Ronald Coase's Impact on Economics

Abstract

Ronald Coase had a profound impact on scholarship worldwide, and not for his ideas alone. Coase's ideas about transaction costs, the nature of the firm, the role of government, and the problem of social cost have been hugely influential. Throughout his long life, he also worked to change the conduct of economics, urging economists to ground their conclusions in careful study of empirical reality rather than theories that work only on the blackboard. Less well known, perhaps, is his work to nurture and shape the emerging fields of law and economics and new institutional economics, or his support to young scholars studying institutional issues around the world. In his final years, he was preoccupied by the rapid transformation of China and the institutional structure of production. This article summarizes Coase's significant intellectual contributions to economics, pointing out along the way some of the traits that made him such a powerful thinker and exceptionally influential scholar.

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Ronald Coase's impact on economics
MARY M. SHIRLEY, NING WANG and CLAUDE MÉNARD
Journal of Institutional Economics / FirstView Article / August 2014, pp 1 - 18
DOI: 10.1017/S1744137414000368, Published online: 05 August 2014
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Journal of Institutional Economics: page 1 of 18
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Millennium Economics Ltd 2014
doi:10.1017/S1744137414000368
Ronald Coase’s impact on economics
MARY M. SHIRLEY∗
Ronald Coase Institute, USA
NING WANG∗∗
Ronald Coase Institute, USA; and Ronald Coase Center for the Study of the Economy, Zhejiang University, China
CLAUDE M ´
ENARD∗∗∗
Centre d’Economie de la Sorbonne, Universit´
e de Paris (Panth´
eon-Sorbonne), France
Abstract. Ronald Coase had a profound impact on scholarship worldwide, and
not for his ideas alone. Coase’s ideas about transaction costs, the nature of the
firm, the role of government, and the problem of social cost have been hugely
influential. Throughout his long life, he also worked to change the conduct of
economics, urging economists to ground their conclusions in careful study of
empirical reality rather than theories that work only on the blackboard. Less well
known, perhaps, is his work to nurture and shape the emerging fields of law and
economics and new institutional economics, or his support to young scholars
studying institutional issues around the world. In his final years, he was
preoccupied by the rapid transformation of China and the institutional structure
of production. This article summarizes Coase’s significant intellectual
contributions to economics, pointing out along the way some of the traits that
made him such a powerful thinker and exceptionally influential scholar.
1. Introduction
Ronald Coase was one of the world’s most influential economists. His work
had a profound and lasting impact on public policy, the study of economics
and of law, and social science throughout the world. This article summarizes his
intellectual life and his contribution to economics. Section 2 briefly describes his
most influential ideas: transaction costs and the nature of the firm, the role of
government, and the problem of social cost.1Coase took issue with the way many
economists approached their subject; Section 3 summarizes his views. Section 4
describes how Coase shaped the emerging fields of law and economics and new
institutional economics, and how he supported young scholars. Coase lived a
long and fruitful life; after he retired from teaching and editing, he continued to
∗Email: mshirley@coase.org
∗∗Email: nwang1952@gmail.com
∗∗∗Email: claude.menard@univ-paris1.fr
1 We only have space to consider a fraction of Coase’s work. He wrote many other influential papers,
for example, on accounting, blackmail, payola, and monopolies.
1

2MARY M. SHIRLEY, NING WANG AND CLAUDE M ´
ENARD
be preoccupied with the development of China and puzzles about the firm; these
topics are discussed in section 5.
2. Coasean ideas with a major impact on economics and policy
Coase’s ideas had enormous impact, but their influence was not instantaneous.
Although the ideas we analyze below progressively permeated our intellectual
landscape, their diffusion was remarkably slow and often plagued with
misinterpretations. For example, only in the 1970s was “The Nature of the Firm”
(1937) perceived as a revolutionary way of analyzing what Coase called “the
institutional structure of production,” the bones and flesh of market economies.
Moreover, the concept at the core of this revolution—transaction costs—was
disseminated largely because of the controversy surrounding his 1960 paper,
“The Problem of Social Cost.”
Transaction costs: “the nature of the firm”
Travelling in the United States, Coase was stimulated by the “lack of any
theory which would explain why . . . industries were organized in the way
they were. My year in the United States was essentially devoted to a search for
a theory of integration” (Coase, 1991a: p. 38). Since theory assumed that the
price mechanism coordinated the economic system, Coase wondered whether
markets supported transactions as efficiently as existing theories suggested.
As is now well known, he gave a deceptively simple answer: there are costs
to using the price mechanism, costs that under certain conditions can make
it advantageous to use alternative arrangements, such as directing resources
through an entrepreneur. Among the costs Coase mentioned were the costs of
information, “of discovering what the relevant prices are” (1937:390), and the
costs of “negotiating and concluding a separate contract for each exchange
transaction which takes place on a market” (390–391). Coase then asked why,
if firms can reduce such marketing costs, are there any market transactions at
all. “Why is not all production carried on by one big firm” (394)?2His answer
was that there are costs to firms as well, and a “point must be reached where
the costs of organizing an extra transaction within the firm are equal to the costs
2 This argument led some to assume that the firm and the market are always substitutes, which was
not Coase’s intention. The presence of the firm did not imply that it always outperforms the market,
particularly because firms cannot replicate internally the strong incentives provided by markets, an
issue that Williamson (1985) termed the “selective intervention” problem. Later (Coase, 1991b) Coase
clarified that the line between the firm and the market was not clear-cut; markets can permeate the
internal organization of firms. The costs that determine whether it is profitable to establish a firm “are
the transaction costs that are saved . . . those which otherwise would have been incurred in market
transactions between the factors now cooperating within the firm” (59).

Ronald Coase’s impact on economics 3
involved in carrying out the transaction in the open market or to the costs of
organizing by another entrepreneur” (395).3
The implications of Coase’s concept of costs to using the market, later termed
transaction costs, only began to be fully apparent in the late 1970s/1980s with
the work of Oliver Williamson and Douglass North (described below), not to
mention Alchian, Demsetz, and Cheung, and many others. Only in the 1980s
and thereafter did what has been identified as transaction cost economics take
off. One reason for this slow gestation was that Coase did not clearly define
transaction costs in his 1937 paper, and remained somewhat vague in his 1960
article. Subsequently, different economists defined transaction costs differently as
the cost of exchanging and enforcing property rights, obtaining information and
measuring attributes, making and enforcing contracts (especially when agents
are opportunistic), etc.4What all these definitions shared was that transactions
were about the transfer of rights, and these transfers required costly supports.
Subsequent work was spurred by Coase’s intuition that transactions do not occur
in a vacuum, but require mechanisms that support and coordinate exchange, such
as markets or firms.
Despite this initial lack of precision, the basic inferences of Coase’s early
ideas in “The Nature of the Firm” had huge consequences for economics.
The first consequence was to raise the profile of firms as solutions to
the organization of transactions that outperformed markets under certain
circumstances. Paradoxically, this was and remains a revolutionary idea
for economic theories that reduce the firm to a technologically determined
production function. Second, once we accept efficient alternatives to markets,
we need to assess the conditions that motivate decision-makers to choose one
alternative over another. “The Nature of the Firm” thus introduced the role of
management as a means of coordination, and opened the ‘black box’ of the firm.
A third consequence was methodological: if there are alternative ways to
organize transactions, we must compare the costs and benefits of the different
arrangements in order to answer the question: which organizes transactions at the
lowest possible cost? This was the meaning of the discussion of labor contracts
in the “Nature of the Firm,” (although Coase mitigated that conclusion when he
revisited the 1937 paper 50 years later—see Coase 1991b).
3 Coase (1937) defined firm costs as the failure of managers to maximize the value of factors of
production, or diminishing returns to management (395). Later he emphasized the coordination costs
created by expansion when firms have diverse activities and operate in different geographical regions
(Coase, 1972).
4 Wallis and North (1986), in their paper measuring the level of transaction costs in the United States,
used an extensive definition of transaction costs, as all the costs borne by the consumer that are not
transferred to the seller of the good (including the opportunity cost of the consumer’s time searching for
the good, obtaining information and establishing credibility as a buyer, as well as legal fees, etc.), plus all
the costs borne by the producer which the producer would not incur were she selling the good to herself
(such as advertising, time spent persuading the consumer and establishing credibility as a seller, legal fees,
etc.).

4MARY M. SHIRLEY, NING WANG AND CLAUDE M ´
ENARD
Fourth, in pointing out the need to assess the comparative advantages of firms
and markets, Coase opened the door to what became the trademark question
of Oliver Williamson: what characteristics of transactions explain the tradeoff
between firms and markets? (We explore his answer below.)
Last, but not least, transaction costs provided a different explanation for
growth and development, as Coase made explicit later:
“The welfare of a human society depends on the flow of goods and services,
and this in turn depends on the productivity of the economic system. Adam
Smith explained that the productivity of the economic system depends on
specialization (he says the division of labor), but specialization is only possible
if there is exchange—and the lower the costs of exchange (transaction costs if
you will), the more specialization there will be and the greater the productivity
of the system. But the costs of exchange depend on the institutions of a country:
its legal system, its political system, its social system, its educational system, its
culture, and so on. In effect, it is the institutions that govern the performance
of an economy, and it is this that gives the “new institutional economics” its
importance for economists” Coase, 1998b: pp. 72–73).
These ideas were at the core of Coase’s exploration of the Chinese experience
(Coase and Wang, 2012), which discussed how China grew rapidly without
strong institutions by, among other things, exploiting informal institutions (such
as family networks), fostering local innovations in institutions through trial and
error, and sometimes using Hong Kong’s stronger institutions (for example, by
signing contracts through a Hong Kong intermediary). These ideas also explain
why Douglass North and followers owe so much to Coase (see below).
The role of government
Coase’s ideas about government ownership and regulation formed gradually.
Over the course of his investigations into British utilities in the 1930s, he
concluded that nationalization had not produced the promised results. His
skepticism about the advantages of government intervention was greater than
that of many economists, who assumed that a benign and well-informed
government was the optimal solution to market failure. Coase, nevertheless,
tempered his skepticism with his belief that economists could only discover
the appropriate boundary line for government action based on “a detailed
investigation of the actual results of handling the problem in different ways”
(Coase, 1960: p. 13). Even though he believed that regulation had produced a
worse result in most circumstances, he did not assume that all regulation was
necessarily bad. Instead, he argued that economists should carefully analyze the
advantages and disadvantages of government regulation by patiently studying
how markets, firms, and governments actually behaved (Coase, 1960:p.44).
Coase put this advice into practice in “The Federal Communications
Commission” (1959). After carefully analyzing the political economy of
broadcasting in the United States, he concluded that the FCC should sell the rights

Ronald Coase’s impact on economics 5
to use radio spectrum frequencies. He argued that the FCC’s current method of
allocating frequencies led to undesirable political control over freedom of the
press, similar to what might arise if government decided who could publish
newspapers or magazines. He further argued that if rights were well defined and
transferrable, they would be traded and combined to maximize output, allowing
private owners to deploy new technologies, adjust to changing markets, and
take other actions to operate more efficiently. The main risk of private control
over the spectrum was interference between signals transmitted on adjacent
frequencies. Coase concluded that private actors with clear property rights would
have every incentive to negotiate agreements or develop technologies to limit
interference and maximize the value of their asset.5Such “spillovers” (what
many call externalities), are byproducts of valuable activities “subject to the same
cost/benefit analysis as other resources” (Hazlett et al., 2011: p. S128). Coase
argued that any decisions about radio spectrum allocation should compare the
effects of the administrative costs associated with government allocation with
the transaction costs associated with market allocation.
Coase’s article provoked strong opposition, with the Commissioner asking in
an FCC hearing on the article, “Are you spoofing us? Is this all a big joke” (Coase,
1998a: 579)?6Opponents in the FCC argued that radio emission rights were
impossible to define and sell, ignoring the long-standing secondary market doing
just that. Opponents further argued that market allocation would neglect public
interest outputs, such as educational programming and news, overlooking the
possibility that these obligations could be required as part of the license. They also
ignored the sizeable rents earned by those fortunate enough to get a license, rents
that auctions would capture for the public. Coase’s FCC paper fueled intense
public debate in both academic and political circles, and generated a number of
unsuccessful reform proposals (summarized in Hazlett, 1998: Table 2). Coase’s
arguments only began to prevail with the surge of wireless telephony in the 1980s.
The public interest arguments were irrelevant for wireless telephony, while the
FCC lacked the capacity to allocate expeditiously thousands of cellular licenses
through comparative hearings. Increasingly, the US Congress and the presidency
also began to focus on the substantial foregone revenues. The promise of revenues
may explain why reforms to spectrum allocation were attached to budget bills,
first to assign nonbroadcast licenses through lotteries in 1981, and finally to
permit competitive auctions for nonbroadcast licenses in 1993.
5 According to Coase (1993b: p. 239) the idea of using the price mechanism to allocate frequencies
was first proposed in print by Leo Herzel in 1951.
6 The strength of opposition to Coase’s proposal can be seen in subsequent events. The Rand
Corporation commissioned Coase to work with two of its economists to produce a report on radio
frequency allocation. Rand subsequently suppressed the 200-page paper in the face of the controversy.
One comment on the Rand draft, quoted anonymously by Coase stated, “I know of no country on the face
of the globe—except for a few corrupt Latin American dictatorships—where the ‘‘sale’’ of the spectrum
could even be seriously proposed.” (Coase, 1998a: p. 579)

6MARY M. SHIRLEY, NING WANG AND CLAUDE M ´
ENARD
FCC license sales finally began in 1994, and over 30 countries have since used
spectrum auctions. Hazlett et al. estimated that the US government captured
almost $53 billion in FCC auctions from 1994 to 2009, and avoided welfare
losses of $17 billion (2011: p. S125). Yet, as Hazlett et al. contended, these gains
were not Coase’s primary legacy. “What Coase fundamentally contributed was
a symmetric analysis of property regime choices, explaining how the costs of the
‘price system’ were real, but that so were the costs of any alternative” (p. S156).
The problem of social cost
In the FCC paper, Coase suggested that if rights to the radio frequency spectrum
were well-defined and transferable, it would not matter what the initial legal
rights were, they would be traded and combined in ways that maximized
the value of production. A group of economists at the University of Chicago
disagreed with this passage and invited Coase to a meeting at the home of Aaron
Director to discuss “his mistake.” As George Stigler (1988) later described it,
those present, and especially Milton Friedman, strongly objected to Coase’s
“heresy.” Yet by the end of the evening, Coase prevailed and was asked to write
up his arguments in an article for The Journal of Law and Economics. The result,
“The Problem of Social Cost,” is one of the most cited articles in social science.7
Social costs, or “spillovers,” are the costs that arise when a business activity
causes harm to another economic actor, such as when noise from an airport or
smoke from a factory bothers its neighbors. Most economists followed Pigou
(1932), concluding that the firm that caused the noise or smoke should be held
liable for the damage, be subject to a tax equivalent to the potential damage,
and be regulated as to where it can locate. Coase, however, argued that social
costs were reciprocal; the planes caused noise or the factory produced smoke, but
forcing the planes or the factory to eliminate these spillovers imposed costs on
them as well. As in the FCC paper, Coase focused on alternatives: for example,
government regulation or lawsuits by neighbors could induce the airport to
reduce the number of flights, but payments from the airport or the government
could induce the irritated homeowners to soundproof their homes. All these
remedies have costs, which economists should carefully evaluate. As Coase put
it, economists should “compare the total product yielded by alternative social
arrangements . . . the total effect of these arrangements in all spheres of life
should be taken into account” (Coase, 1960: p. 43). The goal should not be to
compare a “state of laissez faire and some kind of an ideal world,” but to “start
our analysis with a situation approximating that which actually exists” (Ibid).
By treating the neglect of social costs as a deficiency in the system, economists
of the Pigou persuasion were not paying enough attention to “other changes in
the system which are inevitably associated with the corrective measure, changes
7 According to Shirley (2013), “The Problem of Social Cost” has been cited more than 20,500 times,
and according to Shapiro and Pierce (2012) it is the most cited law review article of all time.

Ronald Coase’s impact on economics 7
which may well produce more harm than the original deficiency” (Coase, 1960:
pp. 26–27).
This argument was transformative, and “The Problem of Social Cost” did
not stop there. To illustrate the costs of alternative approaches, Coase first
described the problem of social harms if the cost of transacting were zero. Under
such unrealistic circumstances, the airport or factory and its neighbors could
negotiate a bargain to allocate rights in a way that would maximize production
regardless of the legal assignment of those rights—liability would not matter.
As Coase later explained it, liability does not matter with zero transaction costs
because contractual arrangements will be made to modify the rights and duties
of the parties so as it make it in their interest to undertake those actions which
maximize the value of production (Coase, 1990 c: p. 178). It was this argument
that was debated as “heresy” at the famous dinner and that Stigler (1966) later
labeled the Coase Theorem.
Although Coase (1960) called the assumption of costless market transactions
“very unrealistic,” a strangely large number of economics texts and articles
failed to recognize that Coase did not advocate addressing social costs by means
of the Coase Theorem.8In fact, his point was the opposite: because market
transactions, firm administration, and government regulation all have positive
costs, we must measure and compare them. “Satisfactory views on policy can
only come from a patient study of how, in practice, the market, firms, and
governments handle the problem of harmful effects” (1960: p. 18). Even more
importantly, because transaction costs are positive we must study the legal
system and other institutions that determine transaction costs and the security of
property rights. As Coase later advised: “It makes little sense for economists to
discuss the process of exchange without specifying the institutional setting within
which the trading takes place since this affects the incentives to produce and the
costs of transacting” (Coase, 1992: p. 718). This exceptional article, combined
with “The Nature of the Firm,” laid the foundation for two new fields: law and
economics and new institutional economics. “The Problem of Social Cost” had
less effect on the analysis of what most economists call externalities. Although
some economists today, following Coase, consider the reciprocal nature of social
costs and compare the costs of alternative remedies, more view externalities as
harms requiring government taxation or regulation.
Impact of Coase’s ideas
Coase ideas influenced numerous economists (as well as lawyers, political
scientists, and other social scholars), probably none more prominent than Oliver
Williamson and Douglass North. If course, we are well aware that Coase
influence went far beyond these two authors, for example, Alchian, Barzel,
Cheung, and Demsetz, are just a few of his initial accomplices and followers.
8 For more on these misunderstandings, see Shirley, 2013.

8MARY M. SHIRLEY, NING WANG AND CLAUDE M ´
ENARD
Here, we focus on North and Williamson because they likely had the most impact
on economists.
Williamson operationalized the concept of transaction costs by using what he
called “the lens of contract” to explore how managers chose between transacting
in the market versus transacting within the firm in a world of incomplete
contracts and opportunism.9Williamson argued that when buyers and suppliers
make transaction-specific investments, for example, when a supplier builds
specialized machines or acquires specialized skills that have value to only one
buyer, there is room for agents to act strategically. Since it is costly and ultimately
impossible for contracts to specify in detail all eventualities—not everything can
be known in advance—there can be substantial surpluses (quasi-rents) subject
to ex post haggling. Following Coase, Williamson also considered the cost of
the alternative to extensive bargaining and costly haggling—vertical integration.
Vertical integration could be costly, for example, if executives extracted rents in
inefficient ways. Williamson argued that the choice between vertical integration
(make) or a contract in the market (buy) would be determined by the extent
to which assets were relationship-specific and contracts were difficult to write.
These, in turn, would depend upon the frequency and complexity of the
transactions between the buyer and seller, and the institutional framework under
which the agents operated. Williamson’s ideas launched a stream of empirical
research to measure these determinants, which found that vertical integration
was indeed affected by complexity and asset specificity.10 Although Williamson
published more theoretical than empirical research, his focus on ways to measure
real world costs and understand business choices was very Coasean, and his
followers have shown the empirical relevance of his theories.
Douglass North developed Coase’s ideas in a macro and historical direction.
To North, “the most important message [from ‘The Nature of the Firm’], one
with profound implications for restructuring economic theory, is that when it is
costly to transact, institutions matter.” (1990: p. 12). In a piece with (North and
Wallis, 1986) measuring the size of the transaction sector in the US economy,
North found that it is indeed very costly to transact: transaction costs grew to
nearly half of United States GDP in 1970 (Table 3.13: p. 121).
North built on Coase’s insights to address Adam Smith’s basic question:
why are some societies rich and some poor? North believed that the answer
lay in their different institutions, which he defined as the formal and informal
constraints that structure human interaction and reduce uncertainty. Institutions,
together with technology, determine the cost of transaction (and transformation),
and “transaction costs are the most observable dimension of the institutional
framework that underlies the constraints in exchange” (North, 1990: p. 68).
9 See especially Williamson, 1971 and 1975.
10 For a summary of Williamson’s influence on research, see Menard and Shirley, 2014b. For a survey
of the empirical evidence, see Lafontaine and Slade, 2007.

Ronald Coase’s impact on economics 9
To North, transaction costs were high because of information costs (including
measurement), combined with enforcement costs (including uncertainty). Based
on a Coasean analysis of actual countries and history, North concluded that these
costs were higher in poorer countries because the institutions that supported
exchange were weaker. North stressed the same institutions as Coase, such
as contracts enforced by courts, which he saw as one of the explanations for
successful European economic development (North and Thomas, 1973). North
also diverged from Coase, becoming increasingly interested in norms, habits, and
conventions, which he saw as the essential underpinning for written rules (see,
for example, North, 2005).11
Williamson’s and North’s work has spurred extensive empirical research. It
also inspired a new generation of scholars who built on Coase’s original ideas
and furthered his goal of changing the nature of economics through an insider
revolution. Most (although not all) of these followers have conducted research
as Coase advised, emphasizing understanding over quantification and realism
over abstraction.
3. The conduct of economics
Coase always believed that economics should be firmly based on empirical
reality. As Medema (1996) pointed out, Coase defined economics differently
from neoclassical economists, who followed Robbins in defining economics as
the study of rational choices and focused primarily on the determinants of prices
and outputs. In contrast, Coase defined economics as the study of “the social
institutions which bind together the economic system: firms, markets for goods
and services, labor markets, capital markets, the banking system, international
trade and so on.” (Coase, 1990b: p. 41).
In his Nobel Lecture, Coase bluntly reproached the profession for practicing
“blackboard economics”, studying “a system which lives in the minds of
economists but not on earth” (Coase, 1992: p. 714). In blackboard economics,
“all the information needed is assumed to be available and the teacher plays
all the parts. He fixes prices, imposes taxes, and distributes subsidies (on the
blackboard) to promote the general welfare. But there is no counterpart to
the teacher within the real economic system” (Coase, 1990 d: p.c 19). Some
may assume that the government plays the role of the teacher, but, “in real
life we have many different firms and government agencies, each with its own
interests, policies, and powers . . . what the government does is choose among
the social institutions which perform the functions of the economic system” (19).
Blackboard economics “misdirects our attention when thinking about economic
policy. For this we need to consider the way in which the economic system would
11 For a summary of the evolution of North’s ideas and his impact on new institutional economics
see Menard and Shirley (2014a).

10 MARY M. SHIRLEY, NING WANG AND CLAUDE M ´
ENARD
work with alternative institutional structures” (19–20). Coase complained that
economists do too little observation of how the economy actually operates, and
instead paint a picture of an ideal economic system, compare it with what they
think they observe, and then “prescribe what is necessary to reach this ideal state
without much consideration for how this could be done” (28).
Coase’ approach is well illustrated by two well-known examples. In his
1974 article, “The Lighthouse in Economics,” he challenged the classic view
of lighthouses as a public good; since they saved lives and money and there was
no way for the private sector to solve the free rider problem, governments should
provide lighthouses for free.12 Ronald Coase investigated the facts and discovered
that at one time private persons built and maintained many lighthouses in Britain,
which were financed by tolls charged whenever ships put into port. He asked why
so many economists had made misleading statements about lighthouses, leading
them to a policy conclusion that was possibly wrong. His answer reflected what
he considered a gross failing of economics:
“Despite the extensive use of the lighthouse example in the literature, no
economist, to my knowledge, has ever made a comprehensive study of
lighthouse finance and administration. The lighthouse is simply plucked out
of the air to serve as an illustration.., .This seems to me the wrong approach.
I think we should try to develop generalisations which would give us guidance
as to how various activities should best be organized and financed. But such
generalisations are not likely to be helpful unless they are derived from studies
of how such activities are actually carried out within different institutional
frameworks” (Coase, 1974: p. 375).
Coase returned to this theme later in a critique of the Fisher Body case, another
“paradigmatic” example, widely cited in textbooks and elsewhere, to illustrate
the use of mergers to prevent “hold up.” Hold up occurs when, for example,
a business purchases a highly specific input with no reasonable substitute, and
the supplier threatens to interrupt supply unless paid what the purchaser deems
an unreasonably high price. Klein et al.(1978) described cases where vertical
integration would be the least costly way to eliminate this risk. Among these
cases was Fisher Body, which supplied bodies that became essential inputs to
General Motor’s cars. According to Klein et al., GM was dissatisfied with Fisher
Body’s price and its refusal to relocate their plants adjacent to GM’s plants,
while Fisher Body refused to relocate because of the risk that GM might not
pay them enough to recover their specific investment in plant and equipment.
12 Samuelson had a different argument. He maintained that even if it were possible to charge,
lighthouse services should be provided for free, “because it costs society zero extra cost to let one extra
ship use the service; hence any ships discouraged from those waters by the requirement to pay a positive
price will represent a social economic loss” (1966: p. 151). Coase (1974) countered that paying the cost
through general taxation would make the service less responsive to its users and raise administrative costs.
He further argued that the magnitude of the actual tolls and the exemptions for frequent users suggested
that light tolls in the UK were unlikely to have discouraged shipping.

Ronald Coase’s impact on economics 11
Since GM had contracted to deal exclusively with Fisher Body, it could not
convincingly threaten to find another supplier. GM decided instead to merge
with Fisher Body, “because they found the contractual relationship with Fisher
intolerable” (Klein et al.1978: p. 310). Based on in-depth studies of the actual
relationship, Coase (2000,2006) and others disputed Klein et al.’s facts about
Fisher Body, arguing that there was no evidence of hold up. Rather, the merger
occurred because GM wanted to associate more closely with the Fisher brothers,
who had already been appointed to high positions in GM. Coase believed that
the errors in the Fisher Body case stemmed once again from economists’ common
practice of thinking up a theory and then searching the data for facts that fit the
theory
Taking issue with Friedman’s influential paper, “Methodology of Positive
Economics” (1953), Coase (in his 1981 Nutter Lecture) detailed his argument
for realism in constructing economic theories. Friedman argued that a theory
should be judged, not by whether its assumptions are realistic, but by “the
precision, scope, and conformity with experience of the predictions it yields”
(4). Coase regarded this view as neither accurate nor desirable (Coase, 1994b
[1981]). He noted that the many quantitative articles he had reviewed as editor
of the Journal of Law and Economics did not test theories, but rather measured
the magnitude of known effects. He emphasized that, “We are not interested
simply in the accuracy of its [a theory’s] predictions. A theory also serves as a
base for thinking. It helps us to understand what is going on by enabling us to
organize our thoughts” (1994b: p. 16).
Coase’s belief that scholars should define their discipline by its subject matter,
not by its approach, separated him from many mainstream economists who
embraced economics as an opportunity to apply analytical tools, detached from
substantive topics. It also gave rise to some misunderstanding about Coase’s
position on the use of mathematics and the development of quantitative studies
in economics. Coase did criticize economists’ fascination with quantitative tools
and technical problems of measurement, which pushed some, notably Posner,
to accuse Coase of wanting to return to the “simpler, looser, nonmathematical
theory of Adam Smith” (1993: p. 75) and showing a “dislike of abstraction”
(76). Coase took issue with this, arguing that what he objected to was “mindless
abstraction or the kind of abstraction which does not help us to understand
the workings of the economic system.” (Coase, 1993a: 97). Coase believed that
economists should first do the messy work of understanding the actual workings
of the economic system, before translating their findings to mathematics for
further work. It is in the same vein that he criticized “economic imperialism,”
the idea that the economic approach should be applied to other disciplines such
as political science, sociology, or the law. Coase did not doubt the general
applicability of the economist’s toolkit, but he feared that this expansionism
would distract economists from studying the economy, doing a disservice to
economics itself.

12 MARY M. SHIRLEY, NING WANG AND CLAUDE M ´
ENARD
Although Coase’ advice did not halt the trend toward abstraction in
economics, he influenced a growing number of economists who put a realistic
understanding of the real world at the top of their research agenda. This influence
developed mainly through his scientific contributions, but also through his active
interventions in support of his ideas. We turn to his activism next.
4. Coase’s scholarly activism
Coase’s ideas were hugely influential in the development of law and economics
and new institutional economics. He also shaped these movements directly
through his work as editor of the Journal of Law and Economics, founder and
president of the International Society for New Institutional Economics (ISNIE),
and founder, research director, and supporter of the Ronald Coase Institute.13
The journal of law and economics
Coase became editor of the Journal of Law and Economics in 1964 and used
his editorship as a tool to change economics. Landes, Carlton, and Easterbrook
described his approach well:
Coase was the editor as intellectual leader . . . Coase sought out and
encouraged faculty members at Chicago and elsewhere to examine how
particular markets actually worked, what factors determined the types of
transactions and contracts that parties entered into, and the role of laws and
legal institutions in shaping markets (Landes et al.,1983: p. iii–iv).
Coase was an active mentor-editor who pursued articles that overturned
conventional wisdom with carefully researched facts. For example, he was in
the audience when Lee Benham, then an assistant professor at the University of
Chicago Business School, presented a paper challenging the conventional wisdom
that advertising increased costs and monopoly power, and quickly recruited
the paper for the Journal. Benham (1972) compared the price of eyeglasses
in states that permitted and prohibited advertising, and demonstrated for the
first time that advertising could lower transaction costs, intensify competition,
and thus reduce the market price. Similarly, when Coase became aware of
contracts between beekeepers and orchard owners in Washington State, he asked
Steven Cheung, then teaching at the University of Washington, to investigate.
As with lighthouses, apples and bees were treated as a “classic” example of
market failure: apple growers could not charge beekeepers for the food the bees
got from their blossoms (Cheung, 1972: p. 12). Cheung (1973) showed that
contracts between beekeepers and apple growers involved fees to the beekeeper
for pollination services and fees (in the form of honey) to the grower for nectar
13 He also supported, among other academic initiatives, a scholarship program at the University of
Buckingham in the UK and the Contracting and Organizations Research Institute at the University of
Missouri at Columbia in the US.

Ronald Coase’s impact on economics 13
collection. Coase’s contribution as editor was best summed up by Hayek (1984)
in a letter nominating him for the Nobel Prize:
“he has by patient work over many years developed what amounts in effect to
a new branch of economic theory of great realistic application, a development
he has painstakingly assisted by his work as editor of the Journal of Law and
Economics of which he was for 16 years an editor who in a rare manner assisted
and guided his contributors.” 14
Other activities
Coase was later active in promoting new institutional economics (NIE), which
began to take shape as a movement within economics in the 1970’s, as a
loosely organized network.15,16 Scholars committed to studying institutions using
Coasean realism felt isolated from mainstream economists and pushed for an
organization to support their network. This bottom up movement formed a new
group, the International Society for New Institutional Economics (ISNIE), which
was launched on October 4, 1996 when Ronald Coase joined Douglass North
to invite interested scholars to join.17 Ronald Coase’s willingness to be ISNIE’s
first President at the age of 87 was fundamental to its success, persuading others
about the seriousness and importance of the new organization.
In his presidential address to ISNIE in 1999, Coase laid out his views on the
tasks of the Society, views that closely parallel his own approach to research:
“First of all, we are a society with a mission and that mission is to transform
economics. When I speak of economics, I have in mind mainstream economics
as expounded in countries in the West and particularly what is called
microeconomics or price theory. Our mission is to replace the current analysis
with something better, the New Institutional Economics . . . I do not think
that as a society we should attempt to plan what members should do. We do
not know, for the most part, what is true or what is false, what is significant
and what is not, nor the character of the interrelations of various parts of the
institutional structure of the economy. It is our aim to find out.”
14 Coase was one of several important scholars who fostered law and economics; in 1991 the first
session of the American Law and Economics Association honored Guido Calabresi, Ronald Coase,
Henry Mann, and Richard Posner as founders of the field (http://www.amlecon.org/index.html). Coase’s
approach to law and economics differed from Posner’s (see Posner, 1993 and comments). Coase wanted
economists to study the impact of law on the economy, while Posner was interested in using economics
to analyze law (see Posner, 1973). Coase encouraged Posner to start the Journal of Legal Studies in 1972
to appeal especially to legal scholars.
15 Menard and Shirley (forthcoming) explore the history and prospects of NIE in detail.
16 This push toward a network was boosted by Rudolf Richter, who organized, initially with Eirik
Furubotn, an annual research seminar on institutions in Germany starting in the summer of 1983.
17 A small group (Alexandra and Lee Benham, Claude Menard, and Mary Shirley) drafted the letter
and enlisted Coase and North; together with John Drobak, they created the new organization.

14 MARY M. SHIRLEY, NING WANG AND CLAUDE M ´
ENARD
Despite ISNIE’s success, Ronald Coase wanted more than an academic society
focused on annual meetings and in February 2000 he propelled and supported
the creation of the Ronald Coase Institute. The Institute’s goal it to help people
around the world improve their own lives by assisting outstanding young scholars
to study important economic problems in their own countries. In helping to
launch and sustain the Ronald Coase Institute, Coase was furthering his vision
that young scholars, not yet captured by conventional wisdom, can transform
the way we see problems. The Institute also reflected his view that, since we
cannot know in advance which research ideas will be transformative, we should
actively seek and assist scholars neglected by more risk-adverse organizations.
5. The lion in winter
Coase never retired from economics. After stepping down as editor of the Journal
of Law and Economics in 1982 at the age of 72, Coase continued as an active
and devoted scholar, producing a steady flow of academic works until the end of
his life in 2013 at nearly 103. He wrote articles about the lives and work of major
economists (Arnold Plant, Duncan Black, George Stigler, and Aaron Director,
among others), about the interpretation of his earlier ideas [for example, “The
Nature of the Firm: origin, meaning and influence” (1988b), his Nobel speech
(1992), “My Evolution as an Economist” (1995), and “Law and Economics and
A. W. Brian Simpson” (1996) (Coase, 1996)]. He took up several new themes,
such as blackmail (1988a) and accounting (1990a). He also continued to write
about themes that had long preoccupied him, two of which we consider below.
China
Even though Coase had never set foot in China—he was eagerly planning a trip
right before his death—he was puzzled how a civilization so far ahead of Europe
in the 13th century could fall so far behind. China’s extraordinary market reforms
further surprised him. How had market supportive institutions, which could not
have existed in Mao’s era and without which a market economy cannot function,
emerged and developed in only three decades? Coase studied China intensively,
organized the 2008 Chicago Conference on China’s Market Transformation, and
co-authored a book with Ning Wang on how China became capitalist (Coase
and Wang 2012).
The book emphasized three major themes. First, “marginal revolutions,” and
not the central government, played the key role in introducing the market and
entrepreneurship back to China despite the weakness of formal institutions
(particularly the legal system) and the lingering grip of the Communist Party.
These “marginal revolutions,” such as the decollectivization of farms, were
often the result of pressure from below and the push and pull of interests and
governments at the local and provincial levels. Second, regional competition
among provincial and local governments and businesses facilitated knowledge

Ronald Coase’s impact on economics 15
discovery and diffusion, allowing China to capitalize on its continental size and
decentralized political structure. Third, China’s lack of a free and open market
for ideas clouded its future, since a healthy capitalist system depended on the
continuous creation and application of knowledge.
The structure of production revisited
The second subject to preoccupy Coase in later years was the “institutional
structure of production,” which he first dealt with in “The Nature of the Firm.”
Coase came to believe that the economics literature had not fully addressed the
firm’s internal operation and external relations. Economics had barely begun to
explore how the firm operated as a mini society with all its complexity and
fluidity, staffed by individuals with different expertise and diverse interests
and governed by a wealth of internal rules and external regulations. Also
underdeveloped was the question of how firms coordinate their production
through market and nonmarket mechanisms, competing and cooperating while
pursuing their separate goals at almost every stage of production. To promote
more research on these issues, Coase organized the 2010 Chicago Workshop on
the Industrial Structure of Production (Coase and Wang, 2011).
6. A beautiful mind
Ronald Coase left us a rich legacy of profound insights from his scholarly work
and bequeathed us new fields of research (law and economics, institutional
economics) that he helped establish. He also set a stellar example in his
willingness to challenge conventional wisdom, reverence for facts and empirical
inquiry, enthusiasm for new and old puzzles, tolerance for different points of
view, and generosity toward other researchers.
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