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 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 unsettling

lessons—both for law as well as for economics. Indeed, while Coase’s

arguments clearly target the Pigouvian attempts to “improve on the market”

through government correctives, there is, lurking in those arguments, a

much more profound critique of neoclassical economics generally.

This broader critique has been all but eclipsed by the focus on the Coase

Theorem and its main offshoot—namely, Chicago transaction cost analysis.

Here, based on a close reading of “The Problem of Social Cost,” I retrieve

Coase’s broader critique from its current obscurity to show its relevance and

bite for contemporary law and economics. In particular, I deploy Coase’s

thought to show that Chicago transaction cost analysis is, on its own terms,

compromised.

Chicago transaction cost analysis has no theory capable of distinguishing

transaction costs from production factor costs. It is accordingly incapable of

delineating the circumstances when it is (or is not) efficiency-enhancing to

“economize on transaction costs.” The surprising upshot is that despite its

stated commitment to enhance efficiency, Chicago transaction cost analysis

is instead engaged in a selective subsidization (or penalization) of various

markets based on criteria that are 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

176IOWA 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 THEOREM177

What I wanted to do was to improve our analysis of the working

of the economic system. Law came into the article because, in a

regime of positive transaction costs, the character of the law

becomes one of the main factors determining the performance of

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 that 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 market are bundles of

rights, rights to perform certain actions. Trade, the dominant

activity in theeconomic system, its amount and character,

consequently depend on what rights and duties individuals and

organizations are deemed to possess—and these are established by

the legal system. An economist, as I see it, cannot avoid taking

the legal system into account.

Ronald H. Coase, The 1987McCorkle Lecture: Blackmail, 74 VA.L.REV. 655,

656 (1988).

Forget the Coase Theorem. Ditch transaction costs. And keep Kaldor–

Hicks at bay. But do 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.1As if Coase had never

1. The Coase Theorem was first formulated not by Coase, but rather by George Stigler

and first found its way in print in GEORGE J.STIGLER,THE THEORY OF PRICE113 (3d ed. 1966).

InThe Problem of Social Costs, the closest Coase ever comes to articulating the Theorem is early in

the article where he writes:

It is necessarytoknowwhetherthedamagingbusinessisliableornotfordamage

caused

sincewithouttheestablishmentofthisinitialdelimitation ofrightsthere

canbeno

mar

ket

transactions

totransfer and recombinethem.Butthe

ultimate result(which

maxi

misesthevalueof

production)

isindependent ofthelegal

positionifthepricingsystem

is

assumed toworkwithout

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, 2J.L.&ECON. 1, 27–2 8

(1959). [hereinafter Coase, Federal Communications Commission]. Coase attributes the

articulation of the “Coase Theorem” to George Stigler. RONALD H.COASE, THE FIRM,THE

MARKET,AND THE LAW14 (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 himself to be doing something altogether different—namely ,

demonstrating “basic defects in the current approach to the problems of welfare economics.”

Coase, Problem of Social Cost, supra, at 42. These problems will be discussed below. See infra text

accompanying notes 25–89.