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.

6. The Theory of The State

It is possible to interpret both the policy implications of Coase's theorem on allocational neutrality and Pigovian corrective policy prescriptions in terms of the underlying conceptions, models, or theories of government. As the analysis above has suggested, under certain conceptions of governmental process, neither Coase nor the Pigovian should have been greatly concerned about institutional change as means of generating allocative efficiency. If distributional considerations are neglected, and if decision-makers for the community are chosen from within the group, the structure of rights will modify allocative outcomes only because of differentials in levels of transactions costs, provided that the decision-takers are motivated by economic self-interest. The policy thrust of Coase's discussion is, however, to the effect that governmental or collective intrusion into the negotiation processes of the market economy tends to retard rather than to advance movement toward allocative efficiency. Conversely, the policy thrust of the whole Pigovian tradition is that governmental or collective intrusion into the market economy tends to be corrective of distortions and leads toward rather than away from those results that might satisfy agreed-on efficiency criteria.

The Pigovian model of the state may be examined first. The decision-taker, the person or group empowered to impose the corrective taxes and subsidies, is presumed to act in accordance with rules laid down for him by the welfare economist. His task is that of measuring social costs and social benefits from alternative courses of action, a task that he is presumed able to carry out effectively. On the basis of such measurements, the decision-taker is to follow the rules laid down, quite independently of the personal opportunity costs that he may face in refusing side payment offers. The Pigovian policy-maker must be an economic eunuch. The idealized allocative results are, of course, identical with those that would emerge under a regime where the decision-maker is wholly "corrupt" in the sense of strict maximization of the potential side payments or rents on his rights to make decisions. If he is expected to behave as a rent-maximizer, however, there would be no need for elaborated and detailed instruction in the form of rules or norms, as derived from the theorems of welfare economics. Within this Pigovian conception, the decision-maker for the group does not and/or should not maximize the rental value of the rights of decision that he is granted. This may be treated either as a positive prediction about bureaucratic behavior or as a normative proposition for bureaucratic behavior.

In the Coase conception, an interpretation that is similar in certain respects seems to follow. If, in fact, governmental decision-makers act as strict rent-maximizers, the neutrality theorem suggests that there should be little or no concern about allocative results, perse. The evidence of such concern must, therefore, indicate some denial of the rent-maximizing behavioral hypothesis. Again, this may be taken as positive prediction or normative statement. The governmental decision-maker, the bureaucrat, empowered to act on behalf of the group, either does not maximize rents on the rights that he commands or he should not do so on moral-ethical grounds. In either case, the Coase concern for allocational efficiency returns since the negotiating pressure toward optimality is removed once the decision-making power is shifted from the market to the public sector.

It is perhaps surprising to find common elements in the basic conceptions of political process held by the proponents of essentially opposing policy positions. But in both the Pigovian framework and in that imputed here to Coase, the governmental decision-maker, either singly or as a member of a choosing group, is and/or should be "incorruptible". In this respect, the two conceptions of governmental process seem identical, despite the sharp differences in information possibilities attributed to the governmental authority in the two models. In the Pigovian tradition, the bureaucrat is both informed and incorruptible; in the Coase framework, he is ignorant and incorruptible.

Agreement on this "incorruptibility" characteristic of governmental decision-makers, and indeed the introduction of the term "corruptible" in this familiar usage, suggests that there exist widely-shared ethical presuppositions concerning the inalienability of the delegated rights to make collective choices. That is to say, some shift away from the unanimity rule for collective decisions may be accepted as necessary, with the accompanying acknowledgment that new and previously nonexistent "rights of decision" are brought into being, rights that have economic value that is potentially capturable by the subset of the citizenry empowered to take decisions on behalf of all. Such rights may, however, be considered to be inalienable; that is, the holder is not entitled to sell them or to exploit his possession of them through collection of personal rewards, either directly or indirectly. It would be inappropriate in this paper to examine in detail the validity of such ethical presuppositions, although this opens up many interesting and highly controversial topics for analysis.

The existence of such presuppositions can scarcely be denied. The pejorative content of such terms as "vote-trading," "logrolling," "political favoritism," "spoils system," "pork-barrel legislation"-these attest to the pervasiveness of negative attitudes toward even minor attempts on the part of possessors of political decision-making rights to increase rental returns. If these attitudes are sufficiently widespread, prohibitions against bureaucratic and political rent-maximization may extend beyond the mere promulgation of ethical norms for behavior. The rewards and punishments that are consciously built into the governmental structure may be specifically aimed at making such rent-maximization unprofitable for any person empowered to take decisions on behalf of the whole group. The designated bureaucrat who is assigned authority over one specific aspect of public policy may not be morally or ethically inhibited from accepting side payments. But he may face harsh legal penalties should he accede to monetary temptations. To the extent that these constitutionally-determined constraints insure that the economic self-interests of governmental decision-makers dictate behavior unresponsive to proffered side-payments (direct or indirect) it may be argued, almost tautologically, that any outcomes chosen for the community by the "incorruptibles" must be, by definition, classified as "efficient". This would produce the paradoxical conclusion that the conditions for efficiency depend critically on the institutional structure and that, even with unchanged personal evaluations, solutions which are deemed efficient under one set of institutions may be inefficient under another.

The avoidance of this paradox becomes possible if we are content to define as allocationally efficient only that set of possible outcomes that could emerge from the contractual negotiation process among persons in the community, on the assumption that no rights are inalienable. In this case, the introduction of inalienability in the rights of governmental decision-takers clearly makes the theorem of allocational neutrality invalid. Under the highly restricted assumptions of zero transactions costs, any activity will be efficiently organized in the absence of governmental intervention, and, absent income effect feedbacks, the allocational outcome will be invariant over differing assignments of private and alienable rights. Under such conditions as these, it is the inalienability of rights that the shift to the public sector introduces which removes the guarantee that outcomes will be efficient, not the shift to governmental decision-taking per se. If we avoid the apparent paradox in this manner, however, the implication is left that the constitutional shift of activities to the public sector is an almost necessary source of inefficiency. When other considerations are accounted for, however, this implication need not follow. When transactions costs are recognized, and especially when distributional implications are considered, efficiency "in the large" may dictate the governmental organization of activities along with the inalienability of the rights delegated necessarily to bureaucratic decision-makers. There is no final escape from the requirements that each particular institutional change proposed must be examined on its own merits, on some case-by-case procedure, with the interdependence among separate organizational decisions firmly in mind.