The article develops R. H. Coase’s insight that the level of transaction costs in the market determines the amount of externalities, thus providing arguments against government intervention. Contrary to Coase, however, we argue that the level of transaction costs cannot be considered as given, and that there is therefore a case for selective and innovative government intervention to reduce such transaction costs. Externalities are approached as intrinsically new and dynamic impacts, whose transaction costs diminish over time, a process that can be accelerated by appropriate government action. In contrast, internalization by means of public intervention through Pigouvian taxation is shown to be epistemologically untenable: if externalities had sufficient information content to allow governments to determine optimal tax levels, these same externalities would already have been fully internalized by the market. The final part of the article proposes two internalization strategies based on a dynamic re-interpretation of the Coasean approach. The first aims at developing feedback mechanisms between generators of externalities and those affected by them through media other than the market. The second seeks to reduce transaction costs in order to extend the domain in which markets can operate effectively by proposing codification strategies for the informational complexities characterizing externalities.
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