Ronald Coase’s Two Windows into COVID-19
Updated: May 11
Max Stearns Ronald Coase, the 1991 Nobel Laureate in Economics, spent most of his teaching career at The University of Chicago Law School. A founder of the modern school of law and economics, Coase wasn’t prolific. I’ve described Coase as the Don McLean of legal scholarship. I’d happily take American Pie and Vincent over many a lengthier playlist. Coase’s greatest hits are impressive indeed--the Coase Theorem and the theory of the firm. Neither publication, nor anything else Coase wrote to my knowledge, discussed pandemics. And yet these two core insights provide separate windows into how, from a regulatory perspective, and from the perspective of personal conduct, we might view COVID-19. Sadly, the White House, influenced in part by a notable libertarian legal scholar, has peered through one window, producing a tragically distorted view. Although not actually a theorem, the Coase theorem is a helpful tautology exposing the importance of clearly defined property rights in promoting efficient resource allocation when property uses conflict.* Coase posited that if the relevant actors have complete information and can transact freely, property rights will be deployed to their most valued uses regardless of liability rule.
Assume a farmer with crops consumed by a neighbor’s cattle. On Coase’s assumptions, whether the farmer can enjoin the rancher, or the rancher’s cattle may freely roam, a fence will separate the properties only if the crops are more valuable to the farmer than to the rancher. The liability rule controls who finances the fence, that is, assuming cattle feed isn’t the crops’ best use. But the rule has no bearing on how the crops will ultimately be used. Whether the fence goes up or not is strictly a function of the crops’ relative value to the neighboring property owners. Coase’s other major insight centered on a separate bargaining dynamic that threatens to undermine efficient resource allocation, known as post-contractual strategic behavior. Assume two businesses enter a long-term contractual relationship, rendering their joint success interdependent. When this occurs, either might later seek to impose obligations on the other contrary to what the parties reasonably anticipated when initially contracting. An automobile manufacturer contracts with an air conditioner supplier for all customized AC components to be installed in a new line of cars. As the two companies customize their production processes to suit each others’ needs, each becomes vulnerable to a kind of extortion in which the other demands terms better than originally anticipated as a precondition to following through. Because litigation is costly, including causing delays, the changed relationship risks undermining allocative efficiency.** Coase posited that the firm is a partial antidote to post-contractual strategic bargaining, supplanting such opportunities via vertical integration. Combining the productive resources of the automobile company and AC supplier into a single firm replaces atomistic contracting with the alternative centralized mechanism of command and control. Conservative and libertarian legal scholars, influenced by law and economics, love Coase. And they imagine Coase vindicates their longstanding visceral distrust of government and regulation, at least beyond clarifying property rights and providing background common law rules. But insisting that Coase demands atomistic contracting with minimal governmental intervention across the board to ensure efficient resource allocation, or to manage a pandemic, shutters, indeed shatters, one of the two Coasian windows. An edgewise view of a handwritten note cannot disclose its plea for help. To be sure, the theory of the firm identifies a market antidote to a structural bargaining failure involving long term relational contracting. The vertically integrated firm arises within private markets. But limiting Coase to that specific context avoids his deeper insight. The underlying pathology involves the divergence between economic arrangements in the benign circumstance of competitive markets, on one side, versus more problematic economic arrangements that thwart such benign market functioning, on the other. No firm can possibly resolve the allocation problems on the vast scale required for life-sustaining essentials during the COVID-19 pandemic. For the very reasons Coase identified, command and control also occasionally demands governmental intervention, and yes, sometimes on a grand scale. Consider shortages in COVID-19 tests, PPE, and ventilators. The Trump administration invited a bidding war among states, and including the federal government, over such pandemic essentials. In a bidding war, governors, or state consortiums, responsive to their constituencies, will rationally bid up the price of these vital goods, and worse yet, in seeking to assure voters they are prepared, will ensure a ready supply in state for whenever the virus wave happens to hit home, despite the desperate and immediate need for such vital goods somewhere else.*** This is akin to having all fire-fighting equipment spread around a corporate campus when a particular building is already aflame.
Atomistic market transactions to address COVID-19 is the dead wrong approach, and Coase doesn’t call for it. Coase supports taking control of the resources and commanding their use to put out the immediate fire, worrying about later spreading to avoid future risks only after the dousing. And the relevant dousing will inevitably involve different waves as the virus hits upon differing parts of the nation sequentially. Ensuring an adequate supply of such vital goods would also have benefitted from relying on the Defense Production Act, rather than voluntary cooperation, as this Administration has done, to mandate production.****
Competitive bidding, as Coase recognized in the context of FCC licensing, sometimes moves scarce resources to where they are more highly valued, but Coase’s own analysis demonstrates why this fails as a response to the pandemic. The only institution capable of the needed response is the federal government, with state bidding wars thwarting the essential scheme. The problem goes deeper still. Based on social media feeds, conservative and libertarian legal scholars have tended to push against policy making driven by the consensus of leading scientists in the US and around the globe. This includes sheltering in place, coupled with cautious guidance on roll backs, supported by concrete evidence, such as demonstrated in the Centers for Disease Control and Prevention (CDC) criteria, and corresponding with effective flattening of the pandemic curve. Rather than counseling deference to such leading experts, the atomistic mindset encourages deference to more individualized determinations, guided by each person’s own lights. And several states are acquiescing, opening their economies prematurely, before satisfying CDC criteria, and without any ability to contain the risks to those individuals behaving irresponsibly or within their own borders. To be sure, conservative or libertarian legal scholars aren’t apt to appear among those flocking to crowded beaches, or to engage in fights or protests at state capitols for the right to avoid masks and get haircuts. But make no mistake. Such pushback provides rich fodder for those who do, and to responsive politicians. We are all part of a complex interconnected web, especially on social media.
Part of the single-paned Coasian mindset involves a frank refusal to concede that these scholars' own quick study of epidemiology and disease statistics might just be less informed than the guidance of leading experts who have dedicated their lifetimes to acquired expertise. The hubris is galling. It isn’t Coasian, and it is profoundly unwise. Wisdom isn’t captured in having studied the benefits of free markets and personal liberties. Wisdom is knowing when to press on such values, and when to pull back, and knowing when others have greater relevant expertise. To be sure, experts sometimes get things wrong. And there is no doubt that the costs of sheltering in place are serious and, for many businesses and workers, dire. We, as a society, should be intensely focused on how best to help those who are most harmed. But relying on half-formed intuitions based on a partial and biased reading of preferred scholars, however notable, is a tragic, indeed fatal, conceit. I welcome your comments.
[Special thanks to Shahar Dillbary for helpful comments on an earlier draft.] Notes: *The tautology involves more complex bargaining dynamics, for example when third parties are introduced, producing what game theorists refer to as cycling. Cycling potentially undermines allocative efficiency, even with Coase’s assumptions, unless cycling is treated as a transactions cost. This saves the theorem, but does so by rendering it tautological. For related works, see here, here, and here
**Oliver Williamson, the 2009 Economics Nobel Laureate, described such opportunistic behavior as seeking appropriable quasi rents.
***Technically, it would be preferable to have the federal government operate as a monopsonistic purchaser, negotiating a better price with relevant suppliers, and then allocating the goods where they are most needed across the nation as various waves peak in succession.
****In economic terms, deploying the Defense Production Act is particularly appropriate, as here, for vital goods concerning which the supply function is highly inelastic, rendering private market production of such goods inadequately responsive to price signaling.