by benefiting two primary constituents: entrenched businesses using regulations as a barrier to entry, and their politically connected lobbyists. Third, and of most significance, mainstream economists agree that without regulation, planes would crash in the sky, the food supply would be contaminated, and working conditions would degenerate to Neolithic-period levels. The acceptance of regulations is as widespread as the supposed underlying rationales are numerous.

Of all the rationales proffered, perhaps the strongest argument for regulations concerns the perceived “market failure” of negative externalities. If the justification for the regulation of negative externalities proves faulty, then the rationale, form, magnitude, and/or existence of all regulations should also be questioned. Analyzing the history of negative externality analysis provides insight into the “justification” of regulation.

Negative Externalities Defined and Pigou’s Recommendation

Externalities exist when costs are imposed (negative externalities) or benefits are realized (positive externalities) by parties other than the economic actor performing or participating in the action creating the costs or benefits. Pollution is a classic example of negative externalities: a power plant operating alongside a cold river may discharge warm water which interferes with a downstream brewery’s similar need for cold water.

The economist A.C. Pigou in his treatise The Economics of Welfare provided the classic and still widely accepted solution: tax or regulate the negative externality.2 Either assess an impactful tax on the warm water discharge from the power plant, or regulate the amount, nature, and timing of this pollution (or ban it altogether). Either way, the effect of warm water upon the downstream brewery and other river users would be lessened.

Coase Counters, But Misses the Solution

Ronald Coase’s classic essay, “The Problem of Social Cost,” challenged the traditional Pigou solution to negative externalities.3 While Pigou saw only liability with the creator of negative externalities, Coase assumed blame to be ambiguous:

The question is commonly thought of as one in which A inflicts harm on B and what has to be decided is: how should we restrain A? But this is wrong. We are dealing with a problem of a reciprocal nature. To avoid the harm to B would inflict harm on A. The real question that has to be decided is: should A be allowed to harm B or should B be allowed to harm A?

In other words, preventing the power plant from discharging warm water would harm its business just as the downstream brewery’s operations would be impaired by any permitted warm water discharge. Coase saw the solution to negative externalities as the recognition of property rights in order to avoid “the more serious harm.” The introduction of property rights would, according to Coase, maximize welfare as one party compensated the other for the negative externality. Either the brewery owns a property right to the river surrounding it, or the power plant owns the right to release warm water into the river.

It did not matter to Coase which party owned the property right, as long as such property rights were recognized and could be potentially adjudicated, a solution should be found which maximized welfare: either A would compensate B, or B would compensate A. According to Coase:

In devising and choosing between the social arrangements we should have regard for the total effect. This, above all, is the change in approach which I am advocating.

Rothbard Solves the Problem

But while Pigou ignored property rights, Coase neutered them in subsuming their ethical basis while attempting to maximize the “total effect” on the economy. Murray Rothbard, in his paper entitled “Law, Property Rights, and Air Pollution,” disagreed with Coase’s value-free property rights:

... income and wealth are important to the parties involved, although they might not be to uninvolved economists. It makes a great deal of different to both of them who has to pay whom.4

Rothbard reconstructs the negative externality solution in accordance with the libertarian theory of property. The concept of homesteading recognizes property ownership when individuals mix their labor with unowned natural resources. Introducing property recognition with the ethical basis of homesteading leads to a natural question regarding the river example: who was there first?

If the power plant started dumping warm water before the down river brewery established its property right, then the power plant has established an “easement right” to its warm water pollution (although limited to that particular waste and only at those levels in existence when downstream owners established their property rights). Alternatively, if the brewery established itself downstream and homesteaded a property ownership in the surrounding waterway, it is protected from warm water discharge by the legal concepts of trespass (physical entry in direct interference with the property) or nuisance (interference with the use and enjoyment of the property).

Rothbard’s proposed legal remedy generates flexibility to address the unique negative externality issues particular to each situation. By invoking property rights grounded in an ethical basis, and not assigned willy-nilly to parties, it eliminates the need for regulations by removing what is regulated: the water is transformed from an unowned item to be regulated by the government into private property with disputes settled by common law.


Regulations have the potential for more mischief than ill-conceived laws, for their enactment derives from bureaucratic edict by unaccountable and nameless officials. Worse, their authorization generally precludes recourse and their enforcement typically abrogates due process.

Reducing the regulatory burden is possible, for Reagan almost cut the Federal Register down by half (from over 90 thousand pages to under 50 thousand). Trump’s efforts, while laudable and beneficial, will likely be mitigated in their potency by entrenched interests and bureaucrats. And ultimately, with a new administration, the efforts could be rendered but temporary.

True regulatory reform requires the recognition, extension, and proper adjudication of property rights as uniquely advocated by the Austrian school. Until then, the ligation of economic regulation will continue.

  • 1. Exec. Order No. 13771, 30 January 2017.
  • 2. A. C. Pigou, The Economics of Welfare, 4th ed. (London: Macmillan and Co.,1932).
  • 3. Ronald H. Coase, “The Problem of Social Cost,” The Journal of Law & Economics III (October 1960).
  • 4. Murray N. Rothbard, “Law, Property Rights, and Air Pollution,” Cato Journal 2, no. 1 (Spring 1982).

Contact Christopher P. Casey

Christopher P. Casey, CFA®, CPA is a Managing Director at WindRock Wealth Management.

Note: The views expressed on Mises.org are not necessarily those of the Mises Institute.
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