Academic journal article Journal of Economic Issues

Two Coases or Two Theorems?

Academic journal article Journal of Economic Issues

Two Coases or Two Theorems?

Article excerpt

Professor Steven Medema |1993~ has written a thoughtful, readable commentary on our recent article |1992~. He suggests that our critique of the Coase Theorem "is largely on the mark"; only pathological modesty could provoke our disagreement. Medema chooses instead to deal with our treatment of Ronald Coase and his relation to the world of zero transaction costs and the Coase Theorem. In particular, Medema contends that we have "gone astray" in the view of the Coase Theorem being "at the heart of Coase's message" |1993~. Rather, the "Coasian world" of zero transactions costs and perfect competition is merely a means to an end for Coase, namely, to attack the Pigouvian tradition.

"What Coase intended with his analysis of the zero transaction costs world," according to the author, "was to show that in such a world, Pigouvian remedies (e.g., taxes, subsidies, and regulations) are not necessary to resolve externality problems" |1993~. Coase, according to the author, rejects the theorem bearing his name and embraces the real world of positive transaction costs. In this regard, there are not two Coases after all, apparently because Coase is not a Coasian!

Coase Theorem I: Is Coase a Coasian?

As we traverse between "The Problem of Social Cost" |1960~ and Coase's later writings |1988, 1992~, a shift nonetheless appears unmistakable. Perhaps the formulators of the Coase Theorem by now have convinced Coase that they misunderstood his original argument. These and "traditional" or Pigouvian economists simply missed Coase's central point regarding the critical importance of positive transactions costs. The Coasians prefer an idyllic world in which government action is not required, whereas the Pigouvians always prefer government action in the face of externalities. While we do not want to play literary critics, what the later Coase claims as his central point (the importance of positive transactions costs) is quite easy to miss in his seminal article |1960~.

At the same time, Coase's disaffection with those dreaded taxes and subsidies made less arguable by Pigou and Pigouvian welfare economics is quite easy to spot. Coase |1960, 1~ opens with an attack on wrong-headed economists who use Pigou's divergence between the private and social product of a factory as the basis for a tax on pollution.(1) After devoting the heart of the article to related court decisions in which the courts end up defending the private polluters, Coase |1960, 28-44~ spends the balance dancing on the grave of Pigouvian welfare economics and advocating an alternative approach. Coase favors a weighing of marginal benefits and marginal costs solely in terms of maximal production.

Coase Theorem I surely is consistent with Coase's distaste for Pigouvian welfare economics because private and social costs are equal under conditions of perfect competition. Moreover, where transactions costs are zero and there are no income effects, law and government are irrelevant because the parties involved will always bargain to the socially optimal solution once rights have been assigned. Since, if Coase Theorem I prevails, there is no need for Pigouvian welfare economics, it is hardly surprising that the "Coasians" embraced Theorem I! The hypothetical cases with zero transactions costs are the clear instances in which the Pigouvians are rebutted; the cases with clarion calls for government action are sufficiently rare as to be endangered species. If Coase's main task is to reduce the population of the Pigouvians, Theorem I is his best weapon. But, showing that there is no need for taxes, subsidies, and regulations in a hypothetical world is an empty proof.

Coase Theorem II: The Importance of Positive Transactions Costs

Let us nevertheless grant for the moment that Coase Theorem I is a misnomer and is in reality the anti-Coase. We now formulate Coase Theorem II: when externalities exist, the appropriate remedy or assignment of rights would optimize production and would take into account positive transactions costs when properly calculating marginal benefits and costs, including opportunity costs. …

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