The Coase Theorem16 April, 2015 at 12:29 | Posted in Economics | 3 Comments
Examining the Coase Theorem relies on a critical analysis of economic theory. The fundamental shortcomings of the most developed theory of the market, general equilibrium theory, as well as the restrictions imposed by the use of partial equilibrium and cases of a bilateral monopoly, undermine the assertions of the Coase Theorem. In the case of a bilateral monopoly, this construct involves serious distributional problems, and the invariance component of the theorem is seriously called into question. In addition, it is possible that the negotiations process may stop when mutually beneficial transactions take place outside of the contract curve. In those cases, social efficiency in the restricted Pareto-optimum sense will not be the outcome …
Faith in the idea that markets allocate resources efficiently is severely shaken by the set of difficulties in general equilibrium theory discussed in this article. The shortcomings of general equilibrium theory in stability theory should alert anyone tempted by the Law and Economics (L&E) movement and its
applicability to fields of legal practice. The bottom line is that we do not have a theory showing how, if at all, markets reach equilibrium allocations. Because efficiency, in terms of Pareto-optimality, is an attribute only of equilibrium allocations, very serious negative implications exist for anyone claiming that markets allocate resources efficiently.
We have concentrated our critique of L&E based on the fact that economic theory is in a very sad state. Proponents of L&E seem to ignore this, appearing instead to believe that there exists somewhere a robust theoretical construct that satisfactorily explains how markets allocate resources efficiently– this article has shown such faith to be groundless. This should be enough to dismiss L&E as another example of the triumph of ideology over science. In addition, the extreme version of L&E transforms justice into a commodity and represents a disturbing backward movement in social thought. The critiques raised in this article should also suffice to call into question the idea that the main objective of legal systems is efficiency, and that efficiency is attained through the market system. There are no grounds to believe in the efficiency of the market system.
One final thought on the role of mathematics is important. In its development, economics as a discipline has been obsessed with the use of mathematical models to build a theory of competitive markets. The only function for the very awkward assumptions … was to allow the theoretician to have access to certain mathematical theorems. Functioning in this manner, economic theory has sacrificed the construction of relevant economic concepts for the sake of using mathematical tools. This is not how scientific discourse should advance, and the followers of L&E are probably not aware of this. In fact, they may have fallen victim to the illusion of scientific rigor conferred by the use, and abuse, of mathematics.
[For yours truly’s own take on the Coase Theorem and Law & Economics — in Swedish only, sorry — see here or my “Dr Pangloss, Coase och välfärdsteorins senare öden,” Zenit, 4/1996]