Criticisms of Coase Theorem: Can Ethical Strength of the Parties Ensure Efficient Resource Allocation?

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Centre for Research on Islamic Management and Business


Ronald Harry Coase (1910–2013), a British economist and author in his famous Coase Theorem states, „As long as private property rights are well defined under zero transaction cost, exchange will eliminate divergence and lead to efficient use of resources or highest valued use of resources.‟ The theorem has greater implications to internalize the externalities through market mechanism. However, the theorem has been criticized by environmental economists since the fundamental flaws of the theorem lie under the invalidity of its assumptions in the reality. Specially, in the presence of environmental externality, the assumptions of the theorem are not valid. This paper focuses on the role of parties in transaction where environmental externality exists, from the perspective of Islamic ethics. The paper argues, in the presence of negative externality where the assumptions of Coase Theorem are not applicable, the internalization of externality can still be possible without any government intervention. Such internalization is related to the ethical strengths of the parties involved in the environmental pollution. The paper further argues, the efficiency of resource utilization is positively related with the ethical strength of the parties in the market.



Coase Theorem, Ethical Strength, Efficient Resource Allocation, Internalization of Externality,, Environmental Pollution


Vol.4, No. 1, June 2016