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

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 economics—namely, 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

lessons—both 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 offshoot—namely, 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, 250–51

(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 possess—a 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, 27–2 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 different—namely ,

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 25–89.