Tuesday, April 6, 2010

Hovenkamp on "Coasean Markets"

Recently, I posted a blog (here) about (among other things) Herbert Hovenkamp's working paper on "Coase, Institutionalism, and the Law & Economics Movement.," which I very much liked. Earlier, Hovenkamp posted a paper on "The Coase Theorem and Arthur Cecil Pigou." Now comes a new working paper from Hovenkamp on "Coasean Markets." Obviously, Herbert Hovenkamp is writing a book about Ronald Coase and his influence on the modern law and economics movement.

When I first saw the latest working paper, it's title gave me pause. I had never before seen the phrase "Coasean Markets," but it smacked of locations where "Coasean bargaining" occurs, and faithful readers of this blog will know that I detest that later phrase because (1) it misinterprets what Coase was trying to say about the importance of transaction costs and (b) cannot be distinguished in any meaningful and non-pernicious way from bargaining simpliciter (see, e.g., here and here). After my initial pause at the title, I became hopeful that Hovenkamp, through the device of "Coasean markets," might be able to provide some useful content to "Coasean bargaining." Alas, my hopes were dashed.

In Hovenkamp's interpretation, "Coasean markets" are a subset of all markets - although it's not at all clear just how they are distinguished from larger markets. However, they seem to be places where (a) bargaining will costlessly transfer goods to highest and best uses, unless transaction costs exist, in which case (b) parties must compare the costs of operating in the "Coasean market" with the costs of leaving the market for "Coasean firms" or other institutional arrangements. This seems to me not to solve the problems of "Coasean bargaining" I have previously discussed but to participate in them.

Several discrete assertions in Hovenkamp's new paper give the game away, and reveal that "Coasean markets" do not resolve but is based on the same interpretive errors as "Coasean bargaining." For example, on page 18, Hovenkamp asserts that "Coase's work has been repeatedly criticized for its failure to develop any theory of bargaining other than the naked assertion that if there are gains to be had from trading to a final resting point such trading will occur." This claim about Coase's "naked assertion" is simply not accurate. It is true that Coase has been "repeatedly criticized" for making such an assertion, but it is an assertion Coase never made. Coase never said that free-market bargaining would always operate to maximize economic value. What he did assert is that such bargaining would always occur in the mythical world of zero transaction costs, under the standard assumptions of neoclassical economic theory (which Coase was concerned to criticize). The bulk of Coase's theory of social costs is premised on the notion that transaction costs are not zero - in fact, they are ever-present and often quite high - and, therefore, market transactions/bargaining will not always move goods to their socially efficient uses. That's precisely why legal rules (re)allocating entitlements can matter. So, contrary to Hovenkamp's assertion, Coase has a theory of bargaining in real, existing markets - that is, when bargaining can be expected or not be expected to occur - which is based on transaction (as well as other) costs as compared to expected gains from trade.

Hovenkamp also misrepresents Coase's views on government intervention in markets. On page 5, he avers  that Coase "has never had any patience for the view that government intervention via involuntary transfers of resources can increase welfare." Again, this is simply not true. Perhaps Hovenkamp missed Coase's statement in his 1959 article on "The Federal Communications Commission" (Journal of Law and Economics 2:1-40, at 29) that "When large numbers of people are involved, the argument for the institution of property rights is weakened and that for general regulations becomes stronger." Coase cited, as an example, pollution, and clearly implied that at least sometimes (if not as often as those such as Pigou supposed) government might more efficiently allocate entitlements by regulation. Coase makes a similar point in "The Problem of Social Cost," which Hovenkamp could not (or should not) have over-looked, when he writes (on page 117 of the version included in his book The Firm, the Market, and the Law (Chicago 1990)) that the government "has powers that might enable it to get some things done at a lower cost than could a private organization." Of course, he again notes that "governmental administrative machinery is not itself costless." Thus, Hovenkamp's assertion about Coase's "impatience" with governmental (re)distribution is not accurate.

In part, Hovenkamp gets Coase wrong on the question of government intervention because Hovenkamp exaggerates the scope of Coase's disagreement with Pigou. Hovekamp asserts (on page 5) that "The Problem of Social Cost was written in large part as a critique of ... Pigou's arguments for government intervention." It is true that Coase was very much concerned to critique Pigou. It is also true that Coase saw less scope for government intervention than Pigou and many other welfare economists. However, Coase did not purport to overturn the entire structure of Pigou's welfare economics. Instead, Coase's goal was more limited: to correct welfare economics by pointing out that the mere existence of an externality could not justify government action to internalize it because sometimes the transaction costs associated with internalizing the externality might exceed the benefits. Nowhere did Coase ever claim that inefficient externalities should not be internalized. Put in general terms, Coase's position is that the costs of government intervention had to be compared with the costs of leaving the externality (a.k.a., market failure) alone, if social welfare was to be maximized.

In the final analysis, I must place Herbert Hovenkamp's concept of "Coasean markets" along side "Coasean bargaining" into the trash bin of Coasean misinterpretations of Coase. Both concepts are partly vacuous, partly pernicious, and misrepresent what Coase was concerned to argue.

UPDATE: Professor Hovenkamp informs me that he is, indeed, writing a book, but it is not actually about Coase per se  (he has just gotten a bit "stuck" on Coase's theories in the course of his work). Rather, it is entitled, The Marginalist Revolution in American Legal Theory, 1880-1970. Sounds like it should be most interesting.

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