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The Cost of Coase

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Abstract

The publication of "The Problem of Social Cost" in 1960 by Ronald Coase brought together two powerful intellectual currents, namely, the economic theory of externalities and the common-law tradition concerning torts and nuisance. The sea is fertile but rough where two ocean currents meet, and the same can be said of the disputes provoked by Coase. Coase developed his argument through a series of concrete examples, such as the rancher and the farmer, the railroad sparks and the corn crops, etc. He steadfastly refused to articulate the general truths underlying the examples; for example, the famous "Coase Theorem" is abstracted from the paper but not stated in it. After two decades of debate the generalizations underlying the examples are still disputed. In this paper I will not attempt the impossible task of offering the "true" or final interpretation of Coase's paper. Hermeneutics is left for others. Rather, I will state and prove those generalizations applicable to Coase's examples which follow from familiar assumptions of economic theory. It seems to me that these generalizations frequently conflict with Coase's examples in the sense that the immediate interpretation of his examples are inconsistent with the provable generalizations. The cost of Coase's paper is that readers are confused or misled about the generalizations which follow from familiar economic assumptions. In the first section of this paper I characterize the dispute by developing one of Coase's examples. The second section formulates some general propositions about correcting externalities through the use of liability law, taxes, and transferable property rights. The third section addresses the problem of bargaining and the Coase Theorem. The formal development of the argument and the proofs, some of which are interesting in their own right, are relegated to the detailed Appendix

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