Notes on the Problem of Social Cost

Ronald Coase

[The following quotes are from the chapter entitled "Notes on the Problem of Social Cost", which summarizes the debate since his original 1960 article, "The Problem of Social Cost" (the original article was in The Journal of Law and Economics, Oct. 1960, 3, 1-44; and the article is also reprinted in the same book). Posted to land-theory May 1999 by Mike O'Mara.]

[the] Coase theorem]:

"The world of zero transaction costs has often been described as a Coasian world. Nothing could be further from the truth. It is the world of modern economic theory, one which I was hoping to persuade economists to leave. What I did in The Problem of Social Costs was simply to bring to light some of its properties. ... Economists, following Pigou whose work has dominated thought in this area, have consequently been engaged in an attempt to explain why there were divergences between private and social costs and what should be done about it, using a theory in which private and social costs were necessarily always equal. It is therefore hardly surprising that the conclusions reached were often incorrect. The reason why economists went wrong was that their theoretical system did not take into account a factor which is essential if one wishes to analyze the effect of a change in the law on the allocation of resources. The missing factor is the existence of transaction costs.

"... However, once transaction costs are taken into account, many of these measures will not be undertaken because making the contractual arrangements necessary to bring them into existence would cost more than the gain they make possible." (pp. 174-5)

"... The same approach which, with zero transaction costs, demonstrates that the allocation of resources remains the same whatever the legal position, also shows that, with positive transaction costs, the law plays a crucial role in determining how resources are used." (p 178)

"Even those sympathetic to my point of view have often misunderstood my argument, a result of which I ascribe to the extraordinary hold which Pigou's approach has had on the minds of modern economists." (p.159)

Ownership Rights and Distribution Results

"Whether a difference in the law will affect the allocation of resources is not so easily settled in the case of previously unrecognized rights. Different criteria for assigning ownership of these rights would seem in this case to lead inevitably to a different distribution of wealth. It might be argued, of course, that since, with zero transaction costs, it costs nothing to make a contract more elaborate, all contingencies will be provided for and therefore no redistribution of wealth could occur. But it would be unreasonable to assume that people could include in contract a reference to rights of which they were unable to conceive. ... [b]ut, apart from such cataclysmic events as the abolition of slavery, these effects will normally be so insignificant that they can be safely neglected." (pp.173-4)

Comment by Mike O'Mara:

His conclusion seems reasonable, since Georgists agree that if the law was changed to introduce Georgist land rights, it would be as dramatic a change in rights as was the abolition of slavery.