Ronald Coase, the eminent British economist and University of Chicago professor emeritus, passed away on September 2 at the age of 102. Professor Coase was one of the best known economists of the past 80 years. He lived a long and extraordinarily productive life until the very end. He is best known for two articles, The Nature of the Firm published in 1937, and The Problem of Social Cost published in 1960. These along with many other achievements earned him the 1991 Nobel Prize in economics.
A recent Economist article, One of the Giants, summed up Professor Coase life’s work in his own words: “I have made no innovations in high theory. . . My contribution to economics has been to urge the inclusion…of features of the economic system so obvious that…they have tended to be overlooked.” “Attention to the overlooked helped Mr Coase transform both law and economics,” the article added.
A second article in the same September, 2013 Economist issue, The man who showed why firms exist, said:
“The job of clever people is to ask difficult questions. The job of very clever people is to ask deceptively simple ones. Eighty years ago a young British economist wondered: why do companies exist? The answer that he gave remains as fascinating today as it was back then. . . Most economists had been content to treat firms as black boxes. Mr Coase wondered what the black boxes were doing there in the first place. He used a scholarship that he won as an undergraduate to visit leading American firms such as Ford and General Motors. He summed up his thinking in his 1937 essay, The Nature of the Firm, which at first attracted no attention whatsoever, but continues to be cited to this day.”
In The Nature of the Firm paper, the young Professor Coase explained that, in principle, a firm should be able to find the cheapest, most productive goods and services by contracting them out in an efficient, open marketplace. However, markets are not perfectly fluid. Transaction costs are incurred in obtaining goods and services outside the firm, such as searching for the right people, negotiating a contract, coordinating the work, managing intellectual property and so on. Thus, firms came into being to make it easier and less costly to get work done.
Three years ago, the University of Chicago Law School, - which he joined as professor of law and economics in 1964, - held a conference in his honor - Markets, Firms and Property Rights: A Celebration of the Research of Ronald Coase.
In a truly remarkable video, Professor Coase, then 99 years old, addressed the conference. He started out by apologizing for not being there in person, because he now gets very tired and was not feeling well. He then proceeded to talk about the subject of the conference with a sharpness of mind we would all wish on ourselves at 39, let alone at 99.
He wanted to clarify some concepts that he had not quite gotten right in The Nature of the Firm. That article, published in 1937 and much cited since then, he thought of as little more than an undergraduate essay.
He started out by talking about markets. Markets are artificial creations, not something that one can find that exist on their own. Markets appear when people decide to create them. They then negotiate with each other and work out the necessary contracts to make them come about. Sometimes markets work out, and sometimes they don’t.
“Firms are a little different,” he then said. “Firms are usually based initially on the family, and they exist in that form, to a large extent today. But firms are not to be analyzed the way I did it in The Nature of the Firm, [which] talked about the firm as if it was an entity in economic theory. . . Firms are organizations in which the different parts of the firm have an interchange with other parts of the firm, . . . it is a sociological problem not an economic problem. . . .”
“I discovered that there were friendships and antagonisms within firms, . . . one part of a firm would feel that another part is always going to mess up what they were doing. It operated in a very different way from the way it does in economic theory where you have a firm maximizing profits, knowing all the things that affected them and acting accordingly. In fact it’s very difficult to imagine a firm acting the way that is described in the textbooks, . . .”
I found these statements truly illuminating, especially in light of our recent global financial crisis. We are still struggling to understand how the so-called best and the brightest got it so wrong, including Nobel Prize winning economists and high government officials who should have known better.
“The Great Recession was the result not only of lax regulation in Washington and reckless risk-taking on Wall Street but also of faulty theorizing in academia. . . The economics profession went astray because economists, as a group, mistook beauty, clad in impressive-looking mathematics, for truth.” They are in love with an “idealized vision of an economy in which rational individuals interact in perfect markets . . . gussied up with fancy equations. . . Unfortunately this romanticized and sanitized vision of the economy led most economists to ignore all the things that can go wrong.”
NY Times columnist David Brooks had a similar opinion of what he called economic scientism. In a 2010 OpEd, he called economic scientism “ . . .the period when economists based their work on a crude vision of human nature (the perfectly rational, utility-maximizing autonomous individual) and then built elaborate models based on that creature.”
Professor Coase, a University of Chicago colleague of many of these same economists, was quite different. In his video remarks he is telling us that not only is it wrong to view individuals as rational entities in an economic model, but firms, like families, should not be viewed as such rational economic entities either. A firms is best viewed as a kind-of rather large and highly complex family. This view of the-firm-as-family will resonate with most of us who’ve actually worked in companies, as I have for the past 43 years.
Humans are social animals, and like all such animals, we are ill-equipped to survive on our own. Our social impulses cause us to naturally gravitate toward forming families and communities to help us get the necessary survival strengths from each other. We do so not only in our personal lives. We also form companies and other such organizations to get things done in our work, especially more complex objectives that require the collective skills of multiple people.
Families are linked together by very strong emotions, including love, nurturing and caring. But, as we well know, the Father Knows Best idealized model of the family is not quite right. The bible, history books, and countless novels, plays and films, remind us that those same powerful emotions that bring us together can also lead to betrayals, sibling rivalries, hard-fought divorces and other behaviors that we would consider quite dysfunctional.
Many of the same emotions apply to organizations. We often refer to the people we work with as being a kind-of extended family. It’s one of the reasons we like our jobs. We depend on colleagues to do well in our jobs, and to achieve whatever professional recognition and financial security we are after. But, as we also know well, organizations are also full of politics and intrigue, as you should expect in any group of people that are simultaneously cooperating and competing with each other. With the proper leadership, organizations can succeed by leveraging their positive feelings while keeping the more negative ones in check. But, quite often, firms become dysfunctional, cannot get much done and go out of business.
In his remarks to the 2009 conference in his honor, Professor Coase told the audience that “We ought to study directly how firms operate and develop our theories accordingly,” rather than solely rely on abstract models, textbooks and papers, including his own The Nature of the Firm.
I find his wise advice particularly relevant to our times, especially as science and technology are now enabling us to dig deeper than ever into the nature of firms, communities, cities, economies and other social organizations. The key lessons from Ronald Coase’s life and work is that we should approach such highly complex social systems with humility; that we should study the behavior of people, families and organizations as they actually are in the real world and not as the elegant mathematical models they are not; and that we should continue to learn and evolve our views throughout our lives, as Professor Coase did until the very end.
May he rest in peace.