The Coase Theorem and the Theory of the State

Read this original piece of literature written by James M. Buchanan, who explains the Coase Theory.

4. Simple Majority Voting

When the unanimity requirement for collective decisions is abandoned, governmental action no longer represents a complex equivalent of a voluntary exchange process. If decisions that are to be binding over the inclusive group can be made by a subset of this group, there is no guarantee that a particular individual holds against the imposition of net harm or damage. Once his own contractual agreement to the terms of governmental or collective action is dropped as a requirement, an individual can no longer be certain that he will share in the gross gains that governmental action will, presumably, generate. From this it seems to follow that collective action, motivated by improvement in the positions of members of a decisive coalition smaller than the totality of community membership, need not produce results that are efficient, even with zero transactions costs. Any nonunanimity voting rule, for example, that of simple majority voting, would seem to produce results that may be, in the net, inefficient.

The neutrality theorum is, however, more powerful than might be suggested by cursory attention to this example. Efficient outcomes will tend to emerge from the contractual process, even under less-than-unanimity voting rules for collective action, if the modified structure of property rights consequent on the departure from unanimity is acknowledged, and if individuals are allowed freely to negotiate trades in these rights. Economists have not fully incorporated the property-rights structure of less-than-unanimity voting rules into their orthodoxy, and they tend to stop short of the extension of the neutrality theorem herein suggested.

Consider a situation in which individuals hold well-defined rights, which are acknowledged by all parties, and which are known to be enforceable without costs. If no collective action is undertaken, individuals trade such rights among themselves in simple exchanges, insuring mutuality of gain. If collective action is undertaken, but only on the agreement of all parties, mutality of gain (or, at the limit, absence of loss) is insured. If this requirement is dropped, and individuals may be subjected to damage or harm through collective action, the value of their initial holdings is necessarily changed, again on the assumption of zero transactions costs. Individuals no longer hold claims that are inviolate against imposed reductions in value. A new and ambiguous set of rights is brought into being by the authorization of governmental action taken without the approval of all parties. Any potentially decisive decision-making coalition, a simple majority of voters in our example here, possesses rights to the nominal holdings of the minority. These rights are, in this instance, ambiguous because they emerge only upon the identification of the majority coalition that is to be decisive with respect to the issue under consideration for collective action. Once identified, however, members of the effective majority hold potentially marketable rights. These may be exchanged, directly or indirectly, and the contractual process will again insure that the efficient allocative outcome will be achieved, and that this will be invariant, given the appropriate assumptions about transactions costs and income effects.

We may illustrate this in a highly-simplified three-person example. Consider a community that includes three men: A, B, and C.Collective decisions are to be made by simple majority voting. Initialholdings of units of an all-purpose and numberable consumption good, let us say, 100 for A, 60 for B, and 30 for C. In this environment, let us suppose that a governmental project is proposed, one that promises to yield benefits of 30 units, distributed equally among the three persons. The gross costs of this project are, however, 40 units; clearly, the proposal is inefficient. Despite this, if B and C can succeed in organizing themselves into a majority coalition, and if they can impose the full tax costs of the proposal on A, they can make net gains. In this case, the results would appear as follows:

Person Benefits Costs Net
A 10 40 -30
B 10 0 10
C  10  0  10

Once B and C are identified as the decisive members of the coalition, however, individual A can negotiate trades, or side payments, that will be mutually beneficial to all parties, and which will keep this inefficient outcome from being achieved. Individual A can, for example, offer either B or C a net gain of 15 units to join a different majority coalition that will disapprove the project. Or, if both B and C hold firm, they can exact from A a payment of 10 units for their agreement to withhold the project. The side payments, which must be allowed to take place under our assumption of zero transactions costs, will insure that all inefficient projects are forestalled, and, similarly, that all efficient projects will be carried out.

The values to individuals of the "property rights in franchise" embodied in a majority-voting regime depend critically on the constitutional limits within which majorities are allowed to take collective-political action. These values will also depend on the technological possibilities for potential coalition gains within the given set of constitutional constraints defined-. Detailed exploration of these interesting and mostly unresolved issues would not be suitable in this paper. For present purposes, the points to be recognized are, firstly, that any departure from unanimity in collective decision processes modifies the structure of rights from that which is defined exclusively by private-sector claims and obligations, and, secondly, that even with this modified set of rights, the theorum on allocational neutrality remains valid within the required, and highly restricted, assumptions concerning transactions costs and income effects.