My comment was not restricted to “penalty clauses”, it includes contracts more generally. Obviously we can think of contracts which would cause negative externalities if they were enforced, e.g. through a penalty clause. Refusing to enforce some of these contracts increases utility.
Re: extortion, it’s not clear what the correct decision-theoretic analysis is. One might think that the real issue is not so much with the extortion itself (since this is in fact a contract to which Coasian arguments should apply), but with any attempt to expend real resources in order to improve one’s bargaining position:
Given that someone is willing to break my legs unless I pay him off, a contract where I pay him off and he refrains from breaking my legs is Pareto efficient and may even maximize utility if, say, the extortionist happens to have a high marginal utility of wealth compared to myself. (Of course, this is a rather convenient assumption: the real point is that pure transfers of resources do not have bad properties in the general case.)
But it is obvious that losses are involved: agents now have a perverse incentive to acquire the potential to extort others (where they didn’t have such an incentive before), and victims have an incentive to boost their own bargaining power by acquiring means of defense or by pre-committing not to pay off extortionists (and this is quite costly as well: it means that negotiation can break down, and extortionists will then want to make good on their threats).
The notion that extortion is avoided if contracts are “free from coercion” is not unproblematic. “Free from coercion” generally means respecting property rights. But how are property rights to be assigned in the first place? Should a railroad operator have the “right” to throw sparks onto a nearby field, or should the field owner be allowed to forbid trains from passing near her property unless they are fitted with a costly spark preventer? Note that here, either of the agents may seek to extort the other! So, although some property right assignments are sensible (the right not to be shot, and not to have one’s legs broken) this doesn’t really solve the problem in the general case.
The principled solution to this problem would be entering a once-and-for-all contract in which we all refrain from seeking increased bargaining power in damaging ways, but obviously the same issues apply to this contract, so we have a vicious cycle. We use a variety of solutions to deal with this, including imperfect contract enforcement, and social norms which forbid extortion: in fact, we generally try to find deals which will benefit others, as opposed to harming them.
My comment was not restricted to “penalty clauses”, it includes contracts more generally. Obviously we can think of contracts which would cause negative externalities if they were enforced, e.g. through a penalty clause. Refusing to enforce some of these contracts increases utility.
Re: extortion, it’s not clear what the correct decision-theoretic analysis is. One might think that the real issue is not so much with the extortion itself (since this is in fact a contract to which Coasian arguments should apply), but with any attempt to expend real resources in order to improve one’s bargaining position:
Given that someone is willing to break my legs unless I pay him off, a contract where I pay him off and he refrains from breaking my legs is Pareto efficient and may even maximize utility if, say, the extortionist happens to have a high marginal utility of wealth compared to myself. (Of course, this is a rather convenient assumption: the real point is that pure transfers of resources do not have bad properties in the general case.)
But it is obvious that losses are involved: agents now have a perverse incentive to acquire the potential to extort others (where they didn’t have such an incentive before), and victims have an incentive to boost their own bargaining power by acquiring means of defense or by pre-committing not to pay off extortionists (and this is quite costly as well: it means that negotiation can break down, and extortionists will then want to make good on their threats).
The notion that extortion is avoided if contracts are “free from coercion” is not unproblematic. “Free from coercion” generally means respecting property rights. But how are property rights to be assigned in the first place? Should a railroad operator have the “right” to throw sparks onto a nearby field, or should the field owner be allowed to forbid trains from passing near her property unless they are fitted with a costly spark preventer? Note that here, either of the agents may seek to extort the other! So, although some property right assignments are sensible (the right not to be shot, and not to have one’s legs broken) this doesn’t really solve the problem in the general case.
The principled solution to this problem would be entering a once-and-for-all contract in which we all refrain from seeking increased bargaining power in damaging ways, but obviously the same issues apply to this contract, so we have a vicious cycle. We use a variety of solutions to deal with this, including imperfect contract enforcement, and social norms which forbid extortion: in fact, we generally try to find deals which will benefit others, as opposed to harming them.