By Rumplestatskin, a professional economist with a background in property development, environmental economics research and economic regulation. Cross posted from MacroBusiness
I have often railed against the economic approach to social organisation problems which can be described as ‘assume first ask questions later’. There are too few good economists following more scientific methods of sound reasoning and the reliance on evidence in light of real world institutional structures.
The first approach is often called ‘thinking like an economist’.
Ronald Coase, who passed away at age 102 earlier this week, was in many ways an outlier in the economics profession. He taught in the the University of Chicago’s Law School, rather than in economics, and was often misinterpreted by his economist peers on important and policy-relevant topics, such as what is known as the Coase Theorem.
We can see his views in an article he wrote in 2012, at age 101, in the Harvard Business Review.
Economics as currently presented in textbooks and taught in the classroom does not have much to do with business management, and still less with entrepreneurship. The degree to which economics is isolated from the ordinary business of life is extraordinary and unfortunate.
Coase’s scepticism is so important today, when the dominant ‘economic way of thinking’ is to apply marginalist equilibrium models to ever more obscure situations (a la Gary Becker). Unless one can be certain that the model is capturing the important characteristics of this particular market or social institution, the results of some manipulation to the model will have no relevance to the realities one is trying to understand.
One example of the original thinking that epitomised Coase’s career is his take on durable goods and the potential monopoly power of sellers in these markets. He raised these important questions a mere 41 years ago, yet almost none of the results from the research agenda that sprang up from it have entered the mainstream, and are certainly not found in most undergraduate textbooks.
You will notice the strong links Coase makes to his descriptive model and ‘business practices’, a phrase you may never read in a whole economics degree. Nor do you much read the phrase “in the twinkling of an eye” to describe the rather arbitrary conceptual compression of time into a single period in economic models.
One important feature of this and other work is that Coase did not make strong policy conclusions, but conditioned his results and explored reasons they may not hold in reality.
These reasons were picked up and explored later by Mark Bagnoli and others, who found that certain critical implicit assumptions in Coase’s model were leading to its conclusions.
Thus the assumption of a continuum of consumers-so innocuous and useful a simplification in other contexts-has proved misleading in the context of durable-goods monopoly.
They explain that the optimal seller of an infinitely durable good (land) will exercise full market power and perfectly price-discriminate, holding back new sales to the market till future time periods to maintain price levels. They label this strategy for sellers the Pacman Strategy “since the monopolist attempts to eat his way down the demand curve.”
This improvement and development of theory in the market for durable goods is still detached from empirical testing, but is at least an attempt to maintain links to “business practices” actually employed by land owners. That is doesn’t fit the mainstream narrative means it is all but ignored by most scholars of economics.
Unfortunately, like his work on The Problem of Social Cost, Coase has been repeatedly misinterpreted by other economists. When you read about the Coase Theorem, you are probably reading about George Stigler’s interpretation of Coase’s discussions around social costs (externalities).
As Coase explains in this interview (at the 0.50) –
It’s not about my work at all. George Stigler, who is a very nice man, wanted to pay me a compliment. So he invented the Coase Theorem, but he named it the Coase Theorem and not the Stigler Theorem.
The reason I don’t like it is that it is a proposition about a system in which transaction costs are zero. Well, that isn’t the way they system actually is. Therefore it is a theoretical proposition. I don’t like that.
He later laments the difficultly in getting economists to understand reason during the now infamous meeting where he convince some Chicago colleagues of the merits of auctioning radio spectrum.
All I said that the FCC should award the right to transmit on a given frequency to the person who paid the highest amount for it. To my astonishment this room, which one would of thought would have welcomed it in Chicago, was rejected by them. We went on for, I don’t know how long, and hour or something like that. At the end that time they all thought I was right.
They were very impressed by the fact the I had changed their views. But I wasn’t particularly impressed because all I was doing was stating the obvious.
Coase relies extensively on real court cases and judgements to describe the apparent arbitrariness of property rights, when examining the judges ruling on Bryant v. Lefever he notes that
The smoke nuisance was caused both by the man who built the wall and by the man who lit the fires. Given the fires, there would have been no smoke nuisance without the wall; given the wall, there would have been no smoke nuisance without the fires. Eliminate the wall or the fires and the smoke nuisance would disappear.On the marginal principle it is clear that both were responsible and both should be forced to include the loss of amenity due to the smoke as a cost in deciding whether to continue the activity which gives rise to the smoke. (original emphasis)
Led by Stigler, economists took this logic and ran with it, turning it into the Coase Theorem, while not fully comprehending that the real contribution of this article is to consider the case where bargaining is costly.
The key point is that “In these conditions [costly bargaining] the initial delimitation of legal rights does have an effect on the efficiency with which the economic system operates”. He goes on to note that every type of social arrangement, including regulation by means of the “special kind” of “super-firm” that is government, has costs and we should seek social arrangements that minimise costs of cooperation relative to the gains.
He explicitly says the perfect market model is irrelevant to almost all real social costs. The main message being that property rights are arbitrary constructions and we should consider the social costs and benefits of any changes from a given starting point. Its message was very relevant for legal scholars considering rights for damage claims.
On his work about the Nature of the Firm, he recently noted that firm organisation is really a sociological problem, not an economic problem. Which seems so obvious since internal firm decisions are rarely priced, nor do they take place within an environment of market-style contracts.
Rarely now do we see the type of common sense thinking that the ‘accidental economist’ Ronald Coase showed throughout his long career. In fact, I would be surprised if a Coase was beginning his career today that he would be able to break into the profession at all, given it’s obsession with formalisation of mathematical models, and disdain for verbal reason informed by real world conditions.
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The modern academic account that supports what Coase was saying can be found here – http://www.sjsu.edu/people/anand.vaidya/courses/c5/s2/Why%20Do%20Humans%20Reason%20Sperber.pdf
The abstract: Reasoning is generally seen as a means to improve knowledge and make better decisions. However, much evidence shows that reasoning often leads to epistemic distortions and poor decisions. This suggests that the function of reasoning should be rethought.
Our hypothesis is that the function of reasoning is argumentative. It is to devise and evaluate arguments intended to persuade. Reasoning so conceived is adaptive given the exceptional dependence of humans on communication and their vulnerability to misinformation. A wide range of evidence in the psychology of reasoning and decision making can be reinterpreted and better explained in the light of this hypothesis. Poor performance in standard reasoning tasks is explained by the lack of argumentative
context. When the same problems are placed in a proper argumentative setting, people turn out to be skilled arguers. Skilled arguers, however, are not after the truth but after arguments supporting their views. This explains the notorious confirmation bias. This bias is apparent not only when people are actually arguing, but also when they are reasoning proactively from the perspective of having to defend their opinions. Reasoning so motivated can distort evaluations and attitudes and allow erroneous beliefs to
persist. Proactively used reasoning also favors decisions that are easy to justify but not necessarily better. In all these instances traditionally described as failures or flaws, reasoning does exactly what can be expected of an argumentative device: Look for arguments that support a given conclusion, and, ceteris paribus, favor conclusions for which arguments can be found.
Ceteris paribus (all other things being equal) is all over economics like a rash. The argumentative machine is, of course, massively corrupted beyond this by main media, schools and universities.
The fault lies not in reason, reason is just a tool.
The fault lies in the character of the tool user.
If you only use your reasoning ability to justify your own selfish schemes and assemble more persuasive BS, then it’s evidence of a character flaw.
The fact that our economy is dominated by bad actors is not evidence of an inherent flaw in the tool, but of the use it has been put to.
The fact that our economy is dominated by bad actors is not evidence of an inherent flaw in the tool, but of the use it has been put to. Watt4Bob
1) Then why so few prosecutions?
2) A bad system would attract bad actors, no?
3) Usury has stability problems apart from actors.
4) Government-backed credit creation is inherently unjust since no one is worthy of stolen purchasing power.
5) Central banking was invented in the 16th century and is STILL a major problem causer.
The ‘Tool’ we’re discussing here is reason.
Coase explains that if we use reason to analyse the situation we can come to a truthful understanding of reality.
Pointing out that most economists only use their ability to reason to bolster their un-reasonable, self-serving arguments does not alter Coase’s point.
This quotation;
”
However, much evidence shows that reasoning often leads to epistemic distortions and poor decisions.”
from the abstract of the article linked by allcoppedout, is pure BS, obviously false on its face, in that reason does not lead us anywhere, reason is led by the person using it, if an individual habitually mis-uses reason to bolster dishonest arguments, that does not mean reason is a faulty tool, it means the use it is put to is faulty.
The article allcoppedout linked does not support Coase, it attempts to refute the utility of reason because;
“… reasoning often leads to epistemic distortions and poor decisions.”
This is the exact opposite of what Coase was trying to teach us, that rather than analyse/explain ecomnomic reality in the abstract, we might instead use our reasoning capacity to analyse the reality that exists right in front of our faces.
Reason does not ‘lead us’ to “…epistemic distortions and poor decisions.”, we lead ourselves there.
Well, sound reasoning with false premise(s) will (necessarily, I should think?) lead to incorrect conclusions. Which would normally cause one to rethink those premises. Except not in economics apparently.
One huge but false premise in our society is the notion that some are creditworthy just because they are likely to be able to return the purchasing power (+ interest) that they and the banks have cooperated to steal.
You can keep beating that horse all you want FB, just don’t expect it to get and take you anywhere.
On the contrary, I expect truth to have an effect. That’s one reason it is called the truth – because it is effective.
Also, when negotiating, it’s very helpful to know what the true situation is wrt justice and that ethical alternatives exist; Progressives give away the store wrt to banking at the start.
@ allcoppedout: I mildly object to sidetracking the discussion to questions about “reasoning.” You point out its misuses. By so doing, however, you open up the arguments to lofty philosophical battles that have little impact on the specific issues at hand. For example, ‘from Mexico’ could provide quotes from Haidt and others that may or may not clarify the issues. I fear the end result will not throw light on the concrete issues.
I take your point Charles. Mine is merely that we have the argument form wrong and economics is the classic form of the problem. We have been distracted from the real debate long before we enter the ‘lists’ here. I wish Watt4 was right and it was a matter of integrity or intellectual honesty. This misses the point.
Coase’s work was something of an argument rebellion – there’s a fair summary of the people involved here – http://www.coase.org/workingpapers/wp-8.pdf – and he is a good example of someone trying to find a new approach in testing assumptions – though there is broad acceptance of the essential core of neoclassical economics – scarcity and competition. It differs radically from the orthodox approach since its core concepts reject assumptions of perfect information, perfect rationality, and zero transaction costs, and instead search for a dynamic model of economic change radically different from the static models of standard neoclassical economics.
My ‘Heathrow Business School’ students liked Coase as most of them thought theory was for the birds. To me he was just another economist in an argumentative machine with loads of people winning in factions that prevent the best argument we could have. There is no real debate for me until we sort out the argumentative machine – though sadly Sperber is way short of what we need, but perhaps enough to re-shape the paradigms or generic frames of reference in which one can come up with a guess with plenty of ‘evidence’ ready-to-hand to make the case to adherents.
The ‘rush to knowledge’ is for people wanting the work taken out of thinking and arguments made facile. I’m long convinced you can’t get anything from Coase, Keen, Veblen, Harvey or even Marx without previous practice in science, actual maths and a broad cross-section of the humanities – and a whole load of that is converging on ‘biological argument form’. All the arguments I see in heterodox economics are older than me and have been convincingly pulverised by the neo-liberal machine. Coase is an example of limited assumption-breaking and evidence disguised in rightist rhetoric appealing to the experienced manager.
Concur, especially with the last paragraph.
I would state that there has never been – any experts – and the scope of the field of inquire has yet to be properly defined. To insinuate other wise is… to project a previously packaged – falsely extrapolated form of ignorance, in an attempt to create some form of self validation, in isolation, group or ad hoc.
skippy… its like watching someone construct a Skinner’s box test, unknowing that they are a participant in a previous and on going test.
PS. Is life just one big Monty Python confuse a cat skit or case of human crib biting (horse reference)? Love to find out before we all kark it as a species.
http://www.youtube.com/watch?v=B2Je1CEPkUM
At the Rate They’re Going
At the rate their going it will take economists 100 years to figure this stuff out, and even that might be optimistic.
James T. Kirk will be captain of the Enterprise, in real life, before they figure this stuff out.
The New York Jets will have won the super bowl 5 more times before they figure this stuff out.
The Messiah will have come and gone before they figure this stuff out.
There will be elected a woman, lesbian, pacifist, progressive, green-party U.S. president, who’s also an African-born Jew, before they figure this stuff out.
There will be strange new languages invented and spoken in countries around the world, that don’t now even exist, before they figure this stuff out.
However, let’s not be too pessimistic, the Rolling Stones may still be on tour when they figure this stuff out.
It will be a while yet, but it won’t be “never”.
Craazyman, you are crazy like a fox!
Really? Just where will the Messiah go after His 2nd Coming?
I hope to the pub for a few cold beers. He’ll have earned them!
Possibly. But His preference was for wine and He hasn’t had any since the Last Supper.
Btw, as someone who has actually read the Bible, I am offended by those who insist the wine He drank (and made at Cana) was non-alcoholic.
faaaak Are there people who really say that? Wow! I mean, just, Wow!
Don’t get offended Beard, just think of Matthew 10:14.
Yes, they exist and among people who claim (correctly, I believe) that the Bible is error-free!
They are one reason I trust NO human doctrines but keep reading the Bible so I’ll know MYSELF what it says.
But you do realize Mick Jagger majored in economics in college, and the 23rd Century Stones Tour opens with “I Can’t Get No Satisfaction”???
Well he tried! And he tried, and he tried, and he tried!
But he couldn’t make any sense out of it.
So gave up and became a rock star.
The Rolling Stones will rename themselves “The Zombies” (once the copyright expires).
Yes, and then he got rich and discovered the US health care system where you can have all your body parts replaced and live to 250. Under British healthcare you can’t live past 100 – not even Maggie Thatcher.
120 years appears to be the absolute limit.
Not if you pay cash and get admitted to the Pete Peterson Medical Clinic For People With No Insurance. They have access to the shadow organ donor market too!
And get to play baseball with Ted W? What an opportunity. Throw a “blooper” ball and settle once and for all whether his homer in the past life was a fluke.
Odd that mainstream coverage of Professor Coase’s passing have missed the obvious connection between his ideas and one of its practical manifestations, i.e. the increasing use of temporary workers and freelancers as technology causes the transactions costs of doing so to drop.
“…increasing use of temporary workers and freelancers as technology causes the transactions costs of doing so to drop.”
I would take issue with the notion that this is a ‘practical manifistation’ of Coase’s ideas.
The way I read Coase, is that use of our capacity to reason honestly, based on actual real-life conditions will lead us to the ‘best’ outcome, as opposed to using our capacity to reason to bolster faulty ideas based on abstractions.
It’s been documented to my satisfation for instance that using more and more temporary workers and freelancers is in fact a behaviour that largely defines the ‘race-to-the-bottom’ and is an example of the sort of faulty ‘thinking’ that Coase obviously deplored, not an example of the utility of his ideas.
Goodbye Coase! 102, that’s awesome.
The Coase theorem was one of the very first concepts I was exposed to in university.
“Economics as currently presented in textbooks and taught in the classroom does not have much to do with business management, and still less with entrepreneurship. The degree to which economics is isolated from the ordinary business of life is extraordinary and unfortunate.”
It *sounds* like Coase could was needlessly beating his head against the wall, if he had recognized the larger context Richard Wolf did- that the economics dept is designed to pass on the myths of capitalism and produce a priesthood of institutional defenders (who couch their defense in mystifying impressive formulae and pseudo-science); while the business school deals with how the economy actually works (at least practically speaking, without regard to any wider social/moral/theoretical implications.)
For a rather less positive view of Coase’s contribution to economics, see here : http://www.theguardian.com/commentisfree/2013/sep/06/ronald-coase-chicago-school-economist-died
The linked article is a gross misrepresentation of the life work of Ronald Coase.
Yet another in a long list of dishonest attempts to obfuscate the mans meaning.
I’ll be charitible and assume the writer is simply ignorant of the truth, which is that Ronald Coase was absolutely not what we call a Chicago School Economist, and the so called Coase Theorem is a gross mistatement of his work.
Read the article, follow the links.
I tried reading the paper on Durability and Monopoly and the paper on Social Costs and from that reading I tend to much agree with the Guardian’s assessment of Coase. Whether he was a member of the Chicago School or not seems immaterial to the Guardian’s views on his work. What is or is not ‘Chicago School’ and who is or is not a part of it seems at best a very slippery question.
Please explain why or how Coase is so great in your opinion. His papers wander about and never truly reach a conclusion as such. This guy got a Nobel price? I hope he has other less obscure works considered for that prize, otherwise I have to really wonder about the Nobel committee.
If Coase indeed favored auctioning off the airwaves what good do you believe came of that? Did he really favor the things stated in the Guardian article’s first paragraph:
“He believed in privatising lighthouses, opposed regulating taxis, thought pollution was a price worth paying for profit, wanted to abolish the BBC and didn’t think private companies could ever be monopolistic – you might not call him extreme but the label ideological would surely be applicable.” If so, exactly how is this NOT ‘Chicago School’ thinking?
Why is this post even here? It seems out of place among the things normally posted to this blog. I hope this isn’t some peculiar form of ‘equal time’ for neo-liberal mystical thought. I’ll consider a different point of view but how can I consider Coase when he never seems to make any particular point. As for his considering real firms and real business versus regular economic theory i just don’t see it. This post, Coase’s wandering papers, and the previous post with Dan Sperber and his similarly wandering paper, that managed to somehow tie Hebbian neural nets with Hayek and seemed to reach no clear conclusions, leave me mystified. Dan Sperber even managed a return appearance earlier in these comments.
What are we supposed to take away from the work of Coase?
The reason this post is here is that it describes one of the most grevious cases of what’s been called replication failure, a gross misrepresentation of an idea, repeated over and over to the point where the original idea has been effectively lost, replaced by a misinterpretation so severe as to negate the original.
Coase’ work, in this case has been suplanted by the misrepresentation rooted in a paper by George Stigler, and it is George Stigler’s mistake that has come to be understood as the ‘Coase Theorem’ which is tragic in that it means almost exactly the opposite of what Coase meant.
For a more complete explanation here’s a link;
http://mpra.ub.uni-muenchen.de/37936/1/MPRA_paper_37936.pdf
Sorry, as to your question;
“What are we supposed to take away from the work of Coase?”
Coase thought that the economists of his day relied too heavily on abstractions they could scrawl on the blackboard, and that they should be more concerned with the real-life effects of all that abstract ‘thinking’.
It’s all water over the dam at this point, but if Coase had been more widely understood, instead of Stigler’s misrepresentation, the Chicago School might have had less negative influence going forward and that could only have been better for those of us who live in the ‘real’ world.
The learning value of the Coase theorem is in seeing how people with an agenda can warp the meaning of valuable observations.
Plus, to distill it down and grossly oversimplify, the ‘Coase thereom’ is essentially:
1) perfect information
2) clear property rights
3) costless bargaining
The rarity of those conditions ‘in the wild’ should make any serious thinker ponder the proper role of public policy in setting the ground rules for markets to function efficiently. And of course it makes some conclude that the very concept of using markets at all is flawed – the state should directly produce and allocate resources.
Indeed, the people intent on destroying the notion of public good are exactly those most intent on promoting secrecy, undermining property rights, and making it difficult for all but the largest actors to navigate society.
P.S., you might like this interview. It is relatively current but still some good ole’ fashioned pre-9/11 thinking.
http://www.coase.org/coaseinterview.htm
My favorite quote comes at the bottom:
“The point I’m going to make when I talk in the meeting is that economists boast that Darwin got his ideas from Malthus and Adam Smith. Well, to me, what is interesting is to see what has happened since Darwin in biology and what has happened to economics since Adam Smith. The differences are startling. They really understand how biological processes work in a way that we do not understand how economic processes work.”
Thank you for explaining things further. I’ll check the URLs you’ve referred me to and ponder further. This post and the Dan Sperber still seem odd for this blog.
We are all Austrians now.
Here’s something to chew on.
“With respect to empirical research in political economy, Coase in his openning address to ISNIE back in 1999 wrote: ” Economics, over the years, has become more and more abstract and divorced from events in the real world. Economists, by and large, do not study the workings of the actual economic system. They theorize about it. As Ely Devons, an English economist, once said at a meeting, “If economists wished to study the horse, they wouldn’t go and look at horses. They’d sit in their studies and say to themselves, ‘What would I do if I were a horse?’” And they would soon discover that they would maximize their utilities.”
I find this curious as he engages in the same thunkit that the quote represents. He never went and looked at the horse in objective totality, only the perspective he could see in a limited plane of time-space… then… he articulated his argument from that prospective. I mean he used the term “real world”, an obvious indicator of observer bias.
skippy… its worse than an archeological dig stopping at Clovis Man and pronouncing “here is the human actor” without keep digging (true story). Someone had to go back and dig further, against the headwinds of his peers and behold[!!!] more evidence that was contrary to the established position (reputations on the line).
PS. part of a comment that went poof thingy.
Even though Coase distances him self from the theorem labeling he is still thoroughly a austrian chicago school thinker. He still attempts to validate the proposition that, the human mind is rooted in market thunkit as a direct result of DNA. Every thing he investigates is focused through the optical lens of the action axiom praxology. Granted he stated off as a socialist, although ones surrounding environment – Upton effect to boot – does have effects over time.
Thank you skippy! I feel more comfortable knowing that I’m not alone in my skepticism about Coase.
I have a strange inkling, as he was not a complete Austrian fundamentalist, more of an articulate left of center with in the temple. That he could be utilized as an ideological bridging device between some polar hard liners and at this point whats there to lose.
skippy… still… that does not change my mind on the historical well spring of this cult nor the means by which they are – consigned – to impose this religion – on everyone else – at what ever cost.
Wow! I read the referenced URLs. I read the interview with Coase, from which I found little illumination. I read the entire MPRA paper discussing Coase but what stood out to me was the following statement in the paper’s ‘abstract’:
“In order to accomplish the first task I have conducted a survey in which I studied 40 articles mentioning the ‘Coase Theorem’ so as to see whether (and in what ways) economists have subscribed to the ‘Coase Theorem’ in their works. The survey resulted that of the most cited and recent articles referring to the‘Coase Theorem’ 75 percent misrepresented Coase 1960.”
I am most definitely not a fan of Coase. I’d assume that those 75% of authors who misrepresented Coase did read his original paper or made an attempt [the alternative theory would be that they were too lazy to read and understand the original paper and trusted entirely and uncritically to the Stigler intelrpretation of the Coase ‘Theorem’]. The author of the MPRA paper nicely calls this lapse ‘replication failure’. Whatever the root cause of this 75% ‘replication failure’, after a scan of the paper I’m most inclined to the opinion that Coase’s writing is discursive and very unclear. [By the way — what seemed to me a much better introduction to Coase was an article in Reason Magazine: http://www.daviddfriedman.com/Academic/Coase_World.html “The Swedes Get It Right”.]
I have several problems with Coase’s view of the externalities problem. I agree with him that assessing taxes to fix externalities doesn’t properly fix them. But that’s as far as I can go. What troubles me: local parties, assuming that they are indeed equal at law [a dubious assumption in too many cases] may reach an agreement that better addresses an externality than some particular government regulation. However, I don’t believe that mitigates the damage done by externalities like air pollution and carbon dioxide production which affect much larger swathes of the population than represented in the torts that Coase discusses. It may be troglodyte thinking but I think there are things that cannot be costed for in dollars and cents; things that no torts or costing schemes can redress. Rather than exert any more efforts at understanding Coase I believe my time might be better spent learning more about the studies of Lin Ostrum.
Ronald Coase was a member of the Mount Pelerin Society. It isn’t an accident that his ideas support the wondrous markets that the neoliberals are pushing on every aspect of life.