Ronald H. Coase

Who Was Ronald H. Coase?

Ronald H. Coase was an economist who made pathbreaking contributions to the fields of transaction cost economics, law and economics, and New Institutional economics. Coase was awarded the Nobel Memorial Prize in Economic Sciences in 1991 for his elucidation of the role of transaction costs, property rights, and economic institutions in the structure and functioning of the economy.

Understanding Ronald H. Coase

Coase was born in England in 1910. He was an only child and suffered from some weakness in his legs that required him to wear braces and later discovered he possessed an early aptitude for learning in school. He attended the University of London where he entered the London School of Economics. In 1951, he came to the United States and began teaching at the University of Buffalo. From there, Coase went on to teach at other universities, including the University of Virginia at Charlottesville and the University of Chicago Law School, where he would spend the majority of his career. Coase was editor of the Journal of Law and Economics and a member of the Mont Pelerin Society as well.

Despite his success, Coase was not one to brag about his achievements. He referred to himself as an accidental economist, having ended up studying in the field because he didn't meet the Latin requirement to study his first choice of history. When he wrote up his biography for the Nobel committee, he stated that all the happenings that led up to his success in life had happened to him by chance. Coase declared that he'd had greatness thrust upon him and that his success was no more than that.

Coase died in Sept. 2013.

Contributions

Coase's notable contributions to economics are the transaction cost theory of the firm, the Coase Theorem of externalities and property rights, and challenging the theory of public goods. Coase's contributions all fall within and developed the general field of New Institutional economics, including transaction cost economics as well as law and economics.  

Theory of the Firm and Transaction Cost Economics

Coase's 1937 paper, "The Nature of the Firm," asked the question of why, given that the prevailing microeconomic theories at the time described the entire economy as a mass of atomistic individual buyers and sellers carrying on business as a constant stream of spot transactions, are actual market economies organized into groups of individuals cooperating together in business firms within which economic activity is carried out according to the direction of management rather than on the arm's-length transactions between the individual members of the firm. At the time, Coase was a socialist and saw the close parallel between production managed by business managers in a capitalist economy to production managed by a central planner in a socialist economy. If markets are superior to central economic planning, asked Coase, then why are capitalist economies organized into a collection of centrally planned firms? Why do firms exist?

In answer, Coase developed the transaction cost theory of the firm. Because the standard microeconomic theory of perfect competition depends on the assumption that market transactions are costless, the most efficient way to organize an economy will rely entirely on market transactions. However, Coase observed that in the real world, transactions costs occur; coordinating economic activity through non-market means, including organized firms, is a way to economize on transactions costs. Coase's argument essentially gave rise to the entire field of transaction cost economics that has developed since the publication of "The Nature of the Firm."

Coase Theorem and Law & Economics

In 1960, Coase published another paper, "The Problem of Social Cost." In this paper, he argued that in the absence of transaction costs, an efficient solution to any economic conflict arising from an externality could be arrived at regardless of the initial distribution of property rights, without the need for a government to impose a solution through regulation, taxation, or subsidy. This idea would come to be known as the Coase Theorem, win Coase his place at the prestigious University of Chicago, and greatly advance the field known as law and economics.

Similarly to his argument in "The Nature of the Firm," Coase went on to argue that because in the real world, transaction costs are not zero, courts can play a role in assigning property rights to arrive at economically efficient legal solutions as disputes arise. Also, as in "The Nature of the Firm," Coase pointed to transaction costs as a key factor in the existence, role, and scope of the institutions that govern the real economy outside the blackboard models of economists.

Public Goods

In a 1974 paper, "The Lighthouse in Economics," Coase famously criticized the theory of public goods on empirical grounds. Under the prevailing theory of public goods, any good whose consumption could not be limited and once produced would supply all the demand in a given geographic area would not be produced except by a government authority due to the economic incentives involved. Lighthouses were commonly cited as an example of such a public good, since no one can be excluded from seeing and using the light projected and a single lighthouse is enough to provide warning of a given navigational hazard. The theory of public goods predicts that no lighthouses will be produced by the operation of a voluntary market and would necessarily be produced by tax-funded government operations. Privately owned and operated lighthouses could never be profitable, and thus would not exist otherwise.

Coase's historical investigation of actual lighthouses showed this not to be the case. Throughout 19th century Britain at least, many lighthouses were privately owned and operated. Their existence was possible due to institutional arrangements that enabled lighthouse owners to bill ships that put in at nearby ports for having benefited from the services of the lighthouse. Once again in this paper, Coase's insight overturned the prevailing view of what he called "blackboard economics" and showed how the real economy could generate institutional solutions to solve problems that could not be solved in the idealized mathematical models of mainstream economic theory.