If the late Ronald Coase could be called upon to advise the Delhi government, he would persuade chief minister Arvind Kejriwal to pay farmers in Punjab and Haryana to stop burning crop residue.

In recent times, air quality in Delhi has remained poor throughout the year for various reasons, including the rapid loss of green cover, construction of homes and infrastructure projects, and vehicular as well as industrial pollution. But for a few weeks every November, it gets almost impossible to breathe. The last straw has been the crop residue burning (CRB) by farmers in Punjab and Haryana, which causes a heavy smog to settle over Delhi.

Delhi residents blame farmers for opting for CRB instead of environment-friendly ways to remove crop residue. Farmers complain that their governments—and Delhi citizens who are responsible for the poor state of Delhi air quality—are imposing additional costs that their consumers won’t absorb in the market. Who is really to blame?

To answer this question, the insights of Nobel laureate Ronald Coase are extremely useful and handy. In his famous and highly cited 1960 paper, The Problem Of Social Cost, Coase argued that harm—or externalities as we call them today—is not unilateral but reciprocal in nature. Both Delhi citizens (by demanding cleaner air) and farmers (by burning crop residue) impose reciprocal harm or externalities. But once we understand the reciprocal nature of the externality, what would be the solution?

The usual command-and-control solution of banning stubble burning has not worked. In Punjab, there is a high monetary penalty for farmers who burn crop stubble, but it is rarely enforced, partly due to limited state capacity. Even now, when the government claims to be vigilant, less than 10% of CRB cases are penalized. This is because politicians in Punjab and Haryana represent their farmer constituents and not the residents of Delhi. Enforcing rules that impose high costs on their core constituents to benefit non-constituents is not politically feasible. Luckily, Coase’s second insight on externalities is most useful once command-and-control policies fail.

The reason farmers burn crop residue is the non-trivial cost of alternatives to CRB, like machines to break down the crop residue into straw that decomposes quickly. A rotavator machine, which breaks down the crop residue, costs almost ₹1 lakh, and about half of that with state subsidies. It is quicker and cheaper to burn the crop stubble. By an aggressive estimate, if the 2 million odd farmers in these states were to eliminate CRB at ₹1 lakh per farmer, it would cost about ₹20,000 crore.

Delhi citizens (as also citizens in many districts of Punjab and Haryana) face enormous health and productivity costs because of stubble burning. A study expected to appear in the International Journal Of Epidemiology by Suman Chakrabarti, Mohammed Tajuddin Khan, Avinash Kishore, Devesh Roy and Samuel P. Scott finds that eliminating crop residue burning could save 14.9 million disability-adjusted life-years lost per year, valued at about ₹2 trillion ($30.58 billion) annually.

The good news is that these costs—avoidable by Delhi residents if CRB were eliminated—are about 10 times the cost that would be incurred by farmers in adopting substitutes to crop burning. Where policymakers see costs, Coase saw potential for gains from trade. If eliminating CRB were tradable, then farmers would be willing to take anything over ₹1 lakh individually and over ₹20,000 crore collectively to stop CRB, which is less by an order of magnitude than the ₹2 trillion that impacted Delhi residents would be willing to pay in order to avoid the harmful effects of CRB. The reason this doesn’t happen is that it is prohibitively costly for 50 million odd citizens affected by CRB to coordinate with the 2 million farmers who burn crop stubble. Also, there exists no such tradable right to eliminate CRB, nor a market where farmers can trade CRB for payment.

This is precisely what Coase pointed out. He demonstrated that the problem is not the nature of the externality, but that the requisite property rights are not well defined and transaction costs are high.

In Coase’s identification of the problem also lies the solution. In a world where property rights are well defined and transactions costs are relatively low, private bargains can be struck to internalize externalities. For this to work, the governments of Punjab, Haryana and Delhi need to create a tradable CRB permit. Farmers will be willing to sell the permit (or their ability to burn crop residue) for a price that compensates them for using alternatives to crop burning. A price that Delhi government and its citizens would be willing to pay, considering the alternative.

Such a system of tradable permits has worked across the world in different contexts, most successfully for industrial pollution. For this to work in India, a proper exchange for CRB permits is required, one in which citizens, non-profit entities and state governments should ideally be able to participate. In addition, if the governments of Delhi, Punjab and Haryana join in, then they would need to set aside a fund only for this purpose. And the exchange must transparently announce the prices of permits as well as the environmental quality.

Coasean solutions exist. But governments need to set up the relevant property rights and create an exchange, and then trust its prices to incentivize the appropriate action.

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