WHEN THE REVOLUTION WAS A PARTY: HOW PRIVATIZATION WAS INVENTED IN THE 1960S

Author: By David Warsh, Globe Staff

Date: Sunday, October 20, 1991
Page: A33
Section: BUSINESS

At one remarkable dinner party in 1960, Coase converted the economics department of the University of Chicago to his views on regulation and privatization. The rest, as they say, is history. The story of that evening is one of the most wonderful episodes in scholarship; it offers lessons for liberals as well as conservatives.

A little background: As a 21-year-old graduate student in the early 1930s, Coase had become interested in why things were organized in capitalist economies as they were, with a few giant firms dominating some markets and other industries characterized by much different arrangements. A Socialist, he had called on presidential candidate Norman Thomas while on a traveling scholarship, but he had called on Ford and General Motors as well.

"Lenin had said that the economic system in Russia would be run as one big factory," Coase recalled a few years ago. ". . . Economists in the West were engaged in a grand debate on the subject of planning, some maintaining that to run the economy as one big factory was an impossibility. And yet there were factories in England and America.

"How did one reconcile the impossibility of running Russia as one big factory with the existence of factories in the West?"

The answer on which he hit to explain both cases was the idea of what he then called marketing costs, everything from finding workers to advertising products. These transactions costs, as they have come to be known -- including search and information costs, bargaining and decision costs, policing and enforcing costs -- are crucial to understanding both big corporations and command economies; the Nobel citation last week compared Coase's identification of them to the discovery of a new set of elementary particles in physics. But this is clearer to us now than it was then. Coase's arguments about the logic of economic organization, published in 1937, were all but ignored for 40 years.

By the 1950s, the restless Coase had moved to America and was ranging far beyond his study of the firm. If the subtle contracts implied by these ubiquitous costs were the essence of economic life, he reasoned, then attention should be paid to the laws by which those contracts were enforced. He became especially interested in broadcasting, where the theory of natural monopoly was deeply ensconced. And in 1958, he mailed a paper called "The Federal Communications Commission" to the citadel of market capitalism that was the economics department of the University of Chicago.

What Coase argued sounds unexceptionable today: That government itself could often make a market in scarce goods that otherwise would enjoy no market. Mildly, he wrote: "Whether a newly discovered cave belongs to the man who discovered it, the man on whose land the entrance to the cave is located, or the man who owns the surface under which the cave is situated is no doubt dependent on the law of property. But the law merely determines the person with whom it is necessary to make a contract to obtain the use of the cave.

"Whether the cave is used for storing bank records, as a natural gas reservoir, or for growing mushrooms, depends, not on the law of property, but on whether the bank, the natural gas corporation, or the mushroom concern will pay the most in order to be able to use the cave."

The cave, by analogy, was little different from the radio spectrum, for which a system of tradeable property rights could be devised as well.

But back in 1958, this was heresy, and Chicago recognized it. Aaron Director, the celebrate Chicago economist who had founded The Journal of Law and Economics, invited Coase to dinner in Chicago -- along with Milton Friedman, George Stigler, Lloyd Mints, Arnold Harberger, John McGee and another dozen academic stars. When the evening began, the vote against Coase was 20 to 1, Stigler recalls, and it would have been worse if Coase hadn't been allowed to vote. At a certain point, "Milton Friedman opened fire and the bullets hit everyone but Coase," he says.

By the end of the evening, Coase had converted them all, and according to John McGee and Steven Cheung, "the debaters stumbled out into the evening air in a state of shock, mumbling to each other that they had witnessed intellectual history." (The episode is recalled in detail in a special 1983 issue of The Journal of Law and Economics.)

What exactly had happened in those few hours of sharp and lofty talk? Nothing less than 150 years of conventional wisdom on the role of goverment had been overturned, quickly and completely, at the level of expert debate. The Chicagoans had gone into the room believing, along with liberals, that there were certain indispensable services that goverment had to provide
because markets couldn't be made to offer them. They had walked out with a new
vision of what government might accomplish through the clever establishment of property rights. Over the next 30 years, they persuaded most liberal economists of the acuity of their intuition.

Practical consequences? Plenty of them. The intellectual underpinnings of everything from accident law to takeover regulation to the structuring of environmental pollution requirements have been rethought in the last 30 years as a result of the conversions that took place that night. Ironically, this ''Coaseian revolution" was led by lawyers, who were quicker than most economists to see the point (though often they pushed it a bit too far).

This sort of phenomenon goes right to the heart of our questions about the ''scientific" status of modern economics. Is it merely dogma, manipulated according to arcane internal rules by its acolytes, as many writers have maintained? Or does it, like the incomparably more successful natural sciences, have some deep and mysterious connection to "the way the world works," a connection whose intricacy can be scouted out through careful observation and experiment?

Mao Tse Tung had opined that "a revolution is not a dinner party," meaning that the rules under which society will function must be hammered out in the rough and tumble of politics, complete with force. Certainly the story of Coase's theorem suggests the opposite possibility -- that economics is capable of producing a kind of truth, which as the saying goes, can never be told in such a way as to be understood without being believed. The reception of Coase's ideas may have taken 50 years, but in the end it has been irrespective of national politics -- as compelling in China as in Spain.

So why did it take so long to award Ronald Coase a Nobel Prize? The answer is that the Swedes have gone out of their way to signal their sense that mathematization was crucial to the formation of modern technical economics. Two years ago they even gave the prize to Norwegian Trgvye Haavelmo for a long-ago contribution to statistical inference.

But Coase has conducted a long and powerful rearguard action against the widespread use of mathematics, which he sees as way of empowering uniformed would-be philosopher-kings. "Blackboard economics," he calls it. The high point of this exercise was a 1974 essay on the history of the law and administration of lighthouses, which showed it to have been exactly the opposite of what economic theorists routinely had asserted to be the case: an excruciating critique of the first few Nobel laureates.

"In my youth it was said that what was too silly to be said may be sung. In modern economics it may be be put into mathematics," he has written. Now the Swedes have forcefully acknowledged the possibility that he is right, after all.

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