Ronald Harry Coase was born on December 29, 1910 in London. In 1932, he earned his bachelor of commerce degree from the London School of Economics. Five years later, Coase married Marion Hartung. Coase would go on to revolutionize the field of economics…twice.
The first time was with his stunningly influential paper, The Nature of the Firm (1937). Coase conceived of his thesis when he was still an undergraduate and self identified socialist. While he was visiting Socialist Party president candidate, Norman Thomas, in the states, Coase asked himself how economists could accuse Lenin of being wrong in thinking the Russian economy could be run like one big factory, when some big US firms seemed to run very well. In pursuing this puzzle, Coase would discover a fundamental insight about why firms exist in the first place.
Firms are like centrally planned economies in that they are insulated from the price system. All transactions within a firm occur without a price mechanism, which is what allows for the economizing of production goods and allocating resources efficiently in a market economy. So why, then, isn’t the economy made up of independent self-employed people who come into contact to trade (always with reference to the price mechanism)?
The key difference, that allows an economy of firms to be run efficiently and prevents an economy of central planning from being run efficiently, is that the former are produced through people’s voluntary decisions – decisions aimed at minimizing “marketing costs” (now referred to as “transaction costs”). These are costs associated with using the market itself: things like search and information costs, bargaining costs, keeping trade secrets, and policing and enforcement costs.
If transaction costs were zero, the economy could just be made up of independent producers. But in the real world, transaction costs are a constant burden on potential exchanges. The solution, people found, is to create firms that, while insulting the inner exchanges from the price system, lower transaction costs. Firms will grow until the net gains from lowered transaction costs, among other economies of scale, outweighs the losses from being separated from price information. Coase pointed out governments often artificially increase transaction costs, through things like sales taxes, and promote inefficiency in firms.
Coase’s explanation for why firms exist is now accepted in mainstream academia and Nature of the Firm was cited a whopping 169 times in academic journals between 1966 and 1980 alone.
In the 1950s Coase acquired US citizenship and taught at the University of Buffalo, then at the University of Virginia in 1958. Two years later Coase whipped up a flurry in economics again with his against-the-grain paper, The Problem of Social Cost, which was so influential (between 1966 and 1980, it was cited an unbelievable 661 times) it led to an entirely new field called law and economics. While the dominant economic view at the time was that externalities (spillover costs that affect those not directly involved with a given transaction – like air pollution) had to be regulated by the government. Coase challenged this view by pointing out that, with zero transaction costs and strong property rights, market actors can often come to a mutually beneficial outcome more efficient than government meddling.
His example was a rancher whose cattle ate his neighbor farmer’s crops. The dominant view at the time said the government should step in and either fine the rancher or limit the number of cattle he could heard. Coase pointed out that, left to their own devices, the farmer could pay the rancher to limit his heard of cattle as long as damages from additional cattle exceeded the rancher’s net returns on these cattle. Making the rancher liable through government intervention didn’t actually have an effect on the number of cattle or the crop losses – it only made both parties less well off.
According to George Stigler, him and his associates at the free market oriented University of Chicago wondered, “how so fine an economist could make such an obvious mistake.” They decided to invite Coase to come and discuss his paper at a dinner at the house of Aaron Director, brother-in-law of Milton Friedman and founder of the Journal of Economics, which Coase would later serve as editor of. Stigler recalls that after “two hours of argument, the vote went from twenty against and one for Coase to twenty-one for Coase.” Stigler named the insight “Coase Theorem.”
Coase would join Stigler and his Chicago buddies in 1964 and retired there 15 years later. Ronald H. Coase was interested in looking at markets, as they exist in the real world. Peter Boettke, leading free market economist and author of Living Economics, wrote Coase, “appreciated the ‘invisible hand’ of the market, but understood that the operation of economics forces at work were always within the context of specific institutions.” While he wrote a mere 12 academic papers in his career, Coase’s contributions were always robust and insightful. Coase was awarded the Nobel Prize in Economics in 1991.
Marion, his wife, died on October 17, 2012 and Ronald passed away less than a year later on September 2 at the age of 102. His lifetime of astounding work continues to play a crucial role in the defense of private property rights, stable and predictable institutions, the rule of law, and a liberal market order. His work was revolutionary in the field of economics. Let what we do with his insights be even more revolutionary. Do us all a favor and read Coase.
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