My reply to Coase Theorem at The Financial Times.

In law and economics, the Coase theorem (pronounced /ˈkoʊs/) describes the economic efficiency of an economic allocation or outcome in the presence of externalities. The theorem states that if trade in an externality is possible and there are sufficiently low transaction costs, bargaining will lead to a Pareto efficient outcome regardless of the initial allocation of property. In practice, obstacles to bargaining or poorly defined property rights can prevent Coasian bargaining. This “theorem” is commonly attributed to Nobel Prize laureate Ronald Coase during his tenure at the University of Chicago. However, Coase himself stated that the theorem was based on perhaps four pages of his 1960 paper “The Problem of Social Cost“,[1] and that the “Coase theorem” is not about his work at all.[2]

This 1960 paper, along with his 1937 paper on the nature of the firm (which also emphasizes the role of transaction costs), earned Ronald Coase the 1991 Nobel Memorial Prize in Economic Sciences. In this 1960 paper, Coase argued that real-world transaction costs are rarely low enough to allow for efficient bargaining and hence the theorem is almost always inapplicable to economic reality. Since then, others have demonstrated the importance of the perfect information assumption and shown using game theory that inefficient outcomes are to be expected when this assumption is not met.

Nevertheless, the Coase theorem is considered an important basis for most modern economic analyses of government regulation, especially in the case of externalities, and it has been used by jurists and legal scholars to analyse and resolve legal disputes. George Stigler summarized the resolution of the externality problem in the absence of transaction costs in a 1966 economics textbook in terms of private and social cost, and for the first time called it a “theorem.” Since the 1960s, a voluminous amount of literature on the Coase theorem and its various interpretations, proofs, and criticism has developed and continues to grow.

Here is the pertinent comment regarding not ‘reason’ but the power of belief systems to the ‘Lower Orders’ from the British énarque! Anyone who refers to the modern day Dr. Pangloss, Steven Pinker, has placed themselves in the position of moralizing dilettante in need of some intellectual gloss!

I stress my growing concern about the west’s political fragility. Will “the centre”, famously discussed in Yeats’ “The Second Coming”, hold, or will extremes again take over?

“I think the fragility of a liberal order is the other thing I’ve learned,” he responds. “I was once a confident optimist and rationalist. I also used to believe that everybody could be persuaded by rational argument. I’ve increasingly realised that people need mythologies, people need nationalisms and people need religions. How people get identities that provide emotional enrichment, without ending up with dangerous forms of extremism, is quite problematic.”

He asks me whether I have read Steven Pinker’s optimistic book on the decline of violence. I reply that we’re one big nuclear war away from this turning out to be completely wrong. “Absolutely,” he responds.

Your assertion that Baron Turner of Ecchinswell is somehow not a technocrat with a fixed commitment to ‘reason’ is ludicrous, he is a reformed Keynesian i.e. a Neo-Liberal, although a surprising one:

He goes back further, to the mid-1970s, when he obtained a double first in history and economics at Cambridge. “I was undoubtedly a Keynesian. I thought his General Theory of Employment (1936) was fascinating. I was also wrong then on some things. I believed in prices and incomes policies and I now think those simply don’t work. And I went through a sort of drying-out process in the early 1980s.” He became convinced, he explains, that macroeconomic stability could be secured by rigid rules and “so what matters is supply-side efficiency. The euro was going to make it easier for people to invest without exchange-rate risk and so would produce a higher level of allocative efficiency [when production reflects the preferences of consumers]. That was clearly wrong.

“Actually, I changed my view on that much faster than people may have realised. In 2003 I wrote an article asking, ‘What happens inside the eurozone if we have a banking and deflation crisis?’ Then the financial crisis drove me back to thinking about the macroeconomics of money and debt and, in the process of doing that and also researching my book [Between Debt and the Devil (2015)] I found myself returning to things that I had thought about 40 years ago.

An engaging and challenging interview, and thank you for prodding me to read it. Yet I feel like the Top Banana being fed lines by the Straight Man!  As to your assertion: ‘Your platitudes seem rather silly.’ I will stand by my assertion, that all we really have is our ‘reason’ to guide us.  A Reason guided by one of cornerstones of Adam Smith’s Theory of Moral Sentiments, the exercise of the point of view of the impartial spectator used by ethical/political actors in situ. See D.D. Raphael’s book The Impartial Spectator, Adam Smith’s Moral Philosophy published by Oxford University Press.



About stephenkmacksd

Rootless cosmopolitan,down at heels intellectual;would be writer.
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