Home >opinion >online views >Ronald Coase: A catalyst for change

The demise of the Classical school and the concurrent rise of the Marxist, and more significantly, the Keynesian school during the former half of the twentieth century, marked a period of cold pessimism against free markets. To be sure, with the pressing questions of macroeconomics of the time, the dominance of the Keynesians was stiffly challenged by the Austrian school (led by Friedrich Hayek, and his lesser-known mentor Ludwig von Mises), and in the years that followed by the Chicago school (led by Milton Friedman). Yet, when it came to the questions of microeconomic functioning of markets, the academic mainstream predisposed to loathe “market failures" went completely unchallenged.

Starting out as a socialist during his youth, it was under the tutelage of Friedrich Hayek and Arnold Plant at the London School of Economics (LSE) that Ronald Harry Coase began a personal journey of understanding the functioning of markets. Hayek’s influence on Coase remained minimal initially as the Austrian professor was busy in his duel with John Maynard Keynes over economic fluctuations. But Hayek’s influence would become evident later when Coase got involved in the study of economics and law. Enrolled in a course on commerce at the LSE, it was Plant’s teaching that engrossed young Coase into the science of economics. Coase would later remember Plant in his 1991 Nobel Prize lecture: “he [Plant] explained how a competitive economic system coordinated by prices would lead to the production of goods and services which consumers valued most highly. Before being exposed to Plant’s teaching, my notions on how the economy worked were extremely woolly".

In the coming decades, various academic papers authored by Coase at various universities, including the University of Chicago, would sow the seeds of a new perspective in economic thought, something that would later come to be known as New Institutional Economics (NIE).

In 1937, at only 26 years of age, Coase authored The Nature of the Firm, a ground-breaking paper tracing the existence of firms—that many found to involve managerial organization characteristic of command economies—in a market economy to the existence of transaction costs. Whether the entrepreneurial coordination of production via voluntary contracts, something eventually bound by the rules of economic calculation, is akin to production organized in a command economy still remains a matter of academic debate. But a more sympathetic reading of Coase would credit him with recognizing the firm as an outcome of markets evolving appropriate institutions to reduce transaction costs (which is quite reminiscent of Hayek’s conception of the market as a spontaneous order).

In 1960, Coase authored The Problem of Social Cost, an influential paper arguing that private parties would readily arrive at economically efficient solutions by reallocating the use of property to solve the problem of economic externalities. At least that’s how George Stigler (mis)understood Coase’s 1960 paper, framing it as “The Coase Theorem". In real, however, Coase argued that the presence of transaction costs would prevent private parties from successfully achieving such economically efficient reallocation of property—thus requiring the intervention of courts. While not completely trusting of a market-based solution, Coase effectively introduced an alternative to the mainstream’s singular preference for Pigouvian taxation in dealing with economic externalities.

More importantly, however, Coase’s paper stimulated further research into the possibility of market-based solutions to economic externalities (see popular works of economists like David Friedman, arguing the case that markets tend to evolve efficiency-maximizing property laws; and Richard Posner, arguing the case that the common law is in fact economically efficient).

The Lighthouse in Economics, a lesser-known work of Coase, used the example of private lighthouses to bulldoze the common contention of the mainstream that certain “public goods" cannot be provided by markets. In The Federal Communications Commission, Coase pointed out to the folly of the US federal government arbitrarily allocating radio broadcasting rights to promote public interest and successfully made the case for allowing competitive bidding and trading of licences.

Quite clearly, it is hard to overstate the influence Coase has had in influencing public policy by backing the case for markets, be it the case of carbon trading, or the trading of broadcasting spectrum. There can also be little doubt that Coase’s contribution to economic science in a career spanning over eight decades has helped to further academic debate into new ground, something that has come to expose the shortcomings in his own work at times. But such creative destruction is an essential part of intellectual progress. It is perhaps Coase’s capability to act as a catalyst in fostering such progress in an academic environment unreceptive of new ideas that is worth lauding at this moment that marks his demise.

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