(As before, you have to imagine that in my Marilyn Monroe voice. Also, aren’t my Photoshop skills coming along nicely?) Today is the 100th birthday of economist and Nobel Laureate Ronald Coase. Why is this interesting? Well, for starters, there’s the fact that he’s still alive. Second, there’s the fact that he’s not only still alive but has a new book coming out with Ning Wang of Arizona State University about China and its economic system. (In case you’re wondering, I currently have a feeling not unlike the one that I get when I am running a marathon and get passed by some 75-year-old dude with his running shorts pulled up to his armpits.) Third, he wrote one of his most influential papers in 1937 but, according to my sources, didn’t get his doctorate until 1951. (There is hope for me yet.)
So why is this guy so important? Well, he made two major contributions to the field of economics. First, he initiated a lot of the theorizing on why companies exist. Think about it- when you hear about Adam Smith and the invisible hand of the market as it relates to the breadmaker’s self interest, you’re implicitly led to envision a world where everyone is essentially a self-directed entrepreneur. However, despite the fact that no one says “I want to work in HR at Bank of America when I grow up,” we see a lot of companies and a lot of employees as opposed to independent contractors. Why is this? After all, it’s theoretically possible to produce all of the things that we currently produce by buying the product and service inputs as needed in an open market. Coase’s explanation is that it has to do with transactions costs- can you imagine how annoying it would be if you had to engage in a market transaction every time you wanted your assistant to write an email? Because of these sorts of logistical costs, it is often easier to hire people into an organization and pay them for the right to tell them what to do rather than have them figure out over and over where their services are most needed.
Coase’s second main contribution is, not surprisingly, the Coase theorem. The Coase theorem states that “if trade in an externality is possible and there are no transaction costs, bargaining will lead to an efficient outcome regardless of the initial allocation of property rights.” Huh?
Personally, I like to refer to the Coase theorem as the “get off my lawn you damn kids” principle, and it is most easily explained via an example. A little while back, I wrote about how households in Eastern Oregon were being offered cash to not complain about noise from wind turbines. I had meant for the post to be about internalizing externalities, but a number of astute commenters pointed out that it was an interesting illustration of what Coase was talking about. In the example from the article, it is implied that households have a right to a quiet environment- if they didn’t, their complaints would fall on deaf ears and wouldn’t be of concern to the wind power company. However, it also follows that the right to pollute via noise is worth more to the wind power company (at least $5,000 per household) than the right to quiet is worth to households (at most $5,000), since a payout of $5,000 per household induced an agreement to not complain from most households. Therefore, when property rights are allocated to households we end up with turbines and no complaints, and this is an efficient outcome since the turbines are worth more to the company than the quiet is to the people. Now suppose that, rather than households having the right to noise, the company had the right to noise pollution. The households wouldn’t be willing to pay enough to make it worth the company’s while to turn off the turbines, but they also wouldn’t have any grounds for complaint, and we would again have turbines and no complaints. Note, however, that in the first scenario the households got $5,000 each, while in the second scenario they didn’t get squat. This is why Coase merely said that the outcome would be efficient, not that the allocation of value or payouts would be fair.
As such, I will leave you with a suggestion from Twitter user @jbarro:
In celebration of Ron Coase’s 100th birthday, go offer your neighbor money to stop making that annoying noise he makes.