Happy 100th Birthday Ronald Coase!!

If you don’t know who Ronald Coase is, you should.  He wrote two of the seminal, influential papers in economics.  The Nature of the Firm was written in the 1930′s.  It rings true today.  He also wrote about the problems of social cost.  It’s brilliant analysis and we still use the framework today to argue about externalities in all kinds of situations.  He is a Nobel Prize winner.

In economics, if you are practicing the dismal science correctly, the foundation of your thinking should be based on Coase.  It is the first thing that University of Chicago students are taught in a microeconomics course, and virtually every business decision revolves in some way around “Coaseian” thinking.  People forget about Coase, and it leads to poor decision making.

Coase will turn intuitive thinking on its ear. Make sure you watch and try to digest the vid to the end. Then you will understand this statement; Maybe you should pay your neighbors to landscape their yards if you want to sell your home at a higher price.

Today, Coase has not put himself out to pasture.  A friend of mine had a child that needed to do a project on an immigrant for school.  They were walking down Clark Street in Chicago and overheard Mr. Coase speaking.  She said, “You have an English accent, are you an immigrant.”.  He replied, “Yes, I am.”  Coase was her immigrant project for school!  Pure random luck for her.

At that time in his life he was still traveling.  He had been to China.  He was writing and lecturing.   The world is lucky to have great thinkers like Coase.  He believes in free markets and the sanctity of the individual.  Building on the themes articulated by Adam Smith, Coase gave us the framework to think about very complex problems elegantly.

Some excerpts of his Nobel lecture.

What I think will be considered in future to have been the important contribution of this article is the explicit introduction of transaction costs into economic analysis. I argued in The Nature of the Firm that the existence of transaction costs leads to the emergence of the firm. But the effects are pervasive in the economy. Businessmen in deciding on their ways of doing business and on what to produce have to take into account transaction costs. If the costs of making an exchange are greater than the gains which that exchange would bring, that exchange would not take place and the greater production that would flow from specialisation would not be realised. In this way, transaction costs affect not only contractual arrangements but also what goods and services are produced. Not to include transaction costs in the theory leaves many aspects of the working of the economic system unexplained, including the emergence of the firm, but much else besides. In fact, a large part of what we think of as economic activity is designed to accomplish what high transaction costs would otherwise prevent or to reduce transaction costs so that individuals can freely negotiate and we can take advantage of that diffused knowledge of whichHayek has told us.

And for those favoring strict government solutions to problems:

“Pigou’s conclusion and that of most economists using standard economic theory was, and perhaps still is, that some kind of government action (usually the imposition of taxes) was required to restrain those whose actions had harmful effects on others, often termed negative externalities. 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 byStigler, 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 domain7. 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.”

Coase was true in the past, and he will be true in the future. Happy Birthday to a great man.

Video explaining externalities and Coase bargaining-tip of the hat to Diane Garnick

tip of the hat to Doug Ross


The information in this blog post represents my own opinions and does not contain a recommendation for any particular security or investment. I or my affiliates may hold positions or other interests in securities mentioned in the Blog, please see my Disclaimer page for my full disclaimer.

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