On Coase and Coasean Economics

|Peter Boettke|

Last night in my graduate seminar on comparative institutional analysis we discussed Ronald Coase's 1991 Nobel Lecture -- "The Institutional Structure of Production." If you haven't read it recently, read it again carefully.  Coase is the master economic theory minimalist, and one of the most illuminating thinkers of the 20th century.  He is also a very humble man, never claiming originality for himself.  But as with most brilliant thinkers, it is only because of their statements that we come to see their point as obvious.  One of my favorite paraphrases of Coase is actually from in paper on the FCC, if you read that article you will see that he attributes his basic idea to Adam Smith --- as I put it, Coase says basically 'my "novel" theory (novel that is if you haven't read Adam Smith)'.  This statement expresses a classic Coasean intellectual sentiment -- understated, but also so fundamentally true.  Coase is all about exchange and the institutions within which exchange takes place. 

The Nobel Prize lecture highlights how the socialist calculation debate -- as communicated through Arnold Plant -- influenced the young aspiring economist Ronald Coase at the LSE, and led to his work on the theory of the firm.  The lecture also straightens out the meaning and purpose of the "Coase Theorem" --- as Coase says:

What I showed in that article, as I thought, was that in a regime of zero transaction costs, an assumption of standard economic theory, negotiations between the parties would lead to those arrangements being made which would maximise wealth and this irrespective of the initial assignment of rights. This is the infamous Coase Theorem, named and formulated by Stigler, although it is based on work of mine. Stigler argues that the Coase Theorem follows from the standard assumptions of economic theory. Its logic cannot be questioned, only its domain. I do not disagree with Stigler. However, I tend to regard the Coase Theorem as a stepping stone on the way to an analysis of an economy with positive transaction costs. The significance to me of the Coase Theorem is that it undermines the Pigovian system. Since standard economic theory assumes transaction costs to be zero, the Coase Theorem demonstrates that the Pigovian solutions are unnecessary in these circumstances. Of course, it does not imply, when transaction costs are positive, that government actions (such as government operation, regulation or taxation, including subsidies) could not produce a better result than relying on negotiations between individuals in the market. Whether this would be so could be discovered not by studying imaginary governments but what real governments actually do. My conclusion; let us study the world of positive transaction costs.

Too many commentators -- and that includes an entire generation of Austrian economists -- have completely missed the importance of Coase's insight. There is obviously room for disagreement with Coase on fine points of theory and the implications of those points.  But the quoted passage deserves to be read very carefully again and again so that its very subtle point sinks in.  In Coase's hands the Pigovian remedies of tax and subsidies to address externalities are rendered either redundant or non-operationaly by a logical analysis grounded in the standard assumptions of economic theory upon which those remedies were recommended in the first place.  Minimal theory, maximum illumination --- that is Coase's defining characteristic as an economic thinker.  We should all be so fortunate to be as 'unoriginal' as Coase in our economic analysis!!!  If only the rest of the economics profession was content with pursuing the logic of Adam Smith's insights on the human propensity to truck, barter and exchange so persistently and consistently to its logical conclusion, then we would be much better economists and policy analysts.

I wrote a tribute to Coase after his death last year, and many years ago now I wrote a paper trying to mimic the Coasean style of analysis to explain the operation of the Soviet-type economy.  As many of my GMU students have heard numerous times, when I taught my comparative institutional analysis graduate class at NYU through the 1990s I would make the students (more alergic to economic minimalism than my students at GMU) read Coase's classic "social cost" paper numerous times throughout the semester.  As Jim Buchanan taught me -- it takes varied iterations to force alien concepts upon reluctant minds.  Those students didn't want to hear about the Coase Theorem, they preferred discussions about Arrow's Theorem and Sen's Paradox.  While discussing Arrow and Sen, I nevertheless returned again and again to Coase (and Buchanan).  I often wonder if 20 years later any of those students think differently about public economics because of that experience.

Perhaps they do, and if so, I hope some of them will consider the following announcement:

Man and the Economy

Call for Papers for a Special Issue in Memory of Ronald Coase

“R. H. Coase: The Man and His Ideas”

Man and the Economy will devote a special issue (December 2014) to the life and ideas of Ronald Coase, the 1991 Nobel Laureate in Economics and Founding Editor of this journal. During his long academic life, Coase devoted himself to economics, which, in his view, should investigate how the real world economy works, with all its imperfections. Coase viewed and practiced economics as a social science, a study of man creating wealth in society through various institutional arrangements. To honor the memory of Coase, we welcome original research articles that extend and develop the Coasian economics, including empirical studies of the structure of production and exchange. We also welcome critical and constructive commentaries that clarify and elaborate the Coasian themes, from a law-and-economics/new institutional economics perspective, which include, but not limited to, topics on transaction costs, property rights, theories of the firm and China’s economic transformation. In addition, we also welcome personal reflections and reminiscences of Coase as a colleague, a teacher, an editor, and/or a friend.

Submissions must be made online via the Journal’s website: http://www.degruyter.com/view/j/me Deadline for submissions is September 30, 2014.

Comments

[PerBylund]

There is plenty of good stuff and illuminating comments in Coase's works, but there is also a lot of vague and ambiguous reasoning. The latter sometimes makes it quite confusing what Coase is trying to say. His 1937 piece is a case in point, in which he (as noted by e.g. Demsetz) misunderstands economic reasoning and opportunity costs to such a degree that he invents "marketing costs" as somehow "outside" of opportunity costs. His argument for the firm is at best a confused tautology based on a misunderstanding.

This being said, his humility and approach is in many ways laudable. Coase was also fearless in challenging rather universally held (mis)conceptions, which is a fantastic quality when right and detrimental when wrong (as in the 1937 piece).

In my view, of the two papers cited by the Royal Swedish Academy of Sciences for his "Nobel" prize, the 1960 piece is far better than the 1937. One can tell that Coase, while sticking to some misconceptions, was much more mature as a scholar when writing the latter.

[SilasX]

What do you think about this critique, i.e. the question of where Coasean bargaining ends and extortion begins?

[BAllanHansen]

That "critique" highlights some of the differences between Coase and his critics. First the author hasn't read Coase. If he had, he would know that Coase used the unrealistic case of zero transaction costs to show why property rights did matter in a the real world of positive transaction costs. Coase's primary point was always that economists should study the real world. If they actually looked carefully at the real world they would see that lighthouses did not have to be provided by the government, farmers can pay beekeepers, and Fisher Body and GM did not merge because of a hold up problem. If the "author" of the "critique" had ever glanced at the real world he might have known that his scheme to make a fortune with his roaming cattle would not work. In the real world farmers that want to keep out roaming cattle put up fences.

As for the first comment, I missed where Coase said that marketing cost were somehow "outside" opportunity costs. I would appreciate it if I could be directed to where he stated that.

[Mark Steckbeck]

Here is how I explain to law school students Coase's insight in "The Problem of Social Cost." It is so important for the legal profession, much less economists, to get Coase's insight correct. You're right—it is simple, but so overlooked.

[Jim Rose]

see http://www.youtube.com/watch?v=yqT6koFnEwA for a great lecture by Coase in 2003 discussing many of the above issues using, at bottom, mostly the price theory he learnt at LSE from arnold plant.