The Institute Blog

Saving Economics from the Economists - A Tribute to the Late Ronald Coase

Editor's Note: On Monday, Nobel Prize winning economist Ronald Coase passed away at 102. Though Coase was a self-decribed "accidental" economist who taught at the University of Chicago's Law School rather than its economics department, his work on transaction costs in  "The Nature of the Firm" and "The Problem of Social Cost" were major contributions in the history of economic thought. As a tribute to Coase, below is an article he wrote in 2012 on the need to reform economics and reconnect it with the real world. The article appears here courtesy of the Harvard Business Review, where the piece originally ran

Economics as currently presented in textbooks and taught in the classroom does not have much to do with business management, and still less with entrepreneurship. The degree to which economics is isolated from the ordinary business of life is extraordinary and unfortunate.

That was not the case in the past. When modern economics was born, Adam Smith envisioned it as a study of the “nature and causes of the wealth of nations.” His seminal work, The Wealth of Nations, was widely read by businessmen, even though Smith disparaged them quite bluntly for their greed, shortsightedness, and other defects. The book also stirred up and guided debates among politicians on trade and other economic policies. The academic community in those days was small, and economists had to appeal to a broad audience. Even at the turn of the 20th century, Alfred Marshall managed to keep economics as “both a study of wealth and a branch of the study of man.” Economics remained relevant to industrialists.

In the 20th century, economics consolidated as a profession; economists could afford to write exclusively for one another. At the same time, the field experienced a paradigm shift, gradually identifying itself as a theoretical approach of economization and giving up the real-world economy as its subject matter. Today, production is marginalized in economics, and the paradigmatic question is a rather static one of resource allocation. The tools used by economists to analyze business firms are too abstract and speculative to offer any guidance to entrepreneurs and managers in their constant struggle to bring novel products to consumers at low cost.

This separation of economics from the working economy has severely damaged both the business community and the academic discipline. Since economics offers little in the way of practical insight, managers and entrepreneurs depend on their own business acumen, personal judgment, and rules of thumb in making decisions. In times of crisis, when business leaders lose their self-confidence, they often look to political power to fill the void. Government is increasingly seen as the ultimate solution to tough economic problems, from innovation to employment.

Economics thus becomes a convenient instrument the state uses to manage the economy, rather than a tool the public turns to for enlightenment about how the economy operates. But because it is no longer firmly grounded in systematic empirical investigation of the working of the economy, it is hardly up to the task. During most of human history, households and tribes largely lived on their own subsistence economy; their connections to one another and the outside world were tenuous and intermittent. This changed completely with the rise of the commercial society. Today, a modern market economy with its ever-finer division of labor depends on a constantly expanding network of trade. It requires an intricate web of social institutions to coordinate the working of markets and firms across various boundaries. At a time when the modern economy is becoming increasingly institutions-intensive, the reduction of economics to price theory is troubling enough. It is suicidal for the field to slide into a hard science of choice, ignoring the influences of society, history, culture, and politics on the working of the economy.

It is time to reengage the severely impoverished field of economics with the economy. Market economies springing up in China, India, Africa, and elsewhere herald a new era of entrepreneurship, and with it unprecedented opportunities for economists to study how the market economy gains its resilience in societies with cultural, institutional, and organizational diversities. But knowledge will come only if economics can be reoriented to the study of man as he is and the economic system as it actually exists.

Comments

0

It's sad that this is thought to constitute a tribute to Coase, when it is so self-serving. Naturally the Harvard Business Review wants to tout a focus on 'entrepreneurship' but maybe they could leave Coase out of it? The idea that modern economics focuses on government, as if it is some direct descendant of Soviet planning, is more than a little ridiculous. Modern economics has many problems but this is definitely not one of them! And I am fairly certain Coase would have agreed.

0

Thank you. Good article, and a fitting tribute.
I have been around a long time and I am struck by the difference between economic theory and the conduct of real world business. Business people and economists stand on opposite sides of a field, and from time to time the business world entices an economist over to its side only for the purpose of providing an intellectual rationalization for a particular business-conduct practice. For example supply-side economics is often little more than a justification for individual greed which at an extreme has the societal impact of constricting the money supply. When James Carville during Bill Clinton's first Presidential campaign told the campaign staff "It's the economy, Stupid", he wasn't talking about classroom or graduate school economics.

0

The problem is not insufficient empirical focus: Einstein didnt prove his theories empirically: others did ...after he had formulated them. Whether explicitly or tacitly, empirics follow (corroborate, by confirming or falsifying) theory.

Neither is the problem that economics "has nothing to do with business management" --although elementary micro-economics can certainly help it (even though I haven't seen most businesspeople base their pricing on systematic analysis of the elasticity of demand, for example, although my sampling may well be distorted, so I'd be surprised that sophisticated organizations dont use it). For the disciplin'es scope is much larger: social organization (that it regards under a specific light). So "a tool the public turns to for enlightenment about how the economy operates" is not essentially different from "an instrument the state uses to manage the economy."

To understand the limitations of economics, we need to see it exactly for what it is: no longer the study of oikos nomia (the management of the household, i.e. of society), but a "catallactics" --a theory of prices, i.e. of (market) exchange, i.e. of choice: a technique of constrained maximization.

Hence Coase's relevant point: "At a time when the modern economy is becoming increasingly institutions-intensive, the reduction of economics to price theory is troubling enough. It is suicidal for the field to slide into a hard science of choice, ignoring the influences of society, history, culture, and politics" If only becasue choices are always choices among options ...that are defined by "society".

Of course, in the face of this reality, most economists find themselves at a conceptual loss: they are like a physician who discovered that the cause of cancer lies in the toxics present in everything we eat, or in modern-day stresses --the problem is not a nail ...but economists only have a hammer!

The problem of inadequate understanding of coordination is heightened --indeed made unsolvable-- by the "mathematization of the discipline" i.e. by in practice defining "economics" as what can be expressed in quantifiable variables --anything else being virtually indistinguishable from poetry. By virtue of this definitory criterion, however, Adam Smith himself would not be recognized as an economist (as Anatole Kaletsky has pointedly observed)! The economist is not the author of the metaphor of the invisible hand (that captured economics's founding insight: the Pareto optimality of unfettered markets, that defined the discipline's conceptual framework and thus its "scope and method") --only Debreu and Arrow, who proved Adam Smith's discovery, would.

The tacit assumption (derived from a positivist epistemology) means that nowadays there is no "science" in the (premathematical) phase of "scientific discovery," as Marc Blaug put it, only the formulation of "scientific proof" (theoretical coherence or empirical corroboration). The problem, of course, is that you cannot prove anything that has not first been revealed ("Hay que mostrar antes que demostrar" as Octavio Paz's untranslatable Spanish quip sums it up). In other words, by identifying economics to analysis, economists have excluded synthesis from the province of what qualifies as "economics." And thereby, they have evinced from admissible discussion the representation of the whole that presides over specific theory and models (what Schumpeter called the "preanalytic vision" that frames theorization, years before Thomas Kuhn defined and popularized the notion with the concept of "paradigm"). In other words, the mathematization of the discipline has demarcated the very synthetic redefinitions that it would need for a fundamental renewal ...out of the scope of admissible pursuit, funding and publication!

0

"At a time when the modern economy is becoming increasingly institutions-intensive, the reduction of economics to price theory is troubling enough. It is suicidal for the field to slide into a hard science of choice, ignoring the influences of society, history, culture, and politics on the working of the economy."

Economics is a supremely crucial science in constant revision and update. If it is to be a useful science, it must involve communication. It follows that economists ignorant of recent discoveries in the sciences of communication, by which I mean 'mutual fortification' rather than the more restricted and non-mutual 'messaging' ordinarily meant by that word, are wasting everyone's time. So how is it that I almost never read about the assumptions relating to effective communication that professional economists depend on? Are those assumptions in any particular situation presumed by economists? If so, then economists wrestle with emotions just like any other participant in the scientific process, and presumption is almost always both arrogant and dangerous.

The decision-making that takes place in 21st Century economies occurs among participants whose numbers are increasing much faster than even population is increasing. It follows that the activity of mutual fortification will be the key activity in any equitable expansion of prosperity (by which I do not mean numerical GDP, of course). Ronald Coate's article hints at this:

"Economics as currently presented in textbooks and taught in the classroom does not have much to do with business management, and still less with entrepreneurship. The degree to which economics is isolated from the ordinary business of life is extraordinary and unfortunate."

Isolation can only be dissolved by the mutual fortification intrinsic to excellent communication. Once economists and business leaders accept that reality fully, then progress in equitable prosperity can begin again. Yet you might well ask: How exactly?

As a theoretical answer worked out in practice by coaching problem-solving teams in large and small organizations in varying cultural contexts, I offer the framework you can find at this 1-page link:

http://www.authentixcoaches.com/images/Eye-Zen_RELs_for_Project_Manager_... .

0

Keynes used to swear his alumni - including my father - to the responsibility: increasingly futures are designed only by economists. It's amazing looked at from this viewpoint how few of the 7 billion people on this earth have any idea that their freedoms, or loss thereof, are being compounded by economists. In fact, if enough economists knew this, maybe they would step back and ask whose futures have they been hired to rule over. Let's hope the Soros sponsored wave of Moocs rethink economics from the ground up massively viralise. Incidentally being stuck in Washington DC (a very top-down capital) , if there is anyone in this region who wants to join in demanding a rethink, please contact me chris.macrae@yahoo.co.uk

0

I agree with the author, but I don't think the profession can to it themselves. Plus many stakeholders in the system do better with the discipline removed from the real world. we'd be getting rid of HFT, banking oligopolies where banks own the company that provides the ningja loans, so they can securitize them, then rig how they trade by market making (lol activites)and trading them on their trading desk. We'd have much less leverage because we'd start to acknowledge risk weightings are nonsense and there is no such thing as risk free assets. the market not being efficient would require a host of changes. the financial sector would be shrunk down to reasonable sixe and financial innovation would be given the scutiny of new drugs put on the market. No, profits are a big reason economics has remained abstract because real world results, data, testing, etc would spoil the party for many

0

Government of India is headed by an Economist and he has played havoc with economies of people and that of the whole nation. Above statement of the Nobel Laureate applies cent percent on India of today.

0

'knowledge will come only if economics can be reoriented to the study of man as he is and the economic system as it actually exists' (Ron Coase 2012 above) exemplifies what Antonio Gramsci called 'organic intellectuals' that are employed to reproduce the existing system (hegemony). This neutral case study aproach is the death of vision, of politics and of social justice for a majority of the world's population in Africa, Asia etc who hopes for economic change.

0

Errr. I believe if you read the article carefully Coase actually wrote it so he probably agreed with it!

0

The most serious problem is that current economics is consisted of monistic theories. That is, price is decided by interaction of demand and supply, and balanced income is formed at the equilibrium of saving and investment. Either price theory or income theory has only one principle, which means monistic. Actually, it is impossible for current economics to catch even an inflection point, since most of economic functions are expressed in an equation. One kinematic principle makes one movement track, that is, one vector, of which moving direction and speed are constant. Accordingly, most economists absorbed in the current economics are used to issuing useless forecasts. Let’s review some examples.

When stock market kept bullish in 2006, some economists expected that the Dow would reach 30,000 or 40,000 points. When the prices of real estate rose continuously in 2006, some economists forecasted that the trend would go further. However, when stock market and real estate market turned into bearish in 2008, it was general for economists to predict that the prices would be fallen into 1/2 or 1/3. Moreover, some economists foretold dollar collapse when the value of dollar continued to decrease in 2008.

The most useless predictions of economists or economic institutes are on business fluctuation. When business cycle is up, many economists anticipate that it will continue to be up, and vice versa. Unfortunately, most of the anticipations have been incorrect. Even when it is correct, it does not have big meaning. What does it mean to foretell that it will be also good in the near future when the economy is really good?

On the other hand, what has important meaning in economic life is to forecast inflections. For instance, it is useful for us to predict when business cycle will be changed up or down. And we need to forecast when turning point is appeared in the future, if a price keeps rising. Simply speaking, the current economics based on monism issues useless outlooks with fundamental limitation to forecast inflection point, because all inflection is made by impact of two more vectors appeared from plural principles.

However, Choe's economics born in Korea has a theoretical structure which is able to predict inflection points. It regards all economic phenomena as synthesis that a few principles interact, not a simple phenomenon that one principle makes. It will be described in detail later. As the theoretical structure of Choe's economics is based on pluralism, it is able to catch inflection points more correctly and frequently compared to that of monism. In practices, Choe's economics has forecasted some inflection points of business cycle and price fluctuation correctly for the last decade.

For reference, Choe's economics is born on modifying three axioms in economics; resources are scarce, economic subjects behave rationally, and the economy is balanced in equilibrium. In Choe's economics, they are modified into; the scarcity of resources is relative and varies, economic subjects intend to behave rationally, and the economy tends to be balanced in equilibrium. This tiny modifications result in revolutionary changes in economics, without discard of great achievements accomplished by many excellent economists. This issue will be discussed later.

In my viewpoint, Choe's economics is alike to heliocentric theory in astronomy, while current economics is similar to geocentric theory. When geocentric theory was dominant, it was believed that the universe is controlled by God. After heliocentric theory, it has become an object of scientific research. Economic prediction is the same. In the current economics, it is under God's territory yet. However it is under scientific territory in Choe's economics. Nonetheless it is still far away to reach the level of quantum mechanics in physics, Choe's economics is, at least, reaching for Einstein's one and making scientific prediction possible.

0

Apologies for calling your comment into question, but I think you'll find that this piece was actually written by Coase last year, and so is likely an adequate representation of his views.

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