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The genius of Ronald Coase

    Ronald Coase, who died on 2nd September aged 102, was Britain’s greatest economist since John Maynard Keynes. In many ways, they, or rather their economics, were complete opposites.  Whereas Keynes formed a new theoretical framework out of the abstractions of macro-economics, Coase’s field of vision was on the visible and the tangible and on the institutions of the market economy. 

    Today Keynes’s ideas are hailed as the way to navigate through the maze of the post-bubble economy to recovery, yet Coase’s ideas offer policymakers something more durable and less problematic. Keynes’s reputation is in the stratosphere whilst in the country of his birth, Coase, winner of the 1991 Nobel prize in economics, is treated almost as a non-person. In contrast to macro-economics, where disputes between economic schools seem as endemic as they appear irresolvable, on micro-economic problems, a field Coase redefined, economists are generally more able to find productive agreement.

    The single most successful policy of Gordon Brown’s chancellorship, the 3G mobile spectrum auction in 2000 which raised £22.5bn, can be traced back to a 1959 paper by Coase which criticized the Federal Communications Commission’s administrative allocation of radio licenses arguing. Instead Coase argued that spectrum rights should be acquired by the highest bidder in a competitive auction. 

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    No economist has a better claim to be the successor of Adam Smith than Coase.  Indeed An Inquiry into the Nature and Causes of the Wealth of Nations was an inspiration for Coase and the intellectual problems economics should tackle. Speaking on the 200th anniversary of its publication, Coase called it a masterpiece. ‘With its interrelated themes, its careful observations on economic life, and its powerful ideas – clearly expressed and beautifully illustrated – it cannot fail to work its magic,’ Coase said. There might come a time when we would have nothing more to learn from the Wealth of Nations or, more accurately, when what we would learn would be irrelevant to our problems, but ‘that time has not yet been reached nor will it, in my view, be reached for a long time to come.’

    I first came across Coase fortuitously. A book by the American economist, Mancur Olson, mentioned ‘Coasean bargains.’ What were Coasean bargains?, a question that led me along the path of discovery to this remarkable economist. Coase was raised in Willesden, both parents working in the Post Office.  Weakness in his legs resulted in Coase being bundled off to a local council school for physical defectives, where the future Nobel prize winner learnt basket weaving. 

    Thanks to his parents’ persistence, he won a scholarship to Kilburn Grammar School. Because Coase had missed a year learning to make baskets, it was too late to learn Latin. This precluded him from studying history at the University of London.  He decided to study for a Bachelor of Commerce degree and went to the London School of Economics. Thus economics came to benefit from basket-weaving.

    In 1931, a travel scholarship to the US enabled Coase to spend a year studying the structure of American industries.  Until then, few economists had thought to ask why firms exist. Coase provided an answer in his 1937 paper, ‘The Nature of the Firm.’ Coase’s insight, what he called marketing costs and later came to be known as transaction costs – that the costs of contracting independent agents is higher than employing labour – was that of true genius.  Like Darwin and his patient observation of natural phenomena, Coase saw what no one else had seen before.

    After settling in the US in 1951, an apparent mistake in his critique of the Federal Communications Commission caught the attention of economists at the University of Chicago.  Coase had argued against the ‘polluter pays’ principle. Given a clear definition of property rights, if transaction costs are zero, the market would provide a solution if the harm caused by the pollution was greater than the benefit foregone in curbing it. This stood on its head the idea developed by Arthur Pigou of externalities and the automatic assumption of the efficacy of pollution taxes as the solution to market failure. The critical question was not the externality and the taxes needed to price it in, but delineation of property rights and the transaction costs that might impede Coasean bargains being made.

    This led to one of the most celebrated confrontations in economics with Coase pitched against Chicago’s brightest.  According to one participant, in the middle of the debate, Milton Friedman opened fire with the bullets hitting everyone except Coase.  Surviving Friedman’s onslaught, Coase knew he had prevailed. Afterwards, he wrote an article ‘The Problem of Social Cost,’ which Coase – an unboastful man - modestly claimed to be the most widely cited article in the whole of the modern economic literature.

    The article was published in the Journal of Law and Economics, which Coase edited from 1964 until 1982.  Coase was critical of what he called ‘blackboard economics’ – to theorise, economists assumed away the stuff of reality. As editor, Coase encouraged economists and lawyers to write, he said, ‘about the way in which actual markets operated and about how governments actually perform in regulating or undertaking economic activities.’ 

    Coase was instrumental in opening up the new academic field of law and economics, studied in the US but more or less neglected in Britain. In combining the study of economics and law, Coase followed Adam Smith. In his bicentenary talk, Coase pointed out that on Adam Smith’s return to Scotland from Oxford, he gave public lectures on literature, rhetoric and jurisprudence.  ‘It seems clear that the lectures on jurisprudence included an early version of some of the leading ideas which were to appear in the Wealth of Nations,’ Coase said.

    The implications for public policy of Coase’s body of work, and more importantly, his approach to economic problems, is immense: the need to focus on what actually happens in economic life – actual events and observations, in a word, on facts; the economic role of firms and institutions; his scepticism of regulation and taxation as policy solution in contrast to the richness of common law.  Coase’s identification of transaction costs as impeding optimal outcomes has huge policy implications.  It suggests that increasing transaction costs with taxes (high stamp duties on property; Tobin-style taxes such as the EU’s proposed financial transaction taxes) are likely to be damaging and are best avoided. It has big implications if Britain ever is to have an intelligent approach towards land use (what is called, and in reality is, government planning) where the focus would be on facilitating Coasean bargains between developers who gain and those who might be adversely affected.

    From the age of 41, Coase spent the rest of his long life in the United States. It was unambiguously to his and his profession’s great gain. It is inconceivable that his work would have received the recognition in Britain that it did in America.  Apart from claiming him as one of its Nobel winners, his alma mater has ignored him.  But like his hero Adam Smith, it is hard to imagine a time when his approach to economics and the problems of public policy will become superfluous or irrelevant. We in Britain have much to learn from Ronald Coase.

    Rupert Darwall is a CPS fellow and author of The Age of Global Warming – A History (2013) published by Quartet Books.

    Rupert Darwall is a corporate strategist, economist and author. He was special adviser to Chancellor of the Exchequer in 1993, and also worked at the Conservative Research Department. He has also advised a number of blue-chip companies on M&A, regulatory, licensing and competition issues.

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