Read this original piece of literature written by James M. Buchanan, who explains the Coase Theory.
In traditional economic-policy discussions, the arguments for and/or against governmental intervention in the private sector rarely take place under explicitly defined models for collective decision-making. For the most part, those who propose "corrections" to the outcomes of voluntary exchange processes, like those who oppose them, are content to treat governmental decisions as exogenous to the valuations of the persons in the economy itself. If, however, these arguments are interpreted consistently within any collective decision-making framework, the structure that can most readily be inferred is neither that of unanimity nor simple majority voting. The model of government that accords most closely with economic policy discussions is one in which authority to take collective action is vested in an administrator, a bureaucrat, an expert, who chooses for the community, presumably on the basis of his own version of the "public interest," or, in technical economist's jargon, some "social welfare function".
It is useful, therefore, to extend our analysis of the theorem on allocational neutrality to this administrative-decision model of public choice. Probably because the model is essentially implicit rather than explicitly postulated, little or no attention has been paid to the alternative means through which the single decision-maker for the collectivity may be selected. Nor need this concern us here. Strictly decision-maker be divinely ordained, democratically elected, arbitrarily appointed, selected in competitive examination, or hereditarily determined. I want to examine a model in which a single person has been empowered to make decisions for a whole community. This defines a specific structure of rights, an assignment, and the problem is to determine the allocative results that will emerge in comparison with those predicted under alternative structures. The first point to be noted is the same as that made with respect to simple majority voting. The delegation of decision-making power to the single person modifies the set of rights in existence, even prior to the onset of any imposed governmental action. The designated chooser for the community holds potentially valued claims that were nonexistent before he is constitutionally authorized to act.
Consider again Hume's drainage of the village meadow. Instead of operating through a rule of unanimity, we now assume that the village has empowered a single person to act on behalf of all persons in the group and, furthermore, it is acknowledged that his decisions will be enforced. Formally, it does not matter whether the decision-maker is chosen from within or from outside the group. For expositional simplicity, however, we shall assume that he is selected from outside the village. We now assume that a drainage project, lumpy in nature, will yield symmetrically distributed benefits to villagers valued at 1000 units of the numeraire commodity. The project will cost a total of 800 units and the taxing institution requires symmetrical sharing. The project is clearly Pareto-efficient, and, as indicated earlier, under an operating rule of unanimity, the project will be undertaken, given our zero transactions costs assumption, and including all free-rider behavior under the transactions costs rubric. The question becomes: Would this project necessarily be selected by the single decision-maker, the alternative structure of property rights under consideration?
It is illegitimate to assume that the single administrator knows the preferences of the citizens, or, even should these be estimated with accuracy, that he would necessarily embody individual values dollar-for-dollar in his own choice calculus. The administrator or bureau-crat will select the project if the costs that he bears are less than the benefits that he, personally, secures. But these costs and benefits are not, and cannot possibly be, those of the community of citizens. Apparently, there is nothing in this model to insure correspondence between the bureaucrat's choices and those results that are to be classified as efficient by orthodox economists' criteria. This suggests that the theorem of allocational neutrality breaks down.
If, however, we move beyond this naive model of administrative behavior, the applicability of the neutrality theorem may be restored. By acting in accordance with his own subjective evaluation, the bureaucrat may be failing to maximize the value of the property right that has been assigned to him constitutionally. To show this, let us assume that, naively, the decision-taker decides against the project noted. In this decision, he deprives the citizenry of benefits valued at1000 units and, at the same time, avoids the imposition of tax costs of 800 units on the community. In a setting with zero transactions costs, where large numbers can readily reach contractual agreements, the citizenry, as an inclusive group of taxpayer-beneficiaries, would be willing to offer side payments up to a total of 200 units to secure a change from negative to positive action on the project. If the decision-maker, the administrator or bureaucrat, uses these side payments, either indicatively or actually, to determine his final choice, the drainage project will be carried out. The theorem of allocational neutrality is apparently validated in this more sophisticated model for bureaucratic behavior. So long as the decision-maker acts to maximize the potential rent on the property right delegated to him, the right to make the final decision for the whole community, the allocative result will be identical to that forthcoming under alternative rights structures, with, of course, the transactions-costs, income-effect assumptions postulated. As in all property-assignment shifts, the distributional results may be quite different under differing assignments. If the bureaucrat maximizes the potential rent on his right to choose for the group, and, furthermore, if he collects this in the form of a personal side payment, there is an income transfer from members of the original group to the "outsider" selected as decision-taker.
Objection may be raised to rent-maximizing as the appropriate norm for bureaucratic behavior, even if we neglect ethical considerations (these will be introduced in Section V). To postulate that the designated decision-maker maximizes the potential side payments that he can receive from taxpayer-beneficiaries, as a group, implies that the decision-maker, himself, is indifferent as among the choice alternatives, that he places no personal evaluation on the differences among these opportunities available to him. If, in fact, the bureaucrat or administrator is external to the affected group of persons in the community, this assumption may seem plausibly realistic. If, however, he is chosen from within the community itself, his own evaluation must be taken into account. Whether the decision-taker is selected from within or without the original group of members, his own evaluation can be, and must be, included in any correct assessment of costs and benefits.
We may return to the numerical illustration introduced above. Suppose that the gross benefits of the proposed drainage project, to all persons other than the decision-taker, amount to 1000 units of a numeraire good (we may call these "dollars"), and that the gross costs, to all persons other than the decision-taker, amount to 800. Suppose, however, that the decision-maker, himself, places a monetary value of, say, 400 dollars on the "natural beauty" of the swampy and undrained meadow. Even should he be required to pay no part of the tax costs of the project, this 400 units of value necessarily becomes a component in the total opportunity cost of the drainage scheme. Under these conditions, the bureaucrat will refuse the proffered side payment of 200 units. The project will not be undertaken.
Does this result suggest that the theorem of allocational neutrality breaks down? The question of whether the decision-taker is selected from within or without the initial membership of the group becomes critical at this point. If the selection is internal, the project is inefficient under the conditions suggested, and it will not be undertaken under any rights assignment. This is because the person's negative evaluation would be an input in any internal contractual negotiations that might produce an allocative outcome. In this case, the neutrality theorem remains valid. Suppose, however, that the bureaucrat is not in the initial group of members. In such case, his own personal evaluation of the project alternatives will not enter and will not affect allocative outcomes when the assignment of rights is limited to initial members. This decision-maker's evaluation will, however, enter as a determinant when he is assigned the rights to choose for the group. The neutrality theorem would not hold valid under these conditions unless the decision-maker should be, in fact, wholly indifferent as among the choice alternatives. This result should not be at all surprising. The theorem allocational neutrality, even under its restricted set of required assumptions, should hardly be expected to extend to rights assignments that embody differing memberships in the group. For fixed membership, the theorem remains fully valid. Even when the decision-maker is selected from outside, the theorem suggests that any change in rights assignments, once the additional member is included, among this new membership will produce identical allocation results.