Tuesday, September 3, 2013

Ronald Coase On Markets, Firms and Property Rights

Ronald Coase just passed away after a long life of over 100 years.  He was one of the most influential economists of the last century because of the impact that his ideas had at the University of Chicago where his economic ideas were incorporated into legal theories that have had a powerful influence worldwide.  The University of Chicago released this video of Coase which was produced in 2009, to honor him after his passing.  He was asked to talk about markets, firms and property rights and he offered his views which may be interest to many of you.  Even at an advanced age he has a sharp mind and a degree of humility which is quite refreshing.

He made a very simple point about markets that is somewhat atypical.  He believes that markets are not a creature of nature.  On the contrary, they are created as a system of contracts. That is, they are developed by human beings in order to accomplish certain objectives and they can be altered by human beings.  The Coase theorem, which is one his most seminal ideas, assumes a perfectly competitive market and suggests that government intervention in markets may be less efficient in the resolution of disputes than actions taken by the parties involved in the dispute to resolve market failures and externalities.

His concept of the firm departs dramatically from the version of the firm that is commonly depicted in economic textbooks.  He correctly views the firm from a sociological perspective, and he claims that his seminal article on the nature of firm is outdated.  He did so because he actually worked with firms in order to work on practical problems.  The various functions within a firm, and the individuals involved in providing information to management, do not seek to maximize corporate profits.  They consider their own interests above the interest of the firm to maximize profits.  Moreover, they do not measure measure marginal costs.  Consequently, firms do not choose to operate at the level in which marginal costs are equal to marginal revenue.  He also argues that firms do not suffer from the problem of diminishing returns to scale as it assumed in economic textbooks.  There can be increasing returns to scale.  The idea of diminishing returns to scale were derived from the analysis of farming.  A plot of land does run into the problem of diminishing returns as it increases the amount of fertilizer to a finite plot off land.  The idea of diminishing returns to scale, like many ideas in economics which were developed during the industrial revolution in England,  do not apply to the modern economy.  Many of our most important industries benefit substantially from economies of scale.  For example,  once the costs of developing networks or software products have been amortized,  the cost of delivering the next product are close to zero, and the additional revenue is primarily profit.

Coase did not take much time in this video to talk about property rights.  On the other hand, they have probably had a significant effect on the legal system.

Coase refers to Richard Posner in this video who wrote an article about Coase and Keynes.  He did not understand why Posner wrote such an article because his contact Keynes and his ideas was not significant.  Posner, is a lawyer who has done a lot of work with economists, like Gary Becker, at Chicago to incorporate economic ideas into the law curriculum.  He may have opposed Keynesian economics like many of the economists at Chicago when he wrote the article.  After observing the consequences of the financial crisis, however, Posner wrote an article on why he has become a Keynesian.  I doubt that this went over well in the economics department at Chicago.

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