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Wednesday, October 26, 2016

The State’s Crystal Ball Cannot Fix Externalities

How can the economic organization be improved upon by endogenous institutional rearrangements?


The following quote is from the closing lines of one of the best articles ever written on externalities – an article, on this topic, second only to Ronald Coase’s classic 1960 article, “The Problem of Social Cost”; the article quoted below is Carl Dahlman’s April 1979 Journal of Law & Economics contribution, “The Problem of Externality“:

The question then ultimately becomes: how can the economic organization be improved upon by endogenous institutional rearrangements?  This is not the outlook of modern welfare theory where the government is seen as a force outside the economic system altogether, which will come to our aid and rectify the havoc wrought by endogenously working market forces, just like the classical deus ex machina.  Coase opens the door for an economic theory of institutions, whereas modern welfare theory can only gaze into its crystal ball of mathematical abstraction and wisely state that heaven on earth is still far off – which is true, but of no particular consequence either for the correct conduct of economic policy or for the theory of externalities.

Republished from Cafe Hayek.


  • Donald J. Boudreaux is a senior fellow with the F.A. Hayek Program for Advanced Study in Philosophy, Politics, and Economics at the Mercatus Center at George Mason University, a Mercatus Center Board Member, and a professor of economics and former economics-department chair at George Mason University.