The Problem of Social Income: The Entity View of the Cathedral

Abstract

In 1960, Ronald H. Coase famously addressed the problem of externalities - actions of business firms that have harmful effects on others - or, as he renamed it, “the problem of social cost.” This problem occurs under every joint economic activity (including business firms) having reciprocal consequences on its stakeholders. This Article seeks to address the underlying economic coordination problem through a comparative analysis of the alternative institutional solutions of ownership, market, taxation, responsibility, and the accounting system of the joint entity.

Each prospective solution carries a distinct strategy. The ownership solution involves the allocation, by law, of control rights that individuals can bargain for. The market solution, in contrast, involves the allocation of that right through a competitive auction. Taxation requires the establishment of a public order concerned with the power to fix and raise taxes, whereas the responsibility solution involves the enforcement of a compensation claim or liability for tort damages. Finally, the entity solution consists of a joint system of governance that is characterized by an accounting system of the joint activity under scrutiny.

Coase claims that the delimitation of property rights is, in and of itself, sufficient to achieve social welfare. But Coase bases this claim on an efficiency criterion that looks solely to the sum of individual welfares, without regard to the possibility of inequitable results. His approach confounds notions of social cost, incurred loss, and lost opportunity gain, and faces distinctive accounting problems with individual availability and capacity to pay, along with the incommensurability of values. This Article takes a different approach. It introduces a “systemic efficiency” or "economic fairness" criterion based on welfare ranges for individuals in addition to the total sum. Using this criterion, this Article argues that, by requiring explicit income-sharing and joint-decision instrumentalities, the entity solution is the most efficient and equitable solution to the social cost problem.

Keywords: social cost, externalities, governance, entity theory, accounting system, economics of regulation, welfare analysis, social performance, social responsibility, Pareto Principle, property rules, liability rules

JEL Classification: D60, K13, L51, M40