Ronald Coase RIP

University of Chicago Law Professor and Nobel Laureate Ronald Coase died yesterday at age 102. Coase was hired by the University of Chicago in 1964, despite not having a law degree. While such hires are not uncommon today, this was basically unheard of at the time. It was definitely a risk that paid off, however, as Coase is credited with basically inventing the Law & Economics movement (a feat all the more impressive given that he did it in what was basically a throwaway paragraph in a piece otherwise about telecommunications law).

Coase's two best known works were "The Nature of the Firm," first published in 1937 (though based on a lecture he delivered in 1932), and "The Problem of Social Cost," published in 1960. The latter is the most-cited law review article of all time. He was awarded the Nobel Prize in 1991, in substantial part because of the massive impact of these articles. The delay in recognition was not lost on him. As he remarked at the time: "It is a strange experience to be praised in my eighties for work I did in my twenties." Speaking of bons mots, Coase is also credited with coining the popular statistics maxim: "If you torture the data long enough, it will confess."

The "Coase Theorem" (he didn't name it), derived from his body of work, is perhaps Coase's most enduring contribution. In a nutshell, the theory holds that if a right to avoid a harm is tradeable and there are zero transaction costs, the market process will result in an efficient allocation of rights regardless of their initial distribution. The Coase theorem is often described as one of the most misunderstood and misapplied concepts in law. Cognizant of these risks, I resolved to not try to apply it at all -- a bold decision for a University of Chicago law student. Nonetheless, based on my classroom recollections I think Wikipedia's illustration of the concept is solid:

For example, two property owners own land on a mountainside. Property Owner #1's land is upstream from Owner #2 and there is significant, damaging runoff from Owner #1's land to Owner #2's land. Four scenarios are considered:

(1) If a cause of action exists (i.e. #2 could sue #1 for damages and win) and the property damage equals $100 while the cost of building a wall to stop the runoff equals $50, the wall will probably exist. Owner #1 will build the wall, or pay Owner #2 between $1 and $50 to tolerate the runoff.

(2) If a cause of action exists and the damage equals $50 while the cost of a wall is $100, the wall will not exist. Owner #2 may sue, win the case and the court will order Owner #1 to pay #2 $50. This is cheaper than actually building the wall. Courts rarely order persons to do or not do actions: they prefer monetary awards.

(3) If a cause of action does not exist, and the damage equals $100 while the cost of the wall equals $50, the wall will exist. Even though #2 cannot win the lawsuit, he or she will still pay #1 some amount between $51 and $99 to build the wall.

(4) If a cause of action does not exist, and the damage equals $50 while the wall will cost $100, the wall will not exist. #2 cannot win the lawsuit and the economic realities of trying to get the wall built are prohibitive.

Importantly, the legal allocation of rights does affect the distribution of who has to pay how much.

Coase continued to write well past the century mark -- his last book, How China Became Capitalist, was published only last year. He was a giant in his field, a giant in academia in general, and his contributions will be missed. As a friend of mine said: "May there be no transaction costs in heaven."