Academic journal article Journal of Economic Issues

Coase, Costs, and Coordination

Academic journal article Journal of Economic Issues

Coase, Costs, and Coordination

Article excerpt

The development of political economy may be attributed to various factors, one of which is surely the need to deal with the problem of coordination - a problem whose import grew with the transition from subsistence economy to the increasing division of labor within and across economies. While the mechanisms of coordination - in particular, markets, firms, and governments - have always occupied a place at the center of economic analysis, albeit with differential degrees of positive and normative emphasis among them at different times and by different schools, relatively little attention has been devoted to the examination of the underpinnings of these mechanisms. This has several implications. First, economic theory offers little in the way of explanation for how these mechanisms function and why they function as they do. Second, there has been, until recently, little offered by way of explanation for the observed pattern of coordination within the economic system and, in particular, why certain activities are coordinated in different ways (e.g., market versus firm, short-term versus long-term contracts, etc.). Third, and reflective of the foregoing, economic theory offers little basis for the normative analysis of and choice among alternative instruments of coordination.

For Ronald Coase, issues such as these are at the heart of economic analysis, one of the central functions of which, in his view, is to understand and to make policy recommendations regarding the appropriate institutional structure of production and exchange - the mechanisms through which production and exchange are to be coordinated. In this essay, I will attempt to outline Coase's contributions in this regard and evaluate their import for economic analysis. While Coase has by no means given us a comprehensive, well-developed theory of coordination, his insights can serve to enhance our understanding of how and why coordination matters.

Why Coordination Matters: The Costs of Coordination

Traditionally, the world of neoclassical economic analysis has been one in which markets, firms, and governments coordinate economic activities in a costless manner. Ronald Coase is perhaps best known for his analysis of the implications of life within such a world - in particular, for pointing out that, if coordination costs were zero, the mechanism employed to coordinate activities would not matter, at least from an allocative perspective. As he has repeatedly pointed out, however, the insights to be gained from contemplating such a world do not lie in the results thereby implied, but rather come from their collisions with the operation of real-world coordination processes - in particular, with the reality that coordination does matter for the pattern of resource allocation within society. And for Coase, the main reason for this (the why within the why, if you will) is that there are costs associated with the coordination processes, that these costs are inevitably present, that they differ both across coordination mechanisms and for each of these mechanism across circumstances, and that, as a result, the choice of coordination mechanism in a given situation has important implications for economic outcomes.

While Coase did not construct a general theory of coordination costs, he did provide important insights into the roles that they can play and the implications that one can draw from them. In "The Nature of the Firm" [1937], Coase set out to answer a question to which, in his view, economic analysis to that point had offered no satisfactory answer: Why do firms exist? The (mainstream) economic analysis of the day, after all, assumed that the pricing mechanism could provide all of the coordination necessary within the economic system. Yet, the firm obviously serves a coordinating purpose, performing functions that could be coordinated instead through the pricing mechanism. The answer, Coase suggested, is that there are costs associated with operating through the pricing mechanism, some of which could be reduced or eliminated by internal organization - the integrated firm relationship. …

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