Wednesday, September 19, 2012

Doubling Down on Misunderstanding Coase

I came across a paper on SSRN entitled, "Transaction Costs Can Encourage Coasean Bargaining." Here is the abstract:
When there are three parties, it is well known that the Coase Theorem may not hold even when there are no transaction costs, due to the emptiness of the core of the corresponding cooperative game [Aivazian and Callen (1981)]. We show that the standard Coasean bargaining game involving three parties is strategically equivalent to an asymmetric three player majority game. Hence, when there are three parties, the Coase Theorem fails if and only if the core of the corresponding three player majority game is empty. We use this equivalence result to derive all instances in which the Coase Theorem will and will not hold with three parties, and show that the Coase Theorem will actually hold most (over 80 per cent) of the time. We also demonstrate, in contrast to Aivazian and Callen (2003), that it is always possible to find a set of transaction costs which, when introduced into a frictionless bargaining situation, will cause an empty core to become non-empty. In other words, with suitably designed transaction costs, it is possible for the Coase Theorem to hold in cases where, in the absence of those transaction costs, it would fail to hold. When there are three parties, rather than hindering agreements, transaction costs can encourage Coasean bargaining.
I have not read the article and do not plan to because, based on the title and abstract alone, the entire project strikes me as misguided. In the first place, we have the problem of defining "Coasean bargaining," as opposed to bargaining simplicter, about which I have blogged on more than one occasion (see, e.g., here). But this paper suffers from an even deeper problem, which really amounts to an outright contradiction, which is disclosed in the second to last sentence of the abstract: "with suitably designed transaction costs, it is possible for the Coase Theorem to hold in cases where, in the absence of those transaction costs, it would fail to hold." By definition, a world of positive transaction costs (of whatever type) is not a world in which the Coase Theorem can apply because the theorem is defined in part by the absence of transaction costs (plus all the other standard assumptions of neoclassical economic theory). There is an outright contradiction between the existence of positive transaction costs and the Coase theoretic assumption of costless transacting.

My conclusion is that whatever the author believes he is writing about, it is not the "Coase theorem;" and whatever bargaining he observes is not "Coasean bargaining" (however defined).

3 comments:

  1. Professor Cole, I am the author of this paper. I am disappointed that you dismissed my paper without reading it. The paper makes two main points. First, when there are three players, the instability problems identified by Avazian and Callen (1981) seem to be relatively rare. Second, the instability problems can sometimes disappear if direct transaction costs are present.

    ReplyDelete
  2. But if direct transaction costs are present, then the "the Coase theorem" cannot possibly hold because its distinguishing feature is the absence of transaction costs.

    ReplyDelete
  3. I encourage you to read the paper. I present a simple example to show that this is incorrect.

    ReplyDelete

I actively moderate comments for spam, advertisements, and abusive or offensive language.