Ronald H. Coase
[An updated version of this biography can be found at Ronald H. Coase in the 2nd edition.]
Ronald Coase is an unusual economist for the twentieth century, and highly unusual for a Nobel Prize winner (he won in 1991). First, his writings are sparse. In a sixty-year career he wrote only about a dozen significant papers—and very few insignificant ones. Second, he uses little or no mathematics, disdaining what he calls "blackboard economics." Yet his impact on economics has been profound. That impact stems almost entirely from two of his articles, one of which was published when he was twenty seven. The other was published twenty-three years later.
Coase conceived of the first article, "The Nature of the Firm," while still an undergraduate on a trip to the United States from his native Britain. At the time he was a socialist, and he dropped in on perennial presidential candidate of the Socialist party Norman Thomas. He also visited Ford and General Motors and came up with a puzzle: how could economists say that Lenin was wrong in thinking that the Russian economy could be run like one big factory, when some pretty big firms in the United States seemed to be run very well? In answering his own question, Coase came up with a fundamental insight about why firms exist. Firms are like centrally planned economies, he wrote, but unlike the latter, they are formed because of people's voluntary choices. But why do people make these choices? The answer, wrote Coase, is "marketing costs." (Economists now use the term "transactions costs.") If markets were costless to use, firms would not exist. Instead, people would make arm's-length transactions. But because markets are costly to use, the most efficient production process often takes place in a firm. His explanation of why firms exist is now the accepted one and has given rise to a whole literature on the issue. Coase's article was cited 169 times in academic journals between 1966 and 1980.
"The Problem of Social Cost," Coase's other widely cited article (661 citations between 1966 and 1980), was even more path-breaking. Indeed, it gave rise to the field called law and economics. Economists
But Coase challenged the accepted view. He pointed out that if the rancher had no legal liability for destroying the farmer's crops, and if transaction costs were zero, the farmer could come to a mutually beneficial agreement with the rancher under which the farmer paid the rancher to cut back on his herd of cattle. This would happen, argued Coase, if the damage from additional cattle exceeded the rancher's net returns on these cattle. If for example, the rancher's net return on a steer was two dollars, then the rancher would accept some amount over two dollars to give up the additional steer. If the steer was doing three dollars' worth of harm to the crops, then the farmer would be willing to pay the rancher up to three dollars to get rid of the steer. A mutually beneficial bargain would be struck.
Coase considered what would happen if the courts made the rancher liable for the damage caused by his steers. Economists
This insight was stunning. It meant that the case for government intervention was weaker than economists had thought. Yet Coase's soulmates at the free-market-oriented University of Chicago wondered, according to George Stigler, "how so fine an economist could make such an obvious mistake." So they invited Coase, who was then at the University of Virginia, to come to Chicago to discuss it. They had dinner at the home of Aaron Director, the economist who had founded the Journal of Law and Economics.
Stigler himself labeled Coase's insight the Coase Theorem.
Of course, because transaction costs are never zero and sometimes are very high, courts are still needed to adjudicate between farmers and ranchers. Moreover, strategic behavior by the parties involved can prevent them from reaching the agreement, even if the gains from agreeing outweigh the transactions costs.
So why were economists so excited by the Coase Theorem? The reason is that it made them look differently at many issues. Take divorce. University of Colorado economist H. Elizabeth Peters showed empirically that whether a state has traditional barriers to divorce or divorce on demand has no effect on the divorce rate. This is contrary to conventional wisdom but consistent with the Coase Theorem. If the sum of a couple's net gains from marriage, as seen by the couple, is negative, then no agreement on distributing the gains from the marriage can keep them together. All the traditional divorce law did was enhance the bargaining position of women. A husband who wanted out much more than his wife wanted him in could compensate his wife to let him out. Not surprisingly, divorce-on-demand laws have made women who get divorces financially worse off, just as the absence of liability for the rancher in our example made the farmer worse off.
Coase has also upset the apple cart in the realm of public goods. Economists often give the lighthouse as an example of a public good that only government can provide. They choose this example, not based on any information they have about lighthouses, but rather on their a priori view that lighthouses could not be privately owned and operated at a profit. Coase showed, with a detailed look at history, that lighthouses in nineteenth-century Britain were privately provided and that ships were charged for their use when they came into port.
Coase earned his doctorate from the University of London in 1951 and emigrated to the United States, where he was a professor at the University of Buffalo from 1951 to 1958, then at the University of Virginia from 1958 to 1964, and then at the University of Chicago from 1964 to 1979, when he retired. Today Coase is a senior fellow in law and economics at the University of Chicago.
"The Nature of the Firm." Economica 4 (November 1937): 386-405.
"The Federal Communications Commission." Journal of Law and Economics 2 (October 1959): 1-40.
"The Problem of Social Cost." Journal of Law and Economics 3 (October 1960): 1-44.
"The Lighthouse in Economics." Journal of Law and Economics 17, no. 2 (October 1974): 357-76.
Related Material on Econlib:
Mike Munger on Subsidies and Externalities. EconTalk podcast with discussion of the Coase Theorem and applications
"Orange Blossom Special: Externalities and the Coase Theorem", by Michael Munger.