Ronald H. Coase: Chicago School or Virginia School Economist?
By Rosolino Candela
It is not uncommon for Ronald Coase to be identified as a “Chicago School” Economist. For several reasons, this would not be an unfair characterization. First, Coase joined the faculty of the University of Chicago Law School in 1964, and remained there until his retirement in the early 1980s, during which time he had also been the Editor of The Journal of Law and Economics until 1982. Secondly, as a student at the London School of Economics, Coase, like other economists of the Chicago School, had been greatly influenced by the work of Frank Knight, particularly Risk, Uncertainty, and Profit (1921). Although Coase had regarded himself as a socialist in his youth, his training at the LSE under Arnold Plant and his study of the workings of the operation of markets in public utilities, postal services, and lighthouses solidified his free-market convictions, as is often identified with Chicago School economists, such as Milton Friedman, George Stigler, or Gary Becker. Moreover, the tendency for government regulation to serve special interests, rather than the public interest, also affirmed his skepticism of government intervention. It would seem, then, that Coase carried all the trappings of a Chicago economist.
However, as economist Steve Medema has argued, the “relationship between Coase and the Chicago School could be considered a case study in the dangers of assuming some sort of Chicago homogeneity” (Medema 2010, p. 262). Indeed, Coase shared similar public policy conclusions as his contemporaries at Chicago. But to identify an economist by his or her free-market policy conclusions, instead of the methodology by which they arrive at such conclusions, renders indistinguishable the distinction between the Chicago School and the Austrian School, or between Chicago and its intellectual cousins at the University of California, Los Angeles (UCLA), University of Washington, or the University of Virginia (UVA) for that matter.
In terms of methodology, I would argue that Coase would be better identified as an economist of the Virginia School, from which Public Choice theory was born at the Thomas Jefferson Center for Studies in Political Economy and Social Philosophy (TJC) at the University of Virginia (UVA) under James Buchanan and Gordon Tullock. Though Buchanan, Tullock, and other faculty members, such as Rutledge Vining and G. Warren Nutter, had been trained at the University of Chicago, what distinction, if any, exists between the “Virginia School” and the Chicago School? Moreover, how can we attribute the distinction of “Virginia School” to Coase?
Though Coase’s own work shares many policy conclusions with that of public choice theorists, particularly skepticism of government intervention to mitigate supposed market failures, the relationship between Coase and Public Choice introduces another danger of homogeneity, since other branches of Public Choice have emerged as well, besides that which emerged at UVA (and later Virginia Tech and George Mason University). These include the “Bloomington School” of Vincent and Elinor Ostrom and the “Rochester School” of William Riker. Moreover, Public Choice was also developed by economists at the University of Chicago, including Gary Becker, Sam Peltzman, and George Stigler (see Mitchell 1988 and Mueller 1976).
What I wish to highlight here is a point that Peter Boettke and I have made in paper recently published in Public Choice, titled “Where Chicago Meets London: James M. Buchanan, Virginia Political Economy, and Cost Theory” (2020), in which we argue that the Virginia School of Political Economy emerged from the marriage of subjective cost theory that had been developed at the London School of Economics (LSE) under F.A. Hayek and Lionel Robbins, and price theory from the University of Chicago.
The work of Frank Knight had been a cornerstone of the education of students at the University of Chicago and the LSE alike in the pre-WWII era, and Knight had been highly influential in Coase’s education. But whereas price theory at Chicago had been primarily Marshallian, in which costs are taken to be objective, price theory at the LSE had been primarily Wicksteedian, in which supply curves are simply the demand curve of suppliers, and therefore part of the total demand curve for a good or service, the value of which is subjective. In his own recollection of the LSE of the 1930s, Coase remarks that, unlike at Chicago, at the LSE, “Marshall was in the calendar of saints but few of us prayed exclusively to him. Marshall was one among many economists studied”, and goes further to state that, “[i]n fact, we thought his views on cost confused” rather than clarified the analysis of market processes (1982, p. 34).
Therefore, what Coase shared with Buchanan and other economists of the Virginia School, which made them distinct from their intellectual cousins at Chicago (see Wagner 2017, 2020), is the fact that they saw opportunity costs not as constraints to which economic actors passively respond, but as variables defined by the act of choice itself. Because of this, Virginia School economists, such as Coase, directed their analytic attention to choice among constraints, and thus saw institutions, organizations, and other contractual arrangements as a by-product of individuals striving to realize the gains from exchange. Virginia School economists therefore took a constitutional perspective, which focuses on analyzing “the rules of game” and how the modification of institutions could generate positive-sum forms of interaction. Therefore, whereas their contemporaries of the post-WWII Chicago School took Pareto-optimality as an assumption that characterizes real-world market outcomes, Coase and the Virginia School understood the conditions of Pareto-optimality to be a by-product of individuals devising institutional arrangements, not only to reduce transaction costs, but also to exhaust the gains from trade.
This distinction is best highlighted not only by how economists at the University of Chicago first reacted to what later became known as the “Coase Theorem,” but also how the Coase Theorem is still interpreted today. “The Problem of Social Cost” (Coase 1960) had been written in response to what Friedman, Stigler, Harberger, and other economists at the University of Chicago had perceived as a fundamental error in Coase’s analysis of Pigovian welfare economics, as had been first argued in the “The Federal Communications Commission” (Coase 1959). However, what needs constant reminding is not only that both of these papers were written when Coase was a faculty member at UVA, but also that, at UVA, his ideas were regarded as an evolution of the common knowledge that he, Buchanan, Nutter, and Vining had inherited from Frank Knight. Surprisingly, as George Stigler (1988) recounts in his autobiography, it was among Knight’s former pupils, including Friedman and himself, at the University of Chicago that Coase’s ideas were considered a revolution that overturned Pigovian welfare economics.
Though the Coase Theorem has become a cornerstone of law and economics and institutional economics generally, Coase’s central message cannot be fully understood unless we first realize how he understands the nature of costs. As he recounted repeatedly, the Coase Theorem was never meant to direct our attention to a world in which transaction costs are zero. In such a world, markets will have already exhausted all the gains from trade, and institutions are therefore redundant. Rather, what Coase was trying to stress is how positive transaction costs represent future profit opportunities for their reduction, and how entrepreneurs will profit from perceiving a way to reduce transaction costs by devising institutional arrangements, thereby creating the gains from trade.
As Coase has highlighted throughout his work, from seminal paper “The Nature of the Firm” (Coase 1937), to his last book, How China Became Capitalist (Coase and Wang 2012), the benefit of institutional and organizational arrangements, such as contracts, firms, money and property rights, are that they reduce the costs of making an exchange (i.e. transaction costs). Costs are not a constraint independent of human choice, but are an artifact of human choice, and therefore can be manipulated by restructuring the payoff structure embodied in institutions through human creativity. It is this understanding of market processes that Coase shared with his colleagues at UVA, and distinguished him from his colleagues that he would later join at the University of Chicago. It is in this respect that Coase should be considered economist of the Virginia School.
Candela, Rosolino A., and Peter J. Boettke. 2020. “Where Chicago Meets London: James Buchanan, Virginia Political Economy, and Cost Theory.” Public Choice 183(3-4): 287– 302.
Coase, Ronald H. 1937. “The Nature of the Firm.” Economica 4(16): 386–405.
Coase, Ronald H. 1959. “The Federal Communications Commission.” The Journal of Law and Economics 2: 1–40.
Coase, Ronald H. 1960. “The Problem of Social Cost.” The Journal of Law and Economics 3: 1–44.
Coase, Ronald H. 1982. “Economics at LSE in the 1930s: A Personal View.” Atlantic Economic Journal 10(1): 31–34.
Coase, Ronald H. and Ning Wang. 2012. How China Became Capitalist. New York: Palgrave Macmillan.
Knight, Frank H. 1921. Risk, Uncertainty and Profit. Boston, MA: Houghton Mifflin.
Medema, Steven G. 2010. “Ronald Harry Coase.” In Ross B, Emmett, ed. The Elgar Companion to the Chicago School of Economics (pp. 259–264). Northampton, MA: Edward Elgar.
Mitchell, William C. 1988. “Virginia, Rochester, and Bloomington: Twenty-Five Years of Public Choice and Political Science.” Public Choice 56(2): 101–119.
Mueller, Dennis C. 1976. “Public choice: A Survey.” Journal of Economic Literature 14(2): 395– 433.
Stigler, George J. 1988. Memoirs of an Unregulated Economist. New York: Basic Books.
Wagner, Richard E. 2017. James M. Buchanan and Liberal Political Economy. Lanham, MD: Lexington Books.
Wagner, Richard E. 2020. “Chicago Political Economy, and Its Virginia Cousin.” GMU Working Paper in Economics No. 20-11. Available at SSRN: https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3597754
Rosolino Candela is a Senior Fellow in the F.A. Hayek Program for Advanced Study in Philosophy, Politics, and Economics, and Associate Director of Academic and Student Programs at the Mercatus Center at George Mason University