^1. See Coase, R.H., “The Problem of Social Cost” (1960) 3 Journal of Law & Economics 1CrossRefGoogle Scholar [hereinafter cited as Coase, “Social Cost”]. For a quite recent reaffirmation of Coase's insistence on the overriding importance of transaction costs, see Coase, R.H., The Firm, the Market, and the Law (Chicago 1988) [hereinafter cited as Coase, The Firm], p. 13:Google Scholar “In sections III and IV [of ‘The Problem of Social Cost’], I examined what would happen in a world in which transaction costs were assumed to be zero. My aim in so doing was not to describe what life would be like in such a world but & to make clear the fundamental role which transaction costs do, and should, play in the fashioning of the institutions which make up the economic system” There are several other such passages in the opening chapter of Coase's 1988 book. Equally blunt is the following passage from a later chapter: “The world of zero transaction costs has often been described as a Coasian world. Nothing could be further from the truth. It is the world of modern economic theory, one which I was hoping to persuade economists to leave.” Ibid., at p. 174.

^2. The critique is advanced most directly in Coase, “Social Cost,” at pp. 28–42. For a recent reassessment of Coase's attack on Pigou, see Simpson, A.W. Brian, “Coase v. Pigou Re-examined” (1996) 25 Journal of Legal Studies 53;Google ScholarCoase, R.H., “Law and Economics and A.W. Brian Simpson” (1996) 25 Journal of Legal Studies 103.CrossRefGoogle Scholar For my purposes, the most important parts of these two articles are Simpson, op. cit., at pp. 65–74, 92–97; and Coase, op. cit., at pp. 111–116. My views on the fairness of Coase's critique are basically unchanged in the aftermath of Simpson's article (though I concede that Coase may have overstated one or two points that are not of direct relevance to my own focus). My continued admiration of Coase's analysis derives not least from the fact that Simpson himself—near the end of his article—interprets Coase along lines very similar to my own interpretation. See note 10 below.

^3. Unlike Pigou, I shall not take any notice of people's inability to capture the full benefits of their own projects. To avoid needless complications, I shall assume that the benefits accruing to each individual from his projects are equivalent to the social benefits thereof.

^4. For the portions of Pigou's analysis on which Coase focuses, see Pigou, A.C., The Economics of Welfare, 4th ed. (London 1932), pt. II, chs. 1, 2, & 9.Google Scholar I should note, incidentally, that Coase looks askance at the term “externality”. See Coase, The Firm, at p. 27. I do not share his reservations.

^5. Coase, “Social Cost”, at p. 31. Cf Coase, The Firm, at p. 178: “The same approach which, with zero transaction costs, demonstrates that the allocation of resources remains the same whatever the legal position, also shows that, with positive transaction costs, the law plays a crucial role in determining how resources are used.”

^6. Of course, Pigou did not advocate the removal of all externalities. As Brian Simpson quite rightly maintains, “Pigou would have been completely off his head if he had argued in favor of intervention, either by regulation or administrative control, or by bounties and taxes, in every situation where a divergence existed between social and private net products. His examples show that he was perfectly well aware of the ubiquity of externalities. Pigou seems to have viewed them as part of the natural order of things.” Simpson, op. cit., at p. 71. Nonetheless, Pigou did regard intervention as desirable in principle; his wise refusal to propose the elimination of all externalities was based on his concern over the costliness and ineptitude of governmental mechanisms rather than on his grasping that even highly effective and inexpensive means of removing externalities can be undesirable in certain circumstances.

^7. Like Coase, I am assuming away the costs involved in attaining due compensation from the railway company.

^8. Coase, “Social Cost”, at pp. 33–34.

^9. It should go without saying that the point made here will apply mutatis mutandis to circumstances involving more than two parties.

^10. Simpson, op. cit., at p. 93. Noting that “[s]econdary responses might be the crux of the matter”, Ibid., at p. 94, Simpson further comments: “Perhaps a fair interpretation [of Coase's attack] would be to say that Pigou did not realize that what must be compared, in the case of fire damage from engines, was the world with and the world without a system of enforced compensation and that in constructing the two worlds for comparison we must take into account all possible courses of action, and not just changes in behavior by one party identified by the conception of active causation,” Ibid., at p. 95.

^11. Coase has very briefly contemplated the possibility of a mitigation-of-damages rule in connection with the argument that appears in the early part of “The Problem of Social Cost” (where the premise of no transaction costs is operative). See Coase, The Firm, at p. 177. However—as far as I know—no one has broached the possibility of a mitigation-of-damages rule in connection with the later parts of Coase's article, on which I am focusing.

^12. Coase, “Social Cost”, at p. 34.

^13. Ibid., at p. 44. To be fair, I should acknowledge that we can find largely similar sentiments in some of Pigou's work: “The issue about which popular writers argue—the principle of laissezfaire versus the principle of State action—is not an issue at all. There is no principle involved on either side. Each particular case must be considered on its merits in all the detail of its concrete circumstance.” Pigou, A.C., A Study in Public Finance, 3rd ed. (London 1947), pp. 127–128,Google Scholar quoted in Simpson, op. cit., at p. 72.

^14. I am grateful for astute comments on this essay from Chiaki Hara of Churchill College, Cambridge. I also wish to thank Pavlos Eleftheriadis (of Queen Mary & Westfield College, London) for asking a perceptive question that prompted me to write this essay.