The Coase Theorem and the Eleventh Amendment

By Farber, Daniel A. | Constitutional Commentary, Summer 1996 | Go to article overview

The Coase Theorem and the Eleventh Amendment


Farber, Daniel A., Constitutional Commentary


The Supreme Court's recent Seminole decision(1) is sure to rekindle the scholarly debate about the proper interpretation of the Eleventh Amendment, adding to an already impressively voluminous literature. So far as we know, however, no one has pointed out the limited significance of this debate: According to standard law and economics reasoning, the Eleventh Amendment may well be irrelevant. Any relevance it does have can only be due to the frictional effects of political bargaining. This is a straightforward consequence of the Coase Theorem.

To understand the Coase Theorem, consider the simple case of a landowner (Mr. Boomer) who is being injured by pollution from a neighbor (the Atlantic Cement Co.).(2) Here's a simple way to see the effect of liability rules. Suppose that Boomer suffers $2000 harm from the pollution. If Atlantic is liable for damage to Boomer, Atlantic won't pollute unless it profits from the pollution to the tune of $2000 or more. If its profits are any lower, it will actually lose money by polluting after it pays damages to Boomer. But if the profits are higher than $2000, Atlantic will chose to pollute, pay damages, and still come out ahead. In effect, tort liability forces Atlantic to perform a cost-benefit analysis that includes both benefits to it and costs to others. Hence, tort liability will lead to an economically efficient outcome.

Coase's brilliant insight was that an economically efficient outcome will follow even without tort liability. Suppose there is no tort liability, and that Atlantic's profits are less than Boomer's $2000 in damages. At first blush it looks like Atlantic will choose to pollute and make its profit, even though a complete cost-benefit analysis would come out negative. After all, what does Atlantic care about Boomer's harm if it doesn't have to pay damages? But there's another way to eliminate the pollution. Boomer can offer to pay Atlantic not to pollute. For example, if Atlantic's profits are $1000 and Boomer's harm is $2000, Boomer could offer Atlantic $1500 not to pollute. This is a winning deal for both sides - each is $500 better off than in the situation where Atlantic pollutes.

This hypothetical exemplifies a more general truth. The Coase Theorem simply states that, assuming that transaction costs don't prevent contracting around legal rules, the legal rules don't matter - or more precisely, that the parties will always bargain their way to an economically efficient outcome, regardless of the legal rule.(3) Bargaining washes away legal rules, in other words.

If the Eleventh Amendment immunity were inalienable, the Coase Theorem would not apply, since it would be impossible to bargain. But one of the few things that is really clear about the Eleventh Amendment is that it is subject to waiver: the Constitution does not paternalistically force states to retain their immunities against their wills. In addition, Congress seems to be free to offer incentives for waiver.(4) For example, in the Seminole case itself, Congress could preempt state laws governing Indian gambling except in states waiving sovereign immunity.) So bargaining is possible. It follows from the Coase Theorem that, if Congress wants to eliminate immunity more than the state wants to keep it, then it will be eliminated-regardless of whether the Constitution recognizes sovereign immunity or gives Congress the power to abrogate immunity. So, to a first approximation, the Eleventh Amendment doesn't matter.

There's a nasty little caveat to the Coase Theorem, however: remember the assumption that transaction costs don't interfere with bargaining. …

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