On Coasean economics

At the Coordination Problem blog Peter Boettke writes on On Coase and Coasean Economics. In part Boettke says,

The Nobel Prize lecture [The Institutional Structure of Production] highlights how the socialist calculation debate -- as communicated through Arnold Plant -- influenced the young aspiring economist Ronald Coase at the LSE, and led to his work on the theory of the firm. The lecture also straightens out the meaning and purpose of the "Coase Theorem" --- as Coase says:

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 by Stigler, 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 domain. 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.

Too many commentators -- and that includes an entire generation of Austrian economists -- have completely missed the importance of Coase's insight. There is obviously room for disagreement with Coase on fine points of theory and the implications of those points. But the quoted passage deserves to be read very carefully again and again so that its very subtle point sinks in. In Coase's hands the Pigovian remedies of tax and subsidies to address externalities are rendered either redundant or non-operationaly by a logical analysis grounded in the standard assumptions of economic theory upon which those remedies were recommended in the first place.

While I agree with what Boettke says I would also add that the really important point Coase makes in the above quote is the call to study, not the zero transaction cost world of neoclassical economics, but the world of positive transaction costs. In such a world Pigou's use of taxes and subsidies may make sense but this can only be determined on a case by case basis, there are not general results.

It should also be noted that it is the study of the positive transaction cost world which makes sense of things like firms - Coase's 1937 paper - and the role of the law - Coase's 1960 paper. To take the firm as an example, in the standard neoclassical model there is no need for firms, consumers can do it all since they live in a world of perfect and costless contracting which means that they can contract directly with owners of the factors of production to arrange production of whatever they want and wouldn’t therefore need the services of the intermediaries we know as firms. Positive transactions costs mean that it is no longer always the case that market transactions are the most efficient method of production.