On Ronald Coase as an Economic Historian?

Can we consider Ronald Coase as an economic historian? Most economists or social scientists that read this blog must appreciate Coase largely for his Nature of the Firm and the Problem of Social Cost. Personally, while I appreciate these works for their theoretical insights (well, isn’t that an understatement!), I appreciate Coase much more for articles that very few know about.

Generally, after these two articles, most economists do not know what Coase wrote about.  Some might know about Coase’s proviso regarding durability and monopoly (a single firm producing a durable good cannot be a monopoly because it competes with its future self) or about his work on the Federal Communications Commission (which is an application of his two main papers).

Fewer people know about his piece about the lighthouse in economics. While it is not an unknown piece, it is mostly known within the subfield of public economics as it concerns the scope for the private provision of public goods. Generally, I found that those who know about the piece know the “takeaway” which was that lighthouses (which because of their low marginal costs and non-excludability have been deemed public goods ever since J.S. Mill) could be produced privately. While this was indeed Coase’s point, this summary (like that Stigler made of the Coase Theorem) misses the peripheral insights that matter. Coase did the economic history job of documenting the institutional details behind the provision of lighthouses which sparked debates in journals such as Journal of Legal Studies, Cambridge Journal of Economics, European Review of Economic History, Public Choice and Public Finance Review (they still go to this day and I am trying to contribute to that with this piece that me and Rosolino Candela have recently submitted). It seems unclear whether or not the lighthouse can even be considered a public good or if it was merely an instance of government failure rather than market failure (or the reverse). Regardless of the outcome, if you read the lighthouse paper by Coase, you will read an application of theory to history bringing a “boring” topic (i.e. that of maritime safety pre-1900) to life through theory.  The lighthouse paper is an application of industrial organization through the Coasean lenses of transaction costs and joint provision. And it is a fine application if I might say!

But that is not his only piece! Has anyone ever read his article in the Journal of Law & Economics on Fisher Body and vertical integration? Or his piece on the British Post Office and private messengers in the same journal?  In those articles, Coase brings theory to life by asking simple questions to history in ways that force us to question some common day conceptions like “vertical integration was the results of holdup problems” or “postal services need to be publicly provided”.  In both of these articles and the lighthouse article, Coase basically applies simple theoretical tools to cut through a maze of details in order to answer questions of great relevance to economic theory and even policy (i.e. the post office example). And this is why, earlier in 2017, I mentioned that Coase should be considered in the league of the top economic historians.

Coase’s “Nature of the Firm”: An Anthropological Critique

But is it a good one? Is it even made in good faith? I need help.

From American anthropologist John D Kelly’s The American Game…:

Ronald Coase’s theory of the nature of the firm rescued, for neo-classical economics, the existence of firms or corporations as rational entities […] Markets always come first, and the problem of the existence of firms is depicted as the problem of why a rational manager would rely on employees rather than markets. State planning and private firms are taking over what already exists, integrated by the price mechanism of markets, and are successful to the extent that they lower costs, since there are a variety of costs involved in market transactions. Thus marginalist analysis implies that an equilibrium will always be found between planning structures and integration by price mechanism, especially since, as Coase says in “The Nature of the Firm,” “businessmen will be constantly experimenting, controlling more or less” and “firms arise voluntarily because they represent a more efficient method of organizing production.” The rise of the firm, as Coase imagines it, is always a movement from many pre-existing contracts to a controlling structure, “For this series of contracts is substituted one.” (94)

The emphasis is mine. Kelly continues:

This imaginary fits poorly the situations that were precisely the actual origins of firms, as when banks gave mortgages to planters, or stock markets funded companies of young agents, prepared to cut plantations into captured wilderness for tropical commodities […] usually employing labor moved long distances and disciplined by direct violence. There is more in the universe than Coase’s imagination, more motives for controlling powers of firms than their cost efficiencies. (94-95)

Kelly goes on to give a brief account of 1) how corporations created commodity production out of thin air, 2) how these corporations were tied to European imperialism, and 3) how they used slaves and indentured servants even when it would have been cheaper to hire the locals.

I want to address Kelly’s summary of Coase’s paper (here is a pdf, by the way, in case you want to follow along), mostly because I’ve never read it although I know it’s important, but first I want to make a couple of digressions. Libertarians would more or less answer Kelly’s three charges listed above as follows: 1) yes, and this is a good thing, 2) state-sponsored corporations and private firms are two distinct entities with two very different incentive structures, and 3) see #2. There is also an issue of accuracy in regards to Kelly’s brief summary of world history since 1600. I don’t want to get into the details here, but I do want you to recognize that I am reading Kelly critically. My last digression is simply to point out that libertarians and Weberian Leftists like Kelly have more in common than we think.

To get back to Coase’s paper, and Kelly’s critique of it, I want to highlight one sentence from Kelly’s book in particular and then turn it over to the peanut gallery in the hopes of gaining some insight:

Markets always come first, and the problem of the existence of firms is depicted as the problem of why a rational manager would rely on employees rather than markets.

Is this the puzzle Coase was trying to grapple with in his paper? I ctrl+f’d Coase’s paper (“employe” – not a typo) and couldn’t find anything that actually confirms Kelly’s summary, but it would be an interesting project (if I am right in stating that Kelly’s summary of Coase’s paper is not accurate) to follow this line of thought and delve into Kelly’s insight about the reliance that entrepreneurs/firms have on employees (rather than markets)…

Should there be a Nobel in Sociology?

A friend of mine recently shared a piece making the case for creating a Nobel prize for the social sciences that I found interesting: see here. Or, for those who wish to be technical, this hypothetical new Nobel would be ‘A Prize in Social Science in Memorial to Alfred Nobel‘.

The general argument is that economics is not a real science, in the same manner that physics and other natural sciences are ‘real’ sciences capable of prediction and measurement. The other social sciences, such as anthropology, sociology, psychology, on the other hand are undervalued and should have greater say in the policy realm.

If economics were a social science like sociology or anthropology, practitioners would set about interviewing those committee members, scrutinising the meetings’ minutes and trying to observe as many meetings as possible. That is how the kind of fieldwork-based, “qualitative” social sciences, which economists like to discard as “soft” and unscientific, operate. It is true that this approach, too, comes with serious methodological caveats, such as verifiability, selection bias or observer bias. The difference is that other social sciences are open about these limitations, arguing that, while human knowledge about humans is fundamentally different from human knowledge about the natural world, those imperfect observations are extremely important to make.

To make his case the author points out that modern economics shies away from doing qualitative research by going out and doing case studies of the economic actors they study. Instead economists sit in their offices and theorize how economic actors behave.

The author is correct to point out that ‘blackboard economics’ is a problem in the field but he goes a bit too far. The economics field has several practitioners who go out and get their hands dirty, granted they are a minority. Ronald Coase’s infamous lighthouse paper* was written after Coase went and did research on how lighthouses actually functioned. Hernando de Soto (the economist, not the Spanish explorer!) similarly has made a name for himself by looking at how developing economies work first hand.

The article is strongest when, instead of attacking economics, it praises the other social sciences.

Karen Ho did years of fieldwork at a Wall Street bank. Her book Liquidated emphasises the pivotal role of zero job security at Wall Street (the same system governs the City of London). The financial sociologist Vincent Lépinay’s Codes of Finance, a book about the division in a French bank for complex financial products, describes in convincing detail how institutional memory suffers when people switch jobs frequently and at short notice.

Should there be nobel prizes for the other social sciences? I am certainly in favor of such a proposal if it aids promote public appreciation for the other social sciences. There is no need however to attack one another. There is room enough in the world for economists, sociologist, psychologists, and the other social sciences.

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*For context, the lighthouse is an example widely used by economists as a public good that would not be produced in the market without state intervention. The benefit of a lighthouse is enjoyed by all, but is not excludable and therefore difficult to make revenue out of. The solution, as Coase points out, is that lighthouses are bundled with other goods such as port fees.

Property rights and reclining seats

Every now and then a flight gets diverted because of trouble onboard. Sometimes, passengers are misbehaving and the decision is made to land and make them leave.

AP has reported that a flight was diverted because of a passenger quarrel over reclining seats. Apparently a passenger tried to recline their seat and the person behind made use of a Knee Defender, a device you can install to prevent the front seat from reclining.

Some time ago, Josh Barro wrote an article for the National Review applying the Coase Theorem to this sort of situation. According to Barro, the passenger behind could negotiate with the person who wants to recline their seat in order to buy them out of the idea.

According to the Coase Theorem, if you have low transaction costs, just clarify the property rights (in this case, the right to recline your seat) and those rights will be negotiated and end up with the person who cares the most about them.

The Theorem is somewhat morally agnostic in this sort of situation: it doesn’t matter very much who gets assigned the right, as long as it’s clear and respected (and for this very reason the Theorem isn’t completely agnostic either).

High transaction costs would have an impact on the initial allocation: passengers are reluctant to negotiate. For this reason, Donald Marron has commented on Barro’s idea, suggesting the ‘reclinee’ (i.e. the person behind the reclining seat) should initially carry the right to recline – this saves a round of negotiations in most cases, if we assume most people are bothered by reclined seats in front of them.

Commenting on the recent events, Barro’s article for the NYT responds to Marron and sticks to the low transaction costs view – he doesn’t think it’s that hard to negotiate with passengers.

There are some important issues that I haven’t seen addressed in this debate so far. To begin with, even though it’s not allowed to defend it as it sees fit because of security regulations (and this is perhaps a different debate), the airline owns the plane. The whole thing. Every seat. And that seems to  be clear enough.

Moreover, I don’t usually think about this detail when I buy a ticket, but it seems that non-reclinable seats (those in the back) are usually available for the same price as normal seats. If, instead, they’re clearly cheaper, then the implicit idea is that your flight ticket gives you the right to recline your seat, not least because you paid for it. The airline could make this clear, of course, in the small print, as a kind of contract clause. And those who want more space already pay for more space, even if they’re flying economy.

Now, of course there’s the issue of people having different sizes and not being very well served by the default space available. Some airlines offer more, some offer less space. I can’t help but think that if this variable is really important (and it seems to be), competition in the sector would make room for more diversity of services offered, and creative arrangements of passenger space onboard. This could drive the price of passenger space down. However, it’s a very heavily regulated market, so the situation isn’t ideal.

Then, there’s the issue of the Knee Defender. Of course, with no explicit rules, a passenger can get one and use it, probably annoying the person who wants to recline the seat. The airline can intervene and make it clear that the person paid for a seat that reclines. The airline could even have a special rule forbidding Knee Defenders onboard the flight. Just because it wants to, because it’s their plane.

In short: If you rent the airline seat for the flight, it can come with the right to recline it. If you own a Knee Defender, the airline could ask you to leave it behind (or keep it), or a passenger could buy it from you, so they can recline their seat.

Why go with the Coase Theorem at all? Maybe the good, old, less agnostic, property rights can do just fine in this sort of situation.

Thoughts on climate change

Last week I heard a sermon on climate change (no, it was an actual sermon). I’m roughly agnostic on the existence and degree of climate change, but I err on the side of assuming it is a large problem of externalities with no obvious property rights solution and will have costs. And I think that under those assumptions there is an important moral element to it. With that in mind, below are some of my thoughts on the weak points of the sermon:

1) Authority is only a starting point; we cannot defer ultimate responsibility to authority. If an expert or someone I trust tells me something about X, and I don’t have any prior knowledge about X, then I believe them. In the case of global warming there are two basic sorts of information you will get from information: a) diagnosis (temperatures could rise X degrees in the coming century), and b) prescription.

The climatology involved in a) is well above my pay grade, and so rather than undergo the costs of informing myself on the existence or importance of climate change, I just figure the truth is somewhere in the middle of what reasonably informed people say and instead focus my effort on my areas of comparative advantage. Now the actions in b) are typically about reducing waste and that’s well within the realm of economic thinking, so I’ll comment on that!

1b) Blindly deferring to authority to assuage your guilt is wrong and bad. Someone says you should drive an electric care to save the environment? Don’t do it before thinking through the matter, this is a big decision for most people. Where’s the energy coming from to power that car? (Coal. That is burned hundreds of miles away from your car… that’s like having a car with a hundred mile long drive shaft.) How much energy and material does it take to make the car? (Hint: look at prices.)

2) It’s called climate change, not climate universal and uniform worsening. If climate change means a warmer climate for Canada and Russia, that will come with extended growing seasons and savings on winter heating costs. Burma? It’s probably going to suffer a lot. Climate change will surely have the biggest impact on the poorest people in the world, and this is where I see the real moral issue because…

3) We can respond to climate change in a way to reduce suffering. Specifically, we can open borders. First off, that would increase human well being, with an enormous benefit to the world’s poorest people. Second, the effects of climate change won’t harm the poor as much as they could. Is climate change still a bad thing if we do this? Sure, but if a building is burning, why not help people get out?

Loose ends:

Should I recycle everything? Only if it will actually help. Recycled aluminum is chemically identical to virgin aluminum and uses fewer resources to produce (which is why it’s cheaper!). Recycling paper creates a lower quality product, uses a lot of energy and creates pollution.

Paper bags are brown, that’s good, right? Plastic bags are almost ethereal; they use a fraction of the material per unit of carrying capacity resulting in big savings. Yes, there are offsetting costs to using plastic, but it isn’t as simple as “this brown, it must be natural and therefore good!” And while we’re on the topic, brown M&Ms are stupid. There’s a layer of white sugar between that brown outer layer and the actually brown chocolate. Brown M&Ms are as unnatural as any of the other colors.

Should I buy local? Maybe if you live in California, but not if you live in Massachusetts. The biggest environmental impact of food is growing it; plowing fields, planting, watering (outside where the water could just evaporate!), and harvesting use a lot more energy than transportation. So if you live in a place with poor growing conditions, then buying local only does more harm. That said, fresh food tastes better, so by all means pay the cost if you value the flavor, just don’t delude yourself into thinking you’re reducing energy usage by doing so.

Consider opportunity cost and present value! So you’ve got a solar panel and now electricity is free for the next 20-30 years! Or you’ve installed new modern insulation for your home. Or you bought a car that costs less to run (and you’ve promised not to increase your usage). But at what cost? If your solar panel used 40 years worth of energy to build and install, then you’ve done more harm than good. And you’ve done that harm upfront. Even if one of these investments has a positive return (it saves more resources than it uses), you should still consider whether it’s a good investment. We don’t have unlimited resources, and that means that if you spend $10,000 on insulation that will give you a 0.4% ROI then you’ve given up the chance to invest that money into something that will generate more good.

“How China Became Capitalist”

That’s the title to this short piece by Nobel laureate Ronald Coase and his co-author Ning Wang published by the Cato Institute. Among the gems:

The presence of two reforms was a defining feature of China’s economic transition. The failure to separate the two is a main source of confusion in understanding China’s reform. The Chinese government has understandably promulgated a state-centered account of reform, projecting itself as an omniscient designer and instigator of reform. The fact that the Chinese Communist Party has survived market reform, still monopolizes political power, and remains active in the economy has helped to sell the statist account of reform. But it was marginal revolutions that brought entrepreneurship and market forces back to China during the first decade of reform when the Chinese government was busy saving the state sector.

Do read the whole thing. The Cato Institute ranks third on my list list of trustworthy think tanks. Hoover and Brookings are two that I think produce university-caliber research. Cato ranks far below Hoover and Brookings in my estimation, but it occupies a lonely third place, as none of the other think tanks out there are even close to Cato’s stature, either.

You can check out Cato’s website here.