100 years of the theory of the firm. Or may be only 50.

Depending on how you pick your starting point there has been, roughly, 50 or 100 years of the mainstream economic theory of the firm.

In support of the 100 years view it has been argued that the mainstream approaches to the firm began in 1921. This (minority) view is succinctly expressed by Harold Demsetz

“[ … ] it can be said without hesitation that Knight launched the modern theory of the firm in 1921” (Demsetz 1988: 244).

The more commonly accepted 50-year position is that the theory of the firm did not begin until the 1970s, with the advent of the Coaseian-based approaches to the firm. 

But even if the earlier starting date is accepted, it must be said that the period 1920 to 1970 is something of a ‘dark age’ for the theory of the firm. It is largely one of missed opportunities with just two works contributing to the way mainstream economists think about the firm today. Knight (1921) and Coase (1937) can be seen as ‘precursors’ to the modern theories of the firm while the theories developed from these precursors represent the ‘opportunities taken’. The ‘opportunities taken’, including the transaction cost approach, the principal agent approach, the incomplete contracts approach and the reference point approach, all of which started to develop post-1970.

Those works which apply the division of labour to the theory of the firm (more correctly, to the theory of firm-level production) as well as the partial models of the firm arising from the ‘rationalisation’ debate along with Plant (1937) and Malmgren (1961) are part of the ‘opportunities missed’ from the 1920 to 1970 period.

Despite the division of labour being a very old idea in economics, dating from at least the ancient Indians, Greeks and Chinese, it took more than two thousand years for it to give rise to a theory of production, but it has not generated a genuine theory of the firm. Following on from the ancient scholars, in the medieval period both Islamic and Christian theologians and philosophers analysed the concept, and consequences, of the division of labour. The pre-classical, classical and neoclassical economists continued and expanded the enquiry, but all without applying the division of labour to the theory of the producer or the firm. One possible exception to this rule is Adam Smith. Zouboulakis (2015) argues that Smith’s discussion of the division of labour does offer an elementary explanation for the existence of firms. In Zouboulakis’s view of Smith the existence of firms is explained through division of labour dynamics. As the market grows more firms are created and they become larger thereby employing more labour and capital and thus there is an increase in specialisation and the division of labour. This in turn increases efficiency and productivity which increases general economic wellbeing.

It was not until the 20th century that a division of labour-based theory of production finally appeared. In the 1920s Lawrence Frank saw an increasing division of labour as giving rise to the vertically integrated producer. In the 1930s E. A. G. Robinson argued that the division of labour affected the size of the producer due to its effects on production technology and management. By the 1950s George Stigler was arguing that the size of the producer was limited by the division of labour due to the division of labour being limited by the extent of the market. In the 1990s Gary Becker and Kevin Murphy saw the size of the producer as being limited not just by the size of the market but also, more often, by coordination costs. In 2018 Michael Rauh showed that the division of labour, which translates to the size of the producer, can be, depending on circumstances, limited by the extent of the labour market, moral hazard or an ‘O-ring’ property. In this paper Rauh utilises a stochastic or ‘O-ring’ production function. Importantly with an O-ring production function, if one part of the production process fails, the whole process fails.

But despite this, belated, interest in the division of labour, within the contemporary mainstream economics literature the division of labour is still very much a minority approach to the analysis of production and has had no impact on the mainstream theory of the firm.

Concerning ‘rationalisation’ Cristiano (2015: 601) explains,

"[i]t was associated with the idea that it was possible to reduce average costs per unit of output by means of larger firms without necessarily incurring the problem of monopoly power—an idea that enjoyed wide circulation in the British press at that time. Henry Clay (1929, p. 171) wrote that rationalization “implies industrial combination with the object of securing not monopoly prices, but certain productive economies". Writing about the situation in Lancashire in 1926, John Maynard Keynes sympathized with ``what the Germans are calling `rationalisation', that is, the concentration of demand on the most efficient plants, which are worked at full stretch and the rest closed down" (1971–89, XIX, p. 579; hereinafter CWK ); "a `rationalising' process designed to cut down overhead costs by the amalgamation, grouping or elimination of mills'' ( CWK, XIX, p. 584)".

During the rationalisation debate, Lavington (1927) and Robinson (1931) argued that the size of the firm is determined by a trade-off between increasing returns to scale and decreasing returns to management. However, these are only partial models of the firm because there is no recognition of the need for transaction costs in the models.

Plant (1937) made a notable, and most surely underrated, contribution to the theory of the firm. The paper is usual for its time in that it made a notable contribution to the theory of organisations before the 1970s renaissance of the theory of the firm. Plant’s ‘Centralize or Decentralize?’ furnished detail and content for several aspects of Coase’s arguments where those facets were left underdeveloped by Coase. 

It is a contribution in which, for example, the “[ . . . ] discussion provides more empirical content than Coase regarding the costs of using the price system and the results on firm size [ . . . ]” (Boudreaux and Holcombe 1989: 149). In Robert Hébert and Albert Link’s view, Plant develops a transaction cost approach to the firm independently of Coase. 

“A “transaction costs” approach to the firm was pioneered independently by Plant (1937), who attempted to explain why firms become centralized or decentralized” (Hébert and Link 2006: 383).

 Carlo Cristiano also sees transaction cost arguments in Plant’s work, 

“[t]he concept of a cost in using the market, along with the idea that business size depends on the balance between this cost and coordination costs, is implicit but nonetheless rather clear in Plant’s argumentation” (Cristiano 2015: 610). 

All this is no mean feat. 

And yet today we see no ‘Plantian’ research agenda. Plant’s work has been ignored in the history of the theory of the firm.

Malmgren (1961) provided the first amplification of Coase’s analysis in his ‘The Nature of the Firm’ paper. 

Malmgren’s primary sources of insight came from the works of Coase, Hayek, Richardson and Penrose. Lise Arena argues that 

“[h]is contributions favoured a multi-disciplinary approach, incorporating ideas not only from economics, but also from organisational theory, game theory and information theory” (Arena 2021: 88).

 Klaes (2000) argues that Malmgren was the first person to associate Coase’s analysis with the idea of transaction costs. 

“Malmgren (1961) was also the first to link Coase (1937) with the notion of transaction costs. It appears that Malmgren broadly adopted Coase’s general strategy of analysing the nature of the firm. However, while Coase focused predominantly on the costs of organizing transactions across the market, while following closely the reasoning of Kaldor (1934) and Robinson (1934) regarding internal limits to firm size, Malmgren predominantly sought to exploit Marschak’s theory of information for the analysis of internal organization” (Klaes 2000: 571, footnote 10).

 Malmgren combined the ideas of Coase, Hayek, Richardson and Penrose in such a way as to be able to examine ideas which have only begun to be examined in the mainstream theory of economic organisation in recent times.

 Three central contributions have been identified in Malmgren’s work (Foss 1996: 349).

 1.  Malmgren ‘operationalised’ the Coaseian approach to the theory of the firm. He ‘operationalises’ - in the sense of Williamson (1985) – the Coaseian approach insofar as he analyses the determines of transaction costs which is something Coase did not investigate in any depth. Transactions within the firm may be less costly than across the market because of the firm’s ability to control information. Firms can provide ‘precedents’ and ‘customs’ which can act as a focal point which eliminates divergence of expectations. Thus ‘intra-firm’ transactions are less costly than ‘inter-firm’ transactions.

“Not only are a number of events predictable over the duration of the entire production plan, but also less information is required to describe that set of events for control purposes [ . . . ] operating rules of quite simple nature replace a more thorough analysis of every possible transaction which might arise in market determined allocation of resources over the set of activities which make up the firm”. (Malmgren 1961: 404).

 2. Malmgren also managed to combine contractual and knowledge-based approaches to the firm and

 3. Also he took an economic approach to notions such as ‘business culture’ which are still not well theorised.

Malmgren argued that if agents shared a common ‘business culture’ or ‘firm-specific mental constructs’ (Foss 1997: 192) (sometimes also referred to as ‘corporate culture’ (Cremer 1990) or ‘models of the world’ (Marengo 1995)) then getting the incentives right was the main objective of organisational design. But if different sections of a firm differ in their understanding of a given message, then creating a common knowledge base and getting a uniform ‘business culture’ so that everyone is on the same page becomes the major organisational objective. That is, Malmgren saw that the coordination of the within-the-firm division of knowledge required a shared ‘corporate culture’.

Along with this Malmgren’s work suggests it could be possible to construct an opportunism-free approach to the theory of the firm, something not contemplated in the economic mainstream even today. Malmgren’s approach sees firms as not as institutions that align incentives, but rather as organisations that control information. So while he takes an overall Coaseian approach it is something of a variation on the Coasian theme and a different variation from that of other later Coaseian followers.

That the firm is different from the market, in Malmgren’s framework, is because of its ability to store knowledge and simulate learning. Firms exist because they can more efficiently solve knowledge-related problems than can the market. The pooling of information in the firm lowers the cost ‘of discovering what the relevant prices are’ and the providing of ‘ ‘precedents’and ‘customs’ which can act as a focal point’ can help ‘complete’ the missing clauses in a long, (incomplete) open-ended employment contract. Thus firms save on information and transaction costs relative to the market. This provides an incentive to create firms.

But, Coase (1937) and Knight (1921) aside, all this post-1920 work has been to no avail as it has not been applied to modern mainstream thinking to do with the theory of the firm. This work represents ‘opportunities missed’ so that the first 50 years of the 1920-2020 period resulted in little of importance being contributed to the theory of the firm.

It had to wait until the 1970s before the theory of the firm took off. It was only post-1970 that the importance of Coase (1937) and Knight (1921) was recognised and the development of the contemporary theory of the firm got underway. 

So counting from 1970, there has only been 50 years of the theory of the firm.

References:

• Arena, Lise (2021). Oxford’s Contributions to Industrial Economics from the 1920s to the 1980s. In Robert A. Cord (ed.), The Palgrave Companion to Oxford Economics (pp.75-100), Cham, Switzerland: Palgrave Macmillan.
• Boudreaux, D. and R. Holcombe (1989). `The Coasian and Knightian Theories of the Firm', Managerial and Decision Economics, 10(2) June: 147-54.
• Coase, Ronald Harry (1937). ‘The Nature of the Firm’, Economica, n.s. 4 no. 16 November: 386-405.
• Crémer, Jacques (1990). ‘Common Knowledge and the Coordination of Economic Activities’. In Masahiko Aoki, Bo Gustaffson and Oliver E. Williamson (eds.), The Firm as a Nexus of Treaties (pp. 53-76), London: Sage.
• Cristiano, Carlo (2015). `Theories of the Firm in England Before Coase: Stemming the Tide of `Rationalization' on the Eve of The Nature Of The Firm ', Journal of the History of Economic Thought, 37(4) December: 597-614. 
• Demsetz, Harold (1988). ‘Profit as a Functional Return: Reconsidering Knight’s Views’. In Harold Demsetz, Ownership, Control, and the Firm: The Organization of Economic Activity, (vol. I pp. 236-47), Oxford: Basil Blackwell.
• Foss, Nicolai J. (1996). ‘Harald B. Malmgren’s Analysis of he Firm: lessons for modern theorists?’, Review of Political Economy, 8(4): 349-66.
• Foss, Nicolai J. (1997). ‘Austrian insights and the theory of the firm’. In Advances in Austrian Economics (Advances in Austrian Economics, Vol. 4, pp. 175-98), Bingley: Emerald Group Publishing Limited.
• Hébert, Robert F. and Albert N. Link (2006). `Historical Perspectives on the Entrepreneur', Foundations and Trends in Entrepreneurship, 2(4): 261-408.
• Klaes, Matthias (2008). ‘Transaction Costs, History Of’. In Steven N. Durlauf and Lawrence E. Blume (eds.), The New Palgrave Dictionary of Economics, 2nd edn., Basingstoke: Palgrave Macmillan.
• Knight, Frank H. (1921). Risk, Uncertainty and Pro t, Boston: Houghton Mifflin Company.
• Lavington, F. (1927). `Technical Influences on Vertical Integration', Economica, 7 (No. 19) March: 27-36.
• Malmgren, H. B. (1961). `Information, Expectations and the Theory of the Firm', Quarterly Journal of Economics, 75(3) August: 399-421.
• Marengo, L.(1995). ‘Structure, Competence, and Learning in Organizations?’, Wirtschaftspolitische Bläter, 42(6): 454-64. 
• Plant, Arnold (1937). `Centralize or Decentralize?'. In Arnold Plant (ed.), Some Modern Business Problems: A Series of Studies (pp. 3-33), London: Longmans, Green and Co.
• Robinson, E. A. G. (1931). The Structure of Competitive Industry, London: Nisbet & Co.
• Williamson, Oliver E. (1985). The Economic Institutions of Capital ism, New York: The Free Press.
• Zouboulakis, Michel S. (2015). ‘Elements of a theory of the firm in Adam Smith and John Stuart Mill’. In George C. Bitros and Nicholas C. Kyriazis (eds.), Essays in Contemporary Economics: A Fests chrift in Memory of A. D. Karayiannis (pp. 45-52), Heidelberg: Springer.

Coase on profit maximisation

One important, and at times controversial, assumption used in most theories of the firm, including that of Coase, but not discussed by Coase in his 1937 article, is that of profit maximisation. Coase learned from Plant that firms maximise profits but in his general approach to it, he appears to have been one which involved taking something of a bet each way. He seems to have thought that while in practice it is unlikely that profit maximisation would be achieved, it was still a useful elemental assumption for the theory of the firm.

In terms of actual business practice Coase wrote:

"[i]t would be Utopian to imagine that a businessman, except by luck, could manage to attain this position [MR=MC and the avoidable costs of the total output less than the total receipts] of maximum profit" (Coase 1981: 102)

and

"[t]his being so, it seems to me that any claim that modern cost accounting (at any rate in the form in which it is to be found in the textbooks) enables unprofitable lines to be discovered and eliminated is misleading. It is only possible to discover whether or not a particular activity is profitable by comparing the avoidable costs with the receipts. And this, as I understand it, is a task which modern cost-accounting methods do not enable one to perform" (Coase 1981: 113).

But he does also seem to have seen it as a useful tool for economic investigation:

"[w]ell, all this suggests that economists are satisfied. Now the fact is that they are satisfied. They are very pleased. To go to a meeting of the American Economic Association is to see thousands of self-satisfied economists. Now there is a reason why this is so. They have found economics useful and are quite happy therefore to go on using it. Now it’s true: it is useful. The concepts which have been developed for handling various problems are useful for handling a wide range of problems. Opportunity costs, supply and demand schedules, marginal costs, marginal revenues, maximization of profits – they’re all very useful concepts that you can use, and not simply for economic problems but for others as well" (Coase 2002: 4).

and

"[n]ow take a person in a firm situation. A man who buys something for 10 dollars and sells it for 8 dollars doesn't last very long. There's an immediate punishment that comes in within the economic system if you don't try to maximise profits and so on. So, I'm very happy with the assumption that people make, that firms make profits. And you can study what firms do and of course, it fits very nicely. They drop the lines that make losses. They expand the lines that make profits and so on. So, I make this difference between people acting in the productive system and people acting as consumers" (Coase in Becker 1995).

When discussing the nature of opportunity costs, Coase writes,

"[t]his particular concept of costs would seem to be the only one which is of use in the solution of business problems, since it concentrates attention on the alternative courses of action which are open to the businessman. Costs will only be covered if he chooses, out of the various courses of action which seem open to him, that one which maximizes his profits. To cover costs and to maximize profits are essentially two ways of expressing the same phenomenon. In practice it is probably better to regard the cost of doing anything as the highest alternative receipts that might have been obtained rather than vaguely as all the alternatives that are open" (Coase 1981: 108).

In a comment on Heflebower (1955) - which critically examined one attack on the standard neoclassical model including profit maximisation, that of full cost pricing - Coase wrote that he wasn't yet ready to give up on the standard marginal analysis:

"I am not willing on the basis of the arguments brought forward so far to abandon ordinary marginal analysis (taking account of demand) as a first approximation. It is clearly not the whole story and there is need for much more research on business behavior. But we should not be disappointed if a good deal of economic theory turns out to be usable after our investigations are completed" (Coase 1955: 394).

Refs.: 

• Becker, Gary S. (1995). 'Gary Becker Discussions: Consumer Behavior'. Video of discussion between Gary Becker and Ronald Coase on the question of, Is the economic theory of utility a useful way of understanding consumer behavior? Available at https://www.freetochoosenetwork.org/ideachannel/ic_program.php?itemId=65
• Coase, Ronald Harry (1937). `The Nature of the Firm', Economica, n.s. 4 no. 16 November: 386-405.
• Coase, Ronald Harry (1955). 'Comment' (on Heflebower (1955)). In Universities-National Bureau Committee for Economic Research, Business Concentration and Price Policy (pp. 392-4), Princeton: Princeton University Press.
• Coase, Ronald Harry (1981). 'Business organization and the accountant'. In J.M. Buchanan and G.F. Thirlby (eds.), L.S.E. Essays on Cost (pp. 95-132), New York: New York University Press.
• Coase, Ronald Harry (2002). 'Why Economics Will Change: Remarks at the University of Missouri, Columbia, Missouri, April 4, 2002', International Society for New Institutional Economics Newsletter, 4(1) Summer: 1, 4-7.

Coase and profit maximisation

One assumption not discussed much in the mainstream theory of the firm is that of profit maximisation. Most theories of the firm take it as a given, a non-controversial notion to base their theory on. Ronald Coase's view isn't so clear cut.

In one case he seemed to have been that in practice profit maximisation was unlikely to be achieved by any firm:

"[i]t would be Utopian to imagine that a businessman, except by luck, could manage to attain this position [MR=MC and the avoidable costs of the total output less than the total receipts] of maximum profit"(Coase 1981: 102)

and

"[t]his being so, it seems to me that any claim that modern cost accounting (at any rate in the form in which it is to be found in the textbooks) enables unprofitable lines to be discovered and eliminated is misleading. It is only possible to discover whether or not a particular activity is profitable by comparing the avoidable costs with the receipts. And this, as I understand it, is a task which modern cost-accounting methods do not enable one to perform" (Coase 1981: 113).

But he also seemed to have seen it as a useful tool for economic investigation:

"[w]ell, all this suggests that economists are satisfied. Now the fact is that they are satisfied. They are very pleased. To go to a meeting of the American Economic Association is to see thousands of self-satisfied economists. Now there is a reason why this is so. They have found economics useful and are quite happy therefore to go on using it. Now it’s true: it is useful. The concepts which have been developed for handling various problems are useful for handling a wide range of problems. Opportunity costs, supply and demand schedules, marginal costs, marginal revenues, maximization of profits – they’re all very useful concepts that you can use, and not simply for economic problems but for others as well" (Coase 2002: 4).

and

"[n]ow take a person in a firm situation. A man who buys something for 10 dollars and sells it for 8 dollars doesn't last very long. These's an immediate punishment that comes in within the economic system if you don't try to maximise profits and so on. So, I'm very happy with the assumption that people make, that firms make profits. And you can study what firms do and of course, it fits very nicely. They drop the lines that make losses. They expand the lines that make profits and so on. So, I make this difference between people acting in the productive system and people acting as consumers" (Becker 1995).

When discussing the nature of opportunity costs, Coase writes,

"[t]his particular concept of costs would seem to be the only one which is of use in the solution of business problems, since it concentrates attention on the alternative courses of action which are open to the businessman. Costs will only be covered if he chooses, out of the various courses of action which seem open to him, that one which maximizes his profits. To cover costs and to maximize profits are essentially two ways of expressing the same phenomenon. In practice it is probably better to regard the cost of doing anything as the highest alternative receipts that might have been obtained rather than vaguely as all the alternatives that are open" (Coase 1981: 108).

In a comment on Heflebower (1955) - which critically examined one attack on the standard neoclassical model including profit maximisation, that of full-cost pricing - Coase wrote that he wasn't yet ready to give up on the standard marginal analysis:

"I am not willing on the basis of the arguments brought forward so far to abandon ordinary marginal analysis (taking account of demand) as a first approximation. It is clearly not the whole story and there is need for much more research on business behavior. But we should not be disappointed if a good deal of economic theory turns out to be usable after our investigations are completed'' (Coase 1955: 394).

So it appears that while Coase thought that businessmen could not enact profit maximisation in practice, it was still a useful simplification for theoretical purposes.

For a short overview of the attacks on the neoclassical model, including those concentrating on profit maximisation, during the 1940-1970 period see Walker (2021: chapter 6).

Refs.:

• Becker, Gary S. (1995). 'Gary Becker Discussions: Consumer Behavior'. Video of discussion between Gary Becker and Ronald Coase on the question of, Is the economic theory of utility a useful way of understanding consumer behavior?
• Coase, Ronald Harry (1955). 'Comment' (on Heflebower (1955)). In Universities-National Bureau Committee for Economic Research, Business Concentration and Price Policy (pp. 392-4), Princeton: Princeton University Press.
• Coase, Ronald Harry (1981). 'Business organization and the accountant'. In J.M. Buchanan and G.F. Thirlby (eds.), L.S.E. Essays on Cost (pp. 95-132), New York: New York University Press.
• Coase, Ronald Harry (2002). 'Why Economics Will Change: Remarks at the University of Missouri, Columbia, Missouri, April 4, 2002', International Society for New Institutional Economics Newsletter, 4(1) Summer: 1, 4-7.
• Heflebower, Richard B. (1955). 'Full Costs, Cost Changes, and Prices'. In Universities-National Bureau, Business Concentration and Price Policy (pp. 359-92), Princeton: Princeton University Press
• Walker, Paul (2021). Foundations of Organisational Economics: Histories and Theories of the Firm and Production, London: Routledge.

The Theory of the Firm: An Overview of the Economic Mainstream, Revised Edition

This is a revised edition of Walker (2017). New sections or subsections have been added on the X-inefficiency model, the division of labour and the firm - both pre and post-1970, ownership of the firm and the human capital based firm. Additions have been made to sections on entrepreneurship, the incomplete contracts approach to the firm, the discussion of Coase’s paper on the ‘The Nature of the Firm’, the discussion of industry-level analysis versus intra-firm analysis, reasons for ignoring firm, a small addition has been made to the Sreni material in section 2.1 and material on Commenda, Waqf and the Clan Corporation has also been added to section 2.1. Appendix 4 has been deleted.

Walker, Paul (2017). The Theory of the Firm: An overview of the economic mainstream, London: Routledge.

The Theory of the Firm: An ... by Paul Walker

Who was Ronald Coase? - with Cento Veljanovski

From the IEA comes this video in which Syed Kamall interviews Cento Veljanovski about the work of Ronald Coase.

 

Becker versus Coase on consumer behaviour

From the Free to Choose Network comes this video of Gary Becker and Ronald Coase talking consumer behaviour. Half an hour very well spent.

Is the economic theory of utility a useful way of understanding consumer behaviour? Ronald Coase and Gary Becker, Nobel Economists at the University of Chicago, explain and discuss the theory of rational maximizing utility. They describe how consumers rank preferences and then attempt to choose the highest preference according to their resources, and they discuss whether firms and households operate with similar principals. They consider whether it is necessary to even have utility theory, and whether economists have been misled on this subject.

Coase and Plant on the market versus the firm

In a 1937 paper, "Centralise or decentralise" Arnold Plant writes,

"[...] centralisation is the means by which the collaborating enterprises secure the advantage of specialised services or equipment which would not otherwise be available to them on such favourable terms, if at all. If the service or merchandise in question is freely bought and sold on any scale in a well-organised market, there will be no need for centralisation of firms. It is the absence of a well-organised market which may justify firms in pooling their requirements".

He sees a clear trade-off between market provision and in-house production. When markets are available and relatively cheap their use makes sense. But when they are expensive, or unavailable, production in a firm makes sense. Today we would express this by saying when transaction costs are high we use the firm but when they are low we use the market.

Plant's line of argument has a somewhat modern, Coaseian, feel to it. The question this gives rise to is, For how long had Plant been thinking in this way? And did he discuss this line of reasoning in classes that Coase took? Or does the causation run in the opposite direction? Plant's paper was published in 1937 and we know that Coase's analysis of the firm was largely complete by 1932. Did Coase discuss his approach with his former teacher? Or did the two of them reach similar conclusions independently?

I'm not sure we know enough to answer these questions, but it does raise an interesting possibility about the development of Coase's ideas on the firm.

Ref.:

• Plant, Arnold (1974). 'Centralise or decentralise?'. In Arnold Plant, "Selected Economic Essays and Addresses (174-98), London: Routledge & Kegan Paul. First published in Arnold Plant (ed.), "Some Modern Business Problems: A Series of Studies", London: Longmans, Green and Co., 1937.

A conversation with Ronald H. Coase

From Newmedia at UFM.edu comes this 2001 video of  A Conversation with Ronald Coase.

Ronald Coase a socialist!

I have just come across an article by Per Bylund at the Mises Institute website on the question Was Ronald Coase an Austrian? At one point Bylund answers the question by saying,

He was hardly an Austrian economist. On the contrary, he was a self-declared socialist - at least in his youth.

Let me quote Coase himself on this,

One may ask how I reconciled my socialist sympathies with acceptance of [Arnold] Plant's [free market] approach. The short answer is that I never felt the need to reconcile them. I would only recall that a fellow student, Abba Lerner, who, in the preface to his Economics of Control, acknowledges Plant's influence in the development of his views, went to Mexico to see Trotsky to persuade him that all would be well in a communist state if only it reproduced the results of a competitive system and prices were set equal to marginal cost. In my case my socialist views fell away fairly rapidly without any obvious stage of rejection (Emphasis added).

So the description should be 'he was a self-declared socialist - ONLY in his youth'.  I'm sure that anyone who has read the older Coase will be surprised to see him call a socialist. If fact in an interview Coase tells a story about his wife going to a party while he was at the University of Virginia,

They thought the work we were doing was disreputable. They thought of us as right-wing extremists. My wife was at a cocktail party and heard me described as someone to the right of the John Birch Society. There was a great antagonism in the '50s and '60s to anyone who saw any advantage in a market system or in a nonregulated or relatively economically free system.

Perhaps being both a socialist and to the right of the John Birch Society is an accomplishment worthy of a Nobel Prize!

Why do financial institutions exist?

Financial institutions have made the news over the last few day, albeit for very strange reasons. But why, you could ask, do such institutions exist in the first place?

Professor Philip Booth argues the answer is very simple, they reduce transaction costs.

Financial institutions exist to reduce transactions costs. Without them, somebody saving money for a rainy day or for their pension would have to seek out and assess the creditworthiness of a vast number of individuals or companies before lending them money. And, without securities markets and banks providing on-demand deposits, the cost of individuals realising their investments at convenient times would be huge.

That firms exist since they reduce transactions costs is the point made by Ronald Coase way back in 1937. According to Coase we carry out a transaction within a firm when doing so costs less than carrying out that transaction across the market.

Of course this is dependent on technology. As technology changes so does the relative advantage of markets compared to firms. This is just as true in finance as anywhere else. For example:

Peer-to-peer lending radically simplifies the “middle-man” in credit transactions; and other innovations are on their way in finance. In China, 2,000 platforms intermediate £100bn of peer-to-peer lending.

Such changes in technology does mean that it is quite possible that banks will go the way of the dodo. The market may become cheaper than the firm. But it doesn't mean that charging interest will go the same way.

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.

Refs.:

• 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.

Let the data speak?

From twitter comes these tweets from Modeled Behavior (Adam Ozimek) @ModeledBehavior

People who think that data never "speaks" and the researcher can get basically any result haven't spent enough time doing empirical research

— Modeled Behavior (@ModeledBehavior) January 8, 2017

Point is, it's true that sometimes the data whispers and we must rely on our ability to hear clearly. But sometimes the data screams.

— Modeled Behavior (@ModeledBehavior) January 8, 2017

and my response

@ModeledBehavior "If you torture the data enough, nature will always confess." Coase. You would scream too if you were being tortured.

— GrumpyMcGrumpyface (@psw1937) January 8, 2017

The Coase quote comes from the third G. Warren Nutter Lecture -- "How Should Economists Choose?" -- which Coase delivered at the American Enterprise Institute for Public Policy Research, Washing­ton, D.C., on November 18, 1981.

But its not the full quote,

I remarked earlier on the tendency of economists to get the result their theory tells them to expect. In a talk I gave at the University of Virginia in the early 1960s, at which Warren Nutter was, I think, present, I said that if you torture the data enough, nature will always confess, a saying which, in a somewhat altered form, has taken its place in the statistical literature. Kuhn puts the point more elegantly and makes the process sound more like a seduction: "nature undoubtedly responds to the theoretical predispositions with which she is approached by the measuring scientist."

A little before this quote Coase had said,

Other studies take the form of a test of the theory espoused by the author: there is a model, then regressions, followed by conclusions. In almost all cases it will be found that the statistical results confirm the theory. Sometimes it does happen that some of the expected relationships are not statistically significant, but they will usually be found to be in the right direction. And when results are obtained that do not square with the theory, which occasionally happens, these results are not usually treated as invalidating the theory but are left as something calling for further study. I would not claim that such studies have never led the investigators to modify their theories, but such cases appear to be rather uncommon. Some articles, of course, involve the testing of alternative theories, and this means that some theories are bound to come out worse. But I doubt whether such studies have often led to a change in the views of the authors. My impression is that these quantitative studies are almost invariably guided by a theory and that they may most aptly be described as explorations with the aid of a theory. In almost all cases, the theory exists before the statistical investigation is made and is not derived from the investigation.

Coase goes on to say,

Quantitative studies, or qualitative studies for that matter, may give someone who believes in a theory a better idea of what that theory implies. But such studies, normally quantitative in the natural sciences and increasingly so in economics, also play, as Kuhn indicates, another and very important role. The choice economists face is a choice between competing theories. These studies, both quantitative and qualitative, perform a function similar to that of advertising and other promotional activities in the normal products market. They do not aim simply at enlarging the understanding of those who believe in the theory but also at attracting those who do not believe in it and at preventing the defection of existing believers. These studies demonstrate the power of the theory, and the definiteness of quantitative studies enables them to make their point in a particularly persuasive form. What we are dealing with is a competitive process in which purveyors of the various theories attempt to sell their wares.

Coase then quotes Dan Patinkin:

What generates in me a great deal of skepticism about the state of our discipline is the high positive correlation be­tween the policy views of a researcher (or, what is worse, of his thesis director) and his empirical findings. I will begin to believe in economics as a science when out of Yale there comes an empirical Ph.D. thesis demonstrating the suprem­acy of monetary policy in some historical period and out of Chicago, one demonstrating the supremacy of fiscal policy.

I have always thought there is too much truth in Patinkin's remark.

Coase comments,

Assuming that Patinkin is right and that the empirical findings of economists at Yale and Chi­cago are not the same, this undoubtedly reflects a difference in their view about how the economic system operates, a difference, that is, in the theories espoused at the two universities.

So empirical results are made to fit the theory?

And,

But there are motives for selecting one theory rather than anotherthat are more worrying, and I think it was this concern that lay behind Patinkin's somewhat facetious remark. In public discussion, in the press, and in politics, theories and findings are adopted not to facilitate the search for truth but because they lead to certain policy conclusions. Theories and findings become weapons in a propaganda battle.

To give some perspective on Coase's whole argument, it should be noted that the point of Coase's lecture was to argue against the position Milton Friedman took in his essay "The Methodology of Positive Economics".

Many economists, perhaps most, think of economics as the science of human choice, and it seems only proper that we should examine how economists themselves choose the theories they espouse. The best-known treatment of this question is that of Milton Friedman, who, in the "Methodology of Positive Economics," his most popular paper, in itself a somewhat suspicious circumstance, tells us "how to decide whether a suggested hypothesis or theory should be tentatively accepted as part of " the positive science of economics. As you all know, the answer he gives is that the worth of a theory "is to be judged by the precision, scope, and conformity with experience of the predictions it yields .... The ultimate goal of a positive science is the development of a 'theory' or 'hypothesis' that yields valid and meaningful ... predictions about phenomena not yet observed.

I should say at once that I do not consider Milton Friedman's answer satisfactory.

[ ... ]

The view that the worth of a theory is to be judged solely by the extent and accuracy of its predictions seems to me wrong. Of course, any theory has implications: it tells us that if something happens, something else will follow, and it is true that most of us would not value the theory if we did not think these implications corresponded to happenings in the real economic system. But a theory is not like an airline or bus timetable. We are not interested simply in the accuracy of its predictions. A theory also serves as a base for thinking. It helps us to understand what is going on by enabling us to organize our thoughts. Faced with a choice between a theory which predicts well but gives us little insight into how the system works and one which gives us this insight but predicts badly, I would choose the latter, and I am inclined to think that most economists would do the same. No doubt it would be their belief that ultimately this theory would enable us to make predictions about what would happen in the real world; but since these predictions would emerge at a later date (and probably would also be about different things), to assert that the choice between theories depends on their predictive powers becomes completely ambiguous.

Coase and central planning

Ronald Coase famously pointed out that the reason we have firms is that there are costs to using the market, transaction costs as we call them now. The existence of transaction costs means that firms can carry out some activities at a lower cost than if we were to transact across the market. But this raises an obvious question, If firms are so great why are there markets? Or, in other words, why isn't everything done in one huge firm with no recourse to markets?

Coase's answer to this question is that there are organisational costs as well as transaction costs. In his 1937 paper Coase asked the question as to why, if by creating a firm, the costs of production can be reduced, are there are any market transactions at all? “Why is not all production carried on by one big firm?” (Coase 1937: 394). The answer according to Coase is, first, that as a firm gets bigger there may be decreasing returns to entrepreneurial activity. That is, the cost of an additional transaction being organised within the firm may rise. Second, as the number of transactions which are organised in-house increases, the entrepreneur may fail to place the factors of production in the uses where their value is maximised. This means that the entrepreneur fails to make the best use of the available factors of production. Finally, the supply price of one or more of inputs to production may increase because the ‘other advantages’ of a small firm are greater than those of a large firm. As a result of these factors a firm will grow to the point where the costs of organising an additional transaction within the firm become equal to either the costs of carrying out the same transaction via the market or the cost of organising the transaction in another firm (Coase 1937: 395).

In more modern terms it would be argued that firms have to cope with, for example, problems such as shirking, which can be covered up in situations of team production; informational complexity and asymmetries; monetary calculation, as the socialist calculation debate made clear; rent seeking and an increase in principal-agent problems.

As firms get larger, teams get bigger and monitoring costs go up. As teams get larger the possibility of shirking increases as the monitor has increased difficulty in detecting that shirking is occurring and who is doing it when it does. When a firm does more in-house appropriable quasi-rents are likely to grow making rent seeking more profitable and more likely. While rent seeking is "personally" profitable it is "socially" destructive and thus decreases the efficiency of an organisation. The larger the is organisation, the larger the asymmetries in information are and therefore the costlier it is to provide the correct incentives for mangers and workers to use their knowledge efficiently and the harder it is to design hierarchies so that the right people get the information they need and have the expertise to use it and to get people to share their information. The costs of communicating, the number of communication channels, delays in information transmission etc all raise as the firm gets bigger. As an organisation become larger with a greater number of levels of management there is an increase in the principal-agent problems that arise. More incentive mechanisms have to be developed, implemented, and monitored, in an effort to ensure that an efficiently working organisation will be created. Ultimately firms will be limited in size by the fact that as they grow and do more in-house they eliminate capital goods and this increases the costs of internal corporate planning and the eventually such costs become prohibitive. This is essential an application of the arguments in the socialist calculation debate to the firm.

So Coase gave us a framework, albeit one that he didn't develop as far as we may have wished, which can be utilised to explain why central planning is limited in the range over which it will work. Central planning only works over a limited range in terms of a firm's size. A firm can only ever be so big. The market will at some point be a cheaper way to manage transactions.

Ref.:
Coase, Ronald Harry (1937). ‘The Nature of the Firm’, Economica, n.s. 4(16) November: 386–405.

Worstall on Davies on Coase on housing

In a previous post I commented on the idea of Steve Davies to apply Coaseian thinking to solving the British (and other countries) housing problem. In part Davies wrote

For Coase the solution was to assign a property right to one of the two sides and then allow a process of bargaining to take place. If the first group have the right then those who do not want development would have to pay them not to do it. If the second, then the developers (and ultimately the buyers) have to pay for the right to develop. Crucially it does not matter which of these two we go for: in either case we will end up with the outcome that maximises total welfare so long as the bargaining process itself is not too costly.

Now at the Adam Smith Institutes's blog Tim Worstall comments on this idea. He writes

We have no doubt this would work and that should be good enough as a solution. However, while it would work we’re really not convinced that it is the correct solution. For what it is saying is that those who wish to prevent building upon land that they do not own have some form of right to say or insist so. That’s why they might be due some compensation from those who do build. And we rather reject that basic contention.

Property ownership does mean that one should be able to dispose of the property as one wishes. Consistent with this is that other people do not have the right to impose their views upon you of how you should dispose of that property. Thus we’re uncomfortable with the idea of creating a right which can then be subject to such Coasean bargaining.

Tim has a point, sorting out who has what rights to object to a housing development could raise the transaction costs of Coaseian type bargaining to such a degree that it would become impractical. And if multiple people or groups claim said rights negotiating with each of them could be expensive and time consuming. However if it is clear who the parties involved are and there are only a few of them, ie transactions costs really are low, then the Coaseian solution could be an improvement over the current situation.

Davies on Coase on housing

At the LSE's British Politics and Policy blog Steve Dacies writes that low house-building levels and the unaffordability of existing homes are problems that have been plaguing Britain for decades. And this is true not just in the UK but most other countries, like New Zealand, as well.

Davies writes,

There is now something of a consensus among academics and commentators that the shortage of housing (and buildings of all kinds) is one of our most pressing problems. Many others such as welfare costs and low productivity are at least partly caused by the lack of house building and the consequent high price of housing. However, this has not as yet led to any political action. The problem of course is the conflict of interest between people who want to build, buy or rent new houses on the one hand, and people who do not want new development on greenfield sites on the other. The second group have so far been able to block any action and this does not seem likely to change.

But the work of Coase shows that this deadlock is quite simply unnecessary and avoidable if we only think about it in the right way, as Mark Pennington explains. Current policy on development is shaped by conventional welfare economics, where two people engaging in a transaction can impose costs on bystanders. So a developer and a house buyer can impose costs on existing home owners and people who wish to preserve the rural environment. This is dealt with by regulations through planning laws.

As Pennington explains, Coase rejects this model. For him the costs are reciprocal – there are two sides each of whom is potentially imposing costs on the other. One wants to build houses, the other to preserve space. To the extent that one side gets its way the other suffers a loss. What we actually have is not an externality or pollution but a conflict over how to use land.

For Coase the solution was to assign a property right to one of the two sides and then allow a process of bargaining to take place. If the first group have the right then those who do not want development would have to pay them not to do it. If the second, then the developers (and ultimately the buyers) have to pay for the right to develop. Crucially it does not matter which of these two we go for: in either case we will end up with the outcome that maximises total welfare so long as the bargaining process itself is not too costly.

Fortunately, in the case of land use the cost of negotiation is low. If we applied this model instead of a complex and costly planning procedure we would simply have a default right, either to build or not, which would have to be bought out. We could make one default apply in some parts of the country and the other in the rest (although this should not matter, it might be politically astute). There would then be a process of bargaining and through this we would actually find out how much people really valued one alternative or the other (as opposed to their asserting it – words are cheap).

The result would be development in some areas but not in others and this would reflect the actual value that people collectively placed on the two competing uses and the associated moral values. This would be different in different places (unlike the inflexible present system). As Pennington points out this would also be an ethically superior outcome because it would reflect ethical and value pluralism rather than having one group’s values imposed on the rest through the political process which is what we have now.

For Coase the world of positive transaction costs is the world we should consider when thinking about policy. High transactions costs can prevent otherwise efficient trades from taking place. But if we can structure things so that transaction costs are low then bargaining between parties will lead us to efficient outcomes. Thus as Davies notes if we assign property rights to either developers or to those who wish to prevent new development and let them bargain the two groups can work the problem out for themselves. Bureaucrats not needed.

Such an approach to housing really would be RMA change!

Coase v. Becker on utility theory

An interesting, and all too short, exchange between Ronald Coase and Gary Becker on utility theory. Coase was not much of a believer in the usefulness of utility theory whereas Becker was.


The video comes from freetochoose.tv.

Stigliz on Coase

In his book Whither Socialism? Joseph Stigliz writes,

Coase went wrong in assuming that there are no transaction costs and no information costs. But the central contention of this book is that information costs (what can be viewed as a special form of transaction costs) are pervasive. Assuming away information costs in an analysis of economic behavior and organization is like leaving Hamlet out of the play.

But as is obvious to anyone who as read Coase the last thing he did was to ignore transactions costs. In fact the opposite is true, Coase's whole framework is based on the very notion of positive transaction costs. To quote Coase,

The world of zero transaction costs has often been described as a Coaseian world. Nothing could be further from the truth.It is the world of modern economic theory, one which I was hoping to persuade economists to leave.

For example, within a Coaseian framework the firm only makes sense in a positive transaction cost setting, if transactions costs are zero then production can take place via market transactions, with no firms needed. As Nicolai Foss has noted,

With perfect and costless contracting [due to zero transaction costs], it is hard to see room for anything resembling firms (even one-person firms), since consumers could contract directly with owners of factor services and wouldn't need the services of the intermediaries known as firms.

When thinking about the law and the actions of the courts Coase made the point that when the courts assign rights and liabilities in a context of zero transaction costs their decision does not matter. If an inefficient allocation of rights is made then the parties can bargain to an efficient one. But if transaction costs as are positive, as Coase stressed they are, then there is no inherent tendency for a welfare-maximising result to emerge, since the existence of these costs may block potentially mutually beneficial exchanges between the parties. In such a case the court's decision does matter.

When it comes to a Coaseian approach to policy Mark Pennington has noted,

[ ... ] the purpose of Coase’s analysis was to highlight the policy implications that flow from recognising the significance of transaction costs. Imperfections or frictions in markets may result in less than optimal outcomes – but these imperfections or frictions exist under any institutional alternative which involves direct government intervention. Deciding whether to rely on one mechanism or another requires a comparative institutions approach which considers the extent of the likely transaction costs under different types of ‘solution’.

So again positive transaction costs are central to the argument.

Stiglits's view show a profound misunderstanding of Coase's work. But it is a misunderstanding that is all too common.

IEA panel discussion on the work of Ronald Coase

From the IEA in London.

The Influence of Coase on Economic Policy – The Next 50 Years

The late Professor Ronald Coase made huge contributions to the development of economics over 75 years. From his paper on the theory of the firm, which was published in 1937 (and cited when he won the Nobel Prize), to his IEA book How China Became Capitalist (published when he was 101), his many insights have had a profound effect on our understanding of a number of different areas of policy. How we deal with environmental problems, land-use planning, broadcasting, telecommunications and transport privatisation are just five areas of current policy that have benefited from or could benefit from the application of Professor Coase’s ideas.

In this panel discussion we are asking our panellists to describe briefly the importance of one or more of Prof Coase’s insights and explain the relevance of his insights to government policy for the future generation.

Speakers: Rupert Darwall, Author and Expert at The Centre for Policy Studies; Prof. Mark Pennington, Department of Political Economy, King’s College London; Prof Martin Ricketts, Professor of Economic Organisation, University of Buckingham; Dr. Cento Veljanovski, Case Associates and Dr. Richard Wellings, Deputy Editorial Director, Institute of Economic Affairs

Forever Contemporary - The Economics of Ronald Coase

is the title of a new book edited by Cento Veljanovksi from the IEA in London. It provides an introduction to the ideas of Ronald Coase.

A quick summary of the book is

• R. H. Coase (1910–2013), a leading modern figure in the classical liberal tradition, was awarded the Nobel Prize in Economics in 1991 for his analysis of the significance of transaction costs and property rights for the functioning of the economy.
• Before Coase’s work in the 1930s, there was no real understanding of the relation between the theory of the firm and the theory of markets. Coase showed that the size and structure of firms, and the location of the border between internal exchange within the firm and external exchange through markets, are systematically related to the costs of transactions.
• These transaction costs, which Coase termed ‘costs of using the price mechanism’, include search and information costs (those involved in finding business partners, rather than having to produce your own inputs), bargaining costs (which rise sharply with the number of contractual partners) and enforcement costs (which, in the absence of a strong and effective legal framework, depend largely on trust in partners). When these costs alter dramatically, for example, as a result of introducing innovative technology, we can expect substantial alterations in firm and market structures.
• Coase was a pioneer in the modern analysis of environmental issues. He showed that, with clear property rights and low transactions costs, private solutions to many environmental problems can be achieved without government regulation. Such solutions were logically independent of the initial distribution of property rights. This is highly relevant to a number of modern economic problems which the government currently handles badly, such as land-use planning.
• His work has had a profound effect on later generations of economists, several of whom themselves won Nobel Prizes. His work on environmental issues, for example, influenced another Nobel Prizewinner in Elinor Ostrom, whose work focused on how common pool resources could be used effectively with minimal government intervention. This is especially relevant to debates about environmental and ecological degradation in forestry, fishing and game animal resources – perhaps particularly in developing economies.
• Similarly his work on the firm led to the development of the ‘New Industrial Economics’, now associated with Oliver Williamson, which has changed our understanding of issues of economic governance. This is relevant to current concerns over corporate social responsibility.
• Coase’s editorship of the Journal of Law and Economics over many years did much to stimulate economic analysis of legal institutions, an innovation which has had a major influence on public policy, particularly in the US. It has fed, for instance, into recommendations for accident compensation.
• Coase’s insights have challenged economists’ assumptions about the nature of public goods, which he demonstrated could often be provided more effectively by various forms of private initiative. He also illuminated such varied topics as the allocation of spectrum bandwith, the regulation of financial institutions and water resource management.
• Methodologically, Coase was opposed to ‘blackboard economics’ which relied on theory or econometric analysis at the expense of more practical investigation. He favoured careful examination of case studies and the history of industries when analysing economic policy issues.
• His work retains considerable significance in the twenty-first century. Coase’s analysis of China’s economic advance, published shortly before his death, sheds light on its future prospects, while his transaction cost approach can be argued to explain the new phenomenon of the ‘sharing’ economy which is reshaping businesses and employment. Furthermore his work should continue to be at the forefront of debates surrounding regulation, broadcasting and the environment. If policymakers and the economists who advise them ignore Coase, they are in danger of perpetuating policies which may work ‘in theory’ but do not work effectively in practice.

The table of contents reads:

1 Introduction   1
     Cento Veljanovski
     A short biography    1
     Coase’s approach    3
     What of the future?    6
     Contributions   8
2 The economics of Ronald Coase    14
     Cento Veljanovski
     What Coase did    14
     Coase’s impact    23
     New Institutional Economics (NIE)    24
     Economic analysis of law    28
     Economics   31
     Regulation   37
     Antitrust   39
     Spectrum: from wireless to mobile phones    42
     Coase’s legacy    44
3 Ownership, governance and the Coasian firm   46
      Martin Ricketts
      The nature of the frm    46
      ‘ownership’ in the Coasian theory of the frm    49
      The hazards of transacting    52
      Competition and the selection of governance structures   57
      Public policy towards the governance of enterprise    64
      Conclusion   68
4 Coase’s contributions to the theory of industrial organisation and regulation    70
      Alex Robson
      Introduction   70
      The nature of the firm: implications for the theory of industrial organisation    73
      Regulating utilities: the Coasean critique of marginal cost pricing    77
      The hold-up problem: implications for regulation    80
      Regulation and industrial organisation of the communications industry    83
      The development of the radio broadcasting industry in Britain    85
      The allocation of radio frequency spectrum in the United States    86
      Conclusion   89
5 Coase on property rights and the political economy of environmental protection    92
       Mark Pennington
       Introduction   92
       Coase on the problem of social cost    94
       Coasian analysis and the scope for environmental markets   100
       Ethical objections to the extension of environmental markets   108
       Conclusion   116
6 Coase and water    118
       Nicola Tynan
       Introduction   118
       Clearly defned property rights    120
       Integrated water resources management    124
       Conclusion   136
7 The Coase research agenda: public goods, transaction costs and the role of collective action   137
       Stephen Davies
       Introduction   137
       Was the lighthouse a public good?    138
       Conditions for private provision    140
       Coase’s research agenda    141
       Bundling private with public goods    147
       Coase’s way    159
8 Stock exchanges as lighthouses    160
        Philip Booth
        Lighthouses – what does not work ‘in theory’ works in practice   162
        Financial regulation – what does not work ‘in theory’ works in practice    163
        Private regulation and stock exchanges    166
       ‘Big bang’ and ‘deregulation’    172
        The further development of statutory regulation    175
        Could bank regulation be provided by market institutions?   178
        Conclusion   182
        Coda   185
9 Coase and the ‘sharing economy’    187
        Michael Munger
        Introduction   187
        Tomorrow 3.0: rent or own?    189
        The power drill trope: it’s about time    191
        Entrepreneurs can sell reductions in transactions costs   195
        Middlemen as brokers and sellers of connections    197
        Why sell products when you can sell reductions in transactions costs?    200
        Coase’s insight    204
Publications by Ronald H. Coase in chronological order    209

Interestingly in the book Coase is seen as "a leading modern figure in the classical liberal tradition", but this is not how everybody sees him. Bylund (2014), for example, sees Coase's paper "The Nature of the Firm" as a defense of socialist economic planning!!!

And not many people have ever called Ronald Coase a socialist!

For me the "The Nature of the Firm" is one of the - if not the - greatest papers in economics in the 20th century. It is this paper that introduced the idea of transaction costs and lead to the modern theory of the firm. Coase asked the big three questions about the firm: questions about the existence of the firm, the boundaries of the firm and the internal organisation of the firm. It is these questions that have largely driven the contemporary theory of the firm.

Ref.:
Bylund, Per (2014). 'Ronald Coase's "Nature of The Firm" and the Argument for Economic Planning', Journal of the History of Economic Thought, 36(3) September: 305-29.

Kenneth Arrow talking about future directions of research in the Coasean tradition

This video is of the Nobel Prize winner Professor Kenneth Arrow talking on the topic of "Future Directions of Research in the Coasean Tradition". This discussion emphasises Coase's first famous paper "The Nature of the Firm".


To some, who see Arrow purely as a general equilibrium (GE) theorist, it may seem odd that he was asked to talk on research in the Coasean tradition. After all GE would be considered "blackboard economics" and thus largely uninteresting, by Coase. But Arrow's work is wider than just GE theory and aspects of it are relevant to the issue under consideration. For example, Arrow's has made contributions to the new institutional economics, which Coase's work founded. Such achievements are discussed in a paper by Oliver Williamson entitled, not too imaginatively, "Kenneth Arrow and the New Institutional Economics" (This paper appears in George Feiwel, ed., Arrow and the Foundations of the Theory of Economic Policy, New York, 1987, pp. 584-99). Thus Arrow's work makes him more suited to discussing the topic at hand than it may at first appear.