Tag: economic theory

Ronald Coase, 1910-2013

The immensely influential scholar and winner of the 1991 Nobel Prize for Economics was 102 years of age and a productive scholar to the end. An excellent short introduction to Coase’s work is found in the Concise Encyclopedia of Economics, edited by David Henderson.

Coase’s famous, seminal article “The Problem of Social Cost,” while the most widely cited in the law and economics canon, is also persistently misunderstood and misrepresented by both friends and foes, as Robert Ellickson shows devastatingly in this essay (h/t Jonathan Adler). Many, even most popular attempts to formulate the “Coase Theorem” veer far from what Coase intended and sometimes into the reverse, above all when they idealize the power of negotiation to overcome the problems of externalities in a highly fictional world that assumes away transactions costs.

As Coase himself pointed out: “The world of zero transactions costs has often been described as a Coasian world. Nothing could be further from the truth. It is the world of modern economic theory, one which I was hoping to persuade economists to leave.” Precisely because across a wide range of circumstances the transactions costs of negotiation are too high to permit reallocations of rights between parties, some initial assignments of liability or property rights do impair real output compared with others.

The University of Chicago’s well-meaning notice, I fear, is among those that misstate the Coase Theorem. “Coase believed the incentives of private parties to resolve disputes in their own best interests, even if there needs to be adjudication by courts, should result in an efficient, mutually beneficial solution that is always preferable to government intervention.” (No, that’s not at all what he wrote, even if one succeeds in disentangling the court adjudication from the “government intervention.”) Likewise, Bloomberg: “Holding the [polluting] company liable and ordering it to pay money to an affected property holder is less likely to yield an optimal result than having the parties negotiate, he wrote.” (No, that’s not it at all either. At most, his theory implies that the optimal liability rule is fact-contingent and should not invariably be assumed to be the one that makes the smokestack owner pay.)

Deirdre McCloskey at Cato Unbound

This month’s Cato Unbound features a lead essay by economist and polymath Deirdre McCloskey. Though she’s been professionally associated with the Chicago School, her ideas are anything but predictable, and she’s been one of the strongest critics of the mainstream of her discipline.

Economic activity, she argues, is driven primarily by forces outside of conventional economic theory. Sure, there’s supply and demand, and we all know the story, and there’s nothing terribly wrong with it, at least as far as it goes. Elaborations on the model aren’t wrong either – externalities, transaction costs, asymmetrical information, problems of coordination and public goods – these too are fine, as far as they go.

Where she disagrees is in her claim that a whole lot of things have to happen inside people’s minds before these things become terribly interesting to talk about. The decision to enter a marketplace, or to behave in ways that we might call “a market,” or even just the decision to look for economic incentives, all depend on some fairly deep value judgments. The creation of a highly market-driven society implies a commitment to a set of values.

What values are we talking about? Here’s a sample:

The Big Economic Story of our times has not been the Great Recession of 2007–2009, unpleasant though it was. And the important moral is not the one that was drawn in the journals of opinion during 2009 — about how very rotten the Great Recession shows economics to be, and especially an economics of free markets. Failure to predict recessions is not what is wrong with economics, whether free-market economics or not. Such prediction is anyway impossible: if economists were so smart as to be able to predict recessions they would be rich. They’re not. No science can predict its own future, which is what predicting business cycles entails. Economists are among the molecules their theory of cycles is supposed to predict. No can do — not in a society in which the molecules are watching and arbitraging.

The important flaw in economics, I argue here, is not its mathematical and necessarily mistaken theory of future business cycles, but its materialist and unnecessarily mistaken theory of past growth. The Big Economic Story of our own times is that the Chinese in 1978 and then the Indians in 1991 adopted liberal ideas in the economy, and came to attribute a dignity and a liberty to the bourgeoisie formerly denied. And then China and India exploded in economic growth. The important moral, therefore, is that in achieving a pretty good life for the mass of humankind, and a chance at a fully human existence, ideas have mattered more than the usual material causes.

A society that denigrates small businesses, small landowners, entrepreneurship, thrift, and innovation will see less of each. It will have different laws, customs, and institutions. Its resources will be used differently. Even its class structure will be different.

Societies that make a place for the artisan, the entrepreneur, the innovator – societies that see these people as valuable – will prosper. That’s the essence of the argument, anyway, and I’m only disappointed that we can’t present it in more detail (McCloskey is in the middle of a four-book series on this one very big idea).

Through the rest of the week, we have a lineup of notable response essayists, including U.C. Davis’s Gregory Clark, science journalist Matt Ridley, and Yale University’s Jonathan Feinstein. Be sure to stop by often, or just subscribe to our RSS feed.