RIP Ronald Coase

Nobel prize winner in economics, “accidental economist” and law school professor, Ronald Coase died 2 September 2013 at 102.  His insights into our everyday lives will live longer.  

Coase, (pronounced like nose) is known for two significant papers.  They were the basis for his 1991 Nobel Prize.   “for his discovery and clarification of the significance of transaction costs and property rights for the institutional structure and functioning of the economy.”

His first, published in 1937, dealt with the nature of businesses.  In particular the reason for their structure.  A business should form and do things for itself only when the cost to do them internally was less than the cost to do them externally.  Hire contractors for example.

The Ford Motor Company was one that carried the internalization of costs to extremes.  They owned iron mines, ships, steel mills and rubber plantations to support their car making operations.  Coase argued that they were right as long as their internal costs were less than the costs to acquire these same objects externally.

The tide has turned in recent times.

His second paper, which has come to be known as the Coase Theorem, deals with external costs in society as a whole.  Costs like regulation and civil courts.

Is it okay to regulate without understanding the cost of the regulation?  For businesses and individuals, regulation is an external cost and if the benefit of incurring it is less than the cost to comply, the regulation should not exist.

By assigning ownership rights to certain societal things, the system becomes less externally expensive.  The auctioning off of drilling rights, timber concessions and mobile telephone spectra all derive from the Coase theorem.  We can be reasonably sure this is the right way to proceed because it took more than 30 years to become an accepted ideas.

Coase argued that people should address their conflicting values by exchange.  Money for rights.  In the spectrum case, the most efficient user could pay the most.

With the now moot discussion of a foreign takeover in the Canadian mobile telephone business, we can see his point.  The least efficient can only survive if they are regulated to remain in business.  That transfers the cost of their inefficiency to society as a whole.

Western societies have come to the point now that a very large share of day to day cost are the hidden cost of regulation.  Some of it may have value but the cost/benefit is unknown and the bureaucracies intend to keep it that way.

By assigning property value to everything, it becomes possible to do such an analysis.  Coase’s point.

Why does it cost more to buy something here than it does in China?  Are the Chinese more generous?  Are they dumb?  Is it easier (cheaper) to do business and to live in China?

The price of a meal in a local restaurant in China is about  one tenth of what it is here for  about the same meal.  Why?  Because the external costs to produce it are less.  No food safety standards, no minimum wage, no unions, no sales tax, no building codes, no health department inspections, no fire regulations, no signage rules, no parking requirements, no zoning compliance and a hundred more.

The food, the chef, the waiter and the space are not much different.  The regulation that surrounds them accounts for the difference in price.  If a steak dinner here was priced at $3.00 plus $27.00 to make sure it was safe to eat it, in this place, at this time, we might start to push back on stupid regulation.  Until it is visible we will not.

There are some evolving alternatives.  You may have noticed that eBay has a cheap way to give me assurance about the reliability of its venders.  The positive feedback rating.  It costs almost nothing and provides useful information.  Similarly the review process at Amazon adds value.  Restaurants panned in Yelp! do poorly.

We would sometimes be wrong to push back because we can not, individually, get enough information to make the correct decision.  I, for one, do not know how to tell a safe meal from an unsafe one.  The question is how much would I pay to remove the risk.  Probably less than $27.  In 2002 the Cato institute pointed out that the agency formerly known as the Office of Management and Budget never rejected a regulation where the projected cost to save one life was less than $100,000,000.  At the same time the FAA did not introduce regulations unless the cost per life saved was less than $3,000,000.  Truth, no doubt lies somewhere between.  We know for sure it does not include the EPA’s wood preservative hazardous waste listing at almost $17 billion per life saved.

Until we know the value of what the regulation prevents and what the regulation costs, there will be a strong move upwards in society’s overhead.  Regulation for regulation sake makes no economic sense and Ronald Coase has provided some tools to think about it.

Don Shaughnessy is a retired partner in an international accounting firm and is presently with The Protectors Group, a large personal insurance, employee benefits and investment agency in Peterborough Ontario.  |  Twitter @DonShaughnessy  |  Follow by email at moneyFYI

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