XXI/2013/2

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London, uk), Ronald Harry Coase died on September 2 2013 in. Chicago ...... Blum W. J. and Kalven Jr. H. 1967, «The Empty Cabinet of Dr. Calabresi Auto Ac-.
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HISTORY OF ECONOMICS IDEAS · XXI/2013/2

HISTORY OF ECONOMIC IDEAS HEI

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XXI/2013/2

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HISTORY OF ECONOMIC IDEAS History of Economic Ideas Online www.historyofeconomicideas.com Editors: Riccardo Faucci (University of Pisa) Nicola Giocoli (University of Pisa), Book review editor Roberto Marchionatti (University of Turin) Editorial Board: Richard Arena (University of Nice), Duccio Cavalieri (University of Florence), Marco Dardi (University of Florence), Peter D. Groenewegen (University of Sydney), Hansjörg Klausinger (University of Vienna), Christian Seidl (University of Kiel) Advisory Board: M. M. Augello (University of Pisa), G. Becattini (University of Florence), A. A. Brewer (University of Bristol), B. J. Caldwell (Duke University), A.  L. Cot (University of Paris i ), R.  W. Dimand (Brock University), S. Fiori (University of Turin), G. C. Harcourt (University of Cambridge, uk ), B. Ingrao («Sapienza» University of Rome), J. E. King (La Trobe University), S. Perri (University of Macerata), C. Perrotta (University of Lecce), P. L. Porta (University of Milan · Bicocca), T. Raffaelli (University of Pisa), J. K. Whitaker (University of Virginia) Editorial Assistants: Giulia Bianchi (University of Pisa) Carlo Cristiano (University of Pisa) Mario Cedrini (University of Turin) Address: The Editor, History of Economic Ideas, Dipartimento di Scienze Economiche, Facoltà di Giurisprudenza, Via Curtatone e Montanara 15, i 56126 Pisa, tel. +39 050 2212845, fax +39 050 2212853, [email protected] History of Economic Ideas is an international peer-reviewed journal and it is indexed and abstracted in Scopus (Elsevier) and in Current Contents/Arts & Humanities, Art & Humanities Citation Index, Social Science Citation Index and Journal Citation Report/Social Science Edition (isi · Thomson Reuters). The eContent is Archived with Clockss and Portico. anvur: a.

«History of Economic Ideas», xxi/2o13/2

IN MEMORIAM: RONALD COASE (1910-2013) Alain Marciano* Université Montpellier 1 Faculté d’Économie

1. Introduction

B

orn on December 29 1910 at Willesden (in a suburb northwest of London, uk), Ronald Harry Coase died on September 2 2013 in Chicago (usa). He had lived a long 102 years, of which almost 50 spent in the usa, where he had migrated in the early 1950s and of which 80 were devoted to the understanding of the functioning of the economy. This is what Coase was interested in – the virtues of a strong and rigorous, even if simple, economic reasoning for all the insights it could provide about the organization of the society and the functioning of the economy. Indeed, Coase was not – and it earned him some criticisms – interested in developing sophisticated mathematical models that provide little insights as how to ‘real world’ works. He was a political economist – having studied with Arnold Plant, Lionel Robbins or Friedrich Hayek (at the lse) and then met James Buchanan, Warren Nutter or Gordon Tullock and Roland McKean (at uva) probably accounts for that. He shared, of course with differences and variations, with all these scholars a conception of his discipline and a way of approaching economics. This makes Coase an important economist – one of the most important economists of the 20th century – worth being read and reminded of. And not only his ‘analytical’ results, that also are of great importance for economics. This mix between methodology and analysis is what we will try to outline in this discussion of his main articles such as «The Nature of the Firm» (1937) and «The Problem of Social Cost» (1960). These two papers stand on the top of Coase’s list of publications, far above the rest of his academic production that they tend to obscure and dwarf by comparison. Each of them, so to speak, account for half of Coase’s Nobel Prize, since they are the only two papers mentioned by the Nobel committee to justify the choice to award the Prize to Coase. The recognition of the Nobel committee is one thing – and we know that their decisions can be controversial. But Coase also obtained the recog* Address for correspondence: [email protected] I thank Elodie Bertrand, Jean-Baptiste Fleury, Maxime Lambrechts and Rustam Romaniuc for comments on earlier versions of this text.

12 Alain Marciano nition from his peers, in economics and beyond (in particular among legal scholars). It is clearly evidenced by the number of citations and references these papers have received. Also of significance to prove how crucial the ideas Coase put forward in these papers are, «The Nature of the Firm» and «The Problem of Social Cost» have given birth to two (complementary) subfields in economics – «transaction cost economics» and «(new) law and economics».1 Coase has contributed to reshape economists’ way of thinking. And they are important to understand Coase’s ideas. Both articles perfectly exemplify, at the same time, Coase’s dissatisfaction with neoclassical economics – because of an obvious lack of realism and also because of its focus on coordination-through-prices only –, his methodology – the need to ground theoretical analysis in empirical studies – and his views on what economics is about – ‘explaining’ how the economy functions rather than to make predictions. 2. The lse, transaction costs markets and «The Nature of the Firm» (1937) In the 1930s, mainstream (neoclassical) economists viewed firms as «black boxes», focusing mainly on a definition of firms based on the technology of production and considering coordination through prices and on markets as separated from coordination through firms, planing and involving entrepreneurs. This is what Coase found unsatisfying with the economics of his time: the «gap in economic theory between the assumption (made for some purposes) that resources are allocated by means of the price mechanism and the assumption (made for other purposes) that this allocation is dependent on the entrepreneur-co-ordinator» (Coase 1937, 389). Coase found necessary to «bridge» (ibidem) that gap. Otherwise, economic theories of firms and markets could not be said to adequately describe what was happening in the ‘real world’. That was his purpose to provide a manageable, tractable and realistic definition of a firm and accordingly realistic explanations of market coordination and coordination through firms, the existence firms and their size. Such an objective could be reached only through empirical work. That was, and has always been, a central point in Coase’s conception of economics and, in the academic year 1931-1932, he had the opportunity to put it into practice. Arnold Plant, his mentor at the lse, earned him a Sir Ernest Cassel Traveling Scholarship that allowed 1 At least, this is how history goes. And one could always stress that it is tricky to identify the founders of a field in economics (and in social sciences, in general) because of the difficulty to determine how far one individual really influenced the rest of the discipline. In that case, what can be said id that the name of Coase is systematically associated with these two subfields of research.

In memoriam: Ronald Coase (1910-2013) 13 Coase to go to the usa where he studied the structure of American firms and industries by visiting factories and carrying out interviews. Coase came back from his trip with relatively clear ideas about markets, firms, coordination and transaction costs. These ideas, said Coase, «must have crystallized in my mind sometime in the summer of 1932» (Coase 1988a, 3) and were presented in his first lecture on «the organization of the business unit» in October 1932, a course he was teaching at the Dundee School of Economics and Commerce, where he had been appointed assistant lecturer. He was 21. He wrote to his friend Ronald Fowler, an assistant lecturer at the lse, that he «believe[d] that it was quite a good lecture» (Coase 1988a, 4), that he «was quite pleased with [him]self» because «it was a new approach (I think) to this subject» but that he «intend[ed] to workup this argument a bit more.» (ibidem). Indeed, although «this lecture … contained the main points which were later to appear in «The Nature of the Firm»: the choice of the transaction as the unit of analysis, the concept of transaction costs, the distinction between the allocation of resources within the firm and through the market, the comparison of the costs of organizing a transaction within the firm and by means of a market transaction, and so on» (ibidem, 4-5), it «needed elaboration» (Coase 1988b, 19). After 2 years spent to «elaborate the argument and embellish it with additional illustrations» (ibidem, 20), «by early summer in 1934» (ibidem, 19), a draft version of the paper was ready. It was eventually published – with «very few changes» to Coase’s own recollection (ibidem) – in 1937.1 In the paper, as we all know now, Coase made a comparative analysis of the respective costs of organizing transaction in firms vs letting these transactions take place on markets. Indeed, markets are not without costs – the so-called ‘transaction costs’, and also search and information costs and bargaining costs, etc.2 Theses costs explained the existence of firms. They also allowed us to understand how big firms should be – when the costs of organizing transactions on markets would exceed those of organizing transactions within firms. That is, Coase «showed in ‘The Nature of the Firm’ that in the absence of transaction costs, there is no economic basis for the existence of firms.» (Coase 2006, 208) The concept of ‘transaction costs’ proved to be so useful that he could be extended ‘beyond firms’ and used to explain the existence of the law 1 Coase explains that «The delay in publishing my ideas was partly due to a reluctance to rush into print and partly to the fact that I was heavily engaged in teaching and research on other projects. I held a teaching position at the Dundee School of Economics and Commerce from 1932 to 1934, at the University of Liverpool from 1934 to 1935 and at the London School of Economics from 1935 on. At the London School of Economics I was assigned a course on the economics of public utilities in Britain». 2 It is interesting to note that Coase did not use the term in 1937 – nor, for that matter, in 1960.

14 Alain Marciano or, more precisely, its influence on the economy: «in ‘The Problem of Social Cost’ I used the concept of transaction costs to demonstrate the way in which the legal system could affect the working of the economic system» (Coase 1988c, 35). Thus, «[t]he actual existence of firms and the law can be seen, therefore, as evidence of the ubiquity and intractability of transaction costs» (Boettke 1997, 21). Transaction-cost-economics and law-and-economics are two sides of the same intellectual coin, two complementary ways to express the same idea. Coase took 25 years to turn the coin and write the law-and-economics version of «The Nature of the Firm», that is «The Problem of Social Cost». In the meantime, he taught at the lse – before and after World War ii – and worked as a statistician for the British government with the Central Statistical Office, Offices of the War Cabinet – during the war. He wrote other important essays, among which an important contribution to the marginal cost controversy (1945, 1946, 1947), in which he criticized a suggestion made by Hotelling to use taxation to fill the gap between marginal and average cost for firms with decreasing costs and demonstrated the possibility to use multi-part pricing. Coase proposed a mechanism that would avoid useless and disruptive intervention from the State in situations – in that case, natural monopolies and public utilities – where State interventions were viewed as legitimized. The broadcasting industry is another of these sectors in which there were monopolies, in which governments were heavily present and that Coase found interesting. He wrote a few pieces at the end of the 1940s (1946, 1947, 1948). He also obtained another – Rockefeller, this time – fellowship that gave him the opportunity to go back to the usa, where he spent 9 months in 1948, and studied the American broadcasting industry. He used the material gathered during this trip to complement what he already knew of the British broadcasting industry and wrote a book (1950), in which he explained the flaws and problems of the British broadcasting system by the existence of a monopoly. That was his last work written in England. In 1951, after earning his Ph.D. from the University of London, and although he was offered the tooke chair at the London School or Economics, Coase preferred to go back again to the usa where he settled permanently. 3. From Buffalo to Virginia and «The Problem of Social Cost» To Robbins’ great disappointment, Coase had in effect accepted the proposal coming from Ralph C. Epstein, of the University of Buffalo – now the State University of New York at Buffalo – where taught when he arrived in the States. A few years after his arrival, in 1957, Coase gave a series of Volker Fund sponsored lectures on Radio, Television and the

In memoriam: Ronald Coase (1910-2013) 15 Press. Murray Rothbard, one of the attendees, then worked for the Fund for which he wrote reports on books and conferences. In one of these memos, Rothbard praised the lectures for being «an excellent piece of work» (Rothbard 2010, 253), «a splendid affair» (ibidem, 255) «which I would recommend most heartily» (ibidem, 253). «[L]ooking forward with enthusiasm to his final research on the matter» with the «‘hope that the final publication will not water down the “radical” spirit of these lectures too much» (ibidem, 255), Rothbard found appealing Coase’s defense of «private enterprise and freedom» (ibidem) in the sectors of post office, radio and television.1 Another attendee was G. Warren Nutter, then professor at the University of Virginia and co-director of the «Thomas Jefferson Center» with Buchanan, who recounted later that «Nutter returned to Charlottesville mightily impressed with Coase, and he immediately commenced to examine the prospects of prying Coase away from the University of Buffalo … After lengthy, and sometimes tortuous negotiations, the deal was made, and after a full year’s delay, Coase shifted to Charlottesville» (Buchanan 2006, 36). In Virginia, Coase met people like James Buchanan, Warren Nutter, Gordon Tullock, Leland Yeager, among others, who were not only liberals but also convinced that economics is more – or rather, something else – than mathematical technique, that economics is a form of moral philosophy.2 They thus had convictions that Coase could share too. As he could share the conviction of these economists that their discipline was changing dramatically, «shifting away from its classical traditions» (Buchanan 2007, 94) and that it was necessary to move back to the roots of the discipline. This, in particular, implied to put the emphasis «on the limits of political process rather than on any schemes to use politics to correct for market failures» (ibidem, 97) – the need to develop such studies was precisely why Buchanan and Nutter had established the «Thomas Jefferson Center». Coase’s previous work corresponded to this approach, as did the first articles he wrote in Virginia – «The Problem of Social Cost» and its prequel, «The Federal Communications Commission» (1959).3 1 He also pointed some errors made by Coase 2010, 56 and regretted «gave collectivist deviations in his [Coase] thinking» (ibidem, 256) 2 Coase also found a group of people who had been influenced by Frank Knight, which was important for him who had also been influenced by Knight: «First of all, owing to the influence of Lionel Robbins, the two main books that we read were Knight’s Risk, Uncertainty and Profit and Wicksteed’s Common Sense of Political Economy […]. Those were the two books we read, and for me they were both important and I studied them very carefully. Knight happens to be one of the most important influences in developing my views» (Coase, in Kitch 1981, 213). 3 More precisely, Coase «began writing the fcc paper and developing the ideas while I was at the Center for Advanced Study in Palo Alto in 1958-59» (Coase in Kitch 1983, 222).

16

Alain Marciano In the latter paper, Coase analyzed how broadcasting licenses were issued in the usa. The system of allocation – a «beauty contest», governmental fiat – was subject to rent-seeking and therefore not efficient. Coase suggested that the allocation of rights between contestants could be made through a market mechanism that would, under certain conditions, lead to the optimal allocation of frequencies and of broadcasting resources generally. Why, or when? Because, and if, individuals were able to bargain between them to determine who was ready to pay the higher price to obtain the right to use a broadcast frequency. Under which conditions? If property rights were well defined and if transactions were costless. Then, after having studied why markets did not work in «The Nature of the Firm», Coase was explaining that markets could work efficiently. He had not forgotten his argument that market transactions «are not costless» (Coase 1959, 27) and markets could fail: «the initial delimitation of rights may be maintained even though some other would be more efficient. Or, even if the original position is modified, the most efficient delimitation of rights may not be attained» (ibidem). Obstacles exist that could prevent an efficient allocation of rights through a market process. However, one should not forget, also argued Coase, the administration and the government are costly too and can also fail in the allocation of resources. Coase was invited to present «The Federal Communications Commission» in a Seminar for the economists of the University of Chicago, a number of whom, Coase explained, thought «[p]art of the argument … to be erroneous»1 because it was «contravening Pigou’s analysis» (Coase 1996, 810).2 After the seminar, Coase was invited at Aaron Director’s place to explain himself. At the beginning of the evening, «all the big shots of Chicago» (Coase 1997) attending the dinner «had a completely wrong idea of what I was getting at».3 They «strongly objected to this heresy. Milton Friedman did most of the talking, as usual. He also did much of the thinking, as usual» (Stigler 1988, 76). Coase found the

1 http://www.nobelprize.org/nobel_prizes/economic-sciences/laureates/1991/coasebio. html. It was the ‘part’ the fact that the allocation of resources is independent from the legal rules. 2 By contrast, in Virginia and especially for Buchanan, there was nothing surprising to it Buchanan wrote that he «distinctly recall the shared surprise those of us at Virginia felt when we learned that Coase’s seminar presentation at the University of Chicago had stirred such controversy. Political economy at Virginia was, indeed, quite different from that at Chicago.» (2006, 40) Actually, Nutter was not convinced at all by the «Coase theorem». He was scheduled to give a talk at Rochester at a workshop entitled something like, «The Fallacy of the Coase Theorem». But he made the mistake of taking a plane from Charlottesville and sitting next to Friedman and when he got to Rochester the paper was retitled «A New Proof of the Coase Theorem» (Stigler in Kitch 1983, 227). 3 http://www.econtalk.org/archives/2012/05/coase_on_extern.html.

In memoriam: Ronald Coase (1910-2013) 17 defense of his approach «pretty strenuous» (Reason 1997), but «[i]n the course of two hours of argument, the vote went from 21 against and one for Coase to 21 for Coase.» (Stigler 1988, 76). To Stigler, it was such an «exhilarating event» (1988, 76), that he «lamented afterward that we had not had the clairvoyance to tape it». For Coase, the evening was stimulating too. Indeed, a turning point in his career. For one thing, «[a]fter that seminar, Aaron [Director] said, “Would you write this up for the Journal,” and I wrote it up in the summer of 1960.» (Coase in Kitch 1983, 221). And it became «The Problem of Social Cost» – «probably the most widely cited article in the whole of the modern economic literature».1 In «The Problem of Social Cost» (1960),2 Coase carried further the analysis of «The Federal Communications Commission». First, he criticized Pigou who, in his analysis of the divergence between the private and social costs due to the existence of harmful effects,3 had missed a most crucial dimension of harms-reciprocity. He ignored that two parties are involved, the «tortfeasor» and the «victim» and that, from an economic point of view, the «tortfeasor» should not always be held liable for the effects his action has on others. It depends on «the value of what is obtained as well as the value of what is sacrificed to obtain it» (1960, 2). But this is only a starting point, and not an original one.4 Much more important are the conclusions Coase derived from this statement. He explained that it may not matter who is liable or that liability may have no impact on the efficiency of the allocation of resources5 because – or when – the individuals involved in an activity with side effects are able to negotiate to bargain to determine which price and who is going to pay for the damage. All the costs induced by a damage, by an harmful 1 http://www.nobelprize.org/nobel_prizes/economic-sciences/laureates/1991/coasebio.html. It may not be totally exact, but it was Coase’s opinion. 2 The third issue of the the Journal of Law and Economics, that includes Coase’s article, was published only in early 1961 (Coase, in Kitch 1993, 221). Coase said later that the title of the paper came from Knigh’s 1924 article – «Some Fallacies in the Interpretation of Social Cost» –, in which Knight already criticized Pigou’s treatment of externalities and public goods: «I would say that the title of my paper came from Frank Knight, and the title of the paper was rather to indicate the topic I was talking about, because, of course, I don’t think the concept of social cost is a very useful one, and I don’t ever refer to it. But it did indicate to people what I was talking about. I knew it, and if there are traces of what Knight says in my work, it wouldn’t surprise me.» (Coase, in Kitch 1983, 215). 3 Coase did not use the expression ‘externalities’ or ‘external effects’. 4 Stigler – and Coase refers to an example given in The Theory of Price (1952) – had already mentioned that pollution has two sides and that «If we assume that the harmful effect of the pollution is that it kills the fish, the question to be decided is: is the value of the fish lost greater or less than the value of the product which the contamination of the stream makes possible» (Coase, 1960, 2). 5 What will be labelled later the «invariance» thesis (Borcherding 1970, 948; Regan 1972, 427).

18 Alain Marciano action, are internalized, paid by the individual who are willing to pay for them, through negotiation that is without State intervention or through a market process. But, of course, we know that there are conditions to be fulfilled for such a result to hold, property rights have to be correctly defined and, above all, that transaction costs have to be equal to zero. Because of these «very unrealistic» assumptions (Coase 1960, 15), Coase insisted that the use of market mechanisms to internalize the costs of external effects should be viewed as only one – out of 4 – mechanisms that can be used to deal with harmful effects. He did not rule out the intervention of the State (precisely because transaction costs exist and are an obstacle to the efficiency of markets). That point was lost to most economists, at least until recently.1 Including the Chicago economists to whom Coase had explained his views! 4. «The Problem of Social Cost» and the «Coase theorem» Coase had been so convincing that, besides being asked to write an article to present his views, other favorable consequences resulted from the seminar and the following discussion at Director’s place. Director and Stigler decided that Coase should be hired at the University of Chicago – and managed to have him hired in 1964.2 And, when he arrived at Chicago, Coase replaced Aaron Director as the editor of the Journal of Law and Economics – he stayed until 1982. Also, last but absolutely not least, Stigler liked Coase’s presentation and explanations so much that he transformed the argument into a theorem, summarizing the 44-page long «The Problem of Social Cost» in a simple, straightforward aphorism: «under perfect competition private and social costs will be equal» (1966, 113) and dubbed it «the Coase theorem». One may, however, wonder if Coase did not win a Pyrrhic victory that evening at Director’s home. In effect, Coase said that it took him «a whole evening of all these economists to get it right».3 But, if the discussion «changed their views in a very sensible way»,4 it was not the way Coase expected to be. To him, the economists who listened to his presentation did not understand his explanations. In the contrary: «in the end they didn’t get it right, because they amended something called 1 See Bertrand 2006, 2009, 2010; McCloskey 1998; Medema 1994, 1995; Medema and Samuels, 1997; Posner 1993; Klaes 2000. 2 Coase «was offered an appointment in the law school, maybe in 1961. He accepted it, but then, not knowing about transaction costs at the time, he rejected it … Two years after that incident I heard there were some squabbles at the University of Virginia and Ronald might be interested in leaving. I then used what little influence I had to get negotiations resumed. Ronald accepted» (Director in Kitch, 219). 3 http://www.econtalk.org/archives/2012/05/coase_on_extern.html. 4 http://www.econtalk.org/archives/2012/05/coase_on_extern.html.

In memoriam: Ronald Coase (1910-2013) 19 the Coase Theorem».1 Would they have understood his views they would never talked about «something called the Coase Theorem». No surprise, therefore, if Coase insisted that he «never liked»2 the Coase Theorem – «a proposition about a system … which couldn’t exist. And therefore it’s quite unimaginable».3 In effect, the Coase theorem – and Coase complained about later in his life – reduces the article to its «most abstract»4 and most unrealistic part, giving the false impression that Coase had built his analysis only around a very unrealistic assumption, that he was trying to analyze only what would happen if the zero-transaction costs assumption held and therefore that he was not interested in explaining ‘real world’ situations. Certainly, Coase had started the article by assuming that there are no transaction costs. He made this choice – that he eventually judged «unfortunate» – «in order to explain my views. I thought, let’s talk about a system where there were no transaction costs». It was a starting point, and a starting point only, that served him to move on towards the analysis of the real cases – in which there are transaction costs. But people «only … read the four pages or only thought about the four pages»5 the theorem occupies in the paper.6 They did not see that, to Coase, it was only by taking into account these costs – the obstacles to the efficient functioning of markets – that his analysis could be useful. Indeed, most – if not all – commentators have criticized Coase for having developed an unrealistic analysis. A few quotations would suf1 http://www.econtalk.org/archives/2012/05/coase_on_extern.html. 2 http://www.econtalk.org/archives/2012/05/coase_on_extern.html. 3 http://www.econtalk.org/archives/2012/05/coase_on_extern.html. 4 http://www.coase.org/coaseinterview.htm. 5 http://www.coase.org/coaseinterview.htm. 6 More precisely, Stigler did not ignore that the theorem was based on unrealistic assumptions – he wrote that «[i]f the proposition strikes you as incredible on first hearing, join the club. The world of zero transaction costs turns out to be as strange as the physical world would be with zero friction» (Stigler 1972, 12). But, to Stigler, a close friend of Milton Friedman and a convinced defender of his methodology, it did not make sense to criticize a theory on the ground that it rests on «heroic» – that is, unrealistic – assumptions. Theories are normative, rather than descriptive, statements. Thus, the confrontation of a theory to empirical data, although not useless, only serves to determine the scope of a theory. Not its validity. From this perspective, to insist on the existence of transaction costs in the real world to prove that Coase is wrong only reveals a prejudice against theory. It certainly cannot be used as a proof against Coase: everybody says that once we put transaction costs in, we are playing in a different ballpark. But that is not so … When people say that the theory no longer holds once we have departed from the zero transaction case, they are making what I think is an unfounded conjecture. (Stigler 1970, 124)

Therefore, and in contrast to what Coase said later, Stigler believed that the theorem was particularly helpful to understand how the system works. In effect, if we accept the Coase theorem, as all did, if we agree that there are transaction costs and if we observe that there are transactions, that is that the economy functions, then the conclusion is that there exist «transaction-costs economizing device[s]» (ibidem, 125) and therefore demonstrates the «enormous real vitality» (ibidem, 31) of the theory. Rather than its lack of adaptation to the real world.

20 Alain Marciano fice … «Coase is right if one accepts the basic» (McKean 1970, 31) but «fairly heroic» (Gilmore 1970, 105) assumptions upon which his analysis rests; there are differences «between Professor Coase’s world in which there are no transaction costs and all exchanges are voluntary and a world in which there are always transaction costs and few, if any, exchanges that are voluntary» (ibidem, 106); Coase’s «abstract theoretical analysis» (ibidem, 116) is a «great value» but does not give us any «guidance in handling real problems in the real world» (ibidem, 116). And one could add many more quotations, that criticize «The Problem of Social Cost» through the Coase theorem, mistaking the first for the second – and therefore misunderstanding what Coase wanted to analyze, real world situations. More broadly, it can be said that most of the references made to «The Problem of Social Cost» are actually references to the «Coase theorem». This is especially the case with legal scholars, a fact that surprised Coase when he discovered it: «[w]hat I learned from reading these articles [citing “The Problem of Social Cost”] was in many ways surprising to me. There were far fewer critical articles (or comments) than I had expected … It was certainly surprising to me to find that the greatest number of citations was to the “Coase Theorem”» (Coase 1996, 811). But, Coase nonetheless believed that his article «was mainly cited because it had been found useful» (ibidem) – indeed, a «gratifying … index of influence» (ibidem). 5. Law-and-economics vs an economic-analysis-of-law In terms of influence, «The Problem of Social Cost» played also a particularly important role in the interest that economists and legal scholars could have for their respective disciplines. As Stigler wrote, «[i]n the field of law and/or economics, b.c. means Before Coase. b.c., the economists paid little attention to most branches of law. a.c., “The Problem of Social Cost” became the most cited article in the literature of the field, perhaps in the entire literature of economics.» (1992, 456) Even if a bit of exaggeration, Stigler’s evaluation captures the belief that «The Problem of Social Cost» marks the origins of ‘new’ (Posner 1975) or ‘modern’ (Hovenkamp 1990, 994) law and economics. Or, as Henry Manne put it, «The Problem of Social Cost … more than any other single work established the paradigm style for the economic analysis of law. Prior to this article, Law and Economics (not so named as yet) was a hodge-podge of economics articles about law with differing styles and methodologies. After that article a field emerged which could be characterized by recognized canons of scholarship and excellence».1 For this 1 http://www.law.gmu.edu/about/history.

In memoriam: Ronald Coase (1910-2013) 21 reason, in particular, Coase – along with Manne, Calabresi and Posner – was awarded the title of founding father of the law and economics movement. That the story be exact or not, or that it be a «Chicago» story (Priest 2005), is not necessarily a problem. What might be more problematic, form Coase’s perspective, is the implication that law-and-economics, to which Coase’s name is linked, does not differ from an economic-analysis-of-law, to which Posner’s name is associated. Because, indeed, there are differences, at least from the perspective of Coase who insisted that «two parts» co-exist in law and economics (Coase 1996, 103; or Coase, in Epstein et alii 1997, 1138), that are «quite separate although there is a considerable overlap» (Coase 1996, 103) and «are separating more and more as time goes by» (ibidem). On one side, stand the economic analyses of the working of the legal system, to which «Judge Posner is the person who has made the greatest contribution.» (ibidem). And, on the other side, one finds the law-and-economics that consists in «study[ing] the influence of the legal system on the working of the economic system» (Coase 1996, 104; Coase, in Epstein et alii 1997, 1138) and that corresponds to what Coase did and, as he later added, he «did not press beyond this» (1988, 35). Fundamentally, these two approaches of law and economics are rooted in two different definition or characterization of economics. Posner, inspired by Gary Becker’s conception of economics as an «approach» (1971), thought of economics as a «powerful tool» (Posner 1973, 399), «an open-ended set of concepts» (Posner 1987, 2), the use of which should not be restricted to the study of economic activities and market decisions. In other words, Posner and his economic-analysis-of-law rests on a definition of economics as a method without subject matter, and that being an economist means using these tools and not have a certain degree – «when used in sufficient density these concepts make a work of scholarship ‘economic’ regardless of its subject matter or its author’s degree» (ibidem, 2). The latter remark echoes what Coase had written a few years before, at the end of the 1970s about the relationships between social sciences and, more specifically, between economics and other social sciences. To Coase, what «distinguishes the economic profession» (Coase 1978a, 207) from other professions and other social sciences is its subject matter. It is the subject matter that represents, «the normal binding force of a scholarly profession» (ibidem, 206), «the dominant factor producing the cohesive force that makes a group of scholars a recognizable profession» (ibidem, 204). Indeed, by contrast with Posner, Coase defined his discipline in spatial terms, drawing limits around the set of questions that it can analyze. The delineation or delimitation of the scope of economics al-

22 Alain Marciano lows them to distinguish the discipline from other social sciences and guarantees the unity of the discipline as well. Therefore, specifically about economics, Coase believed that there exists an area in human activities that is called «the economy» and economists have to restrict their analyses to these activities. Thus, to Coase, there exists a subject matter or object of study for economists and it consists in analyzing economic or market activities: «economists do have a subject matter: the study of the working of the economic system, a system in which we earn and spend our incomes» (Coase 1998, 93). Hence the link with institutions, not as an object of study but because of its influence on economic activities: economists «study the working of the social institutions which bind together the economic system: firms, markets for goods and services, labour markets, capital markets, the banking system, international trade, and so on» (Coase 1978a, 206-207).1 Second, and reciprocally, defining a discipline without a subject matter makes and considering economics as a mere method did not make really sense: economists who «think of themselves as having a box of tools but no subject matter» (ibidem, 206) behave as if they were studying «the circulation of the blood without a body»2 (ibidem) – an obviously abstract and not much connected with the ‘real world’. That was a good reason, for Coase, to disagree with those economists who define their discipline without a subject matter. Coase wrote methodological articles to detail his disagreement and express his own methodological convictions about what economics is and what economists should do. 6. Coase on method All of Coase’s essays, including the very first ones, bear the mark of strong methodological convictions and were the consequence of these positions. But Coase never really insisted on the methodological dimension of his approach and on the broader issue of the methodology of economics until the mid-1970s, that is precisely when economics was changing dramatically, and that Chicago was at the epicenter of these changes. At that time, some of Coase’s colleagues at Chicago, among whom Becker and Posner, pioneered and championed a new way of envisaging economics that allowed them to study issues that were usually studied by other social sciences – marriage, suicide, crime and legal be1 See also Coase 1992, 713, where he describes his approach as follows: «What I have done is to show the importance for the working of the economic system of what may be termed the institutional structure of production». 2 Coase quoted two «memorable … lines from a modern poet», that indeed perfectly explain how necessary is the definition of the subject matter of the discipline: «I see the bridle and the bit alright, But where’s the bloody horse» (Coase 1998, 73).

In memoriam: Ronald Coase (1910-2013) 23 haviors etc. In particular, in those years and still at Chicago,1 Posner ‘launched’ his economic-analysis-of-law, that Coase already saw as different from his law-and-economics. In other words, under the impulsion of Becker, Posner and others, who were «moving more and more into other disciplines» (Coase 1978a, 202), the domain of economics was expanding, the boundaries between disciplines were erased and their subject matter was negated – at the expense of other social sciences. And, this did not correspond to the way Coase defined economics or other social sciences outlined above. Before writing papers – such as «Economics and Contiguous Disciplines» (Coase 1978a) or «Economics and Biology: Discussion» (Coase 1978b; see also Coase 1982) – in which he directly stated his views about his discipline and about what was nicknamed by its detractors «economic imperialism», Coase expressed his opinion indirectly through an analysis of the views of Alfred Marshall and Adam Smith. Writing about these great past economists was not a neutral choice. By pointing at – and praising – crucial elements in Marshall’s method and Smith’s ontology that were totally different from what the economists of his time were doing, Coase anchored his own approach in the writings of important economists. He thus legitimized his views and, accordingly, de-legitimized or un-rooted what economists around him were doing. What great economists of the past used to do was being forgotten, except for Coase who sided with Smith and Marshall. In addition, Coase did not discuss some specific and technical – economic – points of Marshall’s and Smith’s analyses. He chose the methodological and even ontological foundations of their works – «how we should study economics» (Coase 1975, 27) according to Marshall and what was Smith view of human nature. These two dimensions that he viewed as problematic in the evolution of economics and that resulted from this evolution, namely the use of mathematics and the behavioral assumptions. First, Coase related the disappearance of the subject matter of economics to the «increasingly great extent» (1978a, 204) with which «the articles which appear in most of the economics journals … tend to deal with highly formal technical questions of economic analysis, usually treated mathematically.» (ibidem). This is what he discussed by showing that Marshall would not have approved this phenomenon. In a 1975 article Coase dealt with abstraction, unrealism and the use of mathematics and Marshall. He noted Marshall’s interest for real world problems 1 In 1972, Posner had launched the Journal of Legal Studies, hosted at the Law School of the University of Chicago and published by the University of Chicago Press, while Coase was editor of the Journal of Law and Economics, also hosted at the Law School of the University of Chicago and published by the University of Chicago Press.

24 Alain Marciano and his belief that mathematics «would tend to divert our attention from the real world … and to the study of which he thought we should devote our whole energies.» (Coase 1975, 31). To Marshall, «extensive use of mathematics would lead us away from what he considered to be “constructive work”» (ibidem). Thus, explaining that Marshall’s fears were taking shape under our eyes, Coase was conveying the message that all the formal, highly technical and mathematized works that were produced and published in the 1970s were not constructive – not to say useless. He was also telling us that contemporaneous economists had no legitimacy to claim a possible connection with Marshall. Another connection Coase severed or presented as impossible was the connection with the founder of political economy himself, Adam Smith. It relates to the second consequence from «this divorce of the theory from the subject matter», namely «that entities whose decisions economists are engaged in analyzing have not been made the subject of study and in consequence lack any substance.» (Coase 2005, 200) The point is of importance. Indeed, the economics of non-market decision making became possible when the assumption that individuals are selfinterested rational utility maximizers was generalized and that it became the only motive that explained human behavior – including philanthropic and altruist or benevolent behaviors. Coase expressed his disagreement with this way of approaching individual behavior in a 1976 paper devoted to «Smith’s view of man». The paper was published in a special issue of the Journal of Law and Economics gathering «the lectures which were delivered at the University of Chicago Law School in the course of 1976 under the general title ‘1776: The Revolution in Social Thought.’» (Coase 1976a). While Posner’s lecture was about «Blackstone and Bentham», Coase rather focused on the founder of the classical political economy, Adam Smith. In addition, he did not discuss the concept of invisible hand or spontaneous order and the market, as for instance did Milton Friedman when he discussed «Adam Smith’s Relevance for Today» (Friedman 1977). What Coase found relevant for today and for economics today was his «view of man», that is a view of man totally different from the abstraction economists used dominantly and increasingly in their analyses. It was «wrong», he noted, «to believe, as is commonly done, that Adam Smith had as his view of man an abstraction, an “economic man,” rationally pursuing his self-interest in a single-minded way» (Coase 1976, 545; emphasis added). Smith believed that self-interest but also benevolence and sympathy played an important role in human action. These are specific motives that cannot be reduced to self-interest – no explanation of benevolence could be based on selfinterest. In addition, and by contrast with what was admitted at that time, Coase put forward the innovative idea that there was no «Adam

In memoriam: Ronald Coase (1910-2013) 25 Smith Problem» and that the Wealth of Nations and the Theory of Moral Sentiments did not oppose but complement each other. This means that, to Coase, benevolence and sympathy guide non-market but also market decisions. These motives are relevant for economists as well and even necessary to understand the working of the economic system. Therefore, Coase showed that Smith’s view of man did not authorize analyses of market and non-market behaviors in terms of self-interest only. Those who assumed that individuals always behave as if they were selfinterested could not claim the legacy of Smith. Being a political economist, not to say being an economist, does not only imply having a subject matter but also means avoiding too much formalization and adopting a realistic representation of human beings. This is what he wrote in the mid-1970s. But these ideas were so important to him that he tried to promote them until the very last moments of his life. In in 2012, in a short piece for the Harvard Business Review, «Saving Economics from the Economists»,1 and in the editorial announcement for a new journal in which he was involved,2 on the one hand, he deplored the «severely impoverished field of economics»,3 regretting the «troubling enough … reduction of economics to price theory»4 and, on the other, criticized the «the prevailing view where the economic actor is treated as an atomized utility maximizer and the economy as an artifact of mechanical design, which misrepresents the character of man and the nature of the economy».5 He pleaded for the necessary reorientation of the discipline towards «the study of man as he is and the economic system as it actually exists».6 The book he coauthored, with Ning Wang, on China is worth also being mentioned for developing a similar type of argument. He was sufficiently pessimistic about the state of the discipline, and the dominance of mainstream economics and also sufficiently optimistic about the possibility to change it that he, aged of 101 years, wanted to be associated to the creation of a new journal. This tells us a lot about Coase. References Becker G. S. 1971, Economic Theory, New York, Alfred Knopf. Bertrand E. 2006, «The Coasean Analysis of Lighthouse Financing: Myths and Realities», Cambridge Journal of Economics, 30, 3, 389-402. 1 http://hbr.org/2012/12/saving-economics-from-the-economists. 2 «Man and the Economy»: see for instance, a presentation made by Mario Rizzo: http://thinkmarkets.wordpress.com/2013/07/24/a-new-journal-from-the-ronald-coase-institute/. 3 http://hbr.org/2012/12/saving-economics-from-the-economists. 4 http://hbr.org/2012/12/saving-economics-from-the-economists. 5 http://thinkmarkets.wordpress.com/2013/07/24/a-new-journal-from-the-ronald-coaseinstitute/. 6 http://hbr.org/2012/12/saving-economics-from-the-economists.

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Bertrand E. 2009, «Empirical Investigations and their Normative Interpretations: A Reply to Barnett and Block», Public Choice, 140, 1-2, 15-20. — 2010, «The Three Roles of the “Coase Theorem”, in Coase’s Works», European Journal of History of Economic Thought, 17, 4, 975-1000. Blum W. J. and Kalven Jr. H. 1967, «The Empty Cabinet of Dr. Calabresi Auto Accidents and General Deterrence», University of Chicago Law Review, 34, 2, 239-273. Boettke P. 1997, «Where did Economics go wrong? Modern Economics as a Flight from Reality», Critical Review, 11, 1, 11-64 Borcherding Th. E. 1970, «Liability in Law and Economics: Note», American Economic Review, 60, 5, 946-948. Buchanan J. M. 2006, «The Virginia Renaissance in Political Economy. The 1960s Revisited», in R. Koppl (ed.), Money and Markets. Essays in Honor of Leland B. Yeager, London, Routledge, 34-44. — 2007, «Economics from the Outside», in Better than Plowing and Beyond, College Station (tx), Texas A&M University Press. Coase R. H. 1945, «Price and Output Policy of State Enterprise: A Comment», Economic Journal, 55, 217, 112-113. — 1946, «b.b.c. Enquiry?», Spectator, 176, 446-447. — 1946, «The Marginal Cost Controversy», Economica, 13, 51, 169-182. — 1947, «The Marginal Cost Controversy: Some Further Comments», Economica, 14, 54, 150-153. — 1947, «The Origin of the Monopoly of Broadcasting in Great Britain», Economica, 15, 59, 189-210. — 1948, «Wire Broadcasting in Great Britain», Economica, 15, 59, 194-220. — 1950, British Broadcasting: A Study in Monopoly, London-Cambridge (ma), Longmans Green-Harvard University Press. — 1960, «The Problem of Social Cost», Journal of Law and Economics, 3, 1-44. — 1975, «Marshall on Method», Journal of Law and Economics, 18, 1, 25-31. — 1976, «Adam Smith’s View of Man», Journal of Law and Economics, 19, 529-546. — 1978a, «Economics and Contiguous Disciplines», Journal of Legal Studies, 7, 2, 201211. — 1978b, «Economics and Biology: Discussion», American Economic Review, 68, 244-245. — 1982, «How Should Economist Choose? G. Warren Nutter Lecture in Political Economy, Washington, D. C.: The American Enterprise Institute for Public Policy Research», in R. H. Coase (ed.), Essays on Economics and Economists, Chicago, University of Chicago Press, 1994, 15-33. — 1988a, «The Nature of the Firm: Origin», Journal of Law, Economics, and Organization, 4, 1, 3-17. — 1988b, «The Nature of the Firm: Meaning», Journal of Law, Economics, and Organization, 4, 1, 19-32. — 1988c, «The Nature of the Firm: Influence», Journal of Law, Economics, and Organization, 4, 1, 33-47. — 1993, «Law and Economics at Chicago», Journal of Law and Economics, 36, 1, part 2, 239-254. — 1994, Essays on Economics and Economists, Chicago, University of Chicago Press. — 1996, «The Problem of Social Costs: The Citations», Chicago-Kent Law Review, 71, 809-812. — 1997, «Looking for Results: Nobel Laureate Ronald Coase on Rights, Resources, and Regulation», Reasons, 28, 2, 40-46, available at http://reason.com/archives/ 1997/01/01/looking-for-results.

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— 1998, «The New Institutional Economics», American Economic Review, 88, 2, 72-74. — 2005, «The Relevance of Transaction Costs in the Economic Analysis of Law», in F. Parisi and Ch. Kershaw Rowley (eds), The Origins of Law and Economics: Essays by the Founding Fathers, Cheltenham (uk), Edward Elgar. Coase R. H. and Wang N. 2012, How China Became Capitalist, New York, Palgrave Macmillan. Friedman M. 1977, «Adam Smith’s Relevance for Today», Challenge, 20, 1, 6-12. Gilmore G. 1970, «Products Liability: A Commentary», University of Chicago Law Review, 38, 1, 103-116. Hovenkamp H. 1990, «The First Great Law and Economics Movement», Stanford Law Review, 42, 4, April, 993-1058. Kitch E. W. 1983, «The Fire Of Truth: A Remembrance Of Law and Economics at Chicago, 1932-1970», Journal of Law and Economics, 26, 163-234. Klaes M. 2000, «The History of the Concept of Transaction Costs: Neglected Aspects», Journal of the History of Economic Thought, 22, 2, 191-216. Knight F. 1924, «Some Fallacies in the Interpretation of Social Cost», Quarterly Journal of Economics, 38, 4, 582-606. Manne H. G. 1970, «Edited Transcript of aals-aea Conference on Products Liability», University of Chicago Law Review, 38, 1, 117-141. McCloskey D. N. 1998, «The So-Called Coase Theorem», Eastern Economic Journal, 24, 3, 367-371 McKean R. 1970, «Products Liability: Trends and Implications», University of Chicago Law Review, 38, 1, 3-63. Medema S. G (ed.) 1995, The Legacy of Ronald Coase in Economic Analysis, Brookfield (vt), Edward Elgar. — 1994, Ronald H. Coase, New York, St. Martin’s Press. Medema S. G. and Samuels W. J. 1997, «Ronald Coase and Coasean Economics: Some Questions, Conjectures and Implications», in W. J. Samuels, S. G. Medema and A. Schmid (eds), The Economy as a Process of Valuation, Cheltenham (uk), Edward Elgar, 72-128. Posner R. A. 1973, «An Economic Approach to Legal Procedure and Judicial Administration», Journal of Legal Studies, 2, 2, 399-458. — 1975, «The Economic Approach to Law», Texas Law Review, 53, 757-782. — 1987, «The Law and Economics Movement», American Economic Review, May, 1-13. — 1993. «Gary Becker’s Contribution to Law and Economics», Journal of Legal Studies, 22, June, 211-215. Priest G. L. 2005, «The Rise of Law and Economics: A Memoir of the Early Years», in F. Parisi and Ches Kershaw Rowley (eds), The Origins of Law and Economics: Essays by the Founding Fathers, Cheltenham (uk), Edward Elgar. Regan D. H. 1972, «The Problem of Social Cost Revisited», Journal of Law and Economics, 15, 2, 427-437. Rothbard M. 2010, «Strictly Confidential. The Private Volker Fund Memos of Murray Rothbard», Auburn, L. von Mises Institute. Stigler G. 1970, «The Optimum Enforcement of Laws», Journal of Political Economy, 78, 3, May-June, 526-536. — 1972, «The Law and Economics of Public Policy: A Plea to the Scholars», The Journal of Legal Studies, 1, 1, 1-12. — 1988, Memoirs of an Unregulated Economist, Chicago, University of Chicago Press.

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* February 2014 (cz 2 · fg 21)

CONTENTS on ronald coase Alain Marciano, In memoriam: Ronald Coase (1910-2013) Virgile Chassagnon, Christel Vivel, Frank H. Knight and Ronald H. Coase on the nature of the capitalist firm: an analysis of their seminal contributions (1921-1937)

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29

papers Irène Berthonnet, North vs Williamson: the debate over institutions’ efficiency Lennart Erixon, Formalizing a new approach to economic policy: Bent Hansen and the Rehn-Meidner model Alex Millmow, Brotherly love and the making of a British economist

53 69 99

review articles Paolo Paesani, From affluence to austerity in post-war Britain: there and back again 121 book reviews Erik S. Reinert, Francesca L. Viano (eds), Thorstein Veblen: Economics for an Age of Crises (Cavalieri) Chantal Saucier (transl.) and Mark Thornton (ed.), An Essay on Economic Theory: Essai Sur La Nature Du Commerce En Général by Richard Cantillon (Gentle) Benn Steil, The Battle of Bretton Woods. John Maynard Keynes, Harry Dexter White, and the Making of a New World Order (Maes) Olav Bjerkholt and Duo Quin (eds), A Dynamic Approach to Economic Theory. Lectures by Ragnar Frisch at Yale University; Olav Bjerkholt and Ariane Dupont-Kieffer (eds), Problems and Methods of Econometrics. The Poincaré Lectures of Ragnar Frisch, 1933 (Moscati) Cosimo Perrotta, Claudia Sunna (a cura di), L’arretratezza del Mezzogiorno. Le idee, l’economia, la storia (Benassi)

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History of Economic Ideas is published three times a year by Fabrizio Serra editore ®, Pisa · Roma, P. O. Box no. 1, Succ. no. 8, i 56123 Pisa, tel. +39 050 542332, fax +39 050 574888, [email protected], www.libraweb.net Pisa Office: Via Santa Bibbiana 28, i 56127 Pisa, [email protected] Rome Office: Via Carlo Emanuele I 48, i 00185 Roma, [email protected] Print and/or Online official subscription rates are available at Publisher’s website www.libraweb.net. Reduced rate for eshet members: € 95,00; Reduced rate for storep members: € 95,00. Subscriptions should be paid as follows: by cheque/international money order payable to Fabrizio Serra editore®; by postal giro account no. 17154550; by credit card (American Express, Eurocard, Mastercard, Visa). © Copyright 2014 by Fabrizio Serra editore®, Pisa · Roma. Fabrizio Serra editore incorporates the Imprints Accademia editoriale, Edizioni dell’Ateneo, Fabrizio Serra editore, Giardini editori e stampatori in Pisa, Gruppo editoriale internazionale and Istituti editoriali e poligrafici internazionali. Printed in Italy issn 1122-8792 electronic issn 1724-2169 Direttore responsabile: Lucia Corsi Autorizzazione del Tribunale di Pisa n. 10 del 2/5/1994

On Ronald Coase: Alain Marciano, In memoriam: Ronald Coase (1910-2013) · Virgile Chassagnon, Christel Vivel, Frank H. Knight and Ronald H. Coase on the nature of the capitalist firm: an analysis of their seminal contributions (1921-1937) · Papers: Irène Berthonnet, North vs Williamson: the debate over institutions’ efficiency · Lennart Erixon, Formalizing a new approach to economic policy: Bent Hansen and the Rehn-Meidner model · Alex Millmow, Brotherly love and the making of a British economist · Review Articles: Paolo Paesani, From affluence to austerity in post-war Britain: there and back again · Book Reviews.