It is remarkable that Nobel laureate Ronald Coase, who died Monday in Chicago, lived to be nearly 103 years old, and it is unfortunate for his adopted country that his insightful views no longer will be forthcoming. The nation is turning politically more conservative. Government regulation of economic activity is unpopular with many.
Few in the general public will note his passing. But if you are a supporter of politicians including Rand Paul or Ted Cruz, you should bone up on Coase’s work, because it provides the best intellectual underpinning for some libertarian thought.
All economists agree that sometimes markets fail to deliver the economic efficiency implied by the simple free-market model. Where they differ is on how frequently such failures occur and whether government can do anything to remedy such failures or whether government action produces even worse outcomes.
Those economists on the political right see few market failures and government action as making things worse. Those on the political left see frequent failure and government interventions making things better.
Coase, although he grew up in a working-class English household and graduated from and taught at the London School of Economics — then a bastion of British socialism — ended up firmly on the right. But even economists who disagree with many of his conclusions respect the depth and breadth of his thought. He was counted among the handful of great economists of the 20th century.
Externalities are one way in which markets can fail, and Coase devoted much thought to these cases. These are side effects of producing or consuming some good or service that affects people, other than the actual producers and consumers. An example would be acid rain resulting from burning coal to produce electricity. The rain kills fish and causes other harm, but these real economic costs are not paid by the utility company or the users of electricity. (There also are positive externalities.)
Both economic theory and economic history make clear that externalities, if left uncontrolled, cause economic inefficiency. That is, people in society get fewer of their needs and wants satisfied from any given use of resources than they would if such external effects were eliminated.
Moreover, externalities often transfer wealth from those harmed to those causing the harm. In the case of acid rain, the value of properties around the affected lakes falls and fishing becomes less enjoyable for many. Meanwhile, electricity users get cheaper power, or utilities make higher profits than if the pollution were controlled. Depending on one’s philosophical and political views, this may be unjust.
For several decades, our nation’s primary approach has been regulatory command-and-control. Even conservative economists like Milton Friedman and his colleague at the University of Chicago and fellow Nobelist, George Stigler, thought some regulation a necessary evil.
In a famous incident, Coase, then a professor at the University of Virginia, wrote a paper arguing that the Federal Communications Commission’s policy of handing out radio and TV licenses administratively was economically inefficient. He was invited to Chicago to hear why he was wrong. In a meeting at Stigler’s house, the session started with 20 Chicago economists against Coase and ended a few hours later with all convinced he was right.
Perhaps as a result of this meeting, Coase moved to Chicago only a few years later, although as a professor in the law school, not the economics department. From there, his influence on regulatory and antitrust law was so profound that federal judges probably now are more versed in his thought than the average college economics professor.
Policy wheels grind slowly, however, and it took another 30 years before his suggested alternative of auctioning off frequency rights became a common practice worldwide.
Stigler remained involved with Coase’s thought, perhaps not for the best. One idea most relevant to the Paul and Cruz political camp was what became known as the “Coase theorem.”
As generally taught by most economists, including me for 30 years, it says that as long as property rights are well defined and transaction costs are low, you don’t need government regulation to achieve economic efficiency when externalities occur.
Take the situation of a steam train, the sparks from which start fires that destroy farmers’ crops. The common view would have been regulations requiring the railroads to install devices to capture sparks. But that ignores the efficiency question of the cost of spark arrestors versus the cost of fire damage.
The theorem says that it doesn’t matter if you define property rights so that farmers have a right to be protected from sparks or that railroads have the right to emit sparks. If the first, railroads can install spark arrestors or can simply pay the farmers for damages, depending on which is cheaper. If the second, farmers can eat the damages or pay the railroads for the arrestors, again whichever is cheaper. Either policy has incentives for efficient resource use.
Now this depends on good information about cause and effect and it requires no or low transaction costs. In other words, suing and bargaining cannot not use up any resources. But you don’t need the government interference hated by Paul, Cruz and others with a libertarian bent.
Libertarians read the theorem and say “let’s get property rights right and lower transaction costs, and we won’t need government.”
Liberals read “property rights never can be defined with the precision needed and there always will be transaction costs, often enormous ones, so government regulation is necessary.”
Pragmatic centrists say “it is important to have well-defined property rights and to work on low transaction costs, but that will never be sufficient, so the vital question is what kind of regulation you also adopt.”
Ironically, Coase objected to this theorem being given his name and said that Stigler had concocted it out of four lines.
And his own interpretation, at least as teased out by a small group of other economists, has important implications about this precise question of the best type of regulation. But explaining this requires quite some knowledge of economics and more than an additional column.
Suffice to say that questions raised by Coase give us economics issues to work on for a long time.