What Does “Zero Transaction Costs” Mean, Epistemically?
| Nicolai Foss |
What does the Coase Theorem require epistemically? To put it less mysteriously, what are the assumptions concerning agents’ knowledge that must be made for the Coase theorem to hold? Or, to rephrase it somewhat, what does zero transaction costs mean in terms of agents’ knowledge (an inquiry started by Carl Dahlman in this paper)?
In his retrospective (1988) discussion and assessment of the debate on the theorem, “Notes on the Problem of Social Cost,” Coase seems to imply that the Theorem requires omniscience. I think that Barzel makes the same inference in his Economic Analysis of Property Rights. In other words, the Coase Theorem holds iff all resource uses, current as well as future ones, are known by everyone.
Not all writers seem to agree with this interpretation, however.
For example, Israel Kirzner in Competition and Entrepreneurship argues that even if transaction costs were zero, there would still be a need for alertness. Per implication, and if Kirzner is right, the zero transaction cost condition does not require omniscience.
Makowski and Ostroy (2001) in their excellent 2001 JEL paper implicitly side with Kirzner, pointing out that while the Coase Theorem may break down in the presence of asymmetric information (the Bazaar Problem, etc.), it is consistent with Hayekian private knowledge (roughly, the knowledge conditions underlying the general equilibrium model, which — contrary to common conception — does not require omniscience).
I tend to favor the Kirzner/Makowski & Ostroy interpretation. I do so partly for pragmatic/heuristic reasons: I think that the setting underlying the Coase theorem is a much more useful benchmark for economic analysis than the general equilibrium model because it is more “loose” and therefore more flexible. That is, the CT does not make specific assumptions concerning the number of players, the structure of markets, the presence of a forward markets, the auctionarius etc. It is in a sense broader in scope. However, these advantages seem to me to pale if the Coase Theorem requires more extreme epistemic conditions than the general equilibrium model. No economic model should be founded on an assumption of omniscience.
My interpretation of the setting underlying the Coase Therem is that the zero transaction cost assumption implies a setting where players are fully informed about current resource uses (which is already an extreme assumption). However, they are not omniscient, since new resource uses may appear through the exercise of entrepreneurship. Given that transaction costs are zero, any externality problems associated with such new resources will, however, be instantaneously eliminated.