Coase Minus the Coase Theorem-Some Problems with Chicago Transaction Cost Analysis

Author:Pierre Schlag
Position:Distinguished Professor & Byron R. White Professor of Law, University of Colorado
Pages:175-222
SUMMARY

In law as well as economics, the most well-known aspect of Coase’s "The Problem of Social Cost," is the Coase Theorem. Over the decades, that particular notion has morphed into a crucial component of Chicago law and economics-namely, transaction cost analysis. In this Article, I deliberately bracket the Coase Theorem to show that "The Problem of Social Cost" contains far more interesting and... (see full summary)

 
FREE EXCERPT
Coase Minus the Coase Theorem—
Some Problems with Chicago Transaction
Cost Analysis
Pierre Schlag
ABSTRACT: In law as well as economics, the most well -known aspect of
Coase’s “The Problem of Social Cost,” is th e Coase Theorem. Over the
decades, that particular notion h as morphed into a crucial compo nent of
Chicago law and economicsnamely, transaction cost analysis.
In this Article, I deliberately bracket the Coase Theo rem to show that “The
Problem of Social Cost” contains fa r more interesting and unsettl ing
lessonsboth for law as well as fo r economics. Indeed, while Coase’ s
arguments clearly target the Pigouvia n attempts to “improve on the market”
through government corrective s, there is, lurking in those a rguments, a
much more profound critique of neocla ssical economics generally.
This broader critique has bee n all but eclipsed by the foc us on the Coase
Theorem and its main offshootnamely, Chicago transaction cost analysis.
Here, based on a close reading of “The Pro blem of Social Cost,” I retrieve
Coase’s broader critique from it s current obscurity to show its relevance and
bite for contemporary law and economics . In particular, I deploy Coase’s
thought to show that Chicago tra nsaction cost analysis is, on its o wn terms,
compromised.
Chicago transaction cost analysis has no theory capable of distinguishing
transaction costs from producti on factor costs. It is accord ingly incapable of
delineating the circumstances when it i s (or is not) efficiency-enhanci ng to
“economize on transaction costs.” The su rprising upshot is that despite its
stated commitment to enhance effic iency, Chicago transaction cost a nalysis
is instead engaged in a selecti ve subsidization (or penalizati on) of various
markets based on criteria that a re at best opaque and quite possibly,
incoherent.
Distinguished Professor & Byron R. White Professor of Law, University of Colorado.
For comments and criticisms, I wish to thank William Boyd, David Campbell, Kristen Carpenter,
Victor Fleischer, Peter Huang, Steven Medema, Gideon Parchomovsky, Jack Schlegel, Jeanne
Schroeder, & Mark Squillace. Thanks as well to Matthew Molinaro for research assistance.
175
176 IOWA LAW REVIEW [Vol. 99:175
I. BEFORE COASE—THE STATUS QUO ANTE ........................................... 181
II. ENTER COASE ....................................................................................... 184
A. THE MISTAKEN PIGOUVIAN APPROACH ............................................ 184
1. A Tale of Not Just One But Two Hypotheticals ................... 185
2. The Reciprocal Nature of the Harm .................................... 186
3. The Feedback Loop .............................................................. 187
4. Information Deficits ............................................................. 188
5. Idealized Frames ................................................................... 189
6. Putting It All Together ......................................................... 191
B. AGAINST BLACKBOARD ECONOMICS: COMPARING A NON-EXISTENT
ACTUAL TO AN UNATTAINABLE IDEAL .............................................. 192
C. RECONCEPTUALIZING FACTORS OF PRODUCTION ............................... 194
D. THE NATURE OF THE DIFFICULTY ..................................................... 198
III. RETHINKING NEOCLASSICAL ECONOMICS (BUT MOSTLY NOT) ............ 202
A. THE ECONOMISTS ........................................................................... 202
B. THE LAWYERS ................................................................................ 202
C. THE COASE THEOREM .................................................................... 204
D. CHICAGO TCA ............................................................................... 206
IV. PROBLEMS WITH CHICAGO TCA—SHOULD WE ECONOMIZE ON
TRANSACTION COSTS? .......................................................................... 209
A. DISTINGUISHING TRANSACTION COSTS—THE SHORTCOMINGS OF
OPERATIONAL CATEGORIES ............................................................. 212
B. DISTINGUISHING TRANSACTION COSTS—THE LIMITS OF
FUNCTIONALISM ............................................................................. 213
C. THE RECIPROCAL NATURE OF TRANSACTION COSTS .......................... 214
D. THE NESTING PROBLEM .................................................................. 215
E. RAISING THE STAKES—FROM TRAIN SPARKS TO THE INFORMATION
AGE ............................................................................................... 217
CONCLUSION ....................................................................................... 217
2013] COASE MINUS THE COASE THEOREM 177
What I wanted to do was to improve our analy sis of the working
of the economic system. Law c ame into the article because , in a
regime of positive transaction costs, the c haracter of the law
becomes one of the main facto rs determining the performance o f
the economy.
R.H. Coase, Law and Economics at Chicago, 36 J.L. & ECON. 239, 25051
(1993) (writing about The Problem of Social Cost).
Economists commonly assume tha t what is traded on the market
is a physical entity, an ounce of gold , a ton of coal. But, as
lawyers know, what are traded on the ma rket are bundles of
rights, rights to perform certain actio ns. Trade, the dominant
activity in the economic system, its amo unt and character,
consequently depend on what rights and duties individuals and
organizations are deemed to possessa nd these are established by
the legal system. An economist, as I see i t, cannot avoid taking
the legal system into account.
Ronald H. Coase, The 1987 McCorkle Lecture: Blackmail, 74 VA. L. REV. 655,
656 (1988).
Forget the Coase Theorem. Ditch transaction costs. And keep Kaldor
Hicks at bay. But d o hold on to The Problem of Social Cost. We are going to try
to read the article anew. As if George Stigler had never formulated “The
Coase Theorem” or even coined the expression.1 As if Coase had never
1. The Coase Theorem was first formulated not by Co ase, but rather by George Stigler
and first found its way in print in GEORGE J. STIGLER, THE THEORY OF PRICE 113 (3d ed. 1966).
In The Problem of Social Costs, the closest Coase ever comes to articulating the Theorem is early in
the article where he writes:
It is necessary to know whether the damaging business is liable or not for dam age
caused
since without the establishment of this initial delimitation of rights there
can be no
mar
ket
transactions
to transfer and recombine them. But the
ultimate result (which
maxi
mises the value of
production)
is independent of th e legal
position if the pricing system
is
assumed to work wit hout
cost.
R.H. Coase, The Problem of Social Cost, 3 J.L. & ECON. 1, 8 (1960)
[hereinafter Coase, Problem of
Social Cost] (emphasis added). For an earlier statement by Coase that approximates the
Theorem, see R.H. Coase, The Federal Communications Commission, 2 J.L. & ECON. 1, 272 8
(1959). [hereinafter Coase, Federal Communications Commission]. Coase attributes the
articulation of the “Coase Theorem” to George Sti gler. RONALD H. COASE, THE FIRM, THE
MARKET, AND THE LAW 14 (1988) [hereinafter COASE, THE FIRM, THE MARKET, AND THE LAW].
Coase has affirmed that at the time he wrote The Problem of Social Cost, he was not aware of the
Theorem. Instead, he believed h imself to be doing something altoge ther differentnamely ,
demonstrating “basic defects i n the current approach to the prob lems of welfare economics.”
Coase, Problem of Social Cost, supra , at 42. These problems will be discussed below. See infra text
accompanying notes 2589.

To continue reading

FREE SIGN UP