RIP Ronald Coase

"It's a giant of a human thing."
--Paul Scott (Valley of Decision)

Ronald Coase passed away on Monday at the age of 102. Coase was a giant of economic thought. His published work spanned the better part of a century and he was still active in his emeritus years.

I first 'met' Coase during my graduate studies when I read his seminal 1937 paper, "The Nature of the Firm." In it, Coase was among the first to formally consider why some transactions are done on spot markets managed by individual buyers and sellers while others are done by firms that effectively take some transactions off the market and manage them under private control by hierarchy.

Unlike his predecessors who assumed zero transaction costs during exchange, Coase argued otherwise. He observed that positive transaction costs are present in even perfectly competitive markets. For example, buyers incur costs related to searching among alternatives before making a purchasing decision. Sellers research buyer behavior prior to production and sales. If market related transaction costs are high enough, then alternative governance mechanisms (e.g., organizational hierarchies) might mediate exchanges more efficiently.

Coase's observations spawned what today is known as transaction cost economics or new institutional economics. Ironically, I happen to be boning up on theory here due to research interests.

My other primary exposure to Coase has been in nascent self-study of externalities. Coase's influential 1960 paper, "The Problem of Social Cost," was the basis for what became known as the "Coase Theorem." Roughly, the Coase Theorem posits that when property rights are respected and transaction costs are low, then parties that are in dispute over "negative externalities" such as pollution will naturally gravitate toward negotiated solutions that provide the most efficient and mutually beneficial outcomes.

The theorem suggests that property rights as distributed ex ante are not as important as the ability to trade property rights during negotiations to generate mutual gain. This occurs naturally in unhampered markets because consumers will ultimately direct resources toward ends that produce the highest perceived value.

As transaction costs increase (e.g., costs of regulatory compliance, legal and court costs), then the outcomes change and become more asymmetrical in nature.

For a sampling of his thought process, here is a wonderful 1997 interview with Coase beginning bottom of page 1. In fact, I want to circle back to several insights that he shares in this conversation when I have more time.

References

Coase, R.H. 1937. The nature of the firm. Econometrica, 4: 386-405.

Coase, R.H. 1960. The problem of social cost. Journal of Law and Economics, 3: 1-44.