Thursday, March 03, 2011

Coase Theorem Not About Markets

Mainstream economists tend to think of the "laws of demand and supply", for example, as applying to all of human history and independent of institutional structure1. Geoffrey Hodgson has noted the difficulty of finding a definition of "markets" in mainstream economics.

To me, a market must allow for repetitive purchases and sales of a commodity where participants have information on, for example, prices from previous purchases and sales. A contract drawn up between two organizations to last for several years is a bilateral negotiation, not a market transaction, when neither organization is simultaneous to draw up parallel contracts with competing organizations2.

One application of this idea is to labor unions. Maybe the difficulties mainstream economists have with defining "markets" is connected with their backward notions on labor unions, backward notions that others have recently pointed out3.

I was inspired to write this post by Hahnel and Sheeran's article. An train engine with tracks through a farmer's field is an example of application of the Coase Theorem. If vegetation isn't kept a certain distance from the rails, supposedly sparks from the train wheels are likely to start a fire and burn the crops. Do the farmers have a well-defined property right not to have sparks ejected on their fields? Or do trains have a well-defined right to emit sparks? Depending on the answers to these questions, the legal liability for maintaining the track and paying for any resulting fires is different. But, according to the Coase "theorem", if property rights are well-defined and no transaction costs exist, the farmer and the railroad will negotiate an efficient price for allowing the trains to emit sparks. Some conclude that it is government's job to ensure property rights are well-defined and perhaps lower transaction costs. Then the market will come to an efficient solution to the problem of externalities, however property rights are allocated.

Among other criticisms, Hahnel and Sheenan point out that the conclusion is a non-sequitur. This is not an example of a market. I think their treatment of information asymmetries is a formalization of a point I first read from Michael Albert. The Coase set-up will encourage those with property rights to act as bullies, to threaten obnoxious behavior they wouldn't otherwise do, so as to extort payments from their victims.

1 An interesting experiment would be to count the number of occurrences of the word "capitalism" in, say, the American Economic Review or the Journal of Political Economy in the last decade and contrast those counts with the same counts in, say, the Cambridge Journal of Economics, the Review of Political Economy, or the Review of Radical Political Economics.

2 Even if you object to this usage of "market", you should see that the game theoretic models appropriate for a bilateral negotiation under various assumptions about available information is not the typical model of demand and supply schedules.

3 Haven't the criticized economists heard of the theory of the second best? I thought that the case of a large employer and a labor union was a canonical example.

  • Michael Albert. "Nobel Nerve", Z Magazine (Nov. 1991).
  • Robin Hahnel and Kristen A. Sheeran. "Misinterpreting the Coase Theorem" Journal of Economic Issues. V 43, N. 1 (March 2009): 215-238.
  • Geoffrey M. Hodgson Economics and Institutions: A Manifesto for a Modern Institutionalist Economists, Basil Blackwell (1989).
  • R. G. Lipsey and Kevin Lancaster. "The General Theory of the Second Best", Review of Economic Studies, V. 24, N. 1 (1956-1957): 11-32.


Tomboktu said...

"To me, a market must allow for repetitive purchases and sales of a commodity where participants have information on, for example, prices from previous purchases and sales."

Do you mean that an individual purchaser must make repetitive purchases in order for a market to exist?

Some time ago I had read part of Radical Political Economy by Andrew Sayer, where I first came across the question of the definition of a market. It got me wondering about my weekly purchases of milk (oh, the somewhat-out-of-the-way greengrocer is selling it at €1.19 for two litres, the less-out-of-the-way butcher at €1.29, and every other shop in the twon at €1.49). Definitely market transactions.

Paying my teenage niece to paint a garden wall during her school holiday: definitely not a market transaction.

Paying €436 for a washing machine ... hmmm ... I, for one, don't want to be making regular purchases of washing machines.

Robert Vienneau said...

I must have been unclear. I did not mean to imply that these repetitive purchases must be by the same buyer. Hodgson suggests that, "Market to both regulate and establish a consensus over prices and, more generally, to communicate information regarding products, prices, quantities, potential buyers and potential sellers." Posted prices on supermarket shelves seems to be an example of a market institution.

abellia said...

Is health care a market? There are lots of reasons that purchasers accept prices set by the sellers, rather than have a negotiation occur or allow demand (or lack thereof) come into play.