Sunday, 2 March 2014

Coase and the state

Most people see the late Ronald Coase as a defender of free markets, but not all, Bylund (2013), for example, sees Coase as more of a socialist, a supporter of planning, while Ricketts (2014: 52) argues that
One of the characteristics of Coase’s output is that his whole approach to economics makes him very difficult to place in terms of ideology.
So what was Coase's view of the role of the state and planning?

When discussing Coase's approach to public utility pricing Ricketts (2014: 51) writes,
It is important to note here Coase’s scepticism of any government’s ability to know what people were prepared to pay for various outputs or what the opportunity costs of output are. In this he takes a view similar to Hayek (1945) on the information transmitted in prices that are generated through market processes. The prices (and the embedded information about consumers’ valuations and opportunity costs) emerge from market transacting and are most unlikely to emerge from governmental planning. Planning arrangements of all types (within firms as well as governments) rely to a large degree on the information produced across markets.There might be a ‘cost of using the price mechanism’ but there is also a cost of ignoring the price mechanism – deriving from the loss of information that would otherwise be revealed through its operation.
So we see that one argument in favour of using markets, as opposed to using planning, is the loss of information inherent in central planning. But,
On the other hand the foundational insight upon which his work was built that ‘it would seem to be that there is a cost of using the price mechanism’ is equally clearly a statement leading directly to the point that markets have their limits.
So markets have advantages but also limits. Ricketts goes on to say that the great contribution Coase made was to show that the market versus the state dichotomy is a misspecification of the organisational problem facing all communities.
In a world of positive transactions cost the question is where in the great space between individual market transacting and full collective planning it is best to operate (Ricketts 2014: 52).
The position in that space in which you end up will depend on the costs of the various contractual arrangements that could be utilised and will be a matter of business judgement, in a broad sense.

Thus Coase's market supporting credentials are in many ways consequentialist. A point that the deontologist defenders of the market, including many libertarians, will not approve of.

Ricketts writes,
Coase’s ‘market supporting’ credentials do not therefore derive from a position that market contracting is always best.They derive from his point that only the ability to try out different organisational settings and subject them to a test of survivability will reveal what structures are most productive. It is the existence of competition between alternative solutions to the problem of economising on the cost of transacting that is important. Planning and market transacting are both potentially helpful (indeed ideally equally so at the margin) and ‘what this mix should be we find as a result of competition’ (Coase 1992, p. 716). (Ricketts 2014: 53).
The notion that markets are not always "best" is important in the Coasian framework. With the advancement of public-private partnerships, privatisation and contracting out in the West and the collapse of the formerly ‘planned economies’ of the East the boundary between state and private production shifted towards more private provision. At the most general level we have witnessed a substitution of contract (private production) for internal organisation (public provision).
The old plan versus market debate mutated into a much more complex debate about institutional structures. Policymakers now had to consider whether public objectives might be better served by contracting with private suppliers rather than organising production within bureaucracies or state-owned firms (Ricketts 2014: 53).
As I have noted before authors such as Hart, Shleifer and Vishny (1997) that the case for public provision is generally stronger when (i) non-contractible cost reductions have large deleterious effects on quality; (ii) quality innovations are unimportant; (iii) corruption in government procurement is a severe problem. On the other hand their argument suggests that the case for privatisation is stronger when (i) quality-reducing cost reductions can be controlled through contract or competition; (ii) quality innovations are important; (iii) patronage and powerful unions are a severe problem inside the government. But the expanded utilisation of contract implies that judgements about transactions cost have now became central to policy decisions.
In principle these decisions would be taken on the basis of careful appraisal of alternative available contractual settings, as recommended by Coase. Public choice and other political pressures are, however, as capable of influencing judgements about contract as they are about decisions in nationalised or state-owned enterprises. In addition, many contracts can involve very long periods of time, the disposition of large amounts of specific capital and very complex objectives. Such contracts are very likely to require renegotiation as time advances, and the transactions costs incurred therefore can be very significant. Examples in the UK include Private Finance Initiative contracts to build and maintain schools and hospitals or provide accommodation for defence personnel. Public Private Partnership agreements have been used (with notable associated problems) to upgrade infrastructure such as the London Underground (Ricketts 2014: 53).
The takeaway message here is not that the use of contract is wrong but that the multifarious circumstances will often suggest differing contractual responses. One size does not fit all

In general terms what can we say about Coase's approach to the question of the public versus private provision and about Coase's approach to economics more generally?
Coase did not engage in fruitless methodological controversy. His work used conventional terminology and was, to a degree,‘conservative’ of the established tradition. Nevertheless it did highlight the limitations of static neoclassical analysis. Organisational problems and contractual responses derive ultimately from imperfect information and the uncertainty that inevitably accompanies the passage of time.A world of perfect (zero-cost) information would be a determinate one – the future mapped out and encapsulated in a set of agreements covering all future time periods. In fact, institutions such as money or the firm emerge as a way of coping with the fact that we do not inhabit such a world.They enable us to keep our options open and to respond to emerging events. Coase (1937, p. 391) himself wrote of the cost not only of negotiating contracts but of renegotiating them to take account of changing circumstances and ‘the difficulty of forecasting’ or exactly specifying what another party is to do over an extended time period.The response to these contractual costs was ‘the firm’ – a set of loosely specified contracts of employment with a central agent with the flexibility to alter (within limits) the employees’ activities over time (Ricketts 2014: 56).
Coase can be seen as somewhat Marshallian in that Coase's conception of economic life was not one of static equilibrium, as in the neoclassical approach, but of a complex evolving system. In this he followed in the tradition of Marshall, who saw economics as having more affinities with the study of biology than physics.

  • Hart, Oliver D., Andrei Shleifer and Robert W. Vishny (1997). `The Proper Scope of Government: Theory and an Application to Prisons', Quarterly Journal of Economics, 112(4) November: 1127-61.

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