DECENTRALIZATION, EXTERNALITIES, AND EFFICIENCY

In the competitive model, externalities lead to inefficiencies, and in efficiencies increase with the size of externalities. However, as argu ed by Cease, these problems may be mitigated in a decentralized system through voluntary coordination. We show how coordination is limited b y the combination of two factors: respect for individual autonomy and the existence of private information. Together they imply that efficie nt outcomes can only be achieved through coordination when external ef fects are relatively large. Moreover, there are instances in which coo rdination cannot yield any improvement at all, despite common knowledg e that social gains from agreement exist. This occurs when external ef fects are relatively small, and this may help to explain why coordinat ion is so seldom observed in practice. When improvements are possible, we describe how simple subsidies can be used to implement second-best solutions and explain why standard solutions, such as Pigovian taxes, cannot be used. Possible extensions to issues arising in the structur e of research joint ventures, assumptions in the endogenous growth lit erature, and the location of environmental hazards are also described.