Ronald Coase was an unlikely winner of the Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel, popularly known as Nobel Prize in economics. He began his schooling life in a special school for “physically defective” students. He was not able to receive normal academic education upto the age of 10. In London School of Economics he studied business and accountancy, not economics proper, and then taught economics to law students.
Such a person is unlikely to author one of the biggest hits in academic economics, but then Coase was made of different stuff. Avinash Dixit wrote in 2000 about his paper ‘The problem of social cost’: “Coase’s article has been arguably the single largest influence on thinking about economic policy for the last three decades. It is one of the most—if not the most—widely cited economics article in recent times. According to the Social Citation Index volumes since 1972, even Milton Friedman and Paul Samuelson do not have a single publication that has been cited even half as often as ‘The Problem of Social Cost.’ This article was also, by a huge margin, the most widely ordered article in the Bobbs-Merill Reprint Series in Economics.”
To understand the importance of this paper, we need perspective and context. One of the central insights of economics is the presence of ‘invisible hand’ that is pricing system. Pricing system coheres the individual plans into an ordered totality, even though these plans are chalked out in a decentralized setting. There are handful exceptions to this reasoning however, and economists call them market failures.
Externality is one example of market failures. Standard economic arguments lead to the conclusion that in the presence of externality fabled properties of market system cease to hold; that there would be underprovision of goods having positive externality and overprovision of goods having negative externality. To tackle this problem Cambridge economist Arthur Cecil Pigou—peer of more famous John Maynard Keynes– came up with a solution. To complement the market, government should step in. If a good has positive externality then it must be subsidized. If it produces negative externality then it must be taxed. When people demand that ‘pollution tax’ be imposed on gasoline or subsidy be given to green technologies, they are essentially advocating a Pigouvian solution.
Pigouvian solution suffers from many political economy problems since it involves state-intervention and is not favored by people with libertarian preferences. In his paper, Coase outlined an alternative approach for dealing with externalities. He pointed out that economic transactions in a capitalist set up are not limited to price-based mechanisms alone. In particular, if property rights are properly defined, contract enforcing mechanisms are in place and transaction costs are not high enough to preclude voluntary negotiations then a mutually agreed bargain can ensure socially optimal outcome. Unlike the Pigouvian scheme, in Coasian scheme the role of government is restricted to enforcing contracts and securing property rights. In addition, the paper by broadening the role of economic analysis to include court action also laid the foundation of what is known as ‘Institutional Economics’.
One curious and counterintuitive aspect of Coase theorem is that efficiency of bargaining does not depend on the particular distribution of property rights and liability regimes. In environmental jurisprudence there is a principle called ‘polluter pays’. Coase argued that this hallowed principle does not follow from efficiency considerations. Whether a polluter is asked to pay or is paid not to pollute, her marginal profit schedule will remain unchanged and therefore the level of optimal action will remain same.
Coase’s solution was not merely a theoretical curiosity. In fact economists such as Paul Samuelson had flaunted one particular service—light houses—to give an example of a service that can never be adequately provided by the market. Historical research showed that upto about 1833 lighthouses were built by private parties and they essentially used Coasian bargaining for earning profits!
Coase was perhaps one of the last economic theorists who employed an intuitive and discursive approach to economics. He was master of simple thought experiments and toy arithmetical examples that hinted at deep economic relationships. Some have interpreted Coase’s approach to be an indictment of the formal, deductive and mathematical approach of the mainstream economics.
Coase himself pointed out repeatedly how an emphasis on ‘the blackboard economics’ has gripped the academia and led them astray. I personally believe that it is a mistake. In monopoly theory, there is a result called ‘Coase conjecture’. This conjecture deals with monopoly situations in durable goods market such as diamonds. Literally dozens of mathematical papers have been written to flesh out this argument. Point is that Coase’s arguments are often too subtle to be elucidated and communicated without heavy dose of mathematics. That he was able to produce such subtle arguments without use of mathematics is a testament to his precocity and genius, not the cussedness of economics establishment.
A discussion of Coase’s weltanschauung will remain incomplete without discussing his remarkable paper ‘Market for goods and market for ideas’. Part irony, part sarcasm and logically robust, this paper created quite a stir in 1975. In this paper, Coase compared the economic grounds for government regulation in market for goods and market for “activities covered by First Amendment such as speech, writing and exercise of religious belief” and found them similar, except that arguments are even stronger for regulating production of ideas!
As discussed earlier, one reason often given in favor of government regulation is externality: Coase points out that the benefits or harm arising out of ideas are seldom internalized by their producers. Another ground for government intervention is consumer irrationality and stupidity. But if a consumer cannot examine the quality of a can of peach, what are the chances that she will be able to examine the hermeneutics of Gadamer or the dialectical materialism of Marx?
One by one all the grounds are exhausted with almost similar analysis. Conclusion inexorably follows that if a Federal Trade Commission makes sense, so does Federal Press Commission, Federal Political Commission and Federal Philosophy Commission! Assorted Nehruvians of our country like learned Justice Markandey Katju, whose penchant for securing commanding heights of economy is only matched by their zeal for restricting individual freedom and liberty, would surely concur with Coase on this issue!
Coase’s curiosity, determination and scholarship didn’t diminish with his age. He wrote his last book “How China became a capitalist?” with his student Ning Wang when he was more than hundred year old. Ronald Harry Coase(1910-2013) is no more, his ideas will endure.