Professor Ronald H. Coase passed away earlier today at the age of 102 in Chicago, IL (USA). Coase won the Nobel Prize in Economic Science in 1991 for his contributions to the fields of law and economics and his work on transaction costs and property rights.
Professor Coase’s contributions revolutionized economics and law. As profound as his insights was the simple approach with which he encountered reality; challenging the assumptions and conventional wisdom of the established literature by holding up a light to the real world. His seminal paper on transactions costs (The Nature of the Firm, 1937) began with two simple and corollary queries: If markets work so efficiently, why is so much economic activity ‘managed’ outside of the market mechanism under the rubric of “the firm”? If firms are more efficient means of organizing economic activity, then why not manage all economic activity centrally?
To these questions Coase brought to bear the framework of marginal analysis that characterizes modern economic theory. His answer, that there are costs to using the market mechanism (transaction costs) that can be circumvented up to a point by managerial fiat within the firm, continues to underlie most of the modern theories of organizational economics. The boundary of the firm, Coase explained, is determined by the relative (marginal) cost of organizing one more resource via market transactions versus the (marginal) cost of doing so through managerial control.
The second of the two papers for which Coase was awarded the Nobel Prize focused on the nature of harms in property law cases and its implications for understanding the importance of property rights (The Problem of Social Cost, 1960). Coase highlighted the reciprocal nature of harm in the case of property disputes (and externalities in general): A finding in favor of one party necessarily harms the other, thus raising the question of relative economic efficiency–that is, the solution to the problem should consider the net social cost of finding in support of one party or the other, rather than focusing on some perception of unilateral causation.
In The Problem of Social Cost, Coase explained that if markets were costlessly efficient, parties to an externality/property dispute would be able to negotiate a Pareto superior solution to reallocate property rights to their highest-valued uses. Thus, the initial allocation of property rights would be irrelevant, since parties could arrive at privately negotiated solutions costlessly (or at very low cost). This idea was paraphrased and labeled by George Stigler as “The Coase Theorem,” although this was not at all Coase’s point. Quite the opposite. Coase argued that because transaction costs are positive, one cannot necessarily rely on privately negotiated transactions to achieve Pareto superior reallocations. Therefore, the design and enforcement of property rights is extremely important for economic outcomes. Moreover, Coase argued, one must consider the net social benefits of any attempts to reallocate property rights rather than assuming that any “solution” is necessarily preferable to the status quo–whether it be a market-based solution or a government-imposed solution.
Coase’s career was defined by challenging the common assumptions–and often overlooked assumptions–of economics. If economists are to describe and refer to “firms”, they should have a definition of what is meant by a firm and a reason for its existence in the economic landscape. If economists are going to address externalities, then they should recognize the nature of reciprocal harm in dealing with those externalities and the costs–as well as benefits–or proposed solutions. Assumptions of public goods and natural monopolies were bugaboos Coase dispelled by pointing to counter-examples–exceptions which debunked the rule. The case of The Lighthouse in Economics (1974) is but one example of such. When I last visited with Coase a few years ago, he was still working on another such example in the private water supply system in London in the early 1900s (a utility often argued to be a natural monopoly). Coase also offered a simple, yet profound at the time, understanding of the nature of durable goods monopolies and the way they compete with themselves (Durability and Monopoly, 1972).
I first met Coase as a graduate student at Washington University in St. Louis. I later got to know him much better while working at the University of Pittsburgh and eventually with the creation of the Contracting and Organizations Research Institute at the University of Missouri. Professor Coase generously funded CORI in its early days as we endeavored to create a library of contracts that could be used to study how businesses structure their transactions with one another and to further explore the factors affecting the choice of organizational form. Coase came to Missouri in 2001 and spoke to the need of economics to change. True to his lifelong approach, Coase stated, “We need empirical work which actually changes the way we look at the problem.”
Despite being one of the most cited economists of the 20th Century, I believe the significance of Coase’s work is still under-appreciated. Much of what is written about Coase’s work now still misinterprets, misconstrues or misapplies the fundamental nature of his arguments. In attempt to formalize or integrate pieces of his theories into modern economics, the essence of it is often lost–or simply overlooked. I tried to articulate some of that in a chapter I wrote about Coase’s theoretical contributions to Oliver Williamson’s Transaction Cost Economics, published inThe Elgar Companion to Transaction Cost Economics which I co-edited with Peter Klein. I look forward to doing more work along those lines.
Though I have not had much contact with Professor Coase over the past few years, it was inspirational knowing that even in his advanced years he was attempting to complete several research projects he had laid out. He once told me that it would take him until he was 112 years old to complete everything he had lined out at that point. That work may now never be done.
The economics profession is a bit more dismal with his passing, but his legacy lives on for those who continue to question and to change the way we look at the problem.