You are here: Home > Opinion > Editor's Pick

When the Coase Theorem met Chinese reality

: 0 Comment(s)Print E-mail China.org.cn, October 29, 2013

Adjust font size:

Ronald Coase [File photo]

The Observer: Professor Coase said many times that the Coase Theorem should be understood as saying that transaction costs cannot be neglected and that the initial allocation of property rights influences the final resource distribution. But many Chinese scholars interpret it as saying if transaction costs are zero, private transactions can solve the problems of externality. Coase complained that discussions that assume zero transaction costs have nothing at all to do with his work. How should we understand this misrepresentation of the Coase Theorem by domestic scholars?

Chen: The biggest misunderstanding of Coase in China is that he has been hailed as greatest economist after Adam Smith and a rival to Karl Marx. Actually, Coase was among the most controversial of Nobel Prize laureates. Many economists opposed his receiving the prize, including Paul Samuelson, Leonid Hurwicz and James Buchanan. From this point of view, his biggest contribution to economics was that he triggered a huge debate among neoclassical economists, especially on price theory and institutional theory.

In fact, Coase was unable to clearly define the Coase Theorem because his thinking was confused. His observations yielded many results that conflicted with his theory. He was faced with either respecting reality or giving up his faith. On the one hand, he rejected blackboard economics; on the other hand, he clung to price theory.

My own research into the division of labor has convinced me that it has smashed the symmetry of space. The Industrial Revolution smashed the symmetry of time and space. Afterwards we saw imbalances in economic growth as the new superseded the old. The fatal weakness of neoclassical economics is that it presupposes the equality of the two sides in a transaction. But do rich and poor have equal power in negotiations? Is a war between an army equipped with swords and one armed with machine guns fair? Is the social contract between the rich and the poor arrived at by fair negotiations or by force?

The Observer: U.S. discourse has fabricated the myth that the Western system can deliver both wealth and social justice. The Coase theory of transaction costs is an important theoretical support to this myth. According to Coase, the free trade of property rights can reduce transaction costs and solve social conflicts without intervention by the government or the public. But research shows that transaction costs, as a percentage of U.S. GDP, have doubled over the past hundred years. Why is this?

Chen: I must say that, although it has some insights, the Coase Theorem as a whole is mistaken. It is true that transaction costs have fallen as a result of technological progress. But the reduction is small and costs will never reach zero. Meanwhile, technological progress also brings about market development which complicates the division of labor, increases network effects and therefore transaction costs.

This article was first published in Chinese and translated by Li Shen.

Opinion articles reflect the views of their authors, not necessarily those of China.org.cn.

Previous 1 2