Changes

Chicago federal trial judge Milton Shadur explained the legal meaning of this theorem.  “So long as the rule of law is known when parties act, the ultimate economic result is the same no matter which way the law has resolved the issue.”<ref>''Coltman v. Commissioner'', 980 F.2d 1134, 1137 (7th Cir. 1992).</ref>  Whether the law gives an entitlement to a rich man or a poor one, the economic activity will be the same, assuming people can bargain freely with each other.

Chicago federal trial judge Milton Shadur explained the legal meaning of this theorem.  “So long as the rule of law is known when parties act, the ultimate economic result is the same no matter which way the law has resolved the issue.”<ref>''Coltman v. Commissioner'', 980 F.2d 1134, 1137 (7th Cir. 1992).</ref>  Whether the law gives an entitlement to a rich man or a poor one, the economic activity will be the same, assuming people can bargain freely with each other.

An oversimplication of this concept is Ralph Waldo Emerson’s famous statement that if a man can “make a better mouse-trap … [then] the world will make a beaten path to his door.”  Assuming people can deal without regulatory or other barriers, it does not matter who invents the mousetrap or who obtains legal rights to it.  The free market will ensure that the better mousetrap is sold to the public for the benefit of all involved.

An oversimplication of this concept is Ralph Waldo Emerson’s famous statement that if a man can “make a better mouse-trap … [then] the world will make a beaten path to his door.”  Assuming people can buy and sell without regulatory or other barriers, it does not matter who invents the mousetrap or who obtains legal rights to it.  The free market will ensure that the better mousetrap is sold to the public for the benefit of all involved.  

 

But an entire educated class—including lawyers, accountants, and politicians—makes a very good living from transaction costs. Leading academics build their life’s work on the claim that “reforming” legal entitlements and property rights will somehow improve society.  The Critical Legal Studies movement, started in 1977 at a conference at the University of Wisconsin at Madison, asserts that the upper class manipulates the law in order to perpetuate oppression of the lower class.  The Coase theorem, however, disproves all that.  Unchanging legal rules have no effect on economic activity, in the absence of transaction costs.

The meaning of Coase’s insight for government regulation was clear. A society is better off by simply assigning property rights, reducing transaction costs, and getting out of the way so that the market process can reach its most efficient result.  Government regulations that add transaction costs hurt efficiency and prosperity.  In response to the question “What’s an example of bad regulation?,” Coase replied, “I can’t remember one that’s good.”

The meaning of Coase’s insight for government regulation was clear. A society is better off by simply assigning property rights, reducing transaction costs, and getting out of the way so that the market process can reach its most efficient result.  Government regulations that add transaction costs hurt efficiency and prosperity.  In response to the question “What’s an example of bad regulation?,” Coase replied, “I can’t remember one that’s good.”

===The Most Famous Dinner in the History of Economics<ref>Warsh D., ''Knowledge and the Wealth of Nations: A Story of Economic Discovery'' 299 (2006).</ref>===

===The Most Famous Dinner in the History of Economics<ref>Warsh D., ''Knowledge and the Wealth of Nations: A Story of Economic Discovery'' 299 (2006).</ref>===

Initially Professor Coase’s theory was criticized, even by economists.  In 1959 Coase, then in the economics department at the University of Virginia, published an early version in a paper concerning allocation of the radio frequency spectrum.  Coase proposed that the Federal Communications Commission reject its bureaucratic procedures for assigning licenses and simply sell frequencies in the spectrum to the highest bidders.  Coase elaborated on his theory in his paper, but every economist at the University of Chicago objected.  Even though the Chicago economists were predisposed towards free markets, they thought Coase had erred.  

Initially Professor Coase’s theory was criticized, even by economists.  In 1959 Coase, then in the economics department at the University of Virginia, published an early version in an article concerning allocation of the radio frequency spectrum.  Coase proposed that the Federal Communications Commission reject its bureaucratic procedures for assigning licenses and simply sell frequencies in the spectrum to the highest bidders.  Coase elaborated on his theory in his article, but every economist at the University of Chicago objected.  Even though the Chicago economists were predisposed towards free markets, they thought Coase had erred.  

But these economists wanted the truth, and they invited Coase to a friendly dinner at the home of a conservative economist named Aaron Director.  Milton Friedman and George Stigler were among those in attendance who thought Coase had erred.  As the hors d’oeuvres were served, the vote was 20 against Coase’s theory and only Coase in favor of it. As the two-hour discussion proceeded, it became like a scene from the famous movie ''12 Angry Men''.  One by one, bit by bit, the great economists came over to Coase’s side as their objections were resolved.  By the end their leader, Milton Friedman himself heroically admitted that he had been wrong and Coase was right.  To his enormous credit, Professor Friedman then became an energetic champion of Coase’s theory.

These economists wanted the truth, and they invited Coase to a friendly dinner at the home of a conservative economist named Aaron Director.  Milton Friedman and George Stigler were among those in attendance who thought Coase had erred.  When hors d’oeuvres were served, the vote was 20 against Coase’s theory and only Coase in favor of it. As the two-hour discussion proceeded, it became like a scene from the famous movie ''12 Angry Men''.  One by one, bit by bit, the great economists came over to Coase’s side as their objections were resolved.  By the end their leader, Milton Friedman himself heroically admitted that he had been wrong and Coase was right.  To his enormous credit, Professor Friedman then became an energetic champion of Coase’s theory.

The dinner attendees then thanked Coase and invited him to write up his theory more fully for the new ''Journal of Law and Economics'', and that version became the most cited paper in all of economics.

The dinner attendees thanked Coase and invited him to write up his theory more fully for a new publication called the ''Journal of Law and Economics'', and Coase's article became the most cited paper in all of economics.

=== The Man Behind the Coase Theorem ===

=== The Man Behind the Coase Theorem ===

Who is this man behind this revelation?  It took an unconventional education to bring forth this unconventional work.  Professor Ronald Coase, born in 1910 in England, suffered from a physical handicap as a youngster and thus could not attend regular school.  He had to wear leg braces and was eventually enrolled in a school for “physical defectives.”  But that school was managed by the same organization that ran the school for “mental defectives,” and Coase later explained that there was “some overlapping in the curriculum.”<ref>http://www.reason.com/news/printer/30115.html</ref> As a result, Coase spent his days in basket-weaving classes, and was deprived of any formal academic instruction until age 10.

Who is this man behind this revelation?  It took an unconventional education to bring forth this insightful work.  Professor Ronald Coase, born in 1910 in England, suffered from a physical handicap as a youngster and thus could not attend regular school.  He had to wear leg braces and was eventually enrolled in a school for “physical defectives.”  But that school was managed by the same organization that ran the school for “mental defectives,” and Coase later explained that there was “some overlapping in the curriculum.”<ref>http://www.reason.com/news/printer/30115.html</ref> As a result, Coase spent his days in basket-weaving classes, and was deprived of any formal academic instruction until age 10.

He eventually found his way to the London School of Economics, where he remained a socialist until his senior year, when he landed in a seminar taught by Professor Arnold Plant.  That course was devoted to the “invisible hand” and featured stimulating discussions without any readings.  It changed Coase’s life, as he embraced the power of the free market.

He eventually found his way to the London School of Economics, where he was a socialist until his senior year, when he enrolled in a seminar taught by Professor Arnold Plant.  That course was devoted to the “invisible hand” and featured stimulating discussions without any readings.  It changed Coase’s life, as he embraced the power of the free market.

Later he emigrated to the United States and eventually earned a faculty position at the University of Chicago.  His work almost never included a mathematical equation or formula, contrary to the modern trend in economics.  To this day many in the field of law and economics, which Coase helped found, pursue quantification that he would never have done himself.

Later he emigrated to the United States and eventually joined the faculty at the University of Chicago.  His work almost never included a mathematical equation or formula, contrary to the modern trend in economics.  To this day many in the field of law and economics, which Coase helped found, pursue quantification that he would never have done himself.

Professor Coase’s breakthrough was analogous to that of mathematician Kurt Gödel.  Both proved startling limits on their colleagues’ ability to achieve, and as a result both received a chilly reception from their peers. Coase and Gödel took the wind out of their colleagues’ sails, so to speak, by demonstrating what '''''cannot''''' be done. 

Professor Coase’s breakthrough was analogous to that of mathematician Kurt Gödel.  Both deflated the arrogance of their colleagues, and as a result both received a chilly reception from their peers.

===Implications of the Coase Theorem===

===Implications of the Coase Theorem===

In public policy, the Coase theorem implies that greater efficiency and prosperity can be obtained by reducing and eliminating transaction costs.  Bureaucratic hurdles erected by government and the legal system increase transaction costs and reduce efficiency and prosperity.  Society as a whole would be better off if transaction costs were minimized.  Wealth is lost by impeding the ability of people to negotiate private contracts among themselves.  The role of government to increase prosperity should focus on lowering transaction costs, not raising them.  

In public policy, the Coase theorem implies that greater efficiency and prosperity can be obtained by reducing and eliminating transaction costs.  Bureaucratic hurdles erected by government and the legal system increase transaction costs and reduce efficiency and prosperity.  Society as a whole would be better off if transaction costs were minimized.  Wealth is lost by impeding the ability of people to negotiate private contracts among themselves.  The role of government to increase prosperity should focus on lowering transaction costs, not raising them.  

Often the best a court can do to maximize prosperity is to minimize transaction costs that impede negotiations between parties.  But in 1970, as the legal profession ignored Coase, the Warren Court expanded regulatory burdens on state administration of welfare in the mistaken view that more regulations would help the poor.  In 1996, the Republican Congress enacted welfare reform that superseded that decision, conservative legislation that reduced the number of the states’ welfare recipients by an average of 60 percent.

Transaction costs are particularly large in health care, where patients and physicians must waste massive amounts of time determining how much a procedure costs, whether a third party will pay for it, and obtaining payment from that third party (such as government or an insurance company).  In some cases the transaction costs are even infinite, as bureaucrats try to prohibit private contracts entirely for legitimate services.  Canada forbids paying privately for medical services, requiring everyone to depend on government controls.

 

In no industry are the transaction costs greater than in medical services, where patients and physicians must waste massive amounts of time determining how much a procedure costs, whether a third party will pay for it, and obtaining payment from that third party (such as government or an insurance company).  In some cases the transaction costs are even infinite, as bureaucrats try to prohibit private contracts entirely for legitimate services.  Canada forbids paying privately for medical services, requiring everyone to depend on government controls.

The Coase theorem demonstrates that these transaction costs can only detract from overall wealth and efficient economic behavior.  Legal impediments to private contracting for medical services should be removed, as such interference frustrates the ability to reach economically optimal results.  The best that government can do in controlling medical costs is simply to remove the transaction costs and get out of the way so that the parties, patients and physicians can negotiate optimal arrangements.

The Coase theorem demonstrates that these transaction costs detract from overall wealth and efficient economic behavior.  Legal impediments to private contracting for medical services should be removed, as such interference frustrates the ability to reach economically optimal results.  The best that government can do in controlling medical costs is simply to remove the transaction costs and get out of the way so that the parties, patients and physicians can negotiate optimal arrangements.

The Coase theorem also provides economic justification for adhering to Rule of Law, and rejecting an “evolving” Constitution.  As Judge Shadur observed above, as long as there is a rule of law it does not matter to prosperity where that rule assigns the rights.  Legal theorists or litigants cannot devise a new allocation of rights or entitlements that would increase prosperity.  Often the best courts can do is embrace the Rule of Law, and then get out of the way.  Changing rules midstream, as in arbitrarily taking one’s property,  is economically harmful.

The Coase theorem also provides economic justification for adhering to Rule of Law, and rejecting an “evolving” Constitution.  As Judge Shadur observed above, as long as there is a rule of law it does not matter to prosperity where that rule assigns the rights.  Legal theorists or litigants cannot devise a new allocation of rights or entitlements that would increase prosperity.  Often the best courts can do is embrace the Rule of Law, and then get out of the way.  Changing rules midstream, as in arbitrarily taking one’s property,  is economically harmful.