The Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel 1991
Ronald H. Coase

Ronald Harry Coase (/ˈkoʊz/; 29 December 1910 – 2 September 2013) was a British economist and author. He was the Clifton R. Musser Professor Emeritus of Economics at the University of Chicago Law School. After studying with the University of London External Programme in 1927–29, Coase entered the London School of Economics, where he took courses with Arnold Plant. He received the Nobel Prize in Economics in 1991.
Coase, who believed economists should study real markets, not theoretical ones, established the case for the corporation as a means to pay the costs of operating a marketplace. Coase is best known for two articles in particular: "The Nature of the Firm" (1937), which introduces the concept of transaction costs to explain the nature and limits of firms, and "The Problem of Social Cost" (1960), which suggests that well-defined property rights could overcome the problems of externalities (see Coase theorem). Coase is also often referred to as the "father" of reform in the policy for allocation of the electromagnetic spectrum, based on his article "The Federal Communications Commission" (1959), where he criticises spectrum licensing, suggesting property rights as a more efficient method of allocating spectrum to users. Additionally, Coase's transaction costs approach is currently influential in modern organizational economics, where it was reintroduced by Oliver E. Williamson.
Biographical
My father, a methodical man, recorded in his diary that I was born at 3:25 p.m. on December 29th, 1910. The place was a house, containing two flats of which my parents occupied the lower, in a suburb of London, Willesden. My father was a telegraphist in the Post Office. My mother had been employed in the Post Office but ceased to work on being married. Both my parents had left school at the age of 12 but were completely literate. However, they had no interest in academic scholarship. Their interest was in sport. My mother played tennis until an advanced age. My father, who played football, cricket and tennis while young, played (lawn) bowls until his death. He was a good player, played for his county and won a number of competitions. He wrote articles on bowls for the local newspaper and for Bowls News.
I had the usual boy's interest in sport but my main interest was always academic. I was an only child but although often alone, I was never lonely. When I learnt chess, I was happy to play the role of each player in turn. Lacking guidance, my reading (in books borrowed from the local public library) was undiscriminating and, as I now realize, I was unable to distinguish the charlatan from the serious scholar. My mother taught me to be honest and truthful and although it is impossible to escape some degree of self-deception, my endeavours to follow her precepts have, I believe, lent some strength to my writing. My mother's hero was Captain Oates, who, returning with Scott from the South Pole and finding that his illness was hampering the others, told his companions that he was going for a stroll, went out into a blizzard and was never heard of again. I have always felt that I should not be a bother to others but in this I have not always succeeded.
Aged 11, I was taken by my father to a phrenologist. What the phrenologist said about my character was, I feel sure, determined less by the shape of my skull than by the impressions he derived from my behaviour. Out of the various printed summaries of character in his booklet, that chosen for "Master Ronald Coase" started: "You are in possession of much intelligence, and you know it, though you may be inclined to underrate your abilities." This printed summary also included the following remarks: "You will not float down, like a sickly fish, with the tide... you enjoy considerable mental vigour and are not a passive instrument in the hands of others. Though you can work with others and for others, where you see it to your advantage, you are more inclined to think and work for yourself. A little more determination would be to your advantage, however." In the written comments, the pursuits recommended were: "Scientific and commercial banking, accountancy. Also, horticulture and poultry-rearing as hobbies." Added were some comments about my character: "More hope, confidence and concentration required - not suited for the aggressive competitive side of business life. More active ambition would be beneficial." It was also noted that I was too cautious. It was hardly to be expected that this timid little boy would one day be the recipient of a Nobel Prize. That this happened was the result of a series of accidents.
As a young boy I suffered from a weakness in my legs, which necessitated, or was thought to necessitate, the wearing of irons on my legs. As a result I went to the school for physical defectives run by the local council. For reasons that I do not remember I missed taking the entrance examinations for the local secondary school at the usual age of 11. However, as the result of the efforts of my parents I was allowed to take the secondary school scholarship examination at the age of 12. The only thing I now remember is that at the oral examination I caused some amusement by referring to a character in Shakespeare's Twelfth Night as Macvolio. However, this lapse was not fatal and I was awarded a scholarship to go to the Kilburn Grammar School. The teaching there was good and I received a solid education. I particularly remember our geography teacher, Charles Thurston, who introduced us to Wegener's hypothesis on the movements of the continents long before it was generally accepted and who also took us to lectures at the Royal Geographical Society, one of which, on river meanders, discussed the effect of the earth's rotation on the course of rivers. I took the matriculation examination in 1927, which I passed, with distinction in history and chemistry.
It was then possible to spend the two years after matriculation at the Kilburn Grammar School studying for the intermediate examination of the University of London as an external student, which covered the work which would have been taken during the first year at the University as an internal student. I then had to decide what degree to take. The answer was in fact determined by one of those accidental factors which seem to have shaped my life. My inclination was to take a degree in history, but I found that to do this I would have to know Latin and having arrived at the Kilburn Grammar School at 12 instead of 11, there had been no possibility of my studying Latin. So I turned to the other subject in which I had secured distinction and started to study for a science degree, specialising in chemistry. However, I soon found that mathematics, a requirement for a science degree, was not to my taste and I switched to the only other degree for which it was possible to study at the Kilburn Grammar School, one in commerce. Although my knowledge of the subjects on which I was examined was rudimentary, I managed to pass the intermediate examinations and went to the London School of Economics in October, 1929 to continue my studies for a Bachelor of Commerce degree. I took a hodgepodge of courses for Part I of the final examination, which I passed in 1930.
For Part II, I specialised in the Industry Group. I then had an extraordinary stroke of luck, another accidental factor which would affect everything I was to do subsequently. Arnold Plant, who had previously held a chair at the University of Cape Town, South Africa, was appointed Professor of Commerce (with special reference to Business Administration) at the London School of Economics in 1930. I attended his lectures on business administration but it was what he said in his seminar, which I started to attend only five months before the final examinations, that was to change my view of the working of the economic system, or perhaps more accurately was to give me one. What Plant did was to introduce me to Adam Smith's "invisible hand". He made me aware of how a competitive economic system could be coordinated by the pricing system. But he did not merely influence my ideas. My encountering him changed my life. I passed the B. Com, Part II final examination in 1931, but having taken the first year of University work while still at school and three years residence at the London School of Economics being required before a degree could be awarded, I had to decide what to do in this third year. Among the subjects studied for Part II, the one I had found most interesting was Industrial Law and what I had decided to do was to study in this third year for the degree of B.Sc. (Econ), with Industrial Law as my special subject. Had I done so I would undoubtedly have gone on to become a lawyer. But that was not to be. No doubt as a result of Plant's influence, the University of London awarded me a Sir Ernest Cassel Travelling Scholarship and although I did not know it, I was on the road to becoming an economist.
I spent the academic year 1931-32 on my Cassel Travelling Scholarship in the United States studying the structure of American industries, with the aim of discovering why industries were organized in different ways. I carried out this project mainly by visiting factories and businesses. What came out of my enquiries was not a complete theory answering the questions with which I started but the introduction of a new concept into economic analysis, transaction costs, and an explanation of why there are firms. All this was achieved by the Summer of 1932, as the contents of a lecture delivered in Dundee in October 1932, make clear. These ideas became the basis for my article "The Nature of the Firm", published in 1937, cited by the Royal Swedish Academy of Sciences in awarding me the 1991 Alfred Nobel Memorial Prize in Economic Sciences. The delay in publishing my ideas was partly due to a reluctance to rush into print and partly to the fact that I was heavily engaged in teaching and research on other projects. I held a teaching position at the Dundee School of Economics and Commerce from 1932 to 1934, at the University of Liverpool from 1934 to 1935 and at the London School of Economics from 1935 on. At the London School of Economics I was assigned a course on the economics of public utilities in Britain. In 1939, the Second World War broke out and in 1940 I entered government service doing statistical work, first at the Forestry Commission and then at the Central Statistical Office, Offices of the War Cabinet. I returned to the London School of Economics in 1946. I then became responsible for the main economics course, "The Principles of Economics", and also continued with my research on public utilities, particularly the Post Office and broadcasting. I spent nine months in 1948 in the United States on a Rockefeller Fellowship studying the American broadcasting industry. My book, British Broadcasting: A Study in Monopoly, was published in 1950.
In 1951, I migrated to the United States. I went first to the University of Buffalo and in 1959, after a year at the Center for Advanced Study in the Behavioral Sciences, I joined the economics department of the University of Virginia. I maintained my interest in public utilities and particularly in broadcasting and during my year at the Center for Advanced Study in the Behavioral Sciences, I made a study of the Federal Communications Commission which regulated the broadcasting industry in the United States, including the allocation of the radio frequency spectrum. I wrote an article, published in 1959, which discussed the procedures followed by the Commission and suggested that it would be better if use of the spectrum was determined by the pricing system and was awarded to the highest bidder. This raised the question of what rights would be acquired by the successful bidder and I went on to discuss the rationale of a property rights system. Part of my argument was considered to be erroneous by a number of economists at the University of Chicago and it was arranged that I should meet with them one evening at Aaron Director's home. What ensued has been described by Stigler and others. I persuaded these economists that I was right and I was asked to write up my argument for publication in the Journal of Law and Economics. Although the main points were already to be found in The Federal Communications Commission, I wrote another article, The Problem of Social Cost, in which I expounded my views at greater length, more precisely and without reference to my previous article. This article, which appeared early in 1961, unlike my earlier article on "The Nature of the Firm", was an instant success. It was, and continues to be, much discussed. Indeed it is probably the most widely cited article in the whole of the modern economic literature. It, and The Nature of the Firm were the two articles cited by the Royal Swedish Academy of Sciences as justification for awarding me the Alfred Nobel Memorial Prize. Had it not been for the fact that these economists at the University of Chicago thought that I had made an error in my article on The Federal Communications Commission, it is probable that The Problem of Social Cost would never have been written.
In 1964, I moved to the University of Chicago and became editor of the Journal of Law and Economics. I continued as editor until 1982. Editorship of the journal was a source of great satisfaction. I encouraged economists and lawyers to write about the way in which actual markets operated and about how governments actually perform in regulating or undertaking economic activities. The journal was a major factor in creating the new subject, "law and economics". My life has been interesting, concerned with academic affairs and on the whole successful. But, on almost all occasions, what I have done has been determined by factors which were no part of my choosing. I have had "greatness thrust upon me".
Ronald H. Coase died on 2 September 2013.
Ronald Coase: who explored why companies exist
Ronald Coase, who has died at the age of 102, played a key part in developing the intellectual arguments behind the market revolution that swept round the world in the 1980s.
Yet when he won the Nobel Prize for economics in 1991, it was for two articles published almost a quarter of a century apart. The first, “The Nature of the Firm”, was conceived while he was an undergraduate on a trip to America and for the first time provided a rigorous explanation of why companies exist. People created companies, said Coase, to avoid what he called “marketing costs”.
His second influential paper, “The Problem of Social Cost”, came 23 years later in 1960, and showed that the case for government intervention in the marketplace was far weaker than economists had previously thought.
Ronald Harry Coase, the son of two Post Office workers who both left school at the age of 12, was born in the London suburb of Willesden in 1910. Condemned to wear leg irons as a boy, he won a late scholarship to Kilburn Grammar School and then went to the London School of Economics. There Arnold Plant, professor of commerce, introduced him to Adam Smith’s “invisible hand” and helped him win a travelling scholarship to the US to investigate the structure of American industry.
In classical economic theory, agents moved effortlessly towards equilibrium in a frictionless world. In reality, goods are bought and sold in marketplaces – sometimes literal, sometimes virtual – and economic life is dominated by corporations. Classical theories ignored or looked through these institutional arrangements. Economists saw only the investors, employees and customers who obtained, without cost or intermediation, the information they needed to do the business of the market economy.
The need to resolve that tension between model and reality determined the direction of Coase’s career. His key insight was that the costs of making transactions define the nature and shape of economic institutions. In a lecture on his return in 1932, Coase argued that the boundaries of the modern company were determined by the relative costs of market organisation and hierarchical direction.
For example, an assembly line demanded hierarchy because the costs of bargaining between each successive stage of production would be too great. A wheel fits only on an axle for which it has been designed: command and control is superior to markets in these idiosyncratic transactions. But General Motors, for instance, might buy in its tyres because the savings from competitive tendering would be greater than the benefits of ownership. Half a century later, “make” versus “buy” decisions would be routine case studies in business schools. Coase was the first to see how this issue defined the shape of the modern corporation.
Coase returned to Britain first as a lecturer at Dundee and then to LSE, where he published his ideas in 1937. In the same year, he married Marian Ruth Hartung. The couple had no children.
“The Nature of the Firm” made little initial impact. The second world war broke out soon after and Coase joined the talented group of young economists who were recruited to help the organisation of war production. After the war, Coase returned to the LSE and in the 1950s he published “Broadcasting: A Study in Monopoly”, which attacked the position then held by the BBC.
A few years later, ITV was set up but Coase went on to advocate radio spectrum sales on both sides of the Atlantic. He believed that if radio spectrum were treated as property to be sold to the highest bidder, it would be used more efficiently. It took many years for the idea to be adopted as policy in either Britain or the US.
From 1951, he spent some years in relative obscurity studying public utilities at the University of Buffalo. This led to a fuller reflection on the ways in which institutions determined economic outcomes and prompted Coase to write the article that made his reputation.
On the surface, “The Problem of Social Cost” describes a new approach to the externalities that had troubled an earlier generation of economists – the smoking chimneys and suchlike, when production interfered with others. Yet the amount of smoke would be the same whether the chimney owner had to compensate his neighbours for the damage or the neighbours bribed the factory to restrain its output.
This seemed to have a startling consequence. The reason for imposing liability on the factory owner is not justice – the polluter should pay – but efficiency: it is cheaper for the owner to pay the victims than for those who suffer to organise themselves to negotiate with the owner. Legal liability rules should be assessed not for their fairness but for the relative costs they impose.
This approach, drawn from his work, has wide-ranging implications. Market forces drive not only the transactions undertaken within a framework of economic institutions but also the design of economic institutions themselves. If market outcomes are generally efficient, a presumption of efficiency applies not just to the outcomes of the market economy but also to the social framework from which these outcomes emerge – at least at the micro level.
In 1964, Coase was appointed to a chair at the University of Chicago, where he spent the remainder of his career. “Institutions matter” has belatedly become a mantra of economists. More than any other figure in economic thought, he demonstrated how and why that was so.
The economic ideas of Ronald Coase
Ronald Coase passed away on 2 September 2013. He was still working at the incredible age of 102 – often on the Chinese economy. Coase is best known to economists for two statements:
• That transaction costs explain many puzzles in the organisation of society.
• That pricing for durable goods presents a particular worry since even a monopolist selling a durable good needs to compete with its future self.
Both of these statements have influenced the thinking of virtually all living economists, but they have also been interpreted and misinterpreted in many ways.
Transaction costs
First, consider transaction costs, as in “The Nature of the Firm” (1937) and “The Problem of Social Cost” (1960), two papers which have each received over 20,000 citations.
The Problem of Social Cost leads with its famous cattle-versus-crops example. A farmer wishes to grow crops, and a rancher wishes his cattle to roam where the crops grow.
Should the rancher be liable for damage to the crops, or ought we to restrain the farmer from building a fence where the cattle wish to roam?
Coase points out that in some sense both parties are causally responsible for the externality, that there is some socially efficient amount of cattle grazing and crop planting, and that if a bargain can be reached costlessly, then there is some set of side payments where the rancher and the farmer are both better off than having the crops eaten or the cattle fenced.
Further, this bargain is theoretically identical whether you give grazing rights to the cattle and force the farmer to pay for the right to fence and grow crops, or whether you give farming rights and force the rancher to pay for the right to roam his cattle.
This basic principle applies widely in law, where Coase had his largest impact. He cites a case where confectioner machines shake a doctor’s office, making it impossible for the doctor to perform certain examinations. The court restricts the ability of the confectioner to use the machine. But Coase points out that if the value of the machine to the confectioner exceeds the harm of shaking to the doctor, then there is scope for a mutually beneficial side payment whereby the machine is used (at some level) and one or the other is compensated. A very powerful idea indeed.
Powerful, but widely misunderstood. I deliberately did not mention property rights above. Coase is often misunderstood (and, to be fair, he does at many points imply this misunderstanding) as saying that property rights are important, because once we have property rights, we have something that can 'be priced' when bargaining. Hence property rights plus externalities plus no transaction costs should lead to efficiency if side payments can be made.
This is the famous Coase Theorem – if trade in an externality is possible and there are no transaction costs, bargaining will lead to an efficient outcome regardless of the initial allocation of property.
Dan Usher (1998) famously argued that this is “either tautological, incoherent, or wrong”. Costless bargaining is efficient tautologically; if we assume people can agree on socially efficient bargains, then of course they will. But these side payments can exist even when there are no property rights at all. Coase (1960) says that “[i]t is necessary to know whether the damaging business is liable or not for damage since without the establishment of this initial delimitation of rights there can be no market transactions to transfer and recombine them.” Usher is correct; that statement is wrong. In the absence of property rights, a bargain establishes a contract between parties with novel rights that needn’t exist ex-ante.
But all is not lost for Coase. Because the real point of his paper begins with Section VI, not before. Here, he notes that the case without transaction costs is not the interesting one. The interesting case is when transaction costs make bargaining difficult. His foundational point is that social efficiency can be enhanced by institutions (including the firm!) which allow socially efficient bargains to be reached by removing restrictive transaction costs, and particularly that the assignment of property rights to different parties can either help or hinder those institutions. That is, rather than finding interesting theorems in a world without transaction costs, Coase instead argues that efficient side payments are generally hindered by transaction costs, hence the need for institutions which minimise them. He is clear about this in his Nobel lecture (1992), arguing his essential point that “there [are] costs of using the pricing mechanism.” It is these costs that explain why, though markets in general have many amazing features, even in capitalist countries, large firms are run internally as something resembling a command state.
One final misunderstood idea about the Coase Theorem. In his arguments, Coase often implicitly refers to Pareto efficiency, but since property rights are an endowment, we know from the Welfare Theorems that benefits exceeding costs is not a sufficient condition for maximising social welfare (e.g. Arrow 1983). The benefit of a trade to each party is a concept that fundamentally depends on the initial endowment since preferences are maximised conditionally, subject to a budget constraint. Nothing in standard welfare economics requires us to prefer, on the social level, a Pareto dominant allocation.
The Coase conjecture
Coase’s second famous theoretical statement is the Coase conjecture, from a very short 1972 paper, "Durability and Monopoly". The idea is simple and clever.
Let a monopolist own all of the land in the US. If there was a competitive market in land, the price per unit would be P and all Q units will be sold. Surely a profit-maximising monopolist would sell a reduced quantity Q2 less than Q at price P2 greater than P? But once that land is sold, the monopolist still has Q-Q2 units of land. Unless the monopolist can commit to never sell that additional land, buyers will realise he will try to sell it sometime later, at a new maximising price P3 which is greater than P but less than P2. The monopolist then still has some land left over, which he will sell even cheaper in the next period. Hence, why should anyone buy in the first period, knowing the price will fall (and note that the seller who discounts the future has the incentive to make the length between periods of price cutting arbitrarily short)?
The monopolist with a durable good is thus unable to earn rents. Now, Coase essentially never uses mathematical theorems in his papers, and you game theorists surely can see that there are many auxiliary assumptions about beliefs and the like running in the background here. (And Coase was aware of this need to eventually formalise ideas, despite his reputation for being averse to math. From his Nobel Prize lecture (1992): “My remarks have sometimes been interpreted as implying that I am hostile to the mathematisation of economic theory. This is untrue. Indeed, once we begin to uncover the real factors affecting the performance of the economic system, the complication interrelations between them will clearly necessitate a mathematical treatment, as in the natural sciences, and economists like myself, who write in prose, will take their bow. May this period come soon.”)
It is no surprise, given the importance of this conjecture to pricing strategies, antitrust, and auctions, among many others, that there has been much formal work on the conjecture since 1972.
• Nancy Stokey (1981) showed that the conjecture only holds strictly when the seller is capable of selling in continuous time and the buyers are updating beliefs continuously, though approximate versions of the conjecture hold when periods are discrete.
• Gul, Sonnenschein and Wilson (1986) flesh out the model more completely, generally showing the conjecture to hold in well-defined stationary equilibria across various assumptions about the demand curve.
• McAfee and Wiseman (2008) show that even the tiniest amount of “capacity cost”, or a fee that must be paid in any period for X amount of capacity (i.e. the need to hire sales agents for the land), destroys the Coase reasoning.
The idea is that in the final few periods, when there are few remaining customers with inverse demand above cost, even a small capacity cost is large relative to the size of the market, so the firm won’t pay it; backward-inducting agents in previous periods know it is not necessarily worthwhile to wait, and hence they buy earlier at the higher price. It goes without saying that there are many more papers in the formal literature.

References
1. Arrow, Kenneth, Paul Samuelson’s Contributions to Welfare Economics, in Paul Samuelson and Modern Economic Theory (Brown and Solow, eds.), McGraw Hill (1983)
2. Breit, William and Barry T. Hirsch. Lives of the Laureates, 4th ed. Cambridge, Mass: The MIT Press, 2004.
3. Coase, Ronald H (1937), "The Nature of the Firm", Economics
4. Coase, Ronald H (1960), "The Problem of Social Cost", Journal of Law & Economics
5. Coase, Ronald H (1972), "Durability and Monopoly", Journal of Law & Economics
6. Coase, Ronald H (1992), "The Institutional Structure of Production", The American Economic Review
7. George J. Stigler, Two Notes on the Coase Theorem", Yale Law Journal, December, 1989.
8. Hahn, Robert (2013). "Ronald Harry Coase (1910–2013) Nobel-prizewinning economist whose work inspired cap-and-trade".
9. Henderson, David R.,The man who resisted blackboard economics, Wall Street Journal, September 4, 2013.
10. McAfee, Preston and Thomas Wiseman, Capacity Choice Counters the Coase Conjecture, Review of Economic Studies 75.1 (2008)
11. R.H. Coase, The Firm, the Market and the Law.