Coase

100 years ago, Ronald Coase was born. 20 years ago, I was privileged to write a book review of Ronald's book, THE FIRM, THE MARKET, AND THE LAW. Here is part of that review:

"The reason the collection works as a book is that Coase frankly recognizes that though his work (particularly "The Nature of the Firm" and "The Problem of Social Cost," Chapter Five) is often cited it is apparently little read or accepted. In fact, Coase seems frustrated at the misuse of his work, particularly regarding the apocryphal "Coase Theorem":

The world of zero transaction costs has often been described as a Coasian world. Nothing could be further from the truth. It is the world of modern economic theory, one which I was hoping to persuade economists to leave . . . Economists [have] been engaged in an attempt to explain why there are divergences between private and social costs and what should be done about it, using a theory in which private and social costs were necessarily always equal. It is therefore hardly surprising that the conclusions reached were often incorrect.., their theoretical system did not take into account a factor which is essential of one wishes to analyze the effect of a change in the law on the allocation of resources. This missing factor is the existence of transactions costs. (pp. 174-175, red emphasis added.)

So Coase actually thought transactions costs could make social and private costs diverge. Does that mean Pigou was right? Well, yes, Pigou was certainly right, especially when he said:

It is not sufficient to contrast the imperfect adjustments of unfettered enterprise with the best adjustment that economists in their studies can imagine. For we cannot expect that any State authority will attain, or even wholeheartedly seek, that ideal. Such authorities are liable alike to ignorance, to sectional pressure, and to personal corruption by private interest. (1920; p. 296)

The point is that we should READ the classics, not just cite them. Especially when we cite them wrong. Both Coase and Pigou are much more subtle than the caricature they generally get in intermediate micro classes. Happy birthday, Dr. Coase.

(Lagniappe: I should note that a better review of Coase's contribution is Posner's. That is my favorite)