The Coase Theorem

16 Apr, 2015 at 12:29 | Posted in Economics | 3 Comments

Coase thm

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.

Alejandro Nadal

[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]


  1. Mortifying scientific headstands
    Comment on ‘The Coase Theorem’
    It is — first and foremost — important to distinguish between political and theoretical economics. In political economics anything goes, in theoretical economics scientific standards are observed.
    General equilibrium theory is out of science for several compelling reasons. The first inexcusable methodological blunder with equilibrium is this:
    “… you shouldn’t find the fixed equilibria first and then see if an economy converges to it; rather, the convergence process will itself constitute the equilibrium, if any exist.” (Mirowski, 1989, p. 459)
    It is simply inadmissible to put assumptions like equilibrium, decreasing returns, perfect competition, etcetera into the premises. This mistake/error is known since antiquity as petitio principii and J. S. Mill, the founder of economic methodology, dealt with it at length in his System of Logic.
    Political economics in general and equilibrium economics in particular is scientifically worthless. The fact that neither the representative economist nor the Law and Economics movement have realized this until this day is self-disqualifying.
    The corollary of the methodological headstand is the abuse of mathematics. Alejandro Nadal correctly observes:
    “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.” (See intro)
    This abuse is not corrected with Marshall’s silly prescript ‘Burn the mathematics.’ Again, it is theory that has at first put on its feet.
    “The mathematical language used to formulate a theory is usually taken for granted. However, it should be recognized that most of mathematics used in physics was developed to meet the theoretical needs of physics. … The moral is that the symbolic calculus employed by a scientific theory should be tailored to the theory, not the other way round.” (Wittgenstein, quoted in Schmiechen, 2009, p. 368)
    To make a long methodological story short: the fatal defect of Orthodoxy is that all its theorems are derived from behavioral axioms. Yet, no specific behavioral assumption whatever can serve as a starting point for economic analysis. From this follows for New Economic Thinking that the behavioral axioms have to be replaced (2014). To flip from headstand to footstand is called in science a paradigm shift.*
    Egmont Kakarot-Handtke
    Kakarot-Handtke, E. (2014). Economics for Economists. SSRN Working Paper
    Series, 2517242: 1–29. URL
    Mirowski, P. (1989). The Rise and Fall of the Concept of Equilibrium in Economic
    Analysis. Louvain Economic Review, 55(4): 447–468. URL
    Schmiechen, M. (2009). Newton’s Principia and Related ‘Principles’ Revisited,
    volume 1. Norderstedt: Books on Demand, 2nd edition. URL
    * For cross-references see

  2. One of the biggest critics of the mainstream economics profession was Coase:

    “But knowledge will come only if economics can be reoriented to the study of man as he is and the economic system as it actually exists.”

    “…the reduction of economics to price theory is troubling enough. It is suicidal for the field to slide into a hard science of choice, ignoring the influences of society, history, culture, and politics on the working of the economy.”

    • Excellent quotes. Spot on. Thanks.

      As a philosopher, it is abundantly clear to me that the fundamental assumptions of economic theory begin with a theory of man (“human nature”). These are issues that recede into the earliest musings of humans about themselves and their relationship with the world. Earlier than that were the creation myths.

      In modern times, this study has broadened and various sciences have spun off — anthropology, sociology, political science, psychology and cognitive science. Instead of looking at the work that has been done in this foundation area, economists have either made assumptions by generalizing (projecting) their own experience, or importing a particular view like Jeremy Bentham’s. Bentham is considered a third rate thinker at best.

      At least Ludwig von Mises had the sense to specify his neo-Kantian framework, e.g., in Human Action. But much of the foundational aspects in contemporary economics are what philosophers consider gobbledegook.

      Adam Smith can be forgiven for mythologizing the origin of markets and the use of money in barter and Locke for mythologizing the origin of private property in use. But those excuses apply to the 18th century state of knowledge, not now.

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