When the news broke last week that Ronald Coase, the economist and Nobel laureate, had died at the age of 102, what came immediately to mind was John Maynard Keynes’ observation that “practical men, who believe themselves to be quite exempt from any intellectual influences, are usually the slaves of some defunct economist.”
Most of the people running the great Internet companies of today have probably never heard of Coase, but, in a way, they are all his slaves, because way back in 1932 he cracked the problem of explaining how firms are structured, and how and why they change as circumstances change. Coase might have been ancient, but he was certainly not defunct.
As an economics student at the London School of Economics in the 1930s, Coase was puzzled by the fact that economic theory ignored the workings of the firms that make up the economy. Economists were obsessed with the big picture — the way prices act as Adam Smith’s “invisible hand,” bringing supply and demand into equilibrium. However, like Edwardian aristocrats disdaining “trade,” they seemed blandly uninterested in the ways in which businessmen actually made decisions.
“What is studied,” Coase said, “is a system that lives in the minds of economists, but not on Earth.”
So he got a scholarship and went to the US to examine how companies actually worked. The thing that puzzled him was this: Economic theory postulated that the market provided the most efficient way of coordinating economic activity, and yet no large company seemed to use the price mechanism as a way of coordinating its internal activities. Instead, big corporations operated as command-and-control mini-economies of the kind despised by economists. Why was this?
“I found the answer,” Coase said in his 1991 Nobel lecture, “by the summer of 1932. It was to realize that there were costs of using the pricing mechanism... There are negotiations to be undertaken, contracts have to be drawn up, inspections have to be made, arrangements have to be made to settle disputes and so on. These costs have come to be known as transaction costs. Their existence implies that methods of coordination alternative to the market, which are themselves costly and in various ways imperfect, may nonetheless be preferable to relying on the pricing mechanism, the only method of coordination normally analyzed by economists.”
It sounds simple, but it was a groundbreaking insight because it explained why, for example, companies often became vertically integrated as they grew. Transaction costs are why a manufacturer of car tires would come to own and operate rubber plantations in some fetid tropical country; not because its executives want to farm rubber, but because the transaction costs of not owning the supplier are higher than the costs of operating it themselves.
Transaction costs explain more than just how firms operate, they also help to determine what is produced.
“If the costs of making an exchange are greater than the gains which that exchange would bring,” Coase wrote, “that exchange would not take place and the greater production that would flow from specialization would not be realized. In this way, transaction costs affect not only contractual arrangements, but also what goods and services are produced. Not to include transaction costs in the theory leaves many aspects of the working of the economic system unexplained, including the emergence of the firm, but much else besides.”
Coase first outlined his discovery in a lecture at Dundee University, in Scotland, in October 1932. He was 21 years old. His paper, “The Nature of the Firm,” was not published until 1937, though, and seems to have been largely ignored for the next half-century for reasons that only those familiar with the perversities of academic disciplines can fully understand.
Whatever the explanation, the fact remained that Coase’s great insight languished in relative obscurity until the Internet arrived and began to wreak its havoc on the industrial system.
Could Asia be on the verge of a new wave of nuclear proliferation? A look back at the early history of the North Atlantic Treaty Organization (NATO), which recently celebrated its 75th anniversary, illuminates some reasons for concern in the Indo-Pacific today. US Secretary of Defense Lloyd Austin recently described NATO as “the most powerful and successful alliance in history,” but the organization’s early years were not without challenges. At its inception, the signing of the North Atlantic Treaty marked a sea change in American strategic thinking. The United States had been intent on withdrawing from Europe in the years following
My wife and I spent the week in the interior of Taiwan where Shuyuan spent her childhood. In that town there is a street that functions as an open farmer’s market. Walk along that street, as Shuyuan did yesterday, and it is next to impossible to come home empty-handed. Some mangoes that looked vaguely like others we had seen around here ended up on our table. Shuyuan told how she had bought them from a little old farmer woman from the countryside who said the mangoes were from a very old tree she had on her property. The big surprise
The issue of China’s overcapacity has drawn greater global attention recently, with US Secretary of the Treasury Janet Yellen urging Beijing to address its excess production in key industries during her visit to China last week. Meanwhile in Brussels, European Commission President Ursula von der Leyen last week said that Europe must have a tough talk with China on its perceived overcapacity and unfair trade practices. The remarks by Yellen and Von der Leyen come as China’s economy is undergoing a painful transition. Beijing is trying to steer the world’s second-largest economy out of a COVID-19 slump, the property crisis and
Former president Ma Ying-jeou’s (馬英九) trip to China provides a pertinent reminder of why Taiwanese protested so vociferously against attempts to force through the cross-strait service trade agreement in 2014 and why, since Ma’s presidential election win in 2012, they have not voted in another Chinese Nationalist Party (KMT) candidate. While the nation narrowly avoided tragedy — the treaty would have put Taiwan on the path toward the demobilization of its democracy, which Courtney Donovan Smith wrote about in the Taipei Times in “With the Sunflower movement Taiwan dodged a bullet” — Ma’s political swansong in China, which included fawning dithyrambs