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54
Homage to Ronald H. Coase
7. Ronald H. Coase and the emergence of
a new approach to economics
Claude Ménard
According to Virginia Woolf, ‘On or about December 1910, human character
changed’.1 This is when Ronald Coase was born! I do not know whether
human character has changed much since then, but economics surely has.
Looking at Coase’s curriculum vitae over the following 80 years, we find
listed the now famous papers that contributed to remodeling contemporary
economic theory, from ‘The nature of the firm’ (1937) through ‘The marginal
cost controversy’ (1946), to ‘The problem of social cost’ (1960). But the list
of references also contains much less often quoted papers that are highly
significant, either because they fertilized the more synthetic and more abstract papers, or because they transformed deeply the approach to public
policy. These contributions have already been very influential, and they are
far from having produced their full impact.
Ideas developed by Coase, some of them more than 60 years ago, have
been progressively integrated into our intellectual landscape, albeit against
some resistance. Their diffusion has been and remains remarkably slow. It
was only in the 1970s that ‘The nature of the firm’ became fully perceived for
what it really is: a revolution in our way of thinking about ‘the institutional
structures of production’ that constitute the bones and flesh of market economies. Its dissemination actually benefitted from the controversy about the
more recent ‘Problem of social cost’. But it is also remarkable that this latter
paper gave rise to a persistent misunderstanding, as Coase himself repeatedly
noted: most readers put the emphasis on the consequences of the assumption
of zero cost transactions, while this assumption was only his preliminary to
introducing the core of an analysis that focussed on a world (the only one that
fits the real one) in which there are positive transaction costs. If full acceptance and integration of Coase’s best-known ideas has been so slow and
difficult, likely because these involve changing so substantially our conception of what economics is about, no wonder that his less spectacular and more
diffused analyses, embedded as they often are in carefully crafted empirical
studies, still remain to be fully explored and further developed.
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In this presentation, I could not begin to get into the details of these
contributions or of their actual and potential impact. However, I should like
to come back for a moment to two aspects already mentioned that are particularly relevant for the research program of new institutional economics.
The first aspect, and this will be no surprise, is Coase’s introduction of the
apparently very simple idea that there are costs involved in the organization
of transactions, whatever the mode of organization is. The consequences of
this idea, that is, that there are different arrangements for monitoring transactions, and that they are all costly, so that one can be said to be less costly than
another one only in a comparative way, remain far from fully understood, and
continue to be ignored by too many economists. The idea of transaction costs
describes our economies as built from a complex set of alternative modes for
organizing and monitoring economic activities, modes that Coase, in his
Nobel Prize lecture, elegantly called ‘the institutional structures of production’. Continuous tradeoffs have to be made among these structures, in order
to increase the potential volume of transactions while reducing their costs;
these tradeoffs require economic calculation. (In that regard, we remain unambiguously in the domain of economics.) However, the tradeoffs also require
analysis of factors not accessible by calculation, both organizational factors
such as the hierarchical arrangement within firms, and institutional factors
such as the legal system. These factors open the field of economics to other
disciplines, a movement further developed by ‘Coaseans’ such as Harold
Demsetz, Douglass C. North and Oliver E. Williamson.
The second aspect that I want to emphasize is in a certain way the continuation of what precedes: it has to do with the embeddedness of transactions in
their institutional environments. From several of Coase’s papers, we have
learned that transactions involve transfer of rights, an activity that is both
relational and reciprocal (otherwise, it would be extortion, not transaction).
Once more, this apparently simple idea had major consequences. It is so
because Coase analysed these transfers in an economic mode: transactions
and their costs depend on how property rights are defined, on the conditions
of their transfers (for example, through contracts), and on the guarantees that
are provided to the holders of these rights. Studying these rights and their
accompanying mechanisms has generated a stream of research, often encapsulated in the label ‘law and economics’, a field of research as important as
the study of the organizational modes. I would like to emphasize that Coase
not only opened the way to this research; he actually contributed directly to
its development through his leading role as editor of the Journal of Law and
Economics from 1964 to 1982.
To summarize, Coase identified and analysed problems that will no doubt
remain central to modern economics for decades to come, and what has been
said above gives only a weak flavor of his contribution. But this is not enough
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Homage to Ronald H. Coase
to change the path of a discipline. A problem needs its concept, and concepts
need names. In the history of sciences, the ability to find a word that perfectly
encapsulates the nature of a problem is crucial: one has only to consider the
role of the term ‘derivative’ in mathematics. Coase did not invent the term
‘transaction’, but he transformed it into a concept. This is likely to happen in
the future to the expression ‘institutional structure of production’.
I have also alluded to Coase’s empirical works. I would like to come back
to this dimension, because reviews of his contributions tend to neglect it,
while I think it is absolutely essential for understanding the path Coase took
and the ideas he germinated. Everyone who has read his papers carefully, or
the papers of those whom he has directly influenced, and everyone who has
had the chance to talk with Coase, knows the importance he places on the
interdependence between theoretical breakthroughs and empirical analysis.
His sharp critique of ‘blackboard economics’, or what Harold Demsetz2 has
characterized as ‘the economics of Nirvana’, is deeply rooted in this conviction: there cannot be progress in economic knowledge without a careful
examination of facts, and this requires heavy investment in empirical studies
and constant attentiveness to changing facts. If findings threaten a theory, the
latter must be amended, or abandoned.
This fundamental conception about how to advance knowledge and how to
make progress did not remain as a general statement; nor did Coase rely on
‘disciples’ (a word I am sure he dislikes) to go digging into the coal mine.
The specificity of the research program implemented by Coase also lies in
that central role of applied economics. If one looks at the list of his papers,
and particularly if one reads the less often quoted papers, an extremely
rewarding exercise, it is impossible to miss how deeply his theoretical papers
have been stimulated and nourished by his empirical research. Let me mention a few examples. His research from the 1930s on the pig cycle in Great
Britain led to the elaboration of the concept of rational expectation, a paternity that John Muth explicitly acknowledged in his famous paper of 1961. 3 At
about the same time, and more intensely in the 1940s and 1950s, Coase
followed and analysed the development of the broadcasting industry. With his
accumulated knowledge of the sector, he elaborated for the American Federal
Communications Commission, in the late 1950s, an analysis of the allocation
of rights among users of frequencies that many economists viewed as being
so radical as to be merely fanciful, and not worth publishing (a story Coase
once told me with a lot of humor about the circumstances). His efforts to
justify and generalize his idea ended up in the ‘Problem of social cost’. The
provocative ideas of the 1950s made their way to, and progressively changed
the views of, a new generation of regulators about the allocation of rights in
networks industries, about the regulation of public utilities and so forth. We
are still totally immersed in the impact of this revolution. It is amazing to
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read now the papers that Coase published on these issues, some as early as
1946. It is also amazing to discover how much he anticipated in his early
analysis of public monopolies in the postal system and in supply systems for
electricity, as well as in his analysis of the auction system for the development of gas fields. Each of these papers is a gold mine, full of insights and
unconventional views.
Indeed, Coase is surely among the less conventional economists of this
century, as can be so well illustrated by his paper on ‘The lighthouse in
economics’ (1974). He is also unconventional in his human relationships. I
would like to include in this presentation a more personal tone. Everyone
who has known Ronald Coase knows how modest he is and how generous
with his time, and also how convincing he can be. I would like for a moment
to illustrate each of these dimensions of his personality. I was once discussing with him the impact of ‘The nature of the firm’ and how much remained
to be done in the direction he opened. He suddenly looked at me and said,
‘You know, it’s a pity that this paper is so often quoted. It only shows how
slow progress has been in economics’ (the phrasing is not exactly his, but the
idea surely is). And we all know that one of the most rigorous analyses of the
limitations of that paper was provided by Coase himself, 50 years later! His
generosity is also common knowledge. I have personally seen him several
times, including after he was awarded the Nobel Prize, spending literally
hours with doctoral students he had just met and would likely never see
again, trying to help them to determine more precisely the topic of their
research.
I must also mention his Socratic qualities. Coase is a formidable debater.
He consistently refuses to accept ready-made ideas, even when his close
friends express them, and he explores with his opponent alternative answers
that will be more satisfying with regard to the issues he raised. We all know,
because it has been marvelously told by George Stigler,4 how Coase’s presentation of ‘The problem of social cost’ to his colleagues from the University of
Chicago began amidst the ironic and somehow aggressive reactions of the
participants, and ended with their unconditional surrender. There is a lot of
Coase in this capacity to turn an argument upside down and to show aspects
that have been ignored, while giving his interlocutor a sense that he is
participating in the production of the new idea.
But history of science does not care much about personalities; what matters are results. How many economists can claim that there is a ‘theorem’
associated with their name? There is ‘the’ Coase theorem, and many economists argue, among them Sherwin Rosen5 and Lars Werin6, that there may be
more than one. Furthermore, very few economists pass new concepts to
future generations. Coase has already provided us with two of them, and they
are not minor ones: the concept of ‘transaction costs’ and, although this is
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Homage to Ronald H. Coase
less well known, the concept of rational expectations (as acknowledged by
Muth). Finally, although this is much more difficult to grasp in the short run,
he has transmitted to us a new way of thinking about the complex structures
of market economies and about regulations and public interventions in the
economy.
NOTES
1. Virginia Woolf, Mr. Bennett and Mrs. Brown, 1928. Quoted by Ronald H. Coase, in
William Breit and Roger Spencer (eds) (1997), Lives of the Laureates, Cambridge, MA:
MIT Press, p. 228.
2. Harold Demsetz, ‘Information and Efficiency: Another Viewpoint’, Journal of Law and
Economics, 12, 1969, pp. 1–22.
3. John Muth (1961), ‘Rational expectations and the theory of price movements’, Econometrica,
29, pp. 315–35.
4. George Stigler Memoirs of an Unregulated Economist, New York: Basic Books, 1988,
pp. 75–9.
5. Sherwin Rosen (1988), ‘Transaction costs and internal labor markets’, in Sydney Winter
and Oliver Williamson (1991), The Nature of the Firm, Oxford: Oxford University Press,
pp. 75–89.
6 See Chapter 5 in this book.
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