Coase's Twin Towers: The Relation between the Nature of the Firm and the Problem of Social Cost

Abstract

Ronald Coase's The Nature of the Firm (The Firm) may well be the second most cited article in law and economics. Usually, calling something second best is a backhanded compliment. But in this case the praise is sincere, for Coase also wrote the most cited article, The Problem of Social Cost (Social Cost). Much ink has been spilled over each article. Both are justly famous, and together they make Coase a richly deserving recipient of the Nobel Prize in Economics.

The Firm, published in 1937, is most often studied by corporate law or industrial organization specialists (although we should remember Coase's lament that until the 1970s it was "often cited, and little used"). The 1960 Social Cost article — and the Coase Theorem it spawned — has a wider following. Often, then, the two articles are not examined together. But insights can be had by viewing them as responses to the same basic inquiry.

The two articles are linked thematically. Both emphasize the centrality of transaction costs in studying markets and market alternatives. Despite the similarities in theme, the reception of the two articles within law and economics has been quite different. The Firm has been criticized by free-market advocates as flawed or misleading, and many find it contrary to modern conceptions of the firm as a "nexus of contracts." Social Cost and its Coase Theorem, on the other hand, has been applauded and defended by this same school. The attacks on the Coase Theorem largely come from outside law and economics, particularly by "leftists."

Coase has said he does "not wish to discuss why these two articles, using so similar an approach, should have been received so differently." This essay will begin that discussion.

Keywords: social costs, transaction cost, markets, law and economics