The Coase Theorem and the Economics of Transition in Russia

The Coase Theorem is one of the jewels in the crown of neoclassical economics, in the estimation of this dilettante at any rate. The New Palgrave Dictionary of Economics (Norton: 1987) summarizes the theorem as follows:

[I]n a world of zero transaction costs any initial distribution of rights will lead to an efficient outcome (“Law and Economics,” p. 179).

Now, the theorem is subject to certain conditions, one of which is that property rights must be well-defined. “[T]hat is why,” Joseph Stiglitz writes,

advocates of rapid privatization [in Russia] argued one didn’t really need to pay close attention to how privatization was accomplished (Globalization and Its Discontents, Norton: 2002, p. 164)

However, it’s pretty clear that things didn’t go so well, to put it mildly. Why not? Stiglitz contends that the advocates of rapid privatization

took Coase’s ideas further than Coase himself would have done. They believed that political processes were governed in the same way as economics processes…. Unfortunately, the long history of political reforms suggests the distribution of income does matter. It has been the middle class that had demanded the reforms that are often referred to as “the rule of law.” The very wealthy usually do far better for themselves behind close doors (ibid.).

If (if!) I understand Stiglitz correctly, he is arguing that the debacle in Russia provides empirical evidence that the Coase Theorem cannot be extended to a public choice setting. But I’m not sure that’s quite right. After all, another necessary condition for the application of the Coase Theorem is perfect information. Of course, this condition is never met in the real world. But there are degrees of transparency, and the Russian case looks like one in which this condition was not even vaguely close to being met. So if I’ve understood Stiglitz’s argument, and I’ve understood the situation as he described it, then I don’t think the Coase Theorem has been shown to be inapplicable when looking at the economics of political processes. I should add that this would do nothing to vindicate the radical reformers, but that was not my aim.