- Paperback: 226 pages
- Publisher: University of Chicago Press; New edition edition (15 Feb. 1990)
- Language: English
- ISBN-10: 0226111016
- ISBN-13: 978-0226111018
- Product Dimensions: 13.5 x 1.4 x 21.6 cm
- Average Customer Review: 4.5 out of 5 stars See all reviews (4 customer reviews)
- Amazon Bestsellers Rank: 390,485 in Books (See Top 100 in Books)
The Firm, the Market, and the Law Paperback – 15 Feb 1990
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Top Customer Reviews
The most interesting essay is on the origins of the firm. It seeks to address the question of why firms exist at all, rather than simply contractual relationships. Very simply, Coase argues that firms exist because this structure helps reduce transaction costs. Contracting with all the necessary parties is costly and time-consuming, so up to a point it is easier for operations to be brought in-house. And once you get your head around the argument, you can see that it has implications elsewhere (not sure about capital markets, but that's another story). Coase makes his case very clearly so it's not hard work.
I was less interested in the article on externalities, although again it's well-argued and made me think a bit. I like his style of writing which really does run through the logical implications of various scenarios. You might get a bit bored of hearing about ranchers and farmers, but it's ultimately a rewarding read as he exhausts the various scenarios.
The essay on the lighthouse in economics is great. He points out that although numerous writers on economics have used the lighthouse as an example of a resource that needs to be provided by the state (because no one private sector organisation has enough incentive to do it themself) actually this ignores the actual history of lighthouses.
Definitely a good read, with some interesting perspectives.
Most Helpful Customer Reviews on Amazon.com (beta)
Coase is best known for two seminal articles. The earlier article "The Theory of the Firm" is the seminal work on the so-called nexus of contracts theory of the firm, as well as an early source for the transaction cost branch of the New Institutional Economics. The nexus of contracts model treats the firm not as an entity, but as an aggregate of various inputs acting together to produce goods or services. Employees provide labor. Creditors provide debt capital. Shareholders initially provide equity capital and subsequently bear the risk of losses and monitor the performance of management. Management monitors the performance of employees and coordinates the activities of all the firm's inputs. The firm is simply a legal fiction representing the complex set of contractual relationships between these inputs. Besides emphasizing the importance of examining the various contracts making up the firm, however, Coase's fundamental insight was that the contractual nature of the firm does not preclude an element of command and control absent from market transactions. If a corporate employee moves from department Y to department X he does so not because of change in relative prices, but because he is ordered to do so. In other words, markets allocate resources via the price mechanism but firms allocate resources via authoritative direction. The set of contracts making up the firm consists in very large measure of implicit agreements, which by definition are both incomplete and unenforceable. Under conditions of uncertainty and complexity, the firm's many constituencies cannot execute a complete contract, so that many decisions must be left for later contractual rewrites imposed by fiat. It is precisely the unenforceability of implicit corporate contracts that makes it possible for the central decisionmaker to rewrite them more-or-less freely. The parties to the corporate contract presumably accept this consequence of relying on implicit contracts because the resulting reduction in transaction costs benefits them all.
Even better known, and even more central to transaction cost economics, however, is Coase's later article "The Problem of Social Cost," which also is reprinted in full here. In that article, 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." Suppose a steam locomotive drives by a field of wheat. Sparks from the engine set crops on fire. Should the railroad company be liable? In a world of zero transaction costs, the initial assignment of rights is irrelevant. If the legal rule we choose is inefficient, the parties can bargain around it. Put another way, 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 has been widely criticized. The second major set of new material in this book is a chapter entitled "Notes on the Problem of Social Cost," in which Coase answers the more serious criticisms. That essay provides a useful intellectual history of the Coase theorem, as well as a trenchant defense of its main claims. One of the less-well informed criticisms of Coase is that he assumes transaction costs are zero. He does not, as this new essay makes clear. Indeed, as Coase points out, the interesting cases are those in which transactions costs are non-zero. In a world of positive transaction costs, however, the parties may not be able to bargain. This is likely to be true in our example. The railroad travels past the property of many landowners, who put their property to differing uses and put differing values on those uses. Negotiating an optimal solution will all of those owners would be, at best, time consuming and onerous. Hence, the allocation of legal rights becomes quite important.
This is _the_ book to own on the subject as Coase takes his time to explain some of the reasons why economists in general has misunderstood his argument.
It is also well worth reading if you like Oliver Williamson's elaborations on the subject as a reading of Coases original articles reveals much of Williamsons work as just that. If you haven't read Williamson's 1985 The Economic Institutions of Capitalism book I recommend it highly _after_ you've read this.
Coasean economics is important because it pushes us to make fair and realistic comparisons between private and public institutions. In 1959 Coase published an article on the Federal Communications Commission which demonstrated that market imperfections do not automatically imply the need for government regulation. Transaction costs make markets imperfect, but government suffers from its own imperfections. In 1969 Harold Demsetz explained the Coasean approach to institutional analysis in his "Institutions and Efficiency, another Viewpoint". Coase's opponents are guilty of committing the Nirvana Fallacy. Economists used to condemn markets for failing to deliver ideal conditions. Those who compare real imperfect markets to an idealized perfect government will always "prove" the need for government regulation. In reality, the nirvana of perfect government never exists, so the need for governmental intervention is always questionable.
Unfortunately, this 1959 article did not make it into this book. Instead, Coase used his 1960 follow up paper "The Problem of Social Cost" (chapter five) to explain his ideas about law and economics. Chapter five explains "The Coase Theorem" and "The Invariance Proposition". The 1960 paper on social costs is an outgrowth of an informal debate between Coase and Milton Friedman. This is a rare instance where Friedman admitted defeat. Given Friedman's talent for debate, Coase's victory is not a small matter. Having proven his point to the satisfaction of the Chicago economics faculty, Coase was able to join this faculty and edit The Journal of Law and Economics. Not bad for an informal after-dinner debate.
The reprinting of the Problem of Social Cost is important because so many economists misconstrue the Coase Theorem. Contrary to what many believe, Coase does not assume that transaction costs are zero. The idea of zero transaction costs is just a thought experiment. Coase saw little value in thought experiments. The real message from Coase is that we should focus on real examples where transaction costs are positive and vary. Good institutions are the ones that reduce transaction costs to a minimal level. Coase explains his position further in chapter six: notes on the problem of social cost. It is also important to guard against George Stigler's misinterpretation of Coase. The idea that all institutions are imperfect does not imply that we arrive at the least imperfect institutions.
The Marginal Cost Controversy (Chapter Four) and the Lighthouse in Economics (chapter seven) are also notable. Coase demonstrated that Abba Lerner and Harold Hotelling were wrong about the need for government to subsidize firms with declining average costs. Besting Lerner and Hotelling is no small feat. In chapter seven Coase took on none other than John Stuart Mill. It turns out that lighthouses are not necessarily public goods. History and common sense show that entrepreneurs can supply lighthouses for profit.
The Firm, the Market, and the Law is brilliant, but often misunderstood. This is hard to explain because it is highly readable and thought provoking. Some of its points are simple, others are subtle, but they are all well reasoned. Most of the misunderstandings about this book seem to derive from the fact that some people judge Coasean economics based on what they have heard, rather than from reading this book. While I do not agree with everything in this book, reading it (and re-reading it) has made me a better economist. All social scientists and legal scholars could benefit from reading The Firm, the Market, and the Law, if they have not read it already.
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