Ronald Coase (1910-2013), the greatest of the Chicago School economists in my view, died this week. Yet, his work lives on. If it gains the recognition it merits, it will do much to enhance the quality of public debate and public policy. Coase developed a unique understanding of how solutions to real-world organizational and financing problems evolved through the voluntary interactions of individuals and firms.
As a young scholar, Coase studied how businesses in competitive markets actually survived and thrived. Coase recommended that economists look at businesses’ actual practices and organizational structures, as these likely indicated rational approaches to complex competitive challenges. That approach attracted CEI to his work. In our early days, he participated in an intellectual property conference we cosponsored with Liberty Fund, in Aix-en-Provence, France.
Coase saw the economy as an evolving, spontaneously ordered system characterized by entrepreneurial creative destruction, in which firms find their way by experimenting with new organizational forms—such as, for example, alternative creative financing options.
Perhaps Coase’s greatest contribution was his understanding that wealth creation stemmed from the voluntary exchange agreements of two or more parties, but that such agreements were often blocked by transaction costs. The parties had to become aware of each other, incurring search costs. They had to gain each other’s trust, whether by reputation, earlier small experimental exchanges, third party guarantees, escrow accounts or other means. They had to find ways to assure the quality of the good or service.
Ways to address those costs would have been long established within existing markets. But in the entrepreneurial world, where there were no established cost-reducing models to emulate, there would be a need for a great degree of creative experimentation. These experiments would often be tentative, primitive and clumsy, but they would make possible the great leaps forward in institutional innovations.
We at CEI recognized and learned from his observation: Many economists see market failure and collusion in arrangements that they do not understand and, since there is much that they do not understand, they tend to see collusion everywhere! The confused state of antitrust regulatory policy today illustrates that Coase’s work has yet to gain the appreciation it deserves—witness the Justice Department’s blocking of the proposed American Airlines/US Airways merger.
Coase also was one of the most accessible, unassuming economists, in a profession not known for humility. His critique of Arthur Pigou’s work provides an interesting example. Pigou, writing in the first half of the 20th century, recognized that political control of the economy had been problematic, but only in years past, when bureaucrats lacked the knowledge to run a modern economy. But fortunately, Pigou argued, the world had changed. The new “science” of economics and public affairs had helped create a new class of civil servants—well trained, motivated to serve the public good and immune from political influence. All this, Pigou believed, would allow us to replace the archaic laissez-faire free market capitalism of the past with the carefully centrally planned economy of the future. Coase skeptically noted that Pigou saw this utopian vision best embodied in the Interstate Commerce Commission.
CEI also worked with Coase in regard to another of his creative breakthroughs—his analysis of the challenge that declining marginal costs place upon firms. For example, airlines trying to fill empty seats or pharmaceutical firms trying to sell more pills cannot simply charge the marginal cost for each additional item, as that would lead to bankruptcy. Contra some economists’ arguments for subsidies for such firms, Coase demonstrated that in the real world many firms adopt multi-part pricing and other creative alternatives that would be far more likely to advance consumer welfare.
CEI organized a conference on this topic and we traveled to Chicago to interview Coase about it. Vernon Smith, another Nobel Prize economist, was our keynote speaker. Coase, then 93, graciously consented to an interview which we presented at the conference. The video is available here.
Coase was a rarity—a free market theorist deeply grounded in empirical research who sought to better understand the creative strategies employed by real firms in the real world. His work has influenced the work of CEI scholars and of many of our allies. We seek to free entrepreneurial capitalism from the rigidities of state control. Free markets are competitive despite the confusion of too many economists. Our challenge to enlighten the public policy debate of that reality was aided greatly by Ronald Coase—a great man, a brilliant economist and a person worthy of study and emulation.