Foundations, Implications and Critiques of the Coase Theorem: A Reassessment

The paper aims to reassess “the Coase Theorem” in its historical context and highlight the discernible gap between the Coase Theorem and the often-overlooked arguments articulated by Coase. In “the Problem of Social Costs”, Ronald Coase intended to emphasis on the irrelevance of Pigou's argument in dealing with externalities. The theorem implies that in a world with zero-transaction cost, external effects are internalized without government intervention and the allocation of legal rights does not matter. These implications have led observers to criticize the theorem, notwithstanding the accurate scrutiny reveals that almost all of the critiques center around the main assumption of the theorem – namely, zero transaction costs- rather than the theorem itself. While the correctness of the theorem heavily depends on the concept of “transaction costs”, the concept suffers from a lack of clear definition. It is important to note, in that paper, Coase intended to argue that Pigou's analysis in “the Economics of Welfare” is irrelevant, and in a zero-transaction cost world, market forces internalize externalities, and government intervention is not needed. In contrast, when positive transaction cost is considered the allocation of legal rights and liabilities becomes important. This latter point has been almost ignored in the literature and entailed that the Coase theorem is an unrealistic one.