Abstract
“The Problem of Social Cost” is rightly credited with helping to launch the economic analysis of law. George Stigler plays a central role in the professional reception of Coase’s work and, in particular, of the idea that came to be known as the Coase theorem. While Coase’s negotiation result was taken up in the scholarly literature not long after the publication of “The Problem of Social Cost,” it was Stigler who gave the theorem its name and introduced it to scores of readers in The Theory of Price (1966). His remaking of Coase’s idea into a “theorem” had significant rhetorical force, which, combined with the challenge that it pose to received thinking about externality problems, both lent credibility to the idea and made it a force to be reckoned with. The present paper analyzes Stigler’s various commentaries on the Coase theorem with a view to getting at both how Stigler understood the theorem and its import and why he exhibited such a fascination with it over the last 30 years of his life.
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Notes
Coase had first made the argument in a paper on “The Federal Communications Commission,” published in 1959 in the Journal of Law and Economics.
Of course, Frank Knight, Stigler's teacher, had presented a critique of Pigou's analysis in his article, “Some Fallacies in the Interpretation of Social Cost” (1924). However, Stigler makes no mention of this in his discussion, though he does cite the article in his “Recommended Readings” at the end of the chapter.
Indeed, Coase was quick to acknowledge the unrealistic nature of the zero-transaction-costs result already when he first presented it in his article on “The Federal Communications Commission.” See Coase (1959, p. 27 at note 54).
Of course, Coase had already made the existence and magnitude of these costs a centerpiece of his analysis of firm organization in “The Nature of the Firm” (1937).
But Coase was also aware that there is more to policy analysis than wealth maximization. See Coase (1960, p. 43).
Note that Stigler is also referencing only situations where social and private costs diverge “appreciably.” It is not clear what Stigler thinks about situations where the divergence is not appreciable or the magnitude of the divergence necessary to meet the standard of “appreciably.”
Of course, if the same man owned both the cattle and the grain farms, all relevant costs would be internalized and the problem would be resolved efficiently.
There is a bit of an oddity in this statement, since the perfectly competitive environment in which the Coase theorem is said by Stigler to hold contemplates exactly the sort of large numbers situation in which Stigler says that the theorem may well not hold. It would seem that Stigler is referring to a small numbers externality, where the parties involved are operating within perfectly competitive markets for the goods that they produce and sell.
As we shall see, this emphasis on the invariance result recurs throughout Stigler's treatments of the theorem.
Coase himself argued in a subsequent commentary that the perfect competition assumption is unnecessary in a world of zero transaction costs (1988, pp. 174–175). Of course, this is a somewhat different matter than whether perfect competition implies zero transaction costs.
Pigou first worked out his analysis of social cost in Wealth and Welfare (1912). As noted above (note 5 and accompanying text), Pigou allowed that a contracting process could work to remove such divergences, instancing the landlord-tenant relationship (1932, Part II, Chap. 9) However, Pigou did nothing to develop this idea and did not seem to give it any sort of wide applicability.
In Coase theorem jargon, this means that the group had no difficult accepting the efficiency thesis—it was the invariance claim that was controversial.
Personal conversation with this author, March 24, 1997.
This is reflective of a transition that took place in Chicago law and economics from law and economics conceived of as the the study of the impact of the legal/regulatory environment on economic performance to the application of the rational choice model to the analysis of behavior within the legal realm (the economic analysis of law). Stigler had a foot in each camp. See Medema (2011).
The 1890 date presumably refers to Marshall's Principles (1890), where Marshall probed the implications of external economies and diseconomies in production, while 1961 refers to the date that “The Problem of Social Cost” was published, the appearance of the October 1960 issue of the Journal of Law and Economics having been delayed until May 1961. On this last point, see Coase's comments in Kitch (1983, p. 221).
This literature is analyzed in Medema and Zerbe (2000).
What is ironic about Stigler's statement is that it is exactly this emphasis on the importance of the legal-economic nexus that informed so much of the institutional economics (of the older variety) of which Stigler was so critical. See, for example, his comments in Kitch (1983, pp. 169–176).
Of course, this theme resonates with Stigler's own work on regulation (1971) and on the economics of information (1961). Though Stigler himself does nothing to pursue this connection here, he does note the complementarity of his work on information costs and the transaction-cost-related implications of Coase's analysis in the “Eureka” chapter of his Memoirs (1988, p. 80).
In his Nobel lecture, Stigler suggests that Coase's challenge to the Pigovian tradition was that he “in effect argued that the Pigovian theory had assumed noneconomic behavior on the part of economic actors in a wide class of phenomena (1983, p. 542). That is, if economists studying the problem of externality had more deeply explored the idea that agents pursue their self-interest in externality situations, they would have arrived at Coase's conclusion decades earlier.
See, for example, Coase (1993). Of course, Stigler is not alone in this view. Coase was honored as one of the “Four Founders” of law and economics (read: economic analysis of law) at the inaugural meeting of the American Law and Economics Association in 1991.
But there is controversy even on this, as some have argued that the assignment of property rights is not necessary.
See Coase (1988, chapters 1 and 6).
The result is that the invariance proposition does not hold—that there are different efficient outcomes associated with different assignments of rights. The force of this critique is sufficiently powerful that many statements of the Coase theorem contain only the efficiency proposition or qualify the theorem with statements such as “income effects aside.” Interestingly, this is seemingly the only aspect of the Coase theorem milieu that, to this point, had not been subject to any serious debate. See Medema and Zerbe (2000) for a discussion.
The question of whether the Coase theorem holds in the long run had been treated on numerous occasions in the literature, but (to this point) always in the context of the efficiency and invariance propositions. See Medema and Zerbe (2000) for a discussion.
Stigler also countenances the Pigovian tax and subsidy options, and presents a graphical analysis of the optimal Pigovian tax, before suggesting that the appropriate rates of tax or subsidy are difficult to calculate, as a result of which the government tends to pursue regulatory options.
In fact, it is very surprising that Stigler never links Coase's discussion to Edgeworth's analysis—and, in particular, the Edgeworth box—given his interest in and knowledge of the history of economic thought.
He also suggests that economists could assess the empirical relevance of the negotiation results contemplated by the theorem though the study of the efficiency properties of small markets and how outcomes in those markets are affected by shocks. However, he considers the studies of transaction costs “much more interesting and important” (p. 631).
We see this argument paralleled in his attempt, in the next paragraph of his article, to point out the commonalities between the economic analysis of law and public choice analysis and the “certain affinity between” these two movements—each of which involved the application of economic analysis to another field (p. 457), with public choice analysis both illuminating the operation of government per se (as against the received political theory) and informing traditional economic analysis by enhancing the theory of economic policy. And, of course, like public choice analysis, this economic theory of law is not, in Stigler's view, limited to those parts of law that bear directly on economic activity.
But this still does not clarify exactly why Stigler would have chosen to include this result in his textbook, given the “settled truth” nature of textbook treatments. One answer may be that Stigler's “textbook” treatments were a bit provocative (not unlike Stigler's positions in other fora). For example, The Theory of Competitive Price, published in 1942, completely ignored the theory of monopolistic competition—a theory that Stigler found unhelpful (Stigler 1949; Hammond and Hammond 2006). And even when he did include a discussion of monopolistic competition in later editions, it was rather critical, which is unusual in the textbook literature, in that authors tend not to present negative commentary on the theories included in their texts.
It should be noted that Stigler's call for a general theory of transaction costs, while somewhat consonant with Coase's position in “The Problem of Social Cost” and elsewhere (e.g., Coase 1988), is in fact somewhat different than the approach advocated by Coase. Coase seems to have been of the mind that a general theory of transaction costs is not attainable, and that their magnitude and impact can only be assessed on a case-by-case basis.
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I am grateful for the insightful comments that Elodie Bertrand, Jans Horst Keppler, and Alan Marciano have provided on an earlier version of this paper.
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Medema, S.G. A case of mistaken identity: George Stigler, “The Problem of Social Cost,” and the Coase theorem. Eur J Law Econ 31, 11–38 (2011). https://doi.org/10.1007/s10657-010-9196-5
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DOI: https://doi.org/10.1007/s10657-010-9196-5