The Answer Is Transaction Costs

From Commons to Coase and Beyond, With Steven Medema

• Michael Munger • Season 1 • Episode 27

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What if understanding the hidden costs in every transaction could revolutionize how we see economics?  Stephen Medema of Duke University opens up about his academic pivot from computational tax policy to the history of economic thought, weaving in tales of detective-like intrigue and the thrill of uncovering the makers and movers behind economic theories.

Beginning with John R. Commons' critical insights, and moving through Ronald Coase's focus on transaction costs as the critical difference among institutions, we explore  how these issues shape our understanding of efficiency and the "If markets are so great, why are there firms?"  Don't miss four new economics jokes (one is lawyer joke, in honor of common law!), my book recommendations, and get psyched for a summertime return to shorter, more frequent episodes.

Meaning of "Kaleidic":  From Roger Garrison https://webhome.auburn.edu/~garriro/r8lachmann.htm

Letters:
Corner Crossing:  

Books:
•Glenn Loury, Late Admissions: Confessions of a Black Conservative.  https://wwnorton.com/books/9780393881349
(Econtalk Podcast on the Loury book:  https://www.econtalk.org/glenn-loury-tells-all/  )
•Kevin Munger, The Youtube Apparatus, from Cambridge Essentials.  https://www.cambridge.org/core/elements/youtube-apparatus/36600D69788530F805C650B70976A585

If you have questions or comments, or want to suggest a future topic, email the show at taitc.email@gmail.com !


You can follow Mike Munger on Twitter at @mungowitz


Michael Munger:

This is Mike Munger of Duke University, the knower of important things Transaction costs, property rights, what exactly is a trans-action anyway? The tragedy of the John R Commons and what it means for Arthur Cecil Pagu and Ronald Harry Coase. Is the common law efficient and what would it even mean to be efficient in such a kaleidic system? Today's interview takes up these topics with one of my favorite economists and intellectual historians, my Duke colleague, stephen Medema. New twedges plus this month's letters and more Straight out of Creedmoor, this is Tidy C.

Michael Munger:

And now the interview with Stephen Medema, an economist who works in history of thought and focuses on the history of concepts. His work on Pigou, coase and the Coase Theorem is among the best scholarship ever done on those important subjects. My guest today on the Answer is Transaction Cost is Steve Medema, professor and scholar at Duke University. One of the things that I always ask a guest to do is to introduce themselves. Listeners, if they want, always can find Google to find out more information, but the particular way that someone thinks of their own intellectual journey is revealing. Steve, how did you become interested in economics, how did you become interested in intellectual history, and how do those two things go together?

Steven Medema:

The interest in economics actually goes back to a high school government class my senior year, where a wonderful professor named Leon Van Ries basically threw away the textbook and said we're going to talk about the world here and we spent nine months talking about everything from logical fallacies to how the economy works to it was an election year, so tearing apart governmental processes and it was an incredible experience and it got me interested in thinking about things economic. So I enrolled in a econ 101 course my freshman year in college and I was pre-med at the time. My freshman year in college and I was pre-med at the time and econ 101 and Latin three were really fun and biology and chemistry weren't, so I became an economics major.

Michael Munger:

We should say you went to Calvin College. You grew up in Michigan and went to Calvin College, so this was your freshman year at Calvin College.

Steven Medema:

Yes, it was my freshman year at Calvin and I just started taking one economics course after another, and the more I took the more I liked it. Before long I decided I want to go on and get a PhD, and so I did. The political side sort of stayed with me. My earlier interests were sort of in macro policy stuff, but graduate macro theory sort of disabused me of those interests and I gravitated to public finance and that was my major field. In graduate school I also took a field in history of economic thought, one in labor and one in law and economics. But there's sort of a common thread there and that law and economics, public finance, history of ideas interface is what sort of moved me through my career. I started out doing computational general equilibrium tax policy analysis.

Steven Medema:

As one does, sure yes of course, tax policy analysis Well, as one does, sure, yes, of course. But I figured out after about four years of that that all you really, at least all I was really doing was being a computer programmer. You know, once you did the made the programs run, the economics was easy and I was doing some history of economics on the side and it was a lot more fun and people said I had some aptitude for it. So I decided to just focus on that. That's most of what I've done for the last 30 years.

Michael Munger:

I think that's an excellent segue to one question that I wanted to ask what would it mean to have aptitude for that? Our mutual friend, bruce Caldwell, in his emails has a signature that I think is sort of the sine qua non of intellectual history, that sometimes it's taken me. The quote is sometimes it has taken me hours to find the source of a quote and sometimes it takes me days to fail to find the source of a quote. So that seems to me like the kind of aptitude there's an investigative, almost kind of detective work often in intellectual history, if you're serious about it, if you're actually looking at sources, and a lot of people don't have the patience or interest to do that. So what made you good at it?

Steven Medema:

Maybe it was all those Hardy Boys detective books I read when I was a little boy, I don't know. No, I really have no idea. One thing that does come to mind is that I'm very interested in people I consider really brilliant people. It amazes, you know, I'm just an average guy and so I'm reading a book about John von Neumann, for example, right now. You know, one of the most brilliant people of the 20th century at least. And what makes them tick is of interest to me why people believe what they do, how they come to develop ideas.

Steven Medema:

But more recently, actually, my interest is moved a little bit away from that into what other people do with ideas, which explains part of my fascination with the Coase theorem, which I'm sure we'll talk about at some point. But the uses to which ideas are put by others is a fascinating thing for me, and that probably is due to my grad school advisor, warren Samuels, who spent the last 30 years of his career working on a project he never finished before he passed on. The uses of the invisible hand concept in and outside of economics. And, of course, the beginning. There is Adam Smith. But he wasn't concerned about what Adam Smith meant. It's you know, what are the 50 or C in a list of 50 or 60 different ways the invisible hand concept was defined by subsequent people, from God to the state to you know, and all the different ways it was used in academic and non-academic discourse, and that sort of thing is what turns my crank these days.

Michael Munger:

That again, you're a segue meister, so thank you. One of the things that I wanted to turn to was the question of what is the unit of analysis, or what is it that people study, and one thing that you just said that might be interesting is that an interesting thing to study is the idea, the use of an idea, the evolution and implications of an idea. My particular interest in this podcast is the concept of transaction cost, and I got some of that from being a student of Douglas North, but more in a way from thinking about the work of Ronald Coase. Fortunately for me, I had independently discovered something that you are well known for pointing out, in that Coase's let's say his use of Pigou's thought, of Arthur Cecil Pigou's thought, was probably not complete, maybe not entirely fair to how Pigou had made arguments about the way that information and systems would work. But let's go back to the idea of the transaction. One economist who, early on, had argued that the unit of analysis, rather than being price or individual choice or preference, who had argued that the unit of analysis should be the transaction, was Eugen von Bauwerk, who had said that we should start with the idea that there's two people, one of them has a horse and they're going to argue about what the price is. Under what circumstances will we observe a transaction and at what price, and there's a bunch of things that are complicated about that. So any agreement about price requires a disagreement about value, and so the presence or absence of a transaction was something that Bob Bavrick was suggesting.

Michael Munger:

John R Commons ina paper in 1931 in the American Economic Review, and I'm going to read the quote. It's fairly lengthy but it's interesting because he makes this criticism and I don't know that people understand the history of transaction costs very well and I think this was an important moment in that history. So Common says, quoting now these individual actions, and he means the actions of individual buyers and sellers instead of individual behavior. Forgive me, these individual actions are really trans actions with a hyphen instead of either individual behavior or the exchange of commodities, the shift is a change in the ultimate unit of economic investigation.

Michael Munger:

The smallest unit of the classic economists was a commodity produced by labor. So end the quote for a second. One thing that you might study is to what is the commodity, what is its nature? How should we think about it? Cummins is saying that's sort of starting in the middle. There's something that happens before the commodity is created. Now back to the quote. The smallest unit of the hedonic economists was the same or similar commodity, but enjoyed by ultimate consumer. So there you're, looking at the effect on the utility of the consumer as the unit of analysis. The outcome in either case was the materialistic metaphor of an automatic equilibrium, analogous to the waves of the ocean, but personified as seeking their level.

Michael Munger:

But the smallest unit of the institutional economist is a unit of activity, a transaction with its participants. Transactions intervene between the labor of the classic economist and the pleasures of the hedonic economist, simply because it is society that controls access to the forces of nature. And transactions are not the exchange of commodities but the alienation and acquisition between individuals of the rights of property and liberty created by society, which must therefore be negotiated between the parties concerned before labor can produce or consumers can consume, or commodities can be physically exchanged. So the argument that he's making is you should think about the institutional context in which our interactions take place, and all of those things intervene before this thing. Whether it's a commodity or a consumer consuming the commodity, all of those things determine whether those transactions are going to happen, and that's a natural place to think about what are transaction costs. So a number of the contributions that you have made have been to how we should think about transaction costs, particularly in the context of Ronald Coase.

Michael Munger:

Now Coase himself had criticized the people he called the old institutionalists, and that the old institutionalists would include John R Commons who I just read Torstein Veblen and Wesley Mitchell. When Coase first came over to the United States, he apparently had been told that he should talk to Wesley Mitchell and Hayek also had encountered Wesley Mitchell. Hayek, when he encountered Wesley Mitchell, was shocked because Mitchell appeared to be reproducing all of what Hayek saw as the errors of the old German historical school. You know, we're just collecting mountains of data. So Coase characterized Mitchell in particular.

Michael Munger:

Coase could be quite acerbic, maybe not quite fair, but he could be quite acerbic in judging his people that disagreed with him. So Coase had said about Wesley Mitchell that they kept amassing mountains of data and a lot of paper waiting for a theory or perhaps a fire. So Coase was not a fan of this theory without forgive me this data without theory. So Coase's notion was that this metric transactions cost was a way of comparing institutions and he also said we have less to fear from institutionalists who are not theorists than from theorists who are not institutionalists. So his real concern was that people that just collect a bunch of observations we don't care about that. What's interesting and what might be transforming is if people study theorists' theory and then don't have institutional settings, because Coase wanted to know how people actually did things. So that was an overlong introduction. Coase takes up this challenge from Commons that we should study transactions as the unit. That is the thing that we should look at.

Michael Munger:

Coase criticized Pigou for having not understood very well the nature of transactions, and I found a quote from Herbert Hovenkamp, and then I'll shut up and actually let you answer my question. But Herbert Hovenkamp, in the beginning of a paper of his, the first sentence says Understanding Arthur Cecil Pigagu requires that one read him directly and not Coase's texts. So you get a very misleading idea. So what was it that Pagu? What were Pagu's contributions to our understanding of how political economic systems work? What is Coase's contribution and what is the nature of the? I hate to call it misrepresentation, but Coase had a particular view of how we should think about Coase in the context of transactions costs. So there's probably three or four hours of answers there. I'm sorry that was such a long question, but I wanted to give some background, and those quotes from Commons Coase and Hovenkamp, I think, set us up for going in this direction.

Steven Medema:

Yeah, and for the four-hour answer. I guess there's a few chapters in my book, the Hesitant Hand. You know that, get into that at some length. But yeah, Coase's, but yeah, Coase's reading of Pigou is, I guess, what you'd call just a very surface-level reading.

Steven Medema:

If you wanted to be uncharitable, you might call it cherry-picking, Tendentious. Yeah, I mean, it's as if he skipped certain paragraphs, even within the economics of welfare, or whole sections, and ignored some of Pigou's other writings. It's fair to say on the politics front that Pigou didn't delve deep into the issues surrounding the tax, subsidy, regulatory remedies and the ability of government to bring those off. In the economics of welfare he talks a little bit about it and he says it's a prima facie case. But it's only. Maybe Coase didn't know what prima facie meant, I don't know, but it's as if Coase said Coase defined his meaning an obvious case, for you know, and that's not what the term means, it doesn't say per se, it says If you, if you read Pagou's lovely little essay from 1935, it's in, it's a little book called like six essays on economic problems or something like that.

Steven Medema:

It's called State Action and Laissez Faire and basically it reads like a primer on public choice analysis. You know all the stuff that Buchanan and Tulloch and Niskanen and others were pointing to in the 60s and 70s. Pigou's got right there, you know, not with the analytical models underlying it, but you know he recognized the issues. He also had great faith in this. This may be what really put Pigou off or put Coase off. I'm sorry, but Pagu's answer to all that was always you know, specialized boards and commissions can get us past these things. You know the Cambridge man having great faith in people like himself and I do mean himself to solve these sorts of problems, because you know they alone are dispassionate, disinterested, unlike the politicians, and will pursue the social welfare. And you know, people like Coase and Stigler and others had no patience for that, and perhaps rightly so. But on the transaction itself, if you read what Pagout writes before he starts to talk about, you know the things we define as externalities today pollution and all that. When he talks about land tenure, relationships and so on. He talks about exactly the kind of negotiated solutions, um, that that coast you know points to, although coast wasn't advocating them. He thought they were unrealistic. But I mean, he recognized those possibilities too. He just didn't think they applied it really to situations outside of those where people were already in a contractual relationship.

Steven Medema:

Cagou is in some sense a predecessor of Guido Calabresi. If you read Calabresi's stuff on torts in the 1960s and early 70s, he gives us what is in essence a different version of the Coase theorem. But what he's working with is people who are already in contractual relationships in products, liability situations and stuff like that. So I mean Coase is right in saying Pagu did not recognize if that's the right word the full scope of arrangements where people can actually work things out. You know he gave market failure a little too much credit, but he gave the possibilities of things. You know he gave market failure a little too much credit, but he gave it. You know he gave he gave the possibilities of things, you know a little more credit than Coase would allow him to have.

Michael Munger:

I have a little piece where I actually explicitly claim and I'm two thirds serious that Pagu was the first public choice theorist, because he lists the possible problems. So the information problem, organized interest groups, groups of voters who might have collective action problems. What was interesting and I think you and Backhouse point this out in at least one paper the solution of Cambridge economists generally and Pigou as the standard bearer for Marshall, was going to try to advance this argument. A group of experts, a small group of appointed experts, people of goodwill, through trial and error could discover. There is a discovery process and the discovery process is to look for rules that will make private, decentralized solutions work better. That in a way it's a bit like commons, that these transactions take place within a context and deciding what that context can be. If we set up the rules and background, then maybe the market system can work out better. So there's an implicit transaction cost notion there.

Michael Munger:

Coase, when he came over in 1937, he published a paper in 1937. I'm not sure what year he came to the United States, 32 or 33. Year he came to the United States, 32 or 33. Can you tell us something about Kosa's experience in his work on the theory of the firm and what led him to that.

Steven Medema:

Yeah, he had entered the BCom program at LSE and finished his coursework for that in two years and had a third year where he had sort of the ability to do whatever he wanted and he applied for a Cassell traveling scholarship that allowed him to come to the US if he was so inclined and he was interested, thanks in part, I guess, to Plant's lectures on the market and how it worked and being dissatisfied with the idea that the market works itself, that there is control, there is direction, that kind of thing. And in trying to explain why we have a firm type relationship vertically, horizontally, wanted to, as Coase was ought to do throughout his career, actually dig in and explore what's going on. I mean one of the things that, as Coase was ought to do throughout his career actually dig in and explore what's going on. I mean one of the things that defines Coase is his methodological stance. It can't work today. It doesn't work with publish or perish because of all the digging that's necessary, reading, contracts and all that which Coase advocated.

Steven Medema:

But he went to the US and visited firms.

Steven Medema:

He visited some academics too. He was at Chicago for a brief period of time, met Frank Knight and others, but mostly he was visiting with CEOs and the like and trying to get answers to this question about the make versus buy decision, if you want to call it that, what determines the size and scope of the firm. And it's not clear how he got from there to his paper. I mean, there's lots of correspondence in his archives. We know about what happened because he wrote letters to his good LSE friend, ronald Fowler, throughout this trip. But what's less clear is how he came from sort of that massive data that he had in his head from those conversations to that sort of you know, eureka moment, if you want to call it that, where he, you know, realized well, it's about the relative costs of internal versus external organization that determines the firm. But he says he got to this in the early 30s and he was a new lecturer then at what was it? The Dundee School of Economics. Right, yeah, working up there with Duncan Black.

Michael Munger:

He was giving lectures on utilities too, something that he never himself studied Right. So another thing where he had to go outside.

Steven Medema:

Yeah, so he's doing all this different stuff. It comes back to LSE in the mid thirties. That's when he takes up the course on public utilities. I want to say Hicks had been teaching it and gave it up. I forget who it was, but he had to take it over knowing nothing about it. So he starts reading about public utilities to develop lecture notes for the course and that got him interested in other nationalized industries in Britain. So he sort of went through, you know, the post office and the BBC was the big one of course. That ended up leading to other sorts of contributions later down the road. But this sort of comparative cost, comparative institutional perspective, that sort of defines much of what Coase did throughout his career. It really has its seeds in that work on the firm with the make versus buy decision and the horizontal integration decision, all of which he takes up in the paper on the firm.

Michael Munger:

So let's make sure that it's clear to listeners just how sort of fundamental and, in a way, almost embarrassing for the economics profession that is, economists at the time were working and even then groping towards the idea that there might exist equilibria in decentralized market processes that would have certain properties that we could say in terms of economic welfare. So, a society that uses markets we might be able to prove theorems about economic welfare, and prices are able to organize and direct resources towards their highest valued use. And Coase asked well, if markets are so great, why are there firms? Most people, at the end of their day, don't say you know, I had a hard day, prices were in a bad mood today. What they say is I had a hard day, my boss was in a bad mood today, because most of us respond to bosses, not to prices.

Michael Munger:

Well, if prices and markets are so great, why are there firms? And that's an awfully obvious question. And he did not. He had not thought much about what the answer to that might be. He just went out and tried to ask that question. Then, though, he came up with a fundamental answer that he used at a number of places throughout his career, and basically it was marginal cost, marginal cost. He also thought about, when it came to utilities, the marginal cost controversy. You know, what should prices be? So what price should a utility charge? What determines the margin where the last transaction is going to be, either organized within the firm or acquired outside, in the make or buy decision? And the answer was marginal cost.

Michael Munger:

So it actually takes a person of some stubbornness and genius to push things back to first principles we're all used to and it's a cliche. But someone comes out of a job talk in an economics department and said that must have been brilliant. I didn't understand a word of it. Kosh, you could generally understand, although the writing sometimes is tiresome because there's examples piled on top of examples, because he's read all this stuff. So Coase doesn't write that many papers. It's not clear he would get tenure today, as you said and we're half joking, but only half His work was rather slow and he wanted to try to understand things. The 1960 paper is one that led to what was later called the Coase Theorem, and you have made some of the most important contributions to our understanding of the Coase Theorem. What is the Coase Theorem and how does it relate to transaction cost and how does the evil, george Stigler, figure into this story.

Steven Medema:

Well, if I'm going to be true to myself, I'm going to say it's going to be hard to tell you what the Coase theorem is, because there's so many of them floating around out there in the world.

Steven Medema:

If you're going to be true to Coase, it's going to be hard to say right, yeah, but the the basic idea behind the coast theorem is that if you you've got a situation where, uh, let's say a situation of externality, an assignment of property rights will efficiently internalize that external effect, say pollution uh, will, that is, will will get the right to pollute or to not pollute into the hands of those who value it most highly, and that that will be true no matter to whom the court or government or whatever gives the rights.

Steven Medema:

So if pollution persisting is the highest valued use of the air, then whether the government gives the right to pollute to the polluter or the right to be free from pollution to the so-called victims of pollution, we'll see the same amount of pollution in either case. That is, if the right's given to the polluter and it's more valuable in the hands of those who are victims of pollution, they'll simply bribe the polluter to stop polluting, and so you get the same result. In either case, it's the efficient one. That is. To go back to commons, the rights in the transaction end up in the hands of those who value them most highly, regardless of to whom the courts give them in the first place. That's a long-winded Coase theorem in a nutshell.

Michael Munger:

And what you ended with is probably the thing that's most important about the different versions of the Coase theorem Resources tend towards being allocated to their highest valued use. Now, some things might prevent that background in there about subjectiveness, ability to pay and how costly it is for us to discover and implement exchange. So all of those things might be something like what we would now call transaction cost. Coase was very reluctant to define transaction costs. How might, if I were to talk to a student who said, as you know, what students want is they want to be able to have the definition so they can study for the test. What are transaction costs?

Steven Medema:

All costs which keep the Coase theorem from holding. I could give no other answer. I think that the most simple definition of them all is information costs, because most of the other, whether you're talking about haggling costs or whatever why do people haggle? Because they don't know what the other person is truly willing to pay and what their walk away from the deal price is. And so if everybody knows everything about everything else, there's no haggling, there's no bargaining process. Transactions are consummated instantly. So I would define transaction costs as information costs, but if you want to get more general, it's simply all costs associated with the transacting process. Some would say bargaining. I wouldn't even go that far, because lots of transactions don't involve bargaining right In a competitive system, for example.

Michael Munger:

So in my book Tomorrow 3.0, I defined because I was trying to break it down in a way that would be useful for people who might be in a business or consumer context I define transaction cost as triangulation, transfer and trust. Triangulation is that I have to find the thing that I want to buy, or if I have something, I have to find the person who might want to buy it. Transfer is we have to arrange a price, deliver it and make the payment. Trust is I have to be able to rely on your assurance that you'll comply with our agreement. But you're exactly right. All three of those are actually information. All three of those are asymmetric information.

Steven Medema:

Exactly.

Michael Munger:

One of us has information, the other one doesn't have, or else neither of us have the information we would need about how to consummate this transaction, and that information may or may not emerge from processes we call bargaining haggling. Those are not actually things, those are names we give for processes that have to do with the discovery of that information, and so the transactions cost are the way that we discover the information that allows us to consummate this transaction, to figure out if there even is a transaction in the first place, in the sense that we would both be better off. Is there some bargaining space? Because that's not given. I sometimes will say in class suppose I have a widget, it's in my closet, I would sell it for a dollar, you would pay $5 for it. And I asked the student what will happen and they'll say oh well, there'll be a price between one and five. No, it's in my closet, you don't know, I have it, nothing happens, it's not a commodity. So when we start with, everything's already a commodity, everybody has information. None of that is true.

Michael Munger:

So in that context, if transaction costs are high, what is the status of what some people have called the Coase theorem? And in particular, coase himself was interested and other people have talked about it. The Coase theorem seems to have two parts. One is resources move towards higher valued use, and the second is that this process does not depend on the assignment of rights or liabilities. That that's almost epiphenomenal from an economic perspective, now not from a legal perspective. In a legal perspective the litigants care very much about because these things are valuable. But for the economist who's interested in the efficiency of the allocation of resources, the point is that those liability assignments don't matter in the absence of transaction cost. But if there are transactions costs, if there are these asymmetries of information, the assignment of rights might matter very much.

Steven Medema:

Well, you've hit on a lot there. The last thing you talked about is one of the particularly interesting aspects of the whole sort of Coase theorem debate phenomenon over the past 60 years. Now Economists care about the efficiency proposition and that's what they argue about. I mean, they'll argue a little bit about invariance, but for lawyers and legal scholars it's mostly about the invariance proposition. It's not that they don't care about efficiency, but they really don't. They care about justice, and so does it matter if we assign rights one way or the other? You know or not, and so you know the Coase theorem stands received legal theory on its head for all kinds of reasons actually different than standing received economics theory on its head.

Steven Medema:

Two people who are as friendly as Coase and Demsetz looked at. I've got quotes at the header of a paper I've been working on. The first one is by Demsetz that says the Coase theorem is all about efficiency and invariance is just a red herring. And then there's a Posner quote right after it that talks about how the Coase theorem is all about invariance and efficiency is you know whatever.

Michael Munger:

I was lucky enough. In graduate school, harold Demsetz visited Washington University and I had a semester-long course from Harold just pretty much about the Coase theorem and his ability to tease out implication. How could you teach an entire semester on that? But he would all sorts of different ways to set it up and then say and the world is sufficient, is efficient, because he came from the University of Chicago at Los Angeles and was an emissary of this efficiency perspective. So we don't need to worry about any of this stuff because the world is going to be efficient and any attempts to interfere with that are going to make it less efficient. So that was the kind of Chicago ideology at the time. Posner and Coase himself had a different view.

Steven Medema:

Yeah, let me go back. One take on the Coase theorem and this is sort of George Stigler's preferred take is that it shows that the world is efficient and it's derivative of what one might call the Chicago view of the world circa the 1960s, early 1970s, and of Friedman's methodology, and that is the idea that the competitive model. Basically, we all know it's not true, but it's a reasonable first approximation the real world behaves close enough to the competitive model that we don't need monopolistic competition theory, we don't need oligopoly theory, we need monopoly theory to deal with the rare cases of monopoly. But other than that, the competitive model describes everything. And the first theorem of welfare economics shows us that competitive markets are efficient except when you have externalities and a couple other little things. Well, the reason Stigler loved the Coase theorem so much is because Coase showed him hey, when you have externalities, the competitive system reaches an efficient outcome, so we don't need to worry about state action.

Steven Medema:

The Demsetz view is a little different than that, at least as Demsetz evolved. Demset's view is a little different than that, at least as Demset's evolved. That is what Demset's did, which is very much in Coase's spirit and not in Sigler's spirit, is to say look, the real world's loaded with transaction costs. But transaction costs are just like any other cost.

Michael Munger:

They're costs, they're straight up costs. You would always say that Transaction costs are just costs.

Steven Medema:

They're straight up, you would always say that Transactions, cost are just costs, and so the question is then where does the market leave us with regard transaction costs superior or inferior to the what we'll call government intervention solution? Okay, um, so it's, it's, it's. It's a very different thing than chicago, although it's got some chicago, some chicago flavor to it. But the? I mean what? What? If you understand coast, you understand that coast is not about the coast theorem. That's the first 15 pages of a 44-page article.

Steven Medema:

Then he says, okay, the real word is positive transaction costs. It's also positive government costs or government transaction costs, whatever you want to call them. And so we need to choose the solution that imposes the least cost on society as a whole and that's an incredibly powerful point on society as a whole. And that I mean that's an incredibly powerful point. That and the reciprocal nature of harm, which underlies that, are really the true messages of the problem of social cost. And Demsetz really got that. He probably got it better than Coase did in a lot of ways, and it just went right past Stigler because it just didn't agree with his view of the world.

Michael Munger:

Yeah, for Demsets there's a contingent efficiency and that is, given the transactions cost, which are real costs, and given the cost of using government, we will have something that's as efficient as it can be. And comparing that to a world of frictionless surfaces, to use a physics analogy that doesn't make any sense.

Steven Medema:

Right the Nirvana fallacy.

Michael Munger:

Yeah, that's not a feasible world anyway. And so, right literally, he wrote about it in the Nirvana fallacy. Well, coase continued to work on this quite a bit and he had a book the Firm, the Market and the Law in which he kind of lamented that he was best known for a theorem and I'm making air quotes about a world of zero transaction cost, when much of his work had one of his interests had been what are the effects of transaction cost on the way that we transact, of transaction cost on the way that we transact? Coase was interested in how the assignment of liability rules and this is one of the things that law and economics people in law schools are interested in is. It wouldn't make sense.

Michael Munger:

If you take a Stiglerian view, if you take the invariance proposition seriously, it doesn't really matter what liability rule we choose. But in the world of transactions cost the fact that we choose an efficient rule or that, if we don't choose it, we tend towards an efficient rule, then that is applied in an obvious way to the common law. The question is does the common law evolve in a direction towards greater efficiency? I think that's a fascinating implication of this. Can you say something about that way that the question of the efficiency of the common law relating to the Coase theorem to the Coase theorem.

Steven Medema:

Yeah, the definitive source on this is probably George Priest, who's now, I think, emeritus at Yale Law School, but there's different takes on it. But I really like the notion that inefficient common law rules will just get repeatedly litigated. It's basically a competitive markets view of the legal system or an arbitrage view. If there's an efficiency gain out there, people will attempt to push the system toward it, and so if the common law rules are inefficient, you're going to see litigation after litigation after litigation and eventually judges are going to recognize. I think that there's something wrong here. Most judges you don't get to be a federal judge by being stupid, and these things work their way up the food chain and you're going to get to efficient solutions. It doesn't always work that way and it did often take some time, but there's little doubt in my mind that if you take a long enough run view, the market does or the law, I should say does move itself toward efficiency.

Michael Munger:

And to take an evolutionary perspective. Any evolutionary process requires two things One is a source of variation and the other is a source of selection, and so I don't know if elephants are efficient, but they're more efficient than the animals that they replaced. And so the common law may or may not get to efficiency I'm not sure what that means, because it's a sort of perfect, but it gets efficient or in the sense that relatively more efficient liability assignments or rules for giving a context for transactions will replace less efficient rules, and I like the way that you said it. We have both the. We have a source of variation, which is the frequency and intensity of litigation on different rules, and if we have an efficient rule, we're probably going to accept it as a precedent because it gives us something to coordinate around.

Michael Munger:

All of us understand that's the rule, and I've participated in law and economics seminars to try to teach law professors, and it's an interesting question about what they think the unit of analysis is. They say well, judges can always get this right. What you want is a system where there's no litigation, because all the rules are clear, they're all efficient and there's no reason to litigate because I understand how it's going to come out, we'll settle. We get settlements instead of litigation.

Michael Munger:

What you said, I think, is very deep, and it's so obvious that most law professors even miss it. Litigation is a sign that there's something that's not quite right. So that's the source of variation. The source of selection is the choice by judges to use other judges' decisions as a precedent, and if so, one decision stands for a very long time. It's not overturned in a system of stare decisis. Then that selection process gives us efficient-er rules. Saying that the common law is efficient is probably too extreme, because I don't know what's the counterfactual. But that process and it doesn't arise just from Coase, but Coase is a really important step on the road towards that kind of reasoning.

Steven Medema:

Yeah, he actually makes some comments along those lines in the Problem of Social Costs. That's what stimulated Posner to formulate his thesis of the efficiency of the common law, which a bunch of subsequent scholars attempted to test, you know, empirically in various ways, quantitative and other. But I mean, I think this is of a piece with with Coase's larger view of things. You know, in a profession that was increasingly focused on, as you alluded to earlier, sort of determinate, optimal solutions to questions of theory and policy. That's a Warren Samuels line. You know Coase was very comfortable with indeterminacy.

Steven Medema:

Economists tend not to be comfortable with indeterminacy. There's there not to be comfortable with indeterminacy. There's all kinds of, you know, tensions in the history of economics. When I was teaching earlier this year on, you know how we went from cooperative game theory to non-cooperative game theory when economists started getting interested. You know the cooperative theory has tons of indeterminacies in it which drove people nuts. Economists don't like that. They want something very tangible and direct at the end and life isn't that way and the common law doesn't evolve that way. But it's one thing to say the common law evolves in the direction of efficiency on average over time. It's something different, and wrong, I think to say that the common law is efficient right and I like that middle ground, probably for the same reason that I like the history of ideas. It's messy right, and messy can be interesting, yep.

Michael Munger:

Well, I had wanted to ask. You have an article that was published in January of 2024, so pretty recently in the Journal of the History of Economic Thought. The title of it is I Get by With a Little Help From my Friends. You have. I don't mean to call you old because you're not as old as I am, but you have a great deal of experience in working in the field of intellectual history and as an editor you have had to deal with the attempts by people to publish on these questions how, what is the status of intellectual history and history of economic thought in the economic profession now, and what do you think is the future of it? I think there's quite a few young people who listen to this podcast. Is this something that people should consider going into? It is certainly something that a lot of people are interested in, but is it a viable? 20 years ago it was a viable field in academics. Is it a viable field? And if someone were interested in doing it, what kind of things should they study or work on?

Steven Medema:

If you want to work in an economics department, it's probably not a viable first choice field, Certainly not if you have hopes of working at a top flight economics department. And the reason this is very easy to explain. You know, the coin of the realm is top five journal publications and those journals don't publish work in the history of economics. If they change course.

Michael Munger:

What made me think of this was when you said about having a determinate solution, and it is the nature of intellectual history that you can't. So forgive me for interrupting, but that was sort of. The segue over into this is that it seems to be disappearing in economics departments.

Steven Medema:

Yeah, disappearing. You could probably use the past tense if you wanted to. I'm very fortunate to be at Duke, where the department still places some significant value on this. We've got the Center for the History of Political Economy there. A big part of the center's mission is to keep the field going. You don't have a center for labor economics where the faculty there are dedicated to keep the field going in the face of threats of its demise, right? So if you want to write your PhD thesis on the topic in the history of economic thought, you're going to really narrow your job choices.

Steven Medema:

What we see at Duke, for example and I think is actually a nice strategy for a lot of people if you're interested in this is doing history of economics as a secondary field. You know students love history of economic thought classes. They like reading about Adam Smith and Karl Marx and John Maynard Keynes and really everybody in between my students. I start with the Greeks, and Aquinas is actually one of the students' favorite parts of the course, because Aquinas is just so wacky economics-wise by modern standards. But if you lay out what his assumptions were, the context in which it all makes perfect sense. It's a beautiful model. He's got one crazy assumption that makes him think, for example, that interest should be regulated to the level of zero right, that interest should be illegal. The students are fascinated by this stuff and so if you can teach it, departments value you, because for most departments research isn't the be-all and end-all right. They're there to serve the students and if you can offer a course that students are going to love, that makes you a valuable commodity.

Steven Medema:

The problem is it's difficult to get training in the history of economics in any decent PhD program in the country. I mean there's only five or six programs where you can even think of getting any training in the history of economics, which is why we run summer institutes at the Center at Duke. We've got students coming in from top PhD programs all over the world who are interested in this. We give them a boot camp on how to teach a history of economic thought course.

Steven Medema:

Europe's a different story. The history of economics is doing quite well in Europe. There are some brilliant in South America, latin America as well. A lot of brilliant young scholars are working in economics departments and elsewhere there and doing some of the most exciting work in the field. The other thing to note is that some of the best stuff being done. I mean, you can write the 800th paper on what did Adam Smith mean when he was talking about value and price? But the marginal product is, you know, basically zero. What, where, where all the exciting action is these days is in the history of modern economics. You know, post-world War II, when I was a young man, you know, I started working. By the way, I started working on Coast because I wanted to write a book on commons.

Steven Medema:

I have a couple early papers on commons and I was asked to contribute a book to a series on eminent contemporary economists where it was defined as 20th century. I said to the editor of the series, who asked me to do this, I'd be interested in doing a book on commons. And he said well, we've already signed a book. Um, an author to do a book on commons. And, and I said in the same conversation, I said well, you know, it might be interesting to do a book on ronald coast because that coast theorem idea is really interesting. That's all I knew about coast was. Having learned the coast, there have been pub swing classes the world has changed.

Michael Munger:

If you're not already assigned, your career might have been different.

Steven Medema:

Exactly, that is exactly right and that's what started me on the Coase train back in 19, and Coase theorem train back in 1990. But how I got to that was when I started doing that people. Well, you can't write on Coase. He's still alive. Anything after Keynes is way too modern to even think about historicizing. And then Coase himself when I tried to interview him, he sat with me for about 15 minutes right before a memorial session for Stigler at the AEA meetings. He tried to talk me out of publishing the book or even writing it until after he was dead. Coase was about I don't know 82 at the time, maybe, and he lived to 103.

Michael Munger:

So thank God I didn't listen to him. Yeah.

Steven Medema:

But you know there's so much really interesting low-hanging fruit in post-World War II history of economics. What I tell people. You know what excites you in economics. If it's something that excites you in economics, there's got to be a great history there about how all that came to be and the battles over it and attempts to establish legitimacy, or why this challenged ideas and so on and start digging right. We've got archives on so much of this stuff now, a lot of them housed at Duke but at other repositories all over the world. There's tons of exciting work to be done.

Michael Munger:

Well, and so that is an interesting distinction between careful intellectual history and the sort of traditional histories of economic thought. Roger Backhouse has a very nice book on the history of economic thought, and it's used in quite a few places, but when people ask me, what is an intellectual history of economics book that you found interesting, I recommend the Roy Weintraub's book Finding Equilibrium. The process there, and, having looked at the letters and looked at the well, debreu, having refereed one of McKenzie's papers that got turned down and, as a result, wasn't published for two more years, and so now we mostly say Ero de Bru instead of Ero de Bruhan instead of Ero de Bru, mckenzie. It's not exactly contemporary, but it's certainly after Keynes and it's after World War II, so that sort of work is interesting and exciting.

Michael Munger:

All of this, though, comes because that actually is research. That's not learning how to teach history of economic thought. That would be a research enterprise, and it seems to me that the US is losing out on that to Europe, south America. It is not something that you can viably do in an economics department, and, if I can just get on my soapbox for a second, that means that it's going to be done by intellectual historians who don't know much about economics, and it's really hard to write a good intellectual history of a process in economics unless you have a pretty profound understanding of economics, because you'll just get things wrong. You won't understand what the controversies are. So I think it's a shame but maybe it's a luxury that economics departments feel like they can't afford, because it is very difficult to publish such papers in the top economics journals. So to some extent maybe that's some of what's driving it.

Steven Medema:

So to some extent, maybe that's some of what's driving it. Yeah, I think that's, these days, mostly what's driving it. There's a limited number of faculty lines in a department right You've been a department head, you know this and so there are scarce resources that department heads and faculty members try to allocate where it will get the highest rate of return. And then you've got, shall we say, rent-seeking processes within that right.

Michael Munger:

Yes, we shall.

Steven Medema:

One more person for their research group has higher marginal product than one more person for anybody else's, and the history of economics crowd doesn't have any pulling in getting positions and it makes it difficult. And yes, I mean one of the artifacts of that is that a lot of the history of economics being done an increasingly large share, is being done by people outside of economics departments. Occasionally they're trained economists who've managed to land somewhere else. More often they're historians of science or intellectual historians who are trained as such, and what you've got is two groups. You've got economists who don't necessarily, you know, have good chops when it comes to doing history. You know who might confuse survey pieces with history. Yes, because a survey piece is not history. Writing about dead guys does not make it history, yeah. And then you've got historians with no economics training, um, and they're both dangerous. Right, because and we don't need to, you know, talk specifics here.

Steven Medema:

But but when you, when you write about ideas without understanding what the ideas are really all about, what the implications are, why they were developed, how they fit into a larger research program pointed in a particular direction, you're liable to read in things that aren't there. You know you want to put a lot of dots on a page. You can draw lots of lines, different lines that connect the dots, each one of which makes a different shape, lines that connect the dots, each one of which makes a different shape, but only one of those shapes is sort of the right one. And the danger is that the misinterpretation of ideas and why people were doing things can give rise to, you know, bad history, sordid history, serious misinterpretations of what's going on out there. And you know it's not dangerous, like nuclear weapons are dangerous, but we want to understand the past. I mean, that's the goal of history to understand the past. And when you have baked in misunderstandings because you don't know the material you're dealing with, it creates a serious problem.

Michael Munger:

And that is the problem. Once it's baked in, then you get a kind of path dependence, because other people will reference this as being authoritative and you're going off into the blackberry bushes. Well, I really appreciate you having appeared today, Steve, as a guest on Tidy C. I hope that we get a chance to play golf sometime this summer so that you can improve my continuing education in golf. I certainly have a lot to do. Let me ask what is your next research project, or what is it that you're working on now?

Steven Medema:

Well, for the last, the same time I've been working on it for the last geez, dozen years or more now I'm trying to write a life history of the Coase theorem and it seemed basically a biography of the theorem's life. And it's not dead yet. And I mean my economist hat says it never should be, because it's correct as a matter of economic theory, but it just has an interesting life story. The problem is it also has a roughly 10,000 article journal literature associated with it. So I'm in the process of writing that book now and still, and so that you know that, plus some stuff on the history of the Chicago School which interests me, and various other little projects here and there, but the Coase Theorem Project is the big one for now.

Michael Munger:

Well, thanks very much and again, I do appreciate you being a guest on Tidy C.

Steven Medema:

Thanks, Mike.

Michael Munger:

Well, that sound means it's time for the twedges. These week's economics jokes. First, why did the Coase Theorem go to court? Because it couldn't settle its disputes through decentralized bargaining, because the transaction costs were too high. So it decided to let common law weigh in and find the optimal solution from accumulated experience. Now I should explain. I asked ChatGPT to write a joke about the Coase theorem. That's what it came up with. That's not remotely funny, but actually I had to go for a walk after I got that back from ChatGPT. That may be the best 40-word summary I've ever heard of the relationship between the Coase theorem and the common law. So well, that's as good as you can expect from an economics joke Not funny, but insightful. Second, a Ron Reagan joke.

Michael Munger:

An economist is someone who sees something that works in practice and wonders if it can work in theory. Now, the reason to tell this joke this week is that it describes Coase's approach pretty well. Theory says prices, but practice says firms. Can that work? Well, no, unless you bring in transaction costs. So it suggests something that the theory was lacking. Third, an economist is someone who can explain with great clarity and precision tomorrow why all the predictions he made yesterday failed to come true today. Yesterday failed to come true today. And then, fourth, since we were talking about common law and liability, I thought I'd use a plaintiff's attorney joke. Being a plaintiff's attorney is like being part of the band Nickelback the more you do your job, the worse place the world becomes. The world becomes.

Michael Munger:

It's time for letters. The first letter is from CR. Cr writes Dave Schmitz's comment on some limits to property rights where a presumption can be overridden to allow passage, as in the Hinman versus Pacific Air Transport, made me think of the issue of corner crossing. As in the article that I'll put the link on the show notes because it has photos where two no trespassing sign block the corner where two tracks of public land touch Seems crazy to me. Corner crossing should obviously be legal, but courts in Wyoming are still arguing about it. Love the show. Well, thanks, cr, and I actually had meant to mention corner crossing last time and it is worth mentioning this time in the context of the Coase theorem. I'll probably do something more on that later for one of the shorter 15-minute segments that I'm going to do each week for Tidy C over the summer. So stay tuned. But thanks, cr, that's a terrific idea. The second letter from NG.

Michael Munger:

I have a question and I suspect the answer may be transaction costs. I was listening to your discussion on academic publishing and the complete waste that the public repair system has resulted in. However, given the limited number of tenure, track slots, isn't wasteful arms race going to result, no matter what system you create? More broadly, is there any system of measurement or promotion that can or will not be gamified in harmful ways? I know I can create a model of who is deserving, but because the subjects know they're being measured, any system I create is going to be overfit in ways that may be harmful. You can see this in any admissions process, cooperation target or even the earnings of public companies. Is there a way around this problem? End of letter. Well thanks, ng. There's no perfect way around this problem because, as you Well thanks, ng. There's no perfect way around this problem because, as you say, the answer is transaction cost, but some ways are probably better than the other. I don't want to say that Publisher Parish has been a complete waste of time, but it has tended towards a focus or emphasis on research projects that are not ideal, or emphasis on research projects that are not ideal.

Michael Munger:

It's time for Book of the Month. First, Glenn Lowry Late Admissions Confessions of a Black Conservative. There was a terrific econ talk about this and I became interested in the book and I think Russ Roberts' praise of it is every bit deserved. It's certainly worth reading, something you could read in summer on the beach. A difficult book in the sense that it takes up difficult subjects, but it's not an abstruse or academic book. Second, kevin Munger the YouTube Apparatus from Cambridge Essentials. It's a short book, like all of the Cambridge Essentials book, but you'll know a lot more about YouTube after you read this book. Well, it's almost June, so I'm going to try to go back to shorter weekly episodes, though I may not be able to manage that every week. We'll see. The next episode will be released on Tuesday, june 4th. I'll talk about well, transaction costs and the problem of clearing financial instruments as a riddle. Plus, we'll have another hilarious twedge and more next week on Tidy C.