24 April 2013

He Said It: Coase

"The government is, in a sense, a super-firm (but of a very special kind) since it is able to influence the use of the factors of production by administrative decision. But the ordinary firm is subject to checks in its operations by the competition of other firms, which might administer the same activities at lower cost and also because there is always the alternative of market transactions as against organisation within the firm if the administrative costs become too great. The government is able, if it wishes, to avoid the market altogether, which a firm can never do. The firm has to make market agreements with the owners of the factors of production that it uses. Just as the government can conscript or seize property, so it can decree that factors of production should only be used in such-and-such a way. Such authoritarian methods save a lot of trouble (for those doing the organising). Furthermore, the government has at its disposal the police and the other law enforcement officials to make sure that its regulations are carried out.

"It is clear that the government has powers which might enable it to get some things done at a lower cost than could a private organisation (or at any rate one without special governmental powers). But the governmental administrative machine is not itself costless. It can, in fact, on occasion be extremely costly. Furthermore, there is no reason to suppose that the restrictive and zoning regulations, made by a fallible administration subject to political pressure and operating without any competitive check, will necessarily always be those which increase the efficiency with which the economic system operates. Furthermore, such general regulations which must apply to a wide variety of cases will be enforced in some cases in which they are clearly inappropriate. From these considerations it follows that direct governmental regulation will not necessarily give better results than leaving the problem to be solved by the market or the firm. But equally there is no reason why, on occasion, such governmental administrative regulation should not lead to an improvement in economic efficiency. This would seem particularly likely when, as is normally the case with the smoke nuisance, a large number of people are involved and in which therefore the costs of handling the problem through the market or the firm may be high.

"There is, of course, a further alternative, which is to do nothing about the problem at all. And given that the costs involved in solving the problem of regulations issued by the governmental administrative machine will often be heavy (particularly if the costs are interpreted to include all the consequences which follow from the Government engaging in this kind of activity), it will no doubt be commonly the case that the gain which would come from regulating the actions which give rise to the harmful effects will be less than the costs involved in Government Regulation."

--Ronald H. Coase, "The Problem of Social Cost," Journal of Law and Economics 3 (October 1960), pp. 17-18.

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