Download Part I

Contemporary Issues of Public Finance
in Taiwan
Vance Kuang-Ta Lo
Associate Professor
Department of Public Finance
National Chengchi University
October 21, 2016
1
Outlines

Part I:



Part II:


Global Economic Situation and Outlook
Current Domestic Economic Situation
Taiwan’s Current Fiscal Challenges
Part III:



Why Do We Need a Government?
Examples
Remedies
2
Part I
3
Global Economic Situation and Outlook
This part was prepared by the Department of Economic Development of the National
Development Council (NDC), TAIWAN’S ECONOMIC SITUATION AND OUTLOOK,
Quarterly updates can be found on the NDC’s website at
http://www.ndc.gov.tw/en/News9_1.aspx?n=98DD6A0140672599&sms=470111FB454E4B
6D
4
Global Growth Forecast Revised Down Again

With weaker than expected advanced economies, tepid growth rates for emerging
markets, plus geopolitical tensions, both IMF and Global Insight cut their
forecasts for 2016 world real GDP growth rate again in recent month.
World Economic Outlook Projections for 2016
Forecast for Real GDP Growth Rate
from Global Insight
unit：%
%
3.5
3.2
3.4
(2016/1)
2015
3.2
(2016/4) 3.1
(2016/7)
World
Advanced Economies
2.8
(2016/1)
2.9
2.5
(2016/7)
2.6
2.4
(2016/9)
2.3
IMF
IHS Global Insight
Note： The values in parentheses represent the release month.
Source：1. IMF, World Economic Outlook,
2. IHS Global Insight Inc., World Overview
2016f
2.7
2.4 (2.4)
2.1
United States
2.6
1.5 (1.5)
1.5 (1.6)
Eurozone
1.9
1.6 (1.5)
Japan
0.6
0.6 (0.5)
Emerging Markets
3.9
3.9 (3.9)
Mainland China
6.9
6.6 (6.6)
Note：The values in parentheses represent the forecast in
August. 2015 growth rate are from official statistics.
Source：IHS Global Insight Inc., World Overview, Sep. 15,
2016
5
Growth Momentum Slows In the US
US real GDP increased at an annual rate of 1.1% in the second quarter of 2016,
lower than expected, mainly held back by contracting business investment. However,
private consumption grew by a strong 4.4% from 1.6% in the previous quarter.
On August 26th, Fed Chair Janet Yellen said that the case for an increase in the
federal funds rate has strengthened in recent months, in light of recent strong job
growth. However, the markets think a move is more likely after the presidential
election in November.


PMI Index
%
%
Real GDP Growth Rate
6.0
54
5.0
5.0
53.2
52.6
52
4.0
4.0
2.3
3.0
2.0
2.0
2.
6 2.0
50
0.9
1.0
0.8
1.1
49.4
48
0.0
-1.0
-2.0 -1.2
quarter Q1
year
2014
Q2
Q3
Q4
Q1
2015
Q2
Q3
Q4
Q1
2016
Source：U.S. Department of Commerce, Aug. 26, 2016
Q2
46
month 1
8
2
3
4
5
6
7
8
9 10 11 12 1
2
3
4
5
6
7
year 2015
2016
Note：PMI is between 0%~100%. If higher than 50%, it means
manufacturing is in the expansion phase. If lower than 50%, it
means it is in the contraction phase.
Source：ISM, Sep. 1, 2016
6
Eurozone Slows Down
Eurozone real GDP increased by 0.3% quarter on quarter in Q2 of 2016, lower than
0.5% in the previous quarter. In addition, manufacturing PMI was down to 51.7%
in August 2016, slowing for the second consecutive month, reflecting that the
expansion of manufacturing sector has decelerated.
Inflation in the Eurozone was 0.2% in August 2016, unchanged from July. The
ECB faces pressure to adopt a stimulatory monetary policy amid weak inflation and
uncertainty over the effects of Brexit and Euroscepticism.


Real GDP Growth Rate
%
%
54
0.7
PMI Index
0.6
0.6
53
0.5
52.8
0.5
0.4
0.4
52.0
0.4
52
0.4
0.3
51.5
0.3
51.7
51
0.2
0.1
50
month
0
quarter
year
1
2
3
20
15
Source： EuroStat, Sep. 6, 2016
4
1
2
0
1
6
2
1
2
year 2015
3
4
5
6
7
8
9 10 11 12 1
2
3
4
5
6
7
8
2016
Note： PMI is between 0%~100%. If higher than 50%, it means
manufacturing is in the expansion phase. If lower than 50%, it
means it is in the contraction phase.
7
Source：Markit, Sep. 1, 2016
Japan’s Economy Remains Weak

Japan’s real GDP increased at an annual rate of 0.7% in Q2, lower than the 2.1% in
the previous one, mainly because exports contracted further and private capital
expenditure remained weak. Manufacturing PMI rose to 49.5 in August 2016,
contracting at a slower pace. Prime Minister Shinzo Abe announced a 28 trillion
Yen stimulus package to boost the flagging economy in July 2016.

CPI annual inflation rate was -0.4% in July 2016, staying negative for the fourth
consecutive month, mainly due to the fall of international energy prices.
%
Manufacturing PMI
%
CPI Annual Inflation
month
year
month
2015
2016
Note： PMI is between 0%~100%. If higher than 50%, it means
manufacturing is in the expansion phase. If lower than 50%, it
means it is in the contraction phase.
Source：Markit, Sep. 1, 2016
year 2015
2016
Note：Core CPI less fresh food.
Source：Statistics Bureau of Ministry of Internal Affairs and
Communications, Aug. 26, 2016
8
Mainland China’s Economy Shows Signs of Stabilization

Mainland China’s second-quarter GDP growth rate was 6.7% in year-over-year
(yoy) terms, stronger than expected. Total trade and retail sales growth picked up
pace in August 2016, while fixed asset investment growth for the year to August
was unchanged from July, showing that China’s economy improved over the month.

According to an IMF report released on August 12th, the country’s reliance on
credit growth, in particular, clouds the country’s outlook. Without reforms, growth
will stay high in the near term, but will likely weaken even more in the medium
term and with a higher likelihood of a sharp slowdown.
%
Growth Rate of Main Economic Indicators
(% change, year-over-year)
Real GDP Growth Rate
(YoY)
8.0
Retail Sales
7.5
7.0
7.07.0
6.9
Fixed Asset Investment
6.8
6.7
6.7
6.5
6.0
Q1
Q2
Q3
2015
Q4
Q1
Q2
Total Trade
2016
Source：National Bureau of Statistics in Mainland China, Jul. 15, 2016 Source：National Bureau of Statistics in Mainland China, Aug. 12, 2016
9
Current Domestic Economic Situation
10
Foreign Trade Momentum Increases Slightly

Total exports increased by 1.0% year-on-year in August 2016, mainly due to the strong
demand for semiconductors, while Taiwan’s semiconductor manufacturing has benefited
from its advanced technology and the rising global demand for mobile devices.

Imports fell by 0.8% on a year earlier, with mineral products the main contributors to the
decrease.

Exports for the January through August 2016 period were down 6.6% on the same period
a year ago.
US$, billion
60
50
40
The Gross Value and Growth Rate of Exports and Imports
yoy, %
30
Gross value of exports (left scale)
Gross value of imports
(left scale) Export growth (right scale)
20
Import growth (right scale)
1.0
10
0
30
-0.8
20
-10
10
-20
0
-30
1 2 3 4 5 6 7 8 9 101112 1 2 3 4 5 6 7 8 9 101112 1 2 3 4 5 6 7 8 9 101112 1 2 3 4 5 6 7 8
2013
2014
2015
2016
Note: Since FY2016, the general trade system is applied for compilation of external trade statistics and the historical data has
been revised to FY2001.
Source: Ministry of Finance, Sep. 2016
11
Industrial Production Declines Slightly
The Industrial Production Index (IPI) posted an annual decrease of 0.31%
in July 2016, mainly due to fact that building construction had a higher base
period in July 2015 as a result of several major construction projects
obtaining Building Use Permits during that period.
Manufacturing output, which makes up more than 90% of the IPI, rose by
0.65% year-on-year in July. The increase in manufacturing output came
largely from increased production of electronic parts and components, and
chemical material.


The Growth Rate of the Industrial Production Index
y/y, %
20
10
-0.31
0
-10
-20
1
4
2013
7
10
1
4
2014
Source: Ministry of Economic Affairs, Aug. 2016
7
10
1
4
2015
7
10
1
4
201
6
7
12
Retail Trade Solid
In July 2016, wholesale trade decreased by 1.5%, as global conditions
remained weak.
Retail trade rose by 2.8%, driven mostly by stronger general merchandise
store sales as demand increased during the Ghost Festival and hot weather
in July.
Food and beverage services increased by 3.7% in July 2016.



y/y, %
The Growth Rate of Wholesale, Retail Trade, and Food Service
15
Wholesale Trade
Retail Trade
Food and Beverage Services
10
5
3.7
0
2.8
-5
-1.5
-10
-15
2
3
4
5
6
7
8
9
10
11
12
1
2
3
4
5
6
7
2015
Source: Ministry of Economic Affairs, Aug. 2016
8
9
10
11
12
1
2
3
4
5
6
7
2016
13
Employment Remains Steady

The unemployment rate rose from 3.92% in June to 4.02% in July 2016.
The seasonally adjusted unemployment rate held steady at 3.96%.

The labor force participation rate rose from 58.68% in June to 58.84%
in July, up 0.10 percentage points compared with a year earlier.
Unemployment Rate and Labor Force Participation Rate
%
%
6.0
59.0
58.84
58.5
5.5
58.0
5.0
57.5
4.5
4.02
57.0
Labor force participation rate (left scale)
56.5
Unemployment rate (right scale)
3.5
56.0
3.0
1
3
5
7
9
11
2013
1
3
2014
5
7
4.0
9
11
1
3
5
7
2015
9
11
1
3
5
7
2016
Source: DGBAS, Aug. 2016
14
Prices Up Slightly
Taiwan’s CPI in August 2016 moved up 0.57% compared with the same month
last year, mainly due to the 23.02% increase in the fruit index. In addition,
prices of fish and seafood also went up 5.33%, and prices of food eaten outside
the home increased 1.31%. Core prices (excluding fruit, vegetable and energy
prices) increased by 0.77%.
The WPI decreased by 4.10% year-on-year, due to prices of petroleum and coal
products dropping 15.57%, and prices of crude petroleum and natural gas
going down 13.41%


CPI and WPI inflation
y/y, %
4
0.57
0
-4
-4.10
CPI
WPI
-8
-12
1
3
5
7
9
11
2013
Source: DGBAS, Sep. 2016
1
3
5
2014
7
9
11
1
3
5
7
2015
9
11
1
3
5
7
2016
15
Monitoring Indicators Showing “Green” Signal

In July 2016, the trend-adjusted leading index increased by 0.63% to 100.14, and
the trend-adjusted coincident index was up by 1.04% to 101.77.

The total score of the monitoring indicators in July 2016 increased by three points to
23, flashing the “Green” signal for the first month.

Taiwan Business Indicators showed some scattered signs of economic improvement.
Monitoring Indicators
Trend-adjusted Leading and Coincident Index
104
Coincident Index
2016/7
101.77
100
Leading Index
96
7
2014
Source: NDC, Aug. 2016
10
1
4
2015
2016/7
100.14
7
10
201
6
1
4
7
16
Part II
17
Taiwan’s Current Fiscal Challenges
18
Our Current Fiscal Situation


From 2008 to 2014, the annual expenditure is usually greater than
the annual revenue, and the budget fiscal deficit of 2014 was US$
7.1 billion.
If we take the repayment of debt into consideration, the total fiscal
deficit is US$ 9.2 billion, which should be balanced mainly by the
issuance of debt.
US$ billion
Debt Repayments
Difference between revenues and expenditures
75.0
66.4
60.0
30.0
Revenues
Expenditures
63.5
64.0
63.2
62.1
28.0
64.0
58.3
54.7
26.0
24.0
55.7
51.8
45.0
55.6
57.7
56.9
22.0
20.0
49.9
18.0
2.2
16.0
2.20
14.0
30.0
12.0
2.2
15.0
2.2
14.6
3.1
2.6
13.5
8.3
7.6
4.4
3.6
0.0
2008
10.0
2.1
2009
2010
2011
2012
2013
8.0
6.0
7.1
4.0
2.0
2014
0.0
Year
19


However, the outstanding debt in Taiwan has shown an upward
trend. The ratio of outstanding debt to the average nominal GDP for
the previous three fiscal years increased from 30.7% in 2008, 37.5%
in 2013, and 38.1% in 2014, which is approaching to the legal debt
ceiling of 40.6%.
Therefore, it is quite difficult to balance our fiscal deficit by the
issuance of debt. If the government does not adopt any reform
measure, we may face fiscal difficulty in few years.
20
Gradual Increase in Statutory Expenditure

The statutory expenditures have also shown an upward trend from
2008 to 2014. The overall figures also show that our expenditures
are quite rigid and inflexible.
US$ billion
%
70
60
57
60
57
37
39
30
20
64
65
100
90
50
40
60
65
65.2
39
42
68.9
69.9
44
44
45
80
68.8
69.9
69.5
64.5
70
60
10
0
50
2008
2009
2010
2011
General budget expenditure
2012
2013
2014 Year
Statutory expenditure
Ratio
21
Increase in Expenditures due to Change in
Major Policies

Moreover, the structure of the population is changing. For example, a
low fertility and an aging population are having an impact on related
policies. In addition, we are planning to implement the major policies
of “12-Year National Fundamental Education” and “Long-Term Care”
among others. And, thus, we expect that the related expenditures will
be on the increase.
Impact of a low
fertility and aging
population on major
policies
Increase in
related
expenditures
Plans to implement major
policies of “12-Year
National Fundamental
Education” and “LongTerm Care,” etc.
22
Revenue Structure and Tax Burden Ratio

As for our revenue structure, tax revenue composes the main part
of the revenues. The ratio of tax revenue to total revenues was
70.4﹪in 2013. However, our tax burden ratio was only 12.6% in
the same year. This means that there is still room for raising tax
revenue.
Revenue Structure
Tax Burden Ratio
%
US $ billion
50
45
40
35
30
25
20
15
10
5
0
General budget tax revenue
Tax burden ratio
41.43
42.68 42.38
40.11 40.74
13.9
35.05 36.08
15.0
14.5
14.0
13.5
12.9 12.8
12.6
13.0
12.5
12.3
12.0
12.0
11.5
11.0
2008 2009 2010 2011 2012 2013 2014 Year
23
Remarks (1/5)
We think there are three main challenges to Taiwan’s fiscal
account, which lead to concern over continued fiscal deficits and
rising government debt level.
(1) Sub-trend GDP growth
With
its high export dependency, Taiwan’s economic growth is
negatively affected since the onset of the global credit crisis in
2008.
Weakened consumption demand in the developed markets have
been negatively affecting Taiwan’s export sector and the overall
economy.
24
Remarks (2/5)

The growth slowdown has impacted the fiscal accounts in two
ways:

First, it has slowed the growth in fiscal revenue. Taiwan’s general
government net revenue growth has slowed to 0.8% per year from
2008 to now, compared to 3.8% per year from 2004 to 2007.

Second, it has expedited the growth in fiscal expenditure. Because
of the slowdown in growth, the government has to allocate more
spending on infrastructure projects to boost the economy. As a result,
net general government expenditure growth has accelerated to 3.5%
per year between 2008 and now, up from 0.9% per year between 2004
and 2007.
25
Remarks (3/5)
(2) Low tax burden

Taiwan’s tax revenue represented only about 12.2% of GDP in 2012,
which is much lower than other countries.
26
Remarks (4/5)
(3) An aging population





An aging population is the most serious challenge to Taiwan’s
fiscal condition in the coming years.
According to the Council for Economic Planning and Development
(CEPD), Taiwan’s population is expected to rapidly age starting
from 2013 onwards.
The percentage of old-age population (defined as age 65 and
above) is expected to rise from 11.5% of the total population in
2013 to 14.6% in 2018, and continue rising in subsequent years.
At the same time, the working-age population (defined as age 15 to
64), is expected to shrink from 74% of total population in 2013 to
72.7% in 2018.
The old-age dependency ratio is hence expected to drop from
around 6.4 in 2013 to 4.9 in 2018, and continue deteriorating.
27
Remarks (5/5)




The aging of Taiwan’s population is structural, which makes it
very difficult to alter by the government over the medium term.
This should have serious implications on the government’s tax
revenue, and more importantly, on the government’s social security
and pension-related spending.
In 2011, social security and pension expenditure represented 5.5%
of GDP and 28.7% of the general government net expenditure.
The ratios are projected to rise further to over 7% of GDP and 33%
of government expenditure in 2018 as the population ages,
assuming no effective reform measures are introduced to avert the
trend.
28
 Based
on the definition from World Health
Organization (WHO):
the percentage
of elders over
65 years old
＞
7% : Aging
14%: Aged
20%: Super-Aged
Elderly Population
22.0
20.0
18.0
16.0
14.0
12.0
10.0
8.0
6.0
4.0
2.0
0.0
Total, % of population, 2014
 According
to Figure 8, the share of Aged 65 and above
has an upward trend during 1980 to 2060.


Taiwan has been considered as an aging country since 1993.
Taiwan is further forecast to become an aged society and
super-aged society in 2018 and 2025, respectively.
 As
pointed out by Hsueh and Wang (2008), the aging
rates will grow faster in Taiwan than in most of the
developed regions in the future.
 It
will take only 25 years for the aged portion of the
Taiwan population to rise from 7% to 14%, second only
to Japan (taking only 24 years) in terms of the shortest
time span.
 Taiwan’s
population aging is the result of low death
rate due to advance medical technology, low birth rate,
and prolonged life expectancy.
 Figure
9 shows the life expectancy of all Taiwanese,
male and female people.
Years
85
83.19
83
81
79.84
79
76.72
77
75
73
71
69
2014
2013
2012
2011
2010
2009
2008
2007
2006
2005
2004
2003
2002
2001
2000
1999
1998
1997
1996
1995
1994
1993
1992
1991
1990
1989
1988
1987
1986
1985
1984
1983
1982
1981
Both
Male
Female
FIGURE 9: Life Expectancy of Taiwan by Gender (1981-2014)
Source: Department of Household Registration Affairs, Ministry of Interior, ROC, Taiwan.
Year
Significant Decline in Fertility
 Figure
10 presents a time trend of general fertility rate
(GFR, hereafter) and total fertility rate (TFR,
hereafter) of Taiwan during 1981-2014.
 TFR
has been lower than replacement level of 2.1
since 1985.
 In
1985, the TFR was 1.88. It was even lower than 1
in 2010, only 0.895.
 General
fertility rate
(GFR)
the number of births in a year
divided by the number of
women aged 15–44, times
1000. It focuses on the
potential mothers only, and
takes the age distribution into
account.
Let B
= Number of birth
Let W15-44 = Number of women of
reproductive ages
 Total
fertility rate
(TFR)
the total number of children a
woman would bear during her
lifetime if she were to experience
the prevailing age-specific fertility
rates of women. TFR equals the
sum for all age groups of 5 times
each ASFR rate.
Age Specific Fertility Rate (ASFR)
= (Number of births to women in age
group i / Number of women in age
group i) x 1000
Total Fertility Rate (TFR)
= (The sum of the ASFR x The
number of years in each age group) /
1000
 Interestingly,
the fluctuations of both fertility
rates shown in Figures 3 follow Taiwanese
people’s preference of some peculiarly Chinese
characteristics.
 For example, Dragon is most auspicious, but
Tiger is most stigmatized. Snake is also less
auspicious.
 Therefore, every Taiwanese parent is hoping to
have a Dragon baby, but not a Tiger baby.
Rat
Ox
Tiger
• Positive
aspects:
Intelligent,
Charming and
Confident
• Negative
Aspects:
Jealous,
Selfish,
Ruthless
• Positive
aspects:
Hardworking,
Loyal, Patient,
Good Hearted
• Negative
Aspects:
Critical, Petty
and Vain
• Positive
aspects:
Independent,
Productive and
Loyal
• Negative
Aspects:
Stubborn,
Anxious and
Moody
Rabbit
• Positive
aspects: Wellmannered,
caring and
sensible
• Negative
Aspects:
Insecure,
Pessimistic
and Sly
Dragon
• Positive
aspects:
Intelligent,
Charming and
Confident
• Negative
Aspects:
Jealous,
Selfish,
Ruthless
Snake
• Positive
aspects:
Hardworking,
Loyal, Patient,
Good Hearted
• Negative
Aspects:
Critical, Petty
and Vain
Horse
• Positive
aspects:
Independent,
Productive
and Loyal
• Negative
Aspects:
Stubborn,
Anxious and
Moody
Sheep
Monke
y
• Positive
aspects: Wellmannered,
caring and
sensible
• Negative
Aspects:
Insecure,
Pessimistic
and Sly
• Positive
aspects:
Intelligent,
Charming and
Confident
• Negative
Aspects:
Jealous,
Selfish,
Ruthless
Rooster
Dog
• Positive
aspects:
Hardworking,
Loyal, Patient,
Good Hearted
• Negative
Aspects:
Critical, Petty
and Vain
• Positive
aspects:
Independent,
Productive and
Loyal
• Negative
Aspects:
Stubborn,
Anxious and
Moody
Pig
• Positive
aspects: Wellmannered,
caring and
sensible
• Negative
Aspects:
Insecure,
Pessimistic
and Sly
Part III
45
Why should the government have
to intervene the market?

Something wrong in the market, or
something special in the market (so called
market failure)

Examples
1.
2.
3.
Public goods
Externality
Others
Private Goods
1.
： A good whose consumption by
one consumer prevents simultaneous
consumption by other consumers.
2.
：A good for which it is
possible or very easy to prevent consumers
who have not paid for it from consuming it.
Ex：
Public Goods
1.
：A good may be consumed by
many individuals at the same time at no
additional cost.
2.
：A good for which one
cannot at low cost, or even impossible,
prevent those who have not paid for the
good from consuming it.
Ex：
Why do public goods result in the
market failure?
Non-rival ＋ non-excludable




The fundamental problem with non-rival and non-excludable
goods is that someone has to pay for the good’s production,
but
can be excluded from consuming the good once
it is produced.
The incentive for the individual is to let
produce the
good and then use it once it is available for free.
This is known as the
: individuals have
little incentive to pay for their own consumption and instead
will take a “free-ride" on anyone who does pay.
As a result, non-excludable goods tend to be
.
Externality


An externality occurs whenever the actions of
one party make another party worse or better
off, yet the first party neither bears the costs
nor receives the benefits of doing so.
In other words, an externality is the situation
in which an action by an individual producer
or consumer affects other parties (in a good or
bad way), without payment or compensation
for the cost or benefit affecting them.

Examples:



I am smoking at a restaurant.
I am listening to some nice music around you.
A farmer who grows apple trees provides a benefit
to a beekeeper. The beekeeper gets a good source
of nectar to help make more honey.
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Why do externalities result in the
market failure?
Secondhand smoking
1. Smokers
Non-smokers
Negative externality
2. A smoker only will consider his own costs and benefits
→ He decides to smoke one pack per day.
3. From the perspectives of whole society, we need to
consider costs and benefits of both smokers and
non-smokers.
→ Only should allow to smoke half of pack per day.
What can the government do?

Intervene the market directly, say price
control, regulation, tax…

Some new ideas:


The example of public goods
The example of externality
How to Catch the Thief?
 How to let people report their true preferences for a public good?
 How to share the cost of a public good based on individuals’ true
preferences?

Mom lost her $10, either Alex or David stole
the money.

If Alex really stole $6, and David stole $4.
How does Mom know？
Preference Revelation Mechanism
Mechanism A：
 If you said you stole $1, you will be
punished by 1 hand-beating with a ruler.
 Result?
Mechanism B：
 10－(the other person’s report)
 Result?
How to Let Alex Truly Report?

Report honestly 

10－(David’s possible reports)
David reports $0
$1
$2
$3
$4
$5
→
→
→
→
→
→
Coase Theorem


If the transaction (or bargaining) costs are
negligible and the numbers of parties are
few, an efficient solution to an externality is
achieved as long as someone is assigned
property rights,
of who is
assigned the rights.
In other words, we need a buyer and a seller;
that is, we need a “
”.
A market is composed of buyers and sellers:
1. Smokers have to pay non-smokers for smoking
 Non-smokers have the right of clean air
 Non-smokers (sellers/owner); smokers (buyers)
2. Non-smokers have to pay smokers for not smoking
 Smokers have the right of smoking
 Smokers (sellers/owner); non-smokers (buyers)
But, who should have the rights?
(married or divorced?)
Married
(smoky air)
Divorced
(clean air)
Brad
(smoker)
Angelina
(non-smoker)
Total
80
50
130
60
100
160
If Brad has the rights (seller):


Married
(smoky air)
Divorced
(clean air)
Brad
(smoker)
Angelina
(non-smoker)
Total
80
50
130
60
100
160
Brad (seller) will ask Angelina (buyer) at least
to pay him $20.
Angelina (buyer) is willing to pay Brad at most
$50.
 Brad will say YES! They will get divorced!
and more importantly,
Divorced ＝Social optimality
If Angelina has the rights (seller):


Married
(smoky air)
Divorced
(clean air)
Brad
(smoker)
Angelina
(non-smoker)
Total
80
50
130
60
100
160
Angelina (seller) will ask Brad (buyer) at least
to pay her $50.
Brad (buyer) is willing to pay Angelina at most
$20.
 Brad cannot afford it. They will get divorced!
and more importantly,
Divorced ＝Social optimality
Interesting Remarks：
 Who has the property rights does not
matter, the thing is whether or not we
have the
.
 We just care about whether or not we
can have a
to help us.

Problems on “Coase Theorem”:




Too many parties are involved. Higher negotiation
costs.
We do not know who makes pollution.
Each party does not have the same power to
negotiate.
Applications:

The EU Emissions Trading System (EU ETS)
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Thank you
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