Ronald Coase, a luminary in economic thought, is best known for the Coase Theorem, a pivotal concept nestled within his broader analysis in the paper The Problem of Social Cost. To distill it down to its essence: in a realm where transaction costs are negligible, the specifics of property rights and legal frameworks become almost irrelevant. Random assignment of rights will invariably lead to efficient outcomes, with the burden of problem-solving falling on the party best equipped to avoid costs. However, in scenarios rife with high transaction costs, the delineation of rights takes on critical importance. Conflicts emerge from the interactions between parties, and even if one party is deemed “in the wrong,” they might not be the ideal candidate to bear the responsibility for rectifying the situation. Coase articulates this notion succinctly:
Most economists conclude that it would be preferable to hold the factory owner responsible for damages inflicted by smoke, impose a tax on the factory proportional to the emissions, or even relocate the factory away from residential zones (and perhaps from any area negatively impacted by smoke). Yet, I argue that these proposed solutions are misguided, often resulting in outcomes that are neither necessary nor desirable.
Judges appear to intuitively grasp the significance of rights assignment in high transaction cost scenarios, at least in practice. Typically, when disputes arise, judges tend to advocate for settlements, encouraging the parties to negotiate a mutually satisfactory resolution. This inclination suggests a reluctance to impose decisions, perhaps fueled by a desire to lighten their caseloads—an understandable sentiment given their overwhelming workloads. Nonetheless, this behavior hints at a subtle appreciation for economic efficiency among judges.
However, the very nature of transaction costs—including those related to negotiation—can hinder the path to settlement. Emotional turmoil, such as anger or disappointment, often complicates negotiations, effectively acting as transaction costs themselves. As my colleague John Schuler and I elaborated in our 2019 Econlib article Have Coase – Will Travel,* these emotional barriers are formidable, and judges possess limited tools to mitigate them.
In response to these challenges, mediation has emerged over recent decades as a viable strategy for lowering transaction costs. This private, law-adjacent process aims to resolve conflicts by facilitating negotiation between disputing parties. Judges may propose mediation, or it may be voluntarily pursued by the parties involved. Mediators play a crucial role by fostering dialogue, conveying sentiments, and encouraging creative problem-solving, often resembling therapists more than traditional legal figures.
The mediation process exemplifies a Coasean approach, as mediators act as intermediaries to reduce transaction costs and promote efficient legal resolutions. In this light, they align with the traditional role of middlemen in enhancing efficiency across various sectors.
Scholars of common law, from Richard Posner to contemporary thinkers, argue that one of its key strengths is its propensity for economic efficiency. The rise of mediation as a means to alleviate negotiation-related transaction costs further substantiates this argument.
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*For a classroom discussion on this topic, see Have Coase – Will Travel: New Ways to Teach Coase Using Old Media by Jon Murphy, John Schuler, and Jadrian Wooten (2020). Journal of Private Enterprise 25 (4), 71-86.
