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By Hazlett, Thomas W. | Reason, January 1997 | Go to article overview

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Hazlett, Thomas W., Reason


Nobel laureate Ronald Coase on rights, resources, and regulation

When Ronald Coase was awarded the Nobel prize for economics in 1991, many in the profession were stunned. No one could remember a single equation, an estimated parameter, a correlation coefficient - nary a Greek symbol - in any of his articles. How could this poseur - a man who had taught economics at the University of Chicago Law School - properly lay claim to that esteemed title?

It was not the first time in his life that Ronald Coase had surprised people. Born in England in 1910, Coase wore leg braces as a youngster and was placed in a school for "physical defectives." It was run by the same organization, Coase remembers, that ran the school for "mental defectives," and there was "some overlapping in the curriculum." Coase found himself in (literally) basket-weaving classes, and received virtually no academics until the age of 10.

Even at the London School of Economics, Coase was pretty much on his own. He took only business and accounting no economics - until a seminar with Professor Arnold Plant in his senior year. The course - no readings - featured a robust discussion of the invisible hand. Coase, then a socialist, grasped as seminal the idea of spontaneous coordination in the marketplace, and his career as a creative and provocative economic thinker was born.

Again, in a most unusual way. He trekked to America in the early 1930s on a scholarship, and wandered about the industrial heartland researching the methods of business firms. Coase's scientific methodology? He asked businessmen why they did what they did. One key question, for instance, involved why firms chose to produce some of their own inputs (vertical integration), and why they sometimes chose to use the market (buying from independent suppliers). He was fascinated by their answers, but even more by their astute calculation: Firm managers were keenly aware of all the relevant trade-offs. In 1937, Coase published his article "The Nature of the Firm," explaining the basic economics of the business enterprise. It became one of the most influential works in the history of the dismal science, outlining the subtle logic of how firms pursue efficiency in a complicated world. The approach was vastly more sophisticated than the ones in vogue in America in the 1930s, which posited that the corporation was simply an accident waiting to self-destruct.

Again, in 1960, Coase rearranged the study of economics with his essay "The Problem of Social Cost." It analyzed what happens when economic actions affect third parties - say, for instance, when a railroad dumps pollution on a farmer's crops. Before Coase, economic analysis maintained that decentralized decision making - the market - in such cases would predictably fail to achieve an optimal solution, because self-interested actors (say, the railroad owners) would fail to take into account the harm imposed on others. That idea had widespread implications for the economy and provided intellectual justification for a wide range of government interventions.

Coase, whose 1959 article on the Federal Communications Commission had led him to realize how property rights could be used to manage the airwaves, saw something different: The problem actually lay in an improper definition of legal rights. He noted that once property was well-defined and easily tradable, the efficient solution would follow. Ironically, the optimal social outcome would obtain no matter who owned the property. For instance, even if the railroad possessed the right to pollute, the farmer could pay it not to. Indeed, the farmer (really the farmer's customers) would pay whenever the benefit from mitigating pollution exceeded the cost created by pollution. Hence, whenever someone clearly possessed the right to pollute: Voila! Social efficiency! This became famously known as the Coase Theorem.

What was perhaps Ronald Coase's most important contribution to economic understanding, however, was not as an author. …

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