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Opening Address to the Annual Conference
International Society of New Institutional Economics
Washington, DC, USA
September 17, 1999
Ronald Coase
It is a great pleasure for me to
take part in the Third Annual Meeting of the International Society
for New Institutional Economics. It is a great occasion for all of
us, and for economics. What I have decided to talk about is the task
of our Society. What I will be giving you are my personal views.
They may not commend themselves always to other officers of the
Society. Indeed, I’m fairly sure they won’t. But there are two
distinctive features of our Society about which no one will dispute.
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 as it has been
termed by our President-elect, Oliver Williamson. I have no doubt
that we will accomplish our mission. But there is still the question
of how we are going to do it. This I will discuss later.
The second distinctive feature of
our Society is that it is an international society. It is not an
American society that foreigners can join. Our Society is truly
international as is made clear by the countries of origin of
presenters of papers at this meeting as well as their subjects, and
of course, by the composition of our membership. I have no doubt
that our international character will prove to be a great source of
strength. We will be able to draw on the experience and the talent
in countries all over the world. This is particularly important for
the New Institutional Economics since if we are to understand the
effect of different institutional arrangements on the working of the
economic system, the obvious way to do this is to enlarge our
studies beyond a single country and to compare what happens in
different countries with differing arrangements.
It is a great pleasure to me that,
through the generosity of the Earhart Foundation, so many from
countries in transition from a command to a market economy have been
able to attend this meeting. Theirs is an unenviable task but one
which merits our support. I am reminded of a tale told to me by
Frank Paish, a colleague at the London School of Economics. He was
once walking in the country in England and he asked a countryman how
he could get to a certain place. The countryman replied, after
considerable thought, "If I were going there, I wouldn’t
start from here." That’s how I feel about the plight of our
members in the countries in transition to a market economy. We are
certainly going to learn a great deal from their experience about
what the requisites are for an efficient market system. And I hope
that in some way our discussions will be of help to those in
countries in transition who have to tackle this formidable task.
Let us return to our mission.
Economics, over the years, has become more and more abstract and
divorced from events in the real world. Economists, by and large, do
not study the workings of the actual economic system. They theorize
about it. As Ely Devons, an English economist, once said at a
meeting, "If economists wished to study the horse, they wouldn’t
go and look at horses. They’d sit in their studies and say to
themselves, ‘What would I do if I were a horse?’" And they
would soon discover that they would maximize their utilities. What
has happened, as Harold Demsetz explained, is that economists have
been fascinated by Adam Smith’s great insight — that the
economic system could be coordinated by a system of prices without
the need for the existence of a plan. And it is fascinating. As
Hayek has said, it mobilizes that diffused knowledge that exists
throughout the world. If people in Singapore learn something about a
commodity that causes them to want to use more of it than they have
in the past, they enter the market, the additional demand drives up
the price, and consumers in Sweden, Spain, and other places reduce
their consumption so that consumers in Singapore, of whom they are
completely unaware, may consume more.
But this is not the end of the
story. The higher price which emerges for this commodity makes it
profitable for resources previously engaged in the production of
quite different commodities to be used to increase its supply. This
decrease in the supply of these quite different commodities
increases their price, and consumers of these commodities in
Germany, the United States and Burkina Faso reduce their consumption
of them, which moderates the price rise experienced by consumers in
Sweden and Spain and makes possible a smaller reduction in their
consumption than would otherwise be the case. It’s a wonderful
system. Roy Harrod, who attended Edgeworth’s
If we are to understand the effect
of different institutional arrangements on the working of the
economic system, the obvious way to do this is to compare what
happens in different countries with differing arrangements.
lectures, used to tell how
Edgeworth, when he reached the point in his lectures at which price
equated supply and demand, would pause so that he and the class
could savour this magic moment. But by stopping their analysis at
this point, economists fail to answer one fundamental question: what
determines what goods and services are traded on markets and
therefore priced? What determines the flow of real goods and
services and therefore the standard of living?
We can start to answer this
question by going back to Adam Smith. He explained that the
productivity of an economic system depends on specialization (he
called it the division of labour) but as is obvious there can only
be specialization if there is exchange, and whether exchange is
possible depends on the costs of exchange (transaction costs as they
have come to be called). Here we have to leave Adam Smith since,
apart from his discussion of why the use of money is better than
barter, he does not, if my memory serves me, discuss the subject.
However, we know that the costs of exchange depend on the
institutions of a country — the legal system (property rights and
their enforcement), the political system, the educational system,
the culture. These institutions in effect govern the performance of
the economic system. This is the basic reason why the New
Institutional Economics is so important and why, if we are to
achieve our objective, we have to enlist the help of lawyers,
political scientists, sociologists, anthropologists and other social
scientists. This, of course, is what we are going to do in our
Society. The entry of economic analysis into the other social
sciences has been termed economic imperialism. We are engaged in a
completely different enterprise — enlisting the help of those in
the other social sciences to enable us to understand better how the
economic system works.
The need for a shakeup in economics
is demonstrated, so far as I am concerned, by its static character.
It is still the subject that Adam Smith
Economists fail to answer one
fundamental question: What determines what goods and services are
traded on markets and therefore priced? What determines the flow of
real goods and services and therefore the standard of living?
created. We have formalized it,
elaborated it, corrected errors, changed its emphasis, but
essentially it is the same subject. Physics has been completely
transformed since Newton and chemistry since Lavoisier, but not
economics since Smith.
The static character of economics
can be made crystal clear by comparing economics and biology.
Economists take pride in the fact that Darwin was influenced by
Malthus — and he was influenced also, as I learned from Stephen
Jay Gould, by Adam Smith. But contrast what has happened in biology
since Darwin with what has happened in economics since Adam Smith or
Malthus. Biology has been transformed. In The Economist
earlier this month (the issue of September 4th) it was stated:
"Biology is rapidly becoming as ‘hard’ a science — in all
senses — as physics." Biologists have not rejected Darwin —
evolution is still the core of the subject — but they look at
biological processes in a completely different way. Similarly, I am
not rejecting Adam Smith. We should not abandon his great insights.
But I do advocate changes that will ultimately transform economics
from a "soft" science into a "hard" science and
in bringing this about I expect our Society to play a major role. It
may seem strange that I am hoping to transform a soft science into a
hard science by linking it with subjects which by repute are even
softer than economics. But there is no other way. We have to take
account of the effects of the legal system, the political system,
etc. And if my impression is correct, their theories often have a
stronger empirical base than is usual in economics. Of course, one
would also hope that those social scientists attracted to the New
Institutional Economics would be those who believed in rigour. To
those who may feel offended by what I have said about the other
social sciences, I would like to quote to you what I said about law
in the Simons lecture on "Law and Economics at Chicago" in
1992. "Ernest Rutherford said that science is either physics or
stamp collecting, by which he meant, I take it, that it is either
engaged in analysis or in operating a filing system. Much, perhaps
most, legal scholarship has been stamp collecting. Law and economics
is likely to change all that…."
The great triumph of modern biology
was the discovery by Watson and Crick of the structure of DNA. But
to think of its discovery simply in terms of their work is to ignore
that it was the culmination of the work of many people over many
years. Horace Judson at the end of his survey of the history of
modern biology has this to say: "Biology has proceeded not by
great set-piece battles, but by multiple small-scale encounters —
guerrilla actions — across the landscape. In biology, no
large-scale, closely interlocking, fully worked out, ruling set of
ideas has ever been overthrown…. Revolution in biology, from the
beginnings of biochemistry and the study of cells, and surely in the
rise of molecular biology and on to the present day, has taken place
not by overturnings but by openings-up."1
I think this resembles exactly what
I believe will happen in economics. The influence of the New
Institutional Economics will be exerted in the various
sub-disciplines of economics. Guerrilla actions will take place,
which will result in the New Institutional Economics dominating
first one and then another of these sub-disciplines, as indeed is
beginning to happen. When this process has gone on for some time,
the leaders of our profession will find themselves Kings without a
Kingdom. There will be no overturning, but in Judson’s words, an
opening-up. We will not replace price theory (supply and demand and
all that) but will put it in a setting that will make it vastly more
fruitful.
I think we can take heart from what
Francis Crick has said about developments in modern biology in his
book What Mad Pursuit. I will quote some of the things he has
said. They seem to me very relevant to any discussion of our plans
and projects because we are dealing with a subject which has been
extraordinarily successful in modern times, in contrast to
economics, where the performance has, in my view anyway, been
somewhat dismal. I like what Crick says because he stresses the
pitfalls in theoretical approaches and the need for empirical work.
As you probably know, progress in
biology was greatly helped by the movement of physicists into
molecular biology. This is what he says: "In nature, hybrid
species are usually sterile, but in science the reverse is
In economics our choice of theories
will only be fruitful if guided by empirical work.
often
true. Hybrid subjects are often astonishingly fertile, whereas if a
scientific discipline remains too pure it usually wilts."2
This bodes well for us since the New Institutional Economics is a
hybrid subject if ever there was one. So this should give us a lot
of encouragement. Certainly the entry of economists into the study
of law has had a very beneficial effect. And I would expect that the
intermingling of these other social sciences with economics would
exert a powerful, and beneficial, influence on the development of
economics.
Crick also says, "In research
the frontline is almost always in a fog."3 This is
inevitable since the frontline is always dealing with unsolved
problems, with
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.
the data either unavailable or
seemingly inconsistent. So we shouldn’t feel discouraged if we are
in a fog. The job, after all, of the frontline is to dispel it. Of
course, to be in a fog is not necessarily a sign that you are in the
frontline.
Then again Crick says: "[I]t
is virtually impossible for a theorist, by thought alone, to arrive
at the correct solution to a set of biological problems…. The best
a theorist can hope to do is to point an experimentalist in the
right direction...."4 This is, for example, what the
concept of transaction costs does. It does not of itself solve any
problems but it does suggest what should be looked at to find the
solutions.
Crick also says this: "It is
all too easy to make some plausible simplifying assumptions, do some
elaborate mathematics that appear to give a rough fit with at least
some experimental data, and think one has achieved something. The
chance of such an approach doing anything useful, apart from
soothing the theorist’s ego, is rather small...."5
I think you know why I like this quotation.
Finally: "The basic trouble is
that nature is so complex that many quite different theories can go
some way to explaining the results....[W]hat constraints can be used
as a guide through the jungle of possible theories? It seems to me
that the only useful constraints are contained in the experimental
evidence."6 What this comes down to in economics is
that our choice of theories will only be fruitful if guided by
empirical work.
What does all this mean for our
Society? How are we to find our way through the mass of information
such as is revealed by the papers presented at this meeting? How are
we to emulate the triumphs of modern biology? How are we to convert
the New Institutional Economics into a hard science? My answer
To discover even roughly how the
institutional structure of production and exchange works will take a
long time – but it will be a most interesting journey.
to these questions is essentially
Hayekian. 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.
We can make suggestions. We can help. But to reach our goal, it is
better that members should be free to choose the problems they work
on. And because of this we should be tolerant of opposing views.
Sidney Webb, a founder of the London School of Economics, a
socialist and later someone who was taken in by Joseph Stalin (in
which he had a large company), said, and he was a good scholar, that
research consisted of shooting arrows into the air to find out where
the targets were. This means that we should leave people free to
shoot their arrows into the air, and those arrows that find no
targets are nonetheless extremely useful.
Of course, to discover even roughly
how the institutional structure of production and exchange works
will take a long time — but it will be a most interesting journey.
But we do need to create an esprit de corps to sustain us on the
journey. In my talk at the first meeting of our Society, I quoted
Tolstoy’s description in War and Peace of Kutuzov, who led
the Russian troops in battle against Napoleon’s invading army. I
will do so again:
From long years of military
experience he had learned, and
with the wisdom of old age he had
recognized that one man
cannot guide hundreds of thousands of men
struggling with
death, that the fate of battles is not decided by
the orders
given by the commander-in-chief, nor the place in which
the
troops are stationed, nor the number of cannons, nor of
killed,
but by that intangible force called the spirit of the
army, and
he followed that force and led it as far as it lay in
his power.
Our success does not depend on the
number of papers written nor the number of citations nor the number
of prizes gained by our members. It depends on the spirit of the
Society. We have made a good start.
Footnotes
1 Horace
Freeland Judson, The Eighth Day of Creation: Makers of the
Revolution in Biology, New York: Simon and Schuster (1979), p. 612.
2Francis Crick, What Mad Pursuit: A Personal View of
Scientific Discovery, New York: Basic Books (1988), p. 150.
3 Ibid., p. 35.
4 Ibid., pp. 109-110.
5 Ibid., pp. 113-114.
6 Ibid., p. 141.
Note:
This speech was the opening address to the annual conference of the
International Society for New Institutional Economics, delivered in
Washington, D.C. on September 17, 1999. It is reprinted with
permission from the Newsletter of the International Society for New
Institutional Economics, Volume 2, Number 2 (Fall 1999).
http://www.isnie.org
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