Preview of Class #8: Coase’s Theorem

Let’s take a break from the mystery of Adam Smith’s love life in order to preview our next “Advanced Topics” class (BUL5332), which is devoted to something called “the Coase theorem”–named after the late great English economist and legal theorist Ronald H. Coase (b. 1910, d. 2013), who is pictured below. (Rest assured, friends, we will return to Adam Smith next week.) As an aside, one of the most remarkable aspects of Coase’s work is the absence of any advanced mathematics or inscrutable formulas. Instead, Coase relies on logic, plain English, and simple illustrations taken from the common law, such as pollution (the factory smoke example on page 1 of his social cost paper), nuisance (Sturges v. Bridgman or the case of the noisy confectioner on page 2), and cattle trespass (pp. 2-8).

In any case, Professor Coase’s theorem is so central to the field of “law and economics” that I will divide my preview into two parts. Here, I will first describe what Coase did and how he did it. In his 1960 paper on “The Problem of Social Cost,” Professor Coase begins by introducing the problem of “harmful effects,” or what is more commonly called “negative externalities” in economics textbooks. “The standard example,” Coase writes, “is that of a factory, the smoke from which has harmful effects on those occupying neighbouring properties.” In a now-famous passage, Coase makes the following poignant observations:

The traditional approach has tended to obscure the nature of the choice that has to be made [i.e. the legal choice between A, the owner of the factory, and B, the neighbors]. The question is commonly thought of as one in which A inflicts harm on B and what has to be decided is, How should we restrain A? But this is wrong. We are dealing with a problem of a reciprocal nature. The real question that has to be decided is, Should A be allowed to harm B or should B be allowed to harm A? The [correct solution] is to avoid the more serious harm.”

Coase’s irreverent utterance – “But this is wrong. [This is wrong!] We are dealing with a problem of a reciprocal nature” – is to me the single-most powerful and revolutionary statement in the annals of Anglo-American legal history since the great Oliver Wendell Holmes uttered his famous maxim, “The life of the law has not been logic; it has been experience.” For Coase is not just repeating the old saw that there are two sides to every dispute; he is saying something much more significant and original and insightful than that. Stay tuned …

Ronald Coase and the Misuse of Economics | The New Yorker
Ronald H. Coase

About F. E. Guerra-Pujol

When I’m not blogging, I am a business law professor at the University of Central Florida.
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