Information and the Coase Theorem

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Information and the Coase Theorem

• From
• Joseph Farrell
• JEP 1987

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The Coase Theoremand Decentralization

• Absent transaction costs, all must be well!
• This is a decentralization result. It means that
  people will negotiate their way to efficiency.
  Holds even for the provision of public goods and
  the problem of monopoly.
• But the welfare theorem says the same
  Competitive equilibria with complete markets are
  efficient.
• Which one to choose from?

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Coase vs Perfect Competition

• Coase
• No strong assumptions about convexity,
  price-taking, and complete markets.
• Strong assumptions about absence of transaction
  costs.
• While the Coase theorem economizes on formal
  institutions, it demands a lot of coordination
  and negotiation.

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Coase vs Perfect Competition

• Perfect competition
• Efficient even though individuals act
  unilaterally.
• With competitive markets, there is no need for
  coordination.

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Coase vs Perfect Competition

• It is fairly easy to tell when markets are not
  competitive economies of scale, incomplete
  markets (externalities), market power,
• We also know that coordination and negotiation is
  difficult when too many individuals are involved.
• But inefficiencies can remain with bilateral
  externalities and asymmetric information.

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Object of study

• Argue that
• negotiations can fail when when people dont know
  one anothers tastes or opportunities.
• in this case, the Coase theorem fails as a
  decentralization result.
• it is precisely in the case where people know
  each other well that decentralization is least
  interesting. The Coase theorem is thus of little
  use!?

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On the usefulness of decentralization results

• They help us understand why there are
  inefficiencies. OK
• They are used as arguments against gvt
  intervention. Not OK.
• Both the welfare and the Coase theorems state
  that in ideal circumstances, the laissez-faire
  outcome is no less Pareto-efficient than the
  ideal government-dictated outcome. But they do
  not claim that it is better

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On the usefulness of decentralization results

• Only when there are imperfections can
  decentralization be better. But then one needs
  to convince us with a proper model.

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Hayek on knowledge

• The main problem of society is to make the best
  use of its knowledge.
• But knowledge is dispersed among all individuals.
• Decentralization is useful only if it delegates
  decisions to better informed people.
• One thus wants to compare systems especially in
  the presence of private information.

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Getting information revealed

• People often have reasons to lie about their true
  types (as with public goods).
• What if central authorities could devise a way to
  get people to reveal what they know?
• Mechanism design Offer people payments (or
  subsidies) which depend on the revealed
  information.

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Mechanism Design

• Make people pay for the expected externalities
  that they create.
• This leads people to reveal their true types and
  efficient outcomes.
• But it works only when people are forced to
  participate.
• Centralization is thus better?!
• NB Assumes that the central authorities can
  manage all that information. (Hayek did not
  believe so.)

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Administrative vs Political decentralizations

• Administrative decentralization
• Delegate some decisions to lower level
  bureaucrats.
• No real advantage in the context of forced
  participation.
• Probably worse since central planner has global
  view.

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Administrative vs Political decentralizations

• Political decentralization
• People voluntary exchange with others.
• But with private info, some people might prefer
  not to participate.
• It is generally costly to efficiency to bribe
  people who would otherwise refuse to play.

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So why not have centralization?

• Centralization helps
• when decisions are interdependent.
• by forcing recalcitrant people to participate.
• Centralization fails when
• it does not commit itself to its incentive scheme
  (e.g. rent-seeking)
• it cannot properly process all the information
  (centralized schemes must remain relatively
  simple)

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A simple model