RONALD COASE (1910-2013) AND LIBERAL ECONOMICS Ronald Coase received the Nobel Memorial Prize in Economics for 1991 “for his discovery and clarification of the significance of transaction costs and property rights for the institutional structure and functioning of the economy.” Coase died in 2013, almost 103 years old, yesterday was his birthday. Coase was an unorthodox member of the Chicago-school of economics along with people like Gary Becker and George Stigler. They looked at political phenomena (and many other phenomena) with the help of neo-classical economic theory. Can markets be rational? Can rational individuals, participating in markets, make the decisions that allocate resources efficiently for the society as a whole? Can they do this without significant government involvement? Probably the most thoughfull answers to these questions were offered by Coase. Coase explored how that most basic of all economic institutions, the business firm, and how collecting many functions into as single firm, can satisfy society’s needs, independent of government. The importance of understanding the role of transaction costs in economic activity and the influence of alternative institutional structures on economic performance are hallmarks of Coases scholarship, and both the economic analysis of law and the new institutional economics are outgrowths of his work. Coase occupies a significant although somewhat controversial place in the history of the Chicago School of economics. Coase’s impact on economics has been profound. That impact stems almost entirely from two of his articles, one published when he was twenty-seven and the other published twenty-three years later. While in the US as a student, Coase visited Ford and General Motors and came up with a puzzle: how could economists say that Lenin was wrong in thinking that the Russian economy could be run like one big factory, when some big firms in the United States seemed to be run very well? In answering his own question, Coase came up with a fundamental insight about why firms exist. Firms are like centrally planned economies, he wrote, but unlike the latter they are formed because of people’s voluntary choices. Coase showed that firms and markets are alternative ways to organize the very same transactions. But why do people make these choices? The answer, wrote Coase, is “marketing costs.” (Economists now use the term “transaction costs.”) If markets were costless to use, firms would not exist. Instead, people would make arm’s-length transactions. But because markets are costly to use, the most efficient production process often takes place in a firm. His explanation of why firms exist is now the accepted one and has given rise to a whole literature on the issue. Formal organization develop with the direct purpose of reducing transaction costs; which is to say the costs of exchanging goods and services. These are due to opportunism in the presence of bounded rationality and specific assets. Coase is writing about positive and negative externalities: the positive and negative consequences of market decisions that are not included in the optimizing calculations which guides buyers and sellers. Because externalities are not easily measured, they are generally omitted from buyers calculations of costs and benefits. However decisions which yield externalities have become more and more critical as out economies have developed beyond such face to face contacts between buyers and sellers as a typical of primitive economies. Primitive people’s exchanging fish for pigs do not have to worry about depletion of fish populations or the aromatic clouds that form over pig pens. With growing economies, however handling these sorts of externality have become a major responsibility of government. A.C. Pigou claimed that markets are inefficient, as a means of allocating resources, to the extent that the (social) opportunity cost of a resource diverges from its price, or private cost to the user (The Economics of welfare). The inefficiency derives from the overuse (if social cost is greater than the price) or underuse (if social cost is less than the price) of the resource. If I have a factory and I use the air to let out emissions and use the air as a dustbin, and the cost for me of this is low, and the costs to society is large, then I will overuse the atmosphere as a dustbin. The policy prescription which is often held to follow from this conjecture is the need to use a system of taxes or subsidies to make the opportunity cost of the resource as equal to the effective prize as possible. In other words if the amount I pay is equal to the full social cost, I will take all of those social costs into account when making decisions about resource use. I will use the resource only if the advantages to me exceed the full social cost, in resource use, to the full social cost. Ronald Coase famously disagreed with that. He pointed out that if property rights are clearly and exclusively defined, and the cost of writing and enforcing contracts is not too high, market forces will make the opportunity cost and the price of a resource converge. None of these ideas a strictly speaking proven, except is a loose deductive sense. Pigou’s solution demands bureaucratic expert solutions Coase’s solution suggests decentralized market solutions may be a better solution.
Posted on: Tue, 30 Dec 2014 17:30:51 +0000
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