SFB 303 Discussion Paper No. A - 313
Author: Schweizer, Urs
Title: Liberty of Contract versus Coercion through Rules
Abstract: External effects are traditionally claimed to give rise to a discrepancy
between private and social benefits which, in turn, prevents the involved
parties from achieving a first best solution. The government is then called
in to provide the proper remedies. The traditional argument does not stand
firm under scrutiny as it relies on noncooperative behavior of, in essence,
the Prisoners' Dilemma type without however giving much thought to the
implicit assumption of the paradigm which has parties sitting in separate
cells. The paradigm need not fit. Moreover, even if it does, the government
may face similar difficulties in penetrating the walls while administering
the corrective measure. The present paper advocates the view to specify
the assumption of the paradigma in contractual terms. The approach allows
to explore the tradeoff between market and policy failure in a framework
which is well balanced in that it has all institutional arrangements
operating in the same environment as far as the setting of transaction
costs is concerned.
Keywords: bilateral externalities, market failure, policy failure, constitutional
choice
JEL-Classification-Number: 025
Creation-Date: September 1990
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