Sows, Cows, and Coase: The Conflict of Cultures

Abstract

Coase ‘s (1960) seminal paper, “The Nature of Social Cost” provided a newconceptual framework for the analysis of the problem of social costs or externalities, which is different from the standard Pigovian/Pigouvian analysis. The so-called “Coase Theorem” states that given the initial assignment of property rights, parties to a dispute will make bargains or contracts with each other to exchange rights in order to internalize externalities, assuming there are zero transaction costs involved in the exchange of property rights, all rights are alienable, no legal barriers to contracting, and no wealth effects.1 The ultimate result of exchange of rights (which maximizes the value of the product) is independent of the legal system. No government intervention via a system of Pigouvian taxes—after the British economist Arthur C. Pigou—or subsidies is necessary beyond the initial assignment and enforcement of rights. The Coase Theorem, with its zero transaction costs assumption, is relevant for situations involving two/small number of parties to a dispute. Coase’s contribution to the newly emerging law-and-economics literature is to direct economists’ attention to the importance of positive transaction costs which makes bargaining difficult in the presence of many parties to a dispute, and the role of alternative non-market institutional arrangements—the firm, vertically integrated firm, government intervention in the form of Pigouvian taxes/subsidies, and even “doing nothing”—in coping with the problem of social costs. Because Coase placed great emphasis on his analysis of the nature of social costs in a world with positive transaction costs, I shall call this version as the “Coase Theorem-Version II” to differentiate itself from the standard Coase Theorem.2 Both versions of the Coase Theorem implicitly assumes the existence of a state with well-developed legal framework for the settlement of disputes of parties embedded in a culturally homogeneous population.