A Coasean Approach to Cost-Benefit Analysis

Abstract

Government regulation is said to be justified when private markets fail to efficiently allocate resources owing to so-called externalities. Yet as Ronald Coase convincingly showed decades ago, the presence of externalities can be usefully attributed to the of market transactions, putting the entire notion of market failure shaky ground. What kind of failure is it when the parties affected by an alleged externality decline to spend a dollar transacting to capture ninety-nine cents in benefits? Transaction costs are real social costs and, at least conceptually, must be factored in to any social calculus. This essay proposes a relatively simple Coasean approach to cost-benefit analysis where transaction costs are sufficiently low that competition can be expected to drive the parties toward efficient resource allocation. A rule is justified under this approach only if the regulator can show it is likely to reduce the relevant transaction costs. If so, the parties will adjust their private arrangements to reduce any inefficiencies out of self-interest. There is no need for the regulator to quantify total costs and benefits. This is the information the parties--the men and women on the spot--are best able to identify their own.