Information and the Coase
Theorem
From
Joseph Farrell
JEP 1987
The Coase Theorem
and Decentralization
Absent transaction costs, all must be well!
• This is a decentralization result. It means that
people will negotiate their way to efficiency.
Holds even for the provision of public goods and
the problem of monopoly.
• But the welfare theorem says the same:
Competitive equilibria with complete markets are
efficient.
Which one to choose from?
Coase vs Perfect Competition
• Coase:
– No strong assumptions about convexity, pricetaking, and complete markets.
– Strong assumptions about absence of
transaction costs.
“While the Coase theorem economizes on
formal institutions, it demands a lot of
coordination and negotiation.”
Coase vs Perfect Competition
• Perfect competition:
– Efficient even though individuals act
unilaterally.
“With competitive markets, there is no need
for coordination.”
Coase vs Perfect Competition
• It is fairly easy to tell when markets are not
competitive: economies of scale, incomplete
markets (externalities), market power, …
• We also know that coordination and
negotiation is difficult when too many
individuals are involved.
• But inefficiencies can remain with bilateral
externalities and asymmetric information.
Object of study
Argue that
1. negotiations can fail when when people don’t
know one another’s tastes or opportunities.
2. in this case, the Coase theorem fails as a
decentralization result.
3. it is precisely in the case where people know
each other well that decentralization is least
interesting. The Coase theorem is thus of little
use!?
On the usefulness of
decentralization results
1. They help us understand why there are
inefficiencies. OK
2. They are used as arguments against gvt
intervention. Not OK.
Both the welfare and the Coase theorems state that
“…in ideal circumstances, the laissez-faire
outcome is no less Pareto-efficient than the ideal
government-dictated outcome. But they do not
claim that it is better;…”
On the usefulness of
decentralization results
Only when there are imperfections can
decentralization be better. But then one
needs to convince us with a proper model.
Hayek on knowledge
• The main problem of society is to make the best
use of its knowledge.
• But knowledge is dispersed among all individuals.
• Decentralization is useful only if it delegates
decisions to better informed people.
One thus wants to compare systems especially in the
presence of private information.
Getting information revealed
• People often have reasons to lie about their
true types (as with public goods).
What if central authorities could devise a way
to get people to reveal what they know?
• Mechanism design: Offer people payments
(or subsidies) which depend on the revealed
information.
Mechanism Design
• Make people pay for the expected externalities
that they create.
• This leads people to reveal their true types and
efficient outcomes.
• But it works only when people are forced to
participate.
• Centralization is thus better?!
• NB Assumes that the central authorities can
manage all that information. (Hayek did not
believe so.)
Administrative vs Political
decentralizations
• Administrative decentralization:
– Delegate some decisions to lower level
bureaucrats.
– No real advantage in the context of forced
participation.
– Probably worse since central planner has global
view.
Administrative vs Political
decentralizations
• Political decentralization:
– People voluntary exchange with others.
– But with private info, some people might prefer
not to participate.
– It is generally costly to efficiency to “bribe”
people who would otherwise refuse to play.
So why not have centralization?
• Centralization helps
– when decisions are interdependent.
– by forcing recalcitrant people to participate.
• Centralization fails when
– it does not commit itself to its incentive scheme
(e.g. rent-seeking)
– it cannot properly process all the information
(centralized schemes must remain relatively
simple)
A simple model