Academic journal article Journal of Economic Issues

The Myth of Two Coases: What Coase Is Really Saying

Academic journal article Journal of Economic Issues

The Myth of Two Coases: What Coase Is Really Saying

Article excerpt

"When I use a word, it means just what I choose it to mean--either more nor less."

--Humpty-Dumpty in Lewis Carroll's Through the Looking Glass.

In the December 1992 issue of this journal, E. Ray Canterbery and A. Marvasti take issue with the Coase theorem, claiming that it has "generated a negative externality for economists" |1992, 1188~. The literature on the theorem is enormous, running the gamut from criticisms and defenses to real-world illustrations to experimental tests. The Coase theorem (if one can use this term, given the numerous variants floating around in the literature, not to mention the fact that this "theorem" has never been proved) has certainly generated more heat than light. Nonetheless, it remains at the core of much of main stream law and economics.(1)

While Canterbery and Marvasti's critique of the Coase theorem is largely on the mark, I wish to deal with another issue: their treatment of Ronald Coase and his relation to the world of zero transaction costs and the Coase theorem. As Canterbery and Marvasti correctly point out |1992, 1179 at note 1~, the ideas underlying the Coase theorem were first elucidated in Coase's 1959 article "The Federal Communications Commission" and were subsequently more fully developed in "The Problem of Social Cost" |1960~.(2) The first precise formulation of the Coase theorem comes from George Stigler in his book The Theory of Price |1966, 113~.(3) Over the years, the zero transaction costs world of the Coase theorem has become so closely identified with Coase that it is often referred to as a "Coasian world." Those who support this view, as well as the attendant view that the Coase theorem is at the heart of Coase's message, have gone astray, as a close examination of "The Problem of Social Cost" and many of Coase's other writings clearly illustrates. In fact, Coase's writings reveal a view that has some important elements in common with certain aspects of the institutional tradition.

"The Problem of Social Cost"

"The Problem of Social Cost" |1960~ and the subsequent literature that it has generated offer an interesting study in the interpretation of texts. The message of "The Problem of Social Cost," if judged by the professional response, is what has come to be known as the Coase theorem--that if rights are fully specified and transaction costs are zero, voluntary bargaining between agents will lead to an efficient (and according to Coase at the time, an invariant) outcome, regardless of how rights are initially assigned. However, this article makes at least three other major contributions,(4) and even the argument relating to the Coase theorem has been misunderstood.

The zero transaction costs world of the Coase theorem is merely one of the means to an end for Coase, that end being the goal of focusing economists' attention on what he sees as the wrong-headed nature of the Pigouvian approach and, specifically, Pigou's claim that externality problems should be resolved (and can only be resolved) through taxes, subsidies, or regulations |Pigou 1962, chap. 9~. The zero transaction costs world is a world without frictions, a world where markets function perfectly. It is the world of mainstream economic theory, the body of theory that has so whole-heartedly embraced the work of Pigou. What Coase intended with his analysis of the zero transaction costs world was to show that in such a world, Pigouvian remedies (e.g., taxes, subsidies, and regulations) are not necessary to resolve externality problems: "The significance to me of the Coase theorem is that it undermines the Pigouvian system. Since standard economic theory assumes transaction costs to be zero, the Coase theorem demonstrates that Pigouvian solutions are unnecessary in those circumstances" |Coase 1992, 717~.

As noted above, the world of zero transaction costs has often been called a "Coasian world." This is a label that Coase himself explicitly rejects, saying that "nothing could be further from the truth" |1988, 174~. …

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