Posted by: Patrick Allen Foster | September 6, 2013

Ronald Coase, RIP

Ronald Coase, the economist, was 102 when he died, and he was still publishing after his hundredth birthday. He worked at the University of Buffalo and the University of Virginia before joining the faculty at the University of Chicago in 1964. Known for the “Coase Theorem” and for a paper that he wrote in 1937, “The Nature of the Firm,” he received the Nobel (Memorial) Prize in Economics in 1991. An economist, Coase was extraordinarily influential in the development of the field of study now called law and economics.

Professor Bainbrige has a number of posts on Coase’s work. This post includes an excerpt from a book review that Bainbridge wrote in 2003 (emphasis added):

Coase is best known for two seminal articles. The earlier article “The Theory of the Firm” is the seminal work on the so-called nexus of contracts theory of the firm, as well as an early source for the transaction cost branch of the New Institutional Economics. The nexus of contracts model treats the firm not as an entity, but as an aggregate of various inputs acting together to produce goods or services. Employees provide labor. Creditors provide debt capital. Shareholders initially provide equity capital and subsequently bear the risk of losses and monitor the performance of management. Management monitors the performance of employees and coordinates the activities of all the firm’s inputs. The firm is simply a legal fiction representing the complex set of contractual relationships between these inputs. Besides emphasizing the importance of examining the various contracts making up the firm, however, Coase’s fundamental insight was that the contractual nature of the firm does not preclude an element of command and control absent from market transactions. If a corporate employee moves from department Y to department X he does so not because of change in relative prices, but because he is ordered to do so. In other words, markets allocate resources via the price mechanism but firms allocate resources via authoritative direction. The set of contracts making up the firm consists in very large measure of implicit agreements, which by definition are both incomplete and unenforceable. Under conditions of uncertainty and complexity, the firm’s many constituencies cannot execute a complete contract, so that many decisions must be left for later contractual rewrites imposed by fiat. …

Even better known, and even more central to transaction cost economics, however, is Coase’s later article “The Problem of Social Cost,” which also is reprinted in full here. In that article, Coase laid a critical foundation of modern law and economics – the so-called Coase theorem. The Coase theorem has been formulated in various ways, but one useful statement might be that: “When the parties can bargain successfully, the initial allocation of legal rights does not matter.” Suppose a steam locomotive drives by a field of wheat. Sparks from the engine set crops on fire. Should the railroad company be liable? In a world of zero transaction costs, the initial assignment of rights is irrelevant. If the legal rule we choose is inefficient, the parties can bargain around it. Put another way, according to the Coase theorem, rights will be acquired by those who value them most highly, which creates an incentive to discover and implement transaction cost minimizing governance forms.

… One of the less-well informed criticisms of Coase is that he assumes transaction costs are zero. He does not, as this new essay makes clear. Indeed, as Coase points out, the interesting cases are those in which transactions costs are non-zero. In a world of positive transaction costs, however, the parties may not be able to bargain. This is likely to be true in our example. The railroad travels past the property of many landowners, who put their property to differing uses and put differing values on those uses. Negotiating an optimal solution will all of those owners would be, at best, time consuming and onerous. Hence, the allocation of legal rights becomes quite important.

Bainbridge also has a post pointing to some of Coase’s books, and this post provides a roundup of remembrances and tributes to Coates.

This post provides a good overview of some of Coase’s work. (H/T: Tyler Cowen.)

At the Volokh Conspiracy, a number of contributors have posts about Coase. Jonathan Adler has this overview post, a post about how Coase has been misunderstood, and a post on Coase and externalities. Todd Zywicki also has a post on Coase’s approach to property rights and incompatible uses of property rights. Ilya Somin has this post: “One of my personal favorite Coase articles is ‘The Lighthouse in Economics,’ where Coase shows that private entrepreneurs successfully established and operated an enterprise that most economists believed was the classic example of a public good that could only be provided by government. This doesn’t prove that the private sector can provide all public goods (nor did Coase claim that it can); but it does show that we should be more careful than we usually are in asserting that a given good can only be provided by the state just because it is public in nature. Before Coase, most scholars and public policy experts had simply assumed that the private sector was incapable of providing lighthouses without much investigation of the issue.”

Prof. Adler also points to a Wall Street Journal op-ed by economist David Henderson. An excerpt from Henderson’s piece:

In his early 20s, Coase was a socialist, but he had a trait that few socialists have: curiosity about how economies work. On a trip to the United States from his native Britain in 1931 and 1932, he dropped in on perennial Socialist Party presidential candidate Norman Thomas, and he visited Ford and General Motors. How, he wondered, could economists say that Lenin was wrong to believe that the Russian economy could be run like one big factory, when some big firms in the U.S. seemed to run well?

Coase’s answer, in his widely cited 1937 article “The Nature of the Firm”: Companies are like centrally planned economies, but unlike the latter, they are formed because of people’s voluntary choices. But why do people make these choices? Coase wrote that the answer is “marketing costs,” or what economists now call “transaction costs.” If markets were costless to use, there would be no point in forming companies. Instead, people would make arm’s-length transactions. But because markets are costly to use, the most efficient production process often takes place within a company. His explanation of why companies exist spawned a whole literature.

As Profs. Adler, Somin, and others note, it does seem that many people have missed the point of the “Coase Theorem.” Peter Boettke has a clear and very readable post on that topic (emphasis added): “The point of Coase’s intellectual exercise was to get economists (and others) to think not of the zero-transaction cost world, but instead about the role that alternative institutions play in ameliorating or exacerbating conflicts in a world of positive transaction costs. It is all about comparative institutional analysis.”

As Boettke notes, “The Coase theorem as laid out in ‘The Problem of Social Cost’ emerged out of his studying of broadcasting rights and the FCC, and it was written and published while Coase was at the University of Virginia.” For more on Coase’s work with the FCC and spectrum allocation, see this Marginal Revolution post and the embedded video. Also, Nick Gillespie has a piece at Reason looking at why Coase left UVA to go to Chicago. (H/T: Marginal Revolution.)

Finally, Henry Farrell has this post at Crooked Timber: “I met him briefly once, at the third meeting of the International Society for the New Institutional Economics, where he gave the keynote address. His address was followed by the usual kind of discussion, in which various prominent institutional economists asked self-serving ‘questions’ that were obviously crafted to magnify their role, or further their own specific agenda. Coase, who was then in his late eighties, did a wonderful job of deflating them in a fashion that combined acerbity and politeness.”


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