The Nobel Prize

Ronald H. Coase (b. 1910)

Ronald Coase was born in Willesden, London, UK in 1910. He went to school in London and won a place at a high (secondary) school which, at that time, allowed pupils after they had completed their secondary education to study as external students of the University of London for a year. Coase reports that this prompted the first of a number of fortunate incidents that shaped his career as an economist (Nobel Foundation, 2004). His initial intention was to take a degree in history but a late start at high school meant that he had not taken the required prior course in Latin. As an alternative Coase chose chemistry – a subject in which he had demonstrated some earlier promise – but he found the associated mathematics ‘not to my taste’. This left him with only one option: commerce. He passed his first year’s work and enrolled at the London School of Economics (LSE) (part of the University of London) to continue as an undergraduate on a bachelor of commerce degree. He was awarded a BCom by the University of London in 1932. In 1951 he was awarded a PhD in economics by the same institution.

Coase’s first academic appointment was as an assistant lecturer at the Dundee School of Economics and Commerce in 1932. In 1934 he was appointed as assistant lecturer at the University of Liverpool and in 1935 he returned to the London School of Economics, initially as an assistant lecturer, then lecturer (1938) and finally reader (1947). During the Second World War he did statistical work at the Forestry Commission and in the Offices of the War Cabinet. His war service lasted from 1940 to 1946. In 1951, Coase left the UK for the United States where he was appointed Professor of Economics at Buffalo University, New York. In 1958 he moved to the University of Virginia as professor, and in 1964 he joined the University of Chicago, first as professor and from 1971 as the Clifton R. Musser Professor of Economics. Coase spent 1991 as Distinguished Professor (visiting) of Law and Economics at the University of Kansas. Since 1982 he has been Clifton R. Musser Professor Emeritus of Economics and Senior Fellow in Law and Economics at Chicago.

Among Coase’s offices and honours are honorary degrees from a number of universities around the world. He is a distinguished fellow of the American Economic Association and a fellow of the American Academy of Arts and Sciences. Coase is also an honorary fellow of the LSE, a corresponding fellow of the British Academy and a Membre Titulaire of the European Academy. In 1980 he won the Law and Economics Center Prize from the University of Miami and in 1988 he received the D. Francis Bustin Prize from the University of Chicago. In 1991 Coase was awarded the Nobel Memorial Prize in Economics ‘for his discovery and clarification of the significance of transaction costs and property rights for the institutional structure and functioning of the economy’ (Nobel Foundation, 2004).

As noted, Coase spent the first year of his undergraduate career as an external student of the University of London. He then took the usual two further years to complete his degree. However, university regulations required him to be ‘resident’ at the LSE for three years before he could graduate. This presented Coase with the problem of finding something to do to fulfil his final year of residency. Again, Coase records an incident of serendipity that would decisively influence his life and career. He confesses that even as late as five months before his final examinations his ‘notions on how the economy worked were extremely woolly’ (Coase, 1992, p. 715). However, attending the seminars of a newly appointed professor – Arnold Plant – proved to be a turning point. Plant introduced Coase to Adam Smith’s ‘invisible hand’ and gave him a revelatory and ‘coherent view of the economic system’. It seems that Coase also impressed Plant, as under his influence the University of London awarded Coase a Sir Ernest Cassel Travelling Scholarship. Coase used this to spend a year in the United States doing the research that would many years later form a major part of his Nobel citation. Prior to learning of his award, Coase had planned to spend his last year as an undergraduate studying industrial law and he observes that ‘had I done so I would undoubtedly have gone on to become a lawyer’ (Nobel Foundation, 2004).

Coase travelled to the United States intent on ‘studying the structure of American industries, with the aim of discovering why industries were organized in different ways’ (Nobel Foundation, 2004). He was also exercised by a puzzle posed for him by the teachings of Smith (and Plant). The metaphorical invisible hand demonstrated the power that the competitive process had to organise and coordinate production. But in his visits to American firms and factories, Coase was meeting a tier of management whose very function was also to coordinate and organise: ‘Why was it needed if the pricing system provided all the coordination necessary?’ (Coase, 1992, p. 715). The answer to this question, Coase realised, was that ‘there were costs of using the price mechanism. What the prices are have to be discovered. There are negotiations to be undertaken, contracts have to be drawn up, inspections have to be made … and so on. These costs have come to be known as transaction costs’ (Coase, 1992, p. 715). In his 1937 paper in Economica, ‘The Nature of the Firm’, cited by the Royal Swedish Academy of Sciences as part of the reason for his Nobel award, Coase argues that it is the presence of transaction costs that explains the very existence of firms: the contractual and other tasks and processes that give rise to such costs are simply more efficiently managed by the institution of the firm. Markets and the individuals within them could do the job but less efficiently. Coase (ibid., p. 716) characterises the firm as a ‘little planned society’; he argues that the boundary between what is done through the market and what is done by the firm is decided by the competitive process. Coase’s Nobel citation makes reference to one other paper: ‘The Problem of Social Cost’, published in the Journal of Law and Economics (which Coase was later to edit) in 1960. This work gave rise to the famous Coase theorem, which Coase himself credits to fellow Nobel Laureate, George Stigler (see entry for Stigler in the present volume and Stigler, 1989). Coase’s purpose in the ‘Problem of Social Cost’ paper was to offer a critique of the convention established by A.C. Pigou that, in the presence of negative externalities, some form of corrective government action – such as the imposition of a tax – could ‘internalise’ and therefore limit damage to third parties. Coase showed that, where transaction costs are zero, negotiations freely entered into by the offending and offended parties will both eliminate negative externalities and provide for an efficient allocation of resources. Moreover, Coase was able to demonstrate that this outcome will occur however property rights are defined between the parties. For example, a firm at risk of polluting a river would be willing to compensate the riparian owner were a pollution event to arise. On the other hand, if the firm were the riparian owner, then a third-party river user would be willing to pay it to take steps not to pollute. Payments in either direction would vary according to the value each side placed on its output (the firm), or amenity (the river user): the most valued option prevails regardless of who has rights over the river. Of course, where transaction costs are present, affected parties may find it too costly or difficult to undertake the necessary negotiations. In such circumstances, Coase recognised that the assignment of property rights can affect resource allocation and, as Brunner (1992, p. 10) notes, ‘The social problem then is the optimal assignment of rights’. For Coase (1992, p. 718), and those his work has encouraged, this raises the significance of the links between economics and the institutional arena where rights are decided: that of the law. In a wonderful passage from his Nobel lecture he emphasises the importance of the institutional context for economic analysis:
It makes little sense for economists to discuss the process of exchange without specifying the institutional setting within which the trading takes place, since this affects the incentives to produce and the costs of transacting. I think this is now beginning to be recognized and made crystal-clear by what is going on in Eastern Europe today. The time has surely gone in which economists could analyze in great detail two individuals exchanging nuts for berries on the edge of the forest and then feel that their analysis of the process of exchange was complete, illuminating though this analysis may be in certain respects.

Brunner (1992, p. 10) has called ‘The Problem of Social Cost’, one of the outstanding papers published in the postwar period. Blaug (1998, p. 41) is perhaps even more fulsome: It is rare for a single article to generate an entire branch of economics, much less two branches of economics, but the Economics of Property Rights … and the Economics of Law … two rapidly growing sub-disciplines within economics in the last decade or so, can be traced directly to Coase’s article on social cost …

Posner (1993, p. 195) claims that it ‘is widely believed to be the most frequently cited article in all of economics’. Coase’s other notable work includes a study of the allocation of the radio frequency spectrum in the United States published as ‘The Federal Communications Commission’ in the Journal of Law and Economics in 1959. Against the grain of popular wisdom at the time in the industry and in government circles, Coase argued in the paper ‘that it would be better if use of the spectrum was determined by the pricing system and was awarded to the highest bidder’ (Nobel Foundation, 2004). He relates an interesting story of an invitation from a number of Chicago economists (Coase was then at the University of Virginia) to discuss what they thought was an error in this work. At the meeting, Coase persuaded his critics that he was in the right and he was asked to write up his argument for a second paper in the Journal of Law and Economics. This subsequently appeared in 1960 as ‘The Problem of Social Cost’. Coase supposes that without the prompt from Chicago his most famous paper would never have been written (Nobel Foundation, 2004). The central argument in ‘The Federal Communications Commission’ is itself of some contemporary relevance. The economist consultants to the British government on its auction of the ‘3rd generation’ mobile phone licences – which raised some £22.5 billion ($34bn) or 2.5 per cent of UK GDP – cite Coase as the original advocate of the kind of work on which they were engaged (see Binmore and Klemperer, 2002).

Coase’s lifetime work has been drawn together in two volumes: Coase (1988; 1994). The former includes his two classic articles from 1937 and 1960. The latter consists of 15 essays in which Coase evaluates the contributions of outstanding economists, including Adam Smith, Alfred Marshall and George Stigler. The legacy of Coase in economic analysis is explored in a collection of 40 articles edited by Steven Medema (1995).

Main Published Works
(1937), ‘The Nature of the Firm’, Economica, 4, November, pp. 386–405.

(1959), ‘The Federal Communications Commission’, Journal of Law and Economics, 2, October,
pp. 1–40.

(1960), ‘The Problem of Social Cost’, Journal of Law and Economics, 3, October, pp. 1–44.
(1988), The Firm, the Market and the Law, Chicago: University of Chicago Press.
(1992), ‘The Institutional Structure of Production’, American Economic Review, 82, September, pp. 713–19.
(1994), Essays on Economics and Economists, Chicago: University of Chicago Press.
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