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Remarks at the University of Missouri
Columbia, Missouri, USA
April 4, 2002
© 2002 by Ronald Coase
What I’m going to talk about today is why economics will change. I
talk about it because I don’t only think it will change, I
think it ought to change. And also I’d like to say something
about the part which the University of Missouri will play in bringing
it about. It will take a long time. It won’t be an easy task, but
I’m glad there are people here who are willing to undertake it. What
I’m saying today is not in an ordinary sense a lecture, it is just a
talk, perhaps one would say a battle cry. It is just intended to give
my views on this subject, why I think that economics will change.
It is a striking – and for that matter depressing – feature of
economics that it has such a static character. It is still the
subject that Adam Smith created. It has the same shape, the same set
of problems. Now of course we’ve made improvements, we’ve corrected
some errors, we’ve tightened the argument, but one could still give a
course based on Adam Smith. In some respects it would be better; in
some respects it would be worse. But we could base what we say on
Adam Smith.
Adam Smith was a great man. He was perhaps the greatest economist who
has ever been, but the difference between what has happened in
economics and what we find in the natural sciences such as physics,
chemistry, or biology is really quite extraordinary. Isaac Newton was
a great man. He made a great contribution, but you wouldn’t really
base a lecture today in physics on Isaac Newton, or in chemistry on
Lavoisier, or in biology on Charles Darwin. Charles Darwin was a
great man, but we no longer accept his views on inheritance and
therefore on how evolution works. Changes in physics, chemistry, and
biology continue to this day.
It so happens that before taking a degree in commerce, for a short
period I started to take a degree in chemistry. What was taught then
as chemistry was completely different from what is taught today.
Francis Crick has called the old chemistry just a series of recipes.
And my recollection of what I was taught suggests that that was
accurate.
I don’t only think economics will change, I think it ought to change.
You couldn’t give a course today based on what people believed fifty
years ago in chemistry. And if you take biology you clearly could not;
it has been completely changed by Crick and Watson with DNA.
Now in a modern course on economics you could still use Marshall’s
Principles of Economics published in 1890 (over a hundred years
ago), or you could still use Samuelson’s Economics, first
edition, published I think about 1948. The fact of the matter is
that in essentials the subject has not changed. That is what I want
to speak about. Thomas Kuhn in his The Structure of Scientific
Revolutions points out that scientists aren’t receptive to
proposals for a change in their subject unless they are dissatisfied
with the old views. You then get what he calls a paradigm shift.
Well, all this suggests that economists are satisfied. Now the fact
is that they are satisfied. They are very pleased. To go to a
meeting of the American Economic Association is to see thousands of
self-satisfied economists. Now there is a reason why this is so.
They have found economics useful and are quite happy therefore to go
on using it. Now it’s true: it is useful. The concepts which have
been developed for handling various problems are useful for handling a
wide range of problems. Opportunity costs, supply and demand
schedules, marginal costs, marginal revenues, maximization of profits
– they’re all very useful concepts that you can use, and not simply
for economic problems but for others as well.
And the empirical work that is done is very useful. I would cite the
work of the National Bureau of Economic Research as extremely useful
work, but it’s not work which really changes one’s vision. One
doesn’t think of the economic system in a different way. If for
example, tax rates go up, what will happen to the tax receipts? Well,
they might go up, they might go down, and in an extraordinary case
they might even remain the same. What the National Bureau does is to
tell one whether, when tax rates go up, the tax receipts go up or
down. But one always knew they had to do one or the other, and it
doesn’t change one’s view at all of how the system operates. It gives
you useful information, but useful information within the existing
scheme.
Now, what we need if the subject is to proceed is not only that sort
of empirical work. We do need empirical work, but we need something
additional: empirical work which actually changes the way we look at
the problem.
We can see where all this self-satisfaction leads to. If we study
what economists have said about their subject, how do they describe
it? Well, I’ll mention some pretty important economists. Take John
Maynard Keynes. He says of economics that it is a method, it is
a way of thinking, not a doctrine.
We need empirical work which actually changes the way we look
at the problem.
John Hicks says it is a discipline, not a science. Lionel
Robbins talks about economics as studying human behavior
as a relationship between ends and scarce means which have alternative
uses. Gary Becker talks about an economic approach. In
effect what they are saying is that economics is a bag of tools, a way
of analyzing problems, and it no doubt is. It has resulted in what is
termed “economic imperialism,” namely, taking those tools and
analyzing other subjects. I know about economics and law, and
there’s no doubt at all that in studying the legal system, the use of
these tools can be very helpful – and has been. All this
explains, I think, why economists are so happy. They have these tools,
they are useful, they go around not only improving economics but do a
lot to improve other subjects.
Now it is true that there have been a lot of complaints about
formalism in economics – the elegant but sterile reasoning and so on –
but also talks about the lack of realism in economic discussion.
Of course, this is all true, but it’s rather natural if you consider
the subject simply, as Keynes did, as a way of
What is wrong is the failure to look at the system as the object
of study.
thinking. Just thinking, you’re not likely to be so interested
in doing
empirical
work, and the formalistic character of the arguments seems quite
natural.
Now what’s wrong with this situation? What’s wrong with economists
acting in this sort of way? I’ll tell you a tale about an English
economist, Ely Devons. I was at a conference and he said, “Let’s
consider what an economist would do if he wanted to study horses.” He
said, “What would he do? He’d go to his study and think, ‘What would
I do if I were a horse?’ And he’d come up with the conclusion that
he’d maximize his utility.” That wouldn’t take us very far if we were
interested in horses, but we aren’t really interested in horses at
all. What Devons said was, I think, part of the problem, but not the
whole of it. I think it’s not really the most important objection –
the lack of realism.
What I think is important is that economists don’t study the working
of the economic system. That is to say, they don’t think they’re
studying any system with all its interrelationships. It is as if a
biologist studied the circulation of the blood without the body. It
is a pretty gory thought, but it wouldn’t get you anywhere. You
wouldn’t be able to discuss the circulation of the blood in a sensible
way. And that’s what happens in economics. In fact the economic
system is extremely complicated. You have large firms and small
firms, differentiated firms and narrowly specialized firms, vertically
integrated firms and those single-stage firms; you have in addition
non-profit organizations and government entities – and all bound
together, all operating to form the total system. But how one part
impinges on the other, how they are interrelated, how it actually
works – that is not what people study. What is wrong is the
failure to look at the system as the object of study.
Now how does it look? Well, that it’s complicated is not a question,
nor that it could take a long time if we start, as I hope we will, to
study this system. Studying it may take one hundred years. It may take
two hundred years. But anyway, we should start.
You won’t be surprised after hearing the introduction that I think the
key to the development of a sensible analysis is the comparison
between the additional production resulting from the rearrangement of
activities and the cost of the transactions needed to bring the
rearrangement about. If you can get extra production, a higher
standard of living by rearranging activities, you will do so if the
costs of transactions are less than the value of what is gained.
Therefore it follows that if you can lower transaction costs,
there’ll be more
We will never, when we’re dealing with the economic system,
deal with an
easy-to-analyze set of problems.
rearrangements, and the economic system will become more productive.
Transaction costs, in my view, become the factor upon which the
productivity of the economic system depends.
However, transaction costs depend, as we learned from the new
institutional economics, on the working of the legal system (the
system of property rights, the enforcement of property rights, the
ability to foresee what the legal decisions will be, and so on). They
also depend on the political system, they depend on the educational
system, and they are interrelated with other social systems. And in
consequence, economists should enlist the support of lawyers,
sociologists, anthropologists, and others in our work in order to
understand why transaction costs are what they actually are. It’s
the opposite of economic imperialism. We should invite these other
practitioners in these other fields into our realm to help us in
understanding how the economic system actually operates.
The influence of the level of transaction costs of course is also
affected by technological factors. And one example which is very much
discussed today is the influence on transaction costs, and on the
organization of industry, of the development of the Internet. A large
component of transaction costs is of course the costs of obtaining
information. And since the Internet in fact lowers the cost of
getting information, it has an effect of lowering transaction costs.
As a result, one would expect there to be major changes as a result of
the coming of the Internet, coming about through making it easier to
get information and therefore lowering the transaction costs of doing
business.
Now this has been described in a recent article which appeared in the
New York Times in January of this year.1 It was by Professor Hal
Varian of the University of California at Berkeley. This is what
he says. “There was never a
The key to the development of a sensible analysis is the comparison
between the additional production resulting from the rearrangement of
activities and the cost of the transactions needed to bring the rearrangement about.
new economics to go along with the new economy. Sure,
there was a lot of talk about increasing returns, network effects,
switching costs and so on. But these are hardly new concepts; they’ve
been part of the economics literature for decades. Furthermore,
although these are important ideas, they aren’t Big Ideas. They
explain certain phenomena well, but they have limited reach. Those in
search of a really big idea had to look further back in the economics
literature. They hit gold with ‘The Nature of the Firm,’ a 1937
paper….” It’s interesting to think that a paper in 1937 has now
become a part of the literature on the Internet. Of course it is
understandable. Transaction costs fall: what are the effects?
I quote again from something he says later on. “New-economy
advocates found this [the idea of transaction costs] a compelling idea.
One consequence of the Internet has surely been to make it cheaper to
communicate. This should,
If you can get extra production by rearranging activities, you will
do so
if the costs of transactions are less than the value of
what is gained.
in turn, lower transaction costs and change
company boundaries. Their conclusion was that companies would
inevitably downsize and outsource, spin off unnecessary functions, and
carry out more and more transactions using the Internet instead of
internal memos.” However, Professor Varian questions this remark. He
says that although the Internet lowers the costs of transactions
between firms, it also lowers the cost of communication within firms
and makes therefore larger organizations easier to run and organize.
But there are even other factors to take into account. Since you can
make transactions more easily, less costly, you can get rid of
functions that you have to perform but at which you are inefficient.
Getting rid of the operations at which you are inefficient enables you
to lower the costs of your core activity. And this may in effect lead
to greater activity, greater production, and therefore larger firms.
So you really can’t say whether firms are going to get larger or
smaller. Some firms will emerge as small firms, because people can
now find them and deal with them, but other firms will find, because
they can concentrate more on those activities at which they are
efficient, that they get larger. And in fact the whole thing is much
more complicated than that, because the costs of different operations
are going to change, but not in the same way, so there will be
The collection of contracts by CORI will greatly help.
a switching of demand as
between different activities. Another thing: the lower costs of some
businesses will result in greater production there, but some of the
things that are produced will be inputs for other businesses, and
their costs will change. So you’ve got a whole series of interrelated
changes which are going to affect the outcome. We will never, when
we’re dealing with the economic system, deal with an easy-to-analyze
set of problems. This is just an example of the complications with
which you have to deal when once you try to deal with the working of
the actual economic system.
Unfortunately, we lack the data by and large to carry out the
necessary operations. We can specify what seems possible, what could
happen. But specifying what will happen depends on the availability
of the data. And this is where the University of Missouri comes into
this talk. CORI, the Contracting and Organizations Research Institute
here at the University of Missouri, is undertaking the task of
obtaining the information which will enable us to put these vague
Contracts are, in effect, the neurons of the economic system.
ideas into a concrete form. It’s something that
needs to be done, and it is going to be done here. The collection of
contracts by CORI will greatly help, because contracts are the major
means by which one firm interrelates with another firm, or one
organization interrelates with the consumer. They are, in effect, the
neurons of the economic system. Of course, studying the contracts has
to be supplemented by a study of the actions of the firms in modifying
and interpreting the terms of the contracts.
Well, this task has to be done and it’s being done here. I envy you.
At my age, when the act of living is a burden, I wouldn’t have come
here if I didn’t believe that the work which is being done here is of
the utmost importance for the future of economics. Economics will
change, and the change will come in part because of the work which is
being done here at the University of Missouri in Columbia.
Thank you.
Footnote
1 Hal R. Varian, “A New Economy With No New Economics,” The New York Times (on the Web), January 17, 2002.
The Contracting and Organizations Research Institute (CORI)
at the University of Missouri currently has a library of over 690,000 contracts accessible online for research use.
http://cori.missouri.edu/
Note: Ronald Coase was Clifton R.
Musser Professor Emeritus of Economics at the University of Chicago
Law School. He was affiliated with the University of Chicago
since 1964. Earlier he served on the faculty of the Dundee School of
Economics and Commerce (1932-1934), the University of Liverpool
(1934-1935), the London School of Economics (1935-1951), the
University of Buffalo (1951-1958), and the University of Virginia
(1958-1964). He was the editor of the Journal of Law and Economics
from 1964 to 1982. In 1991 he was awarded the Alfred Nobel Memorial
Prize in Economic Sciences.
This talk was delivered at a session organized by the Contracting and
Organizations Research Institute at the University of Missouri. The
text was transcribed from videotape, and then edited by Ronald Coase
and Alexandra Benham. The text was published in the Newsletter of the
International Society for New Institutional Economics,
Volume 4, Number 1 (Summer 2002) and appears here with the permission of Ronald Coase.
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Photo: Alexandra Benham
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Ronald Coase Remembered
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