Property rights, contracts, cyclical social preferences and the Coase theorem: A synthesis

Abstract

In earlier work I demonstrated the relationship between contracts and cyclical social preferences and also that (negative) externalities are a necessary condition for the presence of cyclical social preferences. In this paper I define negative externalities broadly to include effects on members within the same group or organization ‘outvoted’ in a collective decision-making process by a ‘majority’. The Coase theorem states that negative externality problems can be resolved efficiently by contracts, whatever the assignment of property rights, provided there are no transaction costs. Transaction costs are notably neglected in the social choice literature. Thus one might ask whether the Coase theorem might not also hold for the more general case of Arrow's general impossibility theorem, which includes all decisions by political bodies, organizations, groups and individuals and is not limited to decisions related to market participants. If this were so, there would be no need to be concerned about Arrow's general impossibility theorem, since all inefficient outcomes would be removed by contracts. The same would be true for Sen's ‘impossibility of a Paretian liberal’. Also, if such contracts could be enforced, outcomes would be stable, thus removing the instability and inconsistency implied by social preference cycles in which each outcome is dominated by another one. In the present paper I ask whether and under which conditions the Coase theorem can be applied to this general case. In doing so, I shed new light on implicit assumptions of the theorem.