Decentralization, Externalities, and Efficiency.

In the competitive model, externalities lead to inefficiencies and inefficiencies increase with the size of externalities. However, as argued by R. H. Coase (1960), these problems may be mitigated in a decentralized system through voluntary coordination. The authors show how coordination is limited by the combination of two factors: respect for individual autonomy and the existence of private information. Together they imply that efficient outcomes can only be achieved through coordination when external effects are relatively large. Moreover, there are instances in which coordination cannot yield any improvement at all, despite common knowledge that social gains from agreement exist. Copyright 1995 by The Review of Economic Studies Limited.