The Coase Theorem according to Deirdre McCloskey

The Coase theorem is subtle. Deirdre McCloskey gives a good explanation of it here.

Here’s a summary:

  • The Coase theorem implies that one cannot in general efficiently internalize an externality by taxing or subsidizing whoever is generating the externality, because in light of transactions costs, this would generally not result in the right to the resource affected going to the person who values it the most.
  • Another way of putting it, as Coase does, is to point out that “whoever generates the externality” is not a useful notion. Who “causes” the burnt fields of corn — the railway which makes the sparks, or the farmers who plant imprudently to the line?
  • The presence of ears is as much a cause for nuisance as jet engines.

The standard formulation is more confusing. Here’s how Wikipedia describes it:

  • Version 1: A clear delineation of private property rights is an essential prelude to market transactions.
  • Version 2: As long as private property rights are well defined under zero transaction cost, exchange will eliminate divergence and lead to efficient use of resources or highest valued use of resources.
  • Version 3: The allocation of resources is invariant to the assignment of private property rights under zero transaction cost and zero income effect.