Timeless economics

Still makes sense.. and we’ll always have Paris..

Posts Tagged ‘ronald coase

WINNER OF 1991 NOBEL PRIZE IN ECONOMICS

with 3 comments

Ronald Harry Coase was born in Willesden, England, on December 29, 1910 in a suburb of London. As a child, Coase had a weakness in his legs, for which he was required to wear leg-irons. Due to this problem, he attended the school for physical defects. At the age of 12, he was able to enter the Kilburn Grammar School on scholarship. At Kilburn, Coase completed the first year of his Bachelor in Commerce degree and then passed on to the University of London. Coase graduated from the London School of Economics in 1932, and earned a higher doctorate from the University of London in 1951.

During 1931–32, Coase traveled to the United States on a scholarship to study the structure of American industry. This study became the basis for Coase’s lifetime fascination with industrial organization and his later work on the nature of firms and their costs.

Ronald Coase received the Nobel Prize in 1991 for his discovery and clarification of the significance of transaction costs and property rights for the institutional structure and functioning of the economy.

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.

THE NATURE OF THE FIRM

The Nature of the Firm was a brief but highly influential essay in which Coase tries to explain why the economy is populated by a number of business firms, instead of consisting exclusively of a multitude of independent, self-employed people who contract with one another. Coase asks, why and under what conditions should we expect firms to emerge knowing that productions could be carried on without any organization or firm?

Since modern firms can only emerge when an entrepreneur of some sort begins to hire people, Coase’s analysis proceeds by considering the conditions under which it makes sense for an entrepreneur to seek hired help instead of contracting out for some particular task.

Coase explained that firms exist because they reduce the transaction costs that emerge during production and exchange, capturing efficiencies that individuals cannot. Firms are like centrally planned economies, he wrote, they are formed because of people’s voluntary choices. But why do people make these choices? The answer, wrote Coase, is “marketing costs.” (Economists now use the term “transaction costs.”) If markets were costless to use, firms would not exist. Because markets are costly to use, the most efficient production process often takes place in a firm.

For clearer understanding, take for example a broken car. If you are the owner of the car and decided not to bring it to a mechanic shop (which is a firm) it will take you “marketing cost” to fix it by yourself. You need to buy those parts which need to be repair, tools to be used in repairing, fare in going to hardware stores, and effort and time to do the work. That is what Coase tries to explain on why firm exists. If you bring the car directly to the repair shop it won’t take you marketing cost in doing the repairing.

THE PROBLEM OF SOCIAL COST

“The Problem of Social Cost,” Coase’s other widely cited article, was even more path breaking; indeed, it gave rise to the field called law and economics.

Published in the Journal of Law and Economics in 1960, while Coase was a member of the Economics department at the University of Virginia, “The Problem of Social Cost” provided the key insight that it is unclear where the blame for externalities lies.

I take a beach resort as an example. Assume that there is a known tourist spot beach resort which earns a lot of money in its services. Few kilometers away from the resort, there is a small island. Years later this island is dumping its waste into the beach which causes the tourists in the beach resort to have skin infections in their swimming. If that small island keeps their garbage in their place it will also cause health problems to the inhabitants of the island because their area is too small to make a place for their wastes.

Coase argued that without transaction costs it is economically irrelevant who is assigned initial property rights; the people living in the island and the owner of the resort shall work out an agreement about whether to restrict the waste disposal or not based on the economic efficiency of doing so. Since none of them on the ocean, property rights allocation will hence matter only in determining distribution. If the islanders held rights over the sea, the resort owner could pay him to restrict or limit the pollution; if the resort owner held the rights, the islanders could buy the right to pollute.

The Problem of Social Cost” provides more than merely a revolutionary rethinking of the question of externalities. It also suggests a new and interesting approach to the problem of defining property rights.

This seminal argument forms the basis of the famous Coase Theorem as labeled by George Stigler.

COASE THEOREM

In The Problem of Social Cost”, Coase laid a critical foundation of modern law and economics – the so-called Coase theorem. The Coase theorem has been formulated in various ways, but one useful statement might be that: “When the parties can bargain successfully, the initial allocation of legal rights does not matter.” According to the Coase theorem, rights will be acquired by those who value them most highly, which creates an incentive to discover and implement transaction cost minimizing governance forms.

The Coase Theorem describes the economic efficiency of an economic allocation or outcome in the presence of externalities. The theorem states that when 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 rights. The Coase theorem is an important basis for most modern economic analyses of government regulation, especially in the case of externalities.

“Whether a transaction would be organized within a firm or whether it would be carried out on the market depended on a comparison of the costs of organizing such a transaction within the firm with the costs of a market transaction that would accomplish the same result. All this is very simple and obvious. But it took me a year to realize it – and many economists seem unaware of it (or its significance) to this day…As it was a new approach (I think) to this subject, I was quite pleased with myself. One thing I can say is that I made it all up myself. As I said in my Nobel Prize lecture, I was then twenty-one and the sun never ceased to shine.”
– Ronald Coase

Sources and Suggested Reading:

Autobiography of Ronald Coase, http://nobelprize.org/nobel_prizes/economics/laureates/1991/coase-autobio.html

Advertisements

The timeless lighthouse

leave a comment »

(This is a guest blog post from a former student.)

Economics and the Philippines’  Century Old Lighthouses

By Ross Harper Alonso

Over 50 brick lighthouses were built in the Philippines by the Spaniards in the 1800s. This was the time when trade served as the fundamental income generating business for Spanish colonists living in Manila and the Manila Acapulco Galleon Trade being the most lucrative. The lighthouses were needed to light the Spanish trading ship’s way. The Manila Galleon sailed the Pacific for nearly 3 centuries, bringing to Spain then cargoes of luxury goods, economic benefits and cultural exchange but there are no maritime records that say if the Filipinos cashed in on all this by imposing tolls, receiving rent or leasing the land where the lighthouses were built till the Galleon Trade ended in 1821 when the Spanish Crown took direct control of the Philippines. It is possible that this was the reason behind one of the many revolts, since all revolts were triggered by the repressive policies of the Spanish Colonial Government against the native Filipinos. This is all water under the bridge now since they left all their lighthouses behind for us to use when we gained our independence from them in 1898 anyway. Question is, “what did the Philippines do with them all these years?”  

                                                 When a Government Agency Fails

This paper aims to explore the kind of future our Century Old Lighthouses could have had if the Philippines considered some of the policies of the British Lighthouse System.

The Philippine Coast Guard is the oldest and the only humanitarian armed service of the country with functions earlier related principally to the protection of the customs service in safeguarding revenue collections and patrolling the coastline. Since 1901 they were in charge of the Lighthouse Service and their keepers. A Philippine lighthouse is an indispensable public service provided by government that Paul A. Samuelson talked about. Perhaps 115 years ago, lighthouses in the Philippines would not have survived if they were not solely government run but this arrangement should’ve changed 50 years ago.

Unlike the Philippines , the British Lighthouse System had authorities which build and maintain lighthouses. Trinity House, the Commissioners of Northern Lighthouses and the Commissioners of Irish Lights. The expenses of these authorities are met out of the General Lighthouse Fund. The income of this Fund is derived from light dues, which are paid by ship-owners. The actual collection is made by the customs authorities at the ports. (Could have been our very own Coast Guard doing the collection here) The money obtained from the light dues is paid into the General Lighthouse Fund, which is under the control of the Department of Trade. The lighthouse authorities draw on the General Lighthouse Fund to meet their expenditures. The Fund is used to pay for the maintenance of colonial lighthouses and the support of retired lighthouse keepers, their widows and children.

An annual Lighthouse Conference was also held in London to discuss budgets and policies. Given the big role our lighthouses played in our history, one wonders why they were never included in the programs of National Historical Commission.

It is very unfortunate that not a single Philippine government official or economist took the time to study the history of the British Lighthouse system and pick out what we could have used to take care of our Century old lighthouses. This country not only lacks vision and the effort to study alternative institutional arrangements for operating our lighthouse services but also reverence for our past.

                                                        Johnny Come Late    

Lately the Philippine Coast Guard admitted they can no longer maintain our lighthouses. Most of the century old Spanish lighthouses are in ruins. Some partially restored. Three years ago the PCG launched the Adopt a Lighthouse Program, a partnership between the private sector and non-government organization to undertake restoration activities geared toward arresting the deterioration of lighthouses nationwide and preserve their historical significance. Like everything else in this country, the guidelines are vague. No one really knows who makes the final arrangements or the MOA. The PCG or the National Historical Institute?

Times have changed. Ships no longer need the lighthouses to help them navigate. Ships and most water vessels are equipped with high tech GPS now therefore lighthouses no longer serve their purpose but this doesn’t mean they’re totally useless. In fact a private organization can now make a fortune managing an old lighthouse. Bed and Breakfast? Small Inn? Renting it out to historians or honeymooners?

The Americans have been making good use of their old lighthouses. Tourists pay to join their heritage tours and bring home a souvenir. People pay Lighthouse foundations to live as lighthouse keepers for weeks and the money earned is used to maintain and restore their lighthouses. It’s really quite a simple operation. The Americans and other countries with historical sites figured out early that they’re cultural heritage is worth something.

Written by Orlando Roncesvalles

March 21, 2009 at 9:30 PM

NOBEL PRIZE WINNER FOR ECONOMICS IN 1991

with one comment

Ronald Coase received the Nobel Prize in 1991 “for his discovery and clarification of the significance of transaction costs and property rights for the institutional structure and functioning of the economy.” Coase is an unusual economist for the twentieth century, and a highly unusual Nobel Prize winner. First, his writings are sparse. In a sixty-year career he wrote only about a dozen significant papers—and very few insignificant ones. Second, he uses little or no mathematics, disdaining what he calls “blackboard economics.” Yet his impact on economics has been profound. That impact stems almost entirely from two of his articles, one published when he was twenty-seven and the other published twenty-three years later.
Coase conceived of the first article, “The Nature of the Firm,” while he was an undergraduate on a trip to the United States from his native Britain. At the time he was a socialist, and he dropped in on perennial Socialist Party presidential candidate Norman Thomas. He also visited Ford and General Motors and came up with a puzzle: how could economists say that Lenin was wrong in thinking that the Russian economy could be run like one big factory, when some big firms in the United States seemed to be run very well? In answering his own question, Coase came up with a fundamental insight about why firms exist. Firms are like centrally planned economies, he wrote, but unlike the latter they are formed because of people’s voluntary choices. But why do people make these choices? The answer, wrote Coase, is “marketing costs.” (Economists now use the term “transaction costs.”) If markets were costless to use, firms would not exist. Instead, people would make arm’s-length transactions. But because markets are costly to use, the most efficient production process often takes place in a firm. His explanation of why firms exist is now the accepted one and has given rise to a whole literature on the issue. Coase’s article was cited 169 times in academic journals between 1966 and 1980.
“The Problem of Social Cost,” Coase’s other widely cited article (661 citations between 1966 and 1980), was even more path breaking; indeed, it gave rise to the field called law and economics Economists before Coase of virtually all political persuasions had accepted British economist Arthur Pigou’s idea that if, say, a cattle rancher’s cows destroy his neighboring farmer’s crops, the government should stop the rancher from letting his cattle roam free or should at least tax him for doing so. Otherwise, believed economists, the cattle would continue to destroy crops because the rancher would have no incentive to stop them.
But Coase challenged the accepted view. He pointed out that if the rancher had no legal liability for destroying the farmer’s crops, and if transaction costs were zero, the farmer could come to a mutually beneficial agreement with the rancher under which the farmer paid the rancher to cut back on his herd of cattle. This would happen, argued Coase, if the damage from additional cattle exceeded the rancher’s net returns on these cattle. If, for example, the rancher’s net return on a steer was two dollars, then the rancher would accept some amount over two dollars to give up the additional steer. If the steer was doing three dollars’ worth of harm to the crops, then the farmer would be willing to pay the rancher up to three dollars to get rid of the steer. A mutually beneficial bargain would be struck.
Coase considered what would happen if the courts made the rancher liable for the damage caused by his steers. Economists had thought that the number of steers raised by the rancher would be affected. But Coase showed that the only thing affected would be the wealth of the rancher and the farmer; the number of cattle and the amount of crop damage, he showed, would be the same. In the above example, the farmer would insist that the rancher pay at least three dollars for the right to have the extra steer roaming free. But because the extra steer was worth only two dollars to the rancher, he would be willing to pay only up to two dollars. Therefore, the steer would not be raised, the same outcome as when the rancher was not liable.
This insight was stunning. It meant that the case for government intervention was weaker than economists had thought. Yet Coase’s soul mates at the free-market-oriented University of Chicago wondered, according to George Stigler, “How so fine an economist could make such an obvious mistake.” So they invited Coase, who was then at the University of Virginia, to come to Chicago to discuss it. They had dinner at the home of Aaron Director, the economist who had founded the Journal of Law and Economics.

Written by florald

March 21, 2009 at 9:29 PM