Wednesday, 5 April 2017

A point worth making about the Coase theorem

Economist George Stigler dubbed Coase’s insight the “Coase theorem.” Unfortunately, because Coase called attention to what would happen in a world of zero transaction costs, many have interpreted him to mean that ours was a world of zero transaction costs. In Coase’s words, “Nothing could be further from the truth.”  Instead, he highlighted transaction costs because he believed that in many cases they were significant and he thought it important to understand why.
This is from an interesting new book "Applied Mainline Economics: Bridging the Gap between Theory and Public Policy" by Matthew D. Mitchell and Peter J. Boettke.

It is amazing to me just how many people still don't get this point. Many still think Coase's thinking was about a zero transaction cost world when in fact his whole approach to economics was driven by wanting to understand the implications of positive transactions costs. Firms exist because of positive transaction costs (Coase 1932) and the law matters (the allocation of property rights matters) when there are positive transaction costs (Coase 1960).

Part of this confusion is, I think, due to Stigler's statement of the "Coase Theorem" in terms of a zero transaction cost world:
The Coase Theorem thus asserts that under perfect competition private and social costs will be equal (Stigler 1966: 113).
Perfect competition requires zero transaction costs. This seems to have lead many people to believe Coase thought the real world was a zero transaction cost world. Not so.

  • Coase, Ronald Harry (1937). ‘The Nature of the Firm’, Economica, n.s. 4(16) November:386–405.
  • Coase, Ronald Harry (1960). ‘The Problem of Social Cost’, Journal of Law and Economics, 3 October: 1–44.
  • Stigler, George (1966). The Theory of Price 3rd ed., New York: The Macmillan Company.

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