Ronald Coase and the abuse of the economy
It’s a story about the history of economics, mischief and, ultimately, political power. This is the economist Ronald Coase, who died on Monday at the great old age of one hundred and two years.
During his lifetime, Coase, who was born in the London Borough of Willesden and educated in England before moving to America in 1951, turned into an icon of the political right. His famous “Coase Theorem” has been used to justify a hands-off approach of big business by politicians, regulators and judges, leaving pollution and other economic problems to the remedial powers of the free market. During the 1970s and 1980s, when the Chicago School of Economics swept everything before it in Washington and in national courts, Coase’s work proved to be extremely influential. In 1991, the Swedes awarded him a Nobel Prize in economics, just one of the many honors he has received.
Which is quite ironic or tragic, depending on how you see it. As a conservative economist, Coase was instinctively skeptical of government regulations, but he was also an English empiricist who recognized that reality is complicated. He did not believe in laissez-faire and he freely admitted that Coase’s theorem did not apply to many cases of pollution and other examples of what economists call “negative externalities”, especially those that affect a large number of people.
Indeed, Coase did not even see Coase’s theorem as a large-scale economic theory, but simply as a useful mental exercise that could be done before moving on to more realistic cases. It was left to less careful proselytes to exploit the work of Coase in their crusades against the great government. In their hands, his subtle reasoning was withered and distorted. With the help of right-wing groups like the Olin Foundation, politicians who auctioned big business, and judges who thought they were applying the latest economic theory but were actually doing the same thing as politicians, conservatives used the work of Coase to justify tilting the legal balance in favor of business, removing environmental regulations and removing other restrictions on heinous business behavior that had been imposed during the first three quarters of the twentieth century.
It all started at the end of the 1950s, when Coase was thinking about an old problem of economics: how to deal with “those actions of business enterprises which have a bad effect on others”, such as factories making a lot of noise and emitting toxic gases. Standard solutions for these types of pollution were to induce those concerned to hold the polluter accountable in court, or to impose a tax on the activity that would discourage it. Coase, who had been an admirer of Adam Smith since he was a student at the London School of Economics, said these approaches were wrong. In an article published in 1960, he wrote: “I contend that the suggested courses of action are inappropriate, in the sense that they lead to results which are not necessarily, or even usually, desirable.
Why is that ? Careful reading of his article, “The problem of the social cost,” shows that he was making two remarks, one theoretical and the other practical.
Coase’s theoretical contribution was counterintuitive. In an ideal world, he said, it doesn’t matter which party – the company or its neighbors – is held legally responsible for the act of pollution. As long as the two sides could sit down together with all the relevant facts and figures at their fingertips, they could reach a socially acceptable deal without the need for government assistance. To illustrate this, Coase used the example of a herd of a cattle rancher roaming the cultivated fields of a neighboring grain farmer.
If the law said the cattle rancher was legally responsible, he would likely end up paying the cost of a new fence. If installing a fence were prohibitive, he could end up paying the grain farmer for the occasional damage to his crops. But what if the breeder was not legally responsible, perhaps because the ownership lines weren’t clear? Under those circumstances, Coase said, the grain farmer would likely end up paying for a fence. Or, if the grain farmer believed that building a fence would cost more than the occasional damage from stray cattle, he would reluctantly accept the occasional incursion.
The assignment of property rights would determine who pays. But from a broader economic perspective, Coase argued, the outcome would be essentially the same no matter what. Based on the relative costs of installing fencing and the occasional crop damage, the two parties would agree on an outcome that maximizes the value of the output (beef and grain) produced by their farms. The allocation of resources to the various types of production and the value of overall production would be the same.
When Coase presented this argument to a group of economists at the University of Chicago, only one of them initially endorsed it. Twenty rejected it. But by the end of the evening, they were all on his side, which is not surprising. Coase’s Conjecture is an application of the familiar laissez-faire assumption that in a perfect world, where all mutually beneficial bargains are exploited, the market outcome will be (Pareto) efficient, i.e. ‘it will not be possible to improve it without reducing the welfare of at least one of the parties concerned.
Once Chicago’s free traders figured this out, they warmed up to Coase. In 1964, he left the University of Virginia for the Windy City, where he would live his life. A few years later, George Stigler, one of the leaders of the Chicago school, elevated Coase’s conjecture of property rights and negotiation, which had been expressed in commendable English, to the highest level. of theory, and coined the term “Coase Theorem.” Once it was clothed in this shiny new wrapper, many conservative economists, policy experts, and judges have interpreted Coase’s work to say that as long as the Property rights were clearly specified, there was no need for government regulations, “sin taxes” or punitive sanctions, judicial judgments, Market magic could be relied on to produce a desirable result.