The Transaction Costs of Sustainability: Coase’s Proviso and the Roles of Environmentalists and the Government

Abstract

Environmentalists believe that the Coasean approach is economically efficient but environmentally unsustainable. While acknowledging that this approach is not always sustainable, this paper emphasises its important advantage—the presence of a criterion determining when an activity will/will not lead to an efficient/sustainable outcome. Coase formulated this criterion on what is termed in this paper “Coase’s proviso”—the balance between the net benefits of an institutional change (rearrangement of entitlements) and transaction costs associated with this change. The article also defines the terms “best use”, “second (or next) best use” and “best user”. On this basis, the paper restates Coase’s proviso and argues that there is no inherent contradiction between economic efficiency and environmental sustainability. According to the restated proviso, when the transaction costs associated with the institutional transformation establishing the best use of a resource are lower than the net benefits of this transformation, the result will be economically efficient and environmentally sustainable. However, if the transaction costs outweigh the net benefits of the best use, a second (or next) best use may be established, which will still be economically efficient, but most likely environmentally unsustainable. The paper explores a case study to check the relevance of the restated proviso.