Exploiting the Coase Mechanism: The Extortion Problem.

Consider the project of building a smoke-emitting factory in a residential district. Private profits exceed investment outlays, which are sunk. As the factory owner has the right to pollute, the project is privately profitable but external damages render it socially inefficient. Coase bargaining would enable any entrepreneur to earn a profit by proposing such a project without any intention to carry it out. Similar bargaining and outcomes could occur for each available residential plot. The total side-payments may exceed the aggregate value of the site and residential use may be blocked right away. The allocation of pollution rights matters. Copyright 1996 by WWZ and Helbing & Lichtenhahn Verlag AG