I want to make the argument that the Coase Theorem can be applied to a bargaining problem between two (or more) states. More specifically, I want to suggest that the logic of Coasian bargaining potentially undermines the idea of a monopolistic state, and any such state can only be justified insofar as it does not suppress the formation of new states (i.e., does not quell secession). This has implications for theories of territorial secession and federation, the protection of territorially dispersed minorities, and the emergence of non-territorial, ‘virtual’ states.
The Coasian dictum is that in a world without transaction costs, people would bargain with one another to produce the most efficient distribution of resources, regardless of the initial allocation of property rights over said resources. I suggest that the political analogy is to say, in a world without mobility costs, states would bargain with one another to produce the most efficient distribution of citizens, regardless of the initial allocation of authority rights over said citizens.
All this is perhaps more interesting in relation to secession and the formation of new states. When the initial allocation of authority is monopolistic the dictum becomes: in a world without secession costs, states would bargain with one another to produce the most efficient distribution of citizens, regardless of the initial allocation of authority rights over said citizens. Put another way, an initial allocation of political authority is inconsequential (and thus a monopolistic allocation can be ‘justified’) if and only if Coasian bargaining with zero secession costs is allowed to proceed between affected states (i.e., an incumbent state and latent states).
To illustrate, consider the familiar example of the cattle farmer and the crop farmer. In The Problem of Social Cost, Coase uses the example of two neighbouring farming properties with no fencing, such that straying cattle from one farm trample and destroy the crops of the other. This, of course, imposes a negative externality from one farm to the other, which is given as an assumption: no matter what, economic activity on the part of the cattle farmer imposes a negative externality on the crop farmer.
The question is, how much activity (i.e., how many cattle) will the cattle farmer undertake? The more cattle, the greater the externality, up to some point. Coase argued that if we lived in a world without transaction costs, the two farmers would bargain with one another to produce the most efficient distribution of resources, regardless of the initial allocation. That is to say, they would coordinate activities (the cattle farmer would raise so many cattle and the crop farmer would plant so many crops) so as to maximise the joint value of their economic activity, and side payments would be arranged as part of the bargain. If cattle raising was more productive, the cattle farmer would raise more cattle and compensate the crop farmer. In the extreme, the cattle farmer would ‘rent’ both properties and the crop farmer would plant no crops but receive income solely in the form of a side payment from the cattle farmer (or visa versa).
So in this example: (1) two farmers are endowed with an initial allocation of property rights over plots of land; (2) the object of each farm is to maximise income; (3) this is achieved by utilising their property to produce value (via goods); (4) one farmer imposes a negative externality on another; (5) if the two farmers can easily bargain with each other they will internalise the externality with transfer of property and side payments. Essentially, the cattle farmer generates an external cost on the crop farmer by reducing the income derived from the crop farmer’s plots of land. If the cattle-good is more valuable than the crop-good, the cattle farmer will take over more and more plots of land from the crop farmer, until the efficient distribution of resources (plots of land) is achieved. Of course this is all dependent on zero transactions costs (or tolerable operation of bargaining). See FIG 1 below.
FIG 1. Cattle farmer bargains so as to raise more cattle and control more plots of land (without transaction costs)
I make the claim that instead of bargaining over control of plots of land like the farmers, states bargain over control of citizens. Further, states ‘use’ citizens to produce welfare (cf. income) by way of policy (cf. goods). In this analogy: (1) two states are endowed with an initial allocation of authority rights over citizens; (2) the object of each state is to maximise utility; (3) this is achieved by utilising their authority to produce welfare (via policy); (4) one state imposes a negative externality on another; (5) if the two states can easily bargain with each other they will internalise the externality with transfer of authority and side payments. Essentially, the incumbent state generates an external cost on the latent state by reducing the utility derived from the latent state’s citizens. If incumbent-policy is more ‘welfaring’ than the latent-policy, the incumbent state will take over more and more citizens from the latent state, until the efficient distribution of resources (citizens) is achieved. And again, this is all dependent on zero secession costs (or tolerable operation of bargaining).
The more interesting case of secession, however, begins with a monopolistic allocation of authority rights over citizens. In such a case, the incumbent state is imposing a negative externality on the latent state, since it is reducing the utility of potential latent-state citizens and is thus reducing the welfare that would otherwise be produced by the latent state (if it were to exist). Assuming zero secession costs, the latent state would be able to bargain with the incumbent state for authority over its potential citizenry, and we would arrive at the externality-internalising efficient outcome of two states. See FIG 2 below.
FIG 2. Latent state bargains so as to enact policy of its own and control its own citizenry (without secession costs)
We know however, that secession costs are rarely, if ever, tolerable. This is because the chief arbiter of these costs is the incumbent state itself (!) – incumbent states often actively quell secession and suppress bargaining efforts. Interestingly, this tendency might be explained by Coase’s insight as to the reciprocal nature of externality. If secession costs are indeed a barrier to bargaining and the efficient outcome, then the result (that we are left with a monopolistic incumbent state) is a perverse one. See FIG 3 below.
Conversely, if secession costs are zero and the bargaining process results in a monopolistic state, then this is evidence that there was in fact no latent state to begin with (indeed no bargaining takes place), and all is well in the world. See FIG 4 below. The upshot of all of this is that a monopolistic outcome can only be ‘justified’ by appeal to the logic of Coasian bargaining and ‘transaction cost economics’ when secession costs are proven to be small and the bargaining process operates tolerably well. Since the incumbent state is the arbiter of these costs, rather than suppressing bargaining efforts it should actively support the emergence of latent (virtual) states. Paradoxically, anything less would seem to undermine the legitimacy of an observed monopolistic outcome.