Toward an Expanded Economic Theory of Contract

The Coase Theorem in its most innocuous form appears to be little more than a restatement of the Pareto criterion. In a zero transaction costs (hereafter ZTC) world, transactions will continue to occur until there remains no possibility for further transactions which would make at least one party better off while making no other party worse off. If transaction costs are defined broadly enough to include all strategic and bargaining costs, then, as Guido Calabresi asserts, the proposition would appear true by definition.' It must, as he suggests, hold not only for the short run, but for the long run as well.2 However, except by using a very strained characterization of contract (to be discussed below), it can be shown that even this modest version of the Coase Theorem is vulnerable. Before showing this it is worth pausing first to ask whether this trip is really necessary. While exploring all the ramifications of the ZTC assumption may be intellectually challenging, it is not likely that a detailed knowledge of that mythical world will be of much practical use. Indeed, the Coase Theorem-especially in the minimal form presented here-was not proffered as a serious attempt to analyze a ZTC world.3 Rather, Coase was concerned with showing that the treatment of externalities in the Pigovian tradition implicitly partitioned the world into two categories: those things which the market handled perfectly (normal goods with ZTC) and those which