Friday, January 4, 2008

What Conservapedia gets wrong about the Coase Theorem

I just stumbled across the conservapedia entry on the Coase theorem. It starts off fine, just like a text book might describe the idea. Then the entry veers off into the wilderness, stringing together a bunch of statements that exhibit an extremely shallow understanding of what Coase was arguing.
First, there is nothing conservative or liberal about what Coase said. His theorem (and he never actually called it a theorem) builds from his important work on the nature of the firm, which he extended to the problem of social costs. Firms are in part created to internalize transaction costs of production. Think about firm creation in terms of vertical or horizontal integration for examples. The reason that his work has not been widely embraced is that Coase's ideas do not lend themselves to straightforward quantitative research. Economics and the other social sciences turned heavily towards statistical analysis, econometrics and other mathematical tools for analysis, and transactions costs by their very nature are hard to define and measure. This limited the influence of Coase in a classroom, not the politics of his statements.

Second, Coase never claimed there were no transaction costs. He only said that if transaction costs were zero, bargaining would produce an efficient outcome. Two things about this that are important are that economic efficiency does not guarantee the most fair outcome (the importance of fairness is a separate topic), and that clearly defined property rights will reduce transactions costs and increase the liklehood of efficient bargaining. In this latter case there is a clear role of the law and government in preserving property rights through recognition and protection.

The last point about this misguided entry on the Coase theorem is that who is part of the bargaining (and who gets the 'wealth' as conservapedia puts it) is critical to an efficient outcome. It is simply wrong to say that it doesn't matter who owns property or wealth. If the property rights are not distributed in a way that allows for bargaining, then an efficient outcome is impossible. This is the crux of the Coase theorem. Externalities, such as air pollution, are problems precisely because no one owns the polluted air. Assignment of rights over the pollution in the air are extremely important for achieving clean air for everyone. It is inefficient for a coal plant to negotiate a settlement with everyone affected by it's pollution (just like it is impossible for a driver to compensate each individual that is delayed by the driver's presence on the road). It is inefficient because of transaction costs. Only the law (and government) currently have the institutional structure and power to internalize these costs and allow for bargaining and proper compensation.

The Coase theorem is gaining in popularity, and I hope that more academics and policy folks pay attention to it. I also hope that it is not thought of as a weird "conservative" truth because such a label will diminish the power and universality of Coase's ideas.

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