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Friday, July 11, 2008

Getting Coase Wrong

I'm shocked by how often economists misinterpret the Coase theorem. I first found this in Winners, Losers, and Microsoft, when I was editing a pre-release copy. The text had read something along the lines that Coase had shown that in the presence of clear property rights people can negotiate there way to the most efficient outcome, whatever the initial distribution of rights was.

But that is wrong! What he said was, in the presence of clear property rights and low transaction costs people can negotiate there way to the most efficient outcome, whatever the initial distribution of rights was. And Coase himself felt that the Coase theorem rarely applied -- usually transaction costs were too high to get to the efficient solution! (I think the way he put it was that "we live in a non-Cosean world.")

2 comments:

  1. I first found this in Winners, Losers, and Microsoft, when I was editing a pre-release copy.

    Was Gene Callahan one of the losers they listed?

    The text had read something along the lines that Coase had shown that in the presence of clear property rights people can negotiate there way to the most efficient outcome...

    Did you correct their misspelling?

    But seriously folks, Gene is right. Even free market economists usually sum up Coase by saying, "Coase showed that gov't regulation is usually unnecessary, because with low transactions costs..."

    No, Coase's whole point in going through the no-transactions-cost scenario was to show that Pigou's analysis was dumb. I.e. Pigou and most baseline economic models assumed no transactions costs; in that world, you don't need any Pigovian tax!

    So Coase first blew up Pigou, and then showed that in the real world, the legislature should assign property rights such that the default outcome (when there are high transaction costs) is the one that would have occurred if low or no transaction costs, and efficiency is guaranteed.

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