This was written back when production cost dominated. The notes on scale don't really apply today, now that marketing cost and mind share dominate scaling.
Coase quotes Sir Arthur Salter: "The normal economic system works itself. For its current operation it is under no central control, it needs no central survey. Over the whole range of human activity and human need, supply is adjusted to demand, and production to consumption, by a process that is automatic, elastic and responsive." He's quoting Salter out of context. Salter was perhaps the first international central planner - he was in charge of Allied shipping during WWI.
Salter goes on to write, in his "Allied Shipping Control"[1], "By the exacting criteria of war conditions, this system proved to be, at least for those conditions, seriously inadequate and defective. By the new standards, it was blind and it was wasteful. It produced too little, it produced the wrong things, and it distributed them to the wrong people."
This is the fundamental critique of capitalism. The US produces about 4,000 Kcal of food per capita and still has hungry people. Even with huge productive capacity, the system doesn't deliver for the little guy.
Salter is describing economic socialism. Bertrand Russell once contrasted "Allied Shipping Control" with Marx's "Capital" as guides to the achievement of international socialism. Salter represents the bureaucrat's approach, as opposed to the politician's. Salter set things up so that the coal commission had to agree on coal policy across national boundaries, and the steel commission had to agree on steel policy, and then they'd go argue over shipping allocation. Arguments were by field, rather than by country. Marx is all about power - "Who tells whom what to do?", as Lenin put it.
Salter was one of the architects of the European Union, which started as the European Coal and Steel Commission, and a friend of Jean Monnet. He was influential in the design of the machinery of the Common Market. That's worked well; the EU's problems today are over immigration.
Coase and Salter were writing in an era when people considered these questions seriously. The Great Depression made it clear that unbridled capitalism could break down. All the productive capacity was still there, the workers still had their skills, yet people were starving. Something was fundamentally wrong with the system.
The Communists argued that their system was fundamentally better. (The failure mode of communism was that it centralized power so much that it encouraged tyranny. In retrospect, one can ask whether the problem was communism or just Russia. Since 1900, Russia has had a Czar with absolute power, a brief period of liberal communism that collapsed, dictatorial communism, bureaucratic communism, a brief period of liberal capitalism that collapsed, oligarchy, and now capitalist dictatorship. Russia without a strongman doesn't work. But that's another subject.)
The US coped with the Depression by trying to get capitalism under control, moving away from "greed is good, greed works". There was a lot of business opposition at the time. But not enough to stop it, for two reasons. One was that the Depression wasn't good for business, either. But the other was fear of communism as a competing economic system. It looked like communism was working - they weren't having a great depression. Capitalism had real ideological competition. This kept it honest.
This worked for a long time, from the 1930s to the 1970s. But by 1980, communism, as an economic system, wasn't working well. Nobody took it seriously any more. This freed up capitalism to go to its default "greed is good, greed works" mode, which is where we are today.
Now we have "secular stagnation" - plenty of excess productive capacity, but we can't deliver a good standard of living to everybody. The new thing is that we need far fewer people to make production go. For most of history, the problem was making enough stuff. Coase wrote in an era when making enough stuff was still a big problem. We're past that now. And we have no clue how to organize an economic system that deals with it.
Coase is great. On a related note: not long ago, I discovered the wikipedia pages on "Internalization theory" and the "Eclectic paradigm", which descend from his ideas.
Those views deal a bit more with intellectual property and the fact that knowledge is a non-excludable good (as long as intellectual property rights are difficult to enforce). For me it's interesting to think of how this relates to giant tech companies, their secrecy, and internal-only software stacks.
(The eclectic paradigm relates to multinational corporations, which face some alternatives related to location/ownership/internalization.)
Bar none my favourite question in economics, especially as it pertains to modern political dialogue. People claim central planning has been "proven wrong" while ignoring ie: Apple being very much centrally planned internally, which eliminates a ton of interesting discussion.
> As D. H. Robertson points out, we find “islands of conscious power in this ocean of unconscious co-operation like lumps of butter coagulating in a pail of buttermilk.” But in view of the fact that it is usually argued that co-ordination will be done by the price mechanism, why is such organisation necessary? Why are there these “islands of conscious power”? Outside the firm, price movements direct production, which is co-ordinated through a series of exchange transactions on the market. Within a firm, these market transactions are eliminated and in place of the complicated market structure with exchange transactions is substituted the entrepreneur-co-ordinator, who directs production. It is clear that these are alternative methods of co-ordinating production. Yet, having regard to the fact that if production is regulated by price movements, production could be carried on without any organisation at all, well might we ask, why is there any organisation?
> In view of the fact that while economists treat the price mechanism as a co-ordinating instrument, they also admit the co-ordinating function of the “entrepreneur,” it is surely important to enquire why co-ordination is the work of the price mechanism in one case and of the entrepreneur in another.
Fundamentally, it´s an issue of scale. It can be proven that central planning is the least efficient form of organisation at scale, because the information capacity of a hierarchically organised network will always be less than that of a mesh or federal mesh system.
However for small systems, those network capacity limits aren´t reached - so it doesn´t matter, and there´s also a joker in the pack for mesh networks, in that if they can´t self-regulate their traffic, the resulting broadcast storm (which socially we are now in worldwide) will drive their good-put (user traffic) to very low levels.
Besides the information capacity issue though, there are also considerations of command and control, so if you have a central planner that really knows what they´re doing (and the issue of information capacity is essentially that most central planners can´t), then that topology will be advantageous. Especially in competition with other centrally planned organisations - like Microsoft say.
We have so much information capacity now that's no longer an issue.
Gosplan, the Soviet state planning apparatus, ran on an monthly information cycle and a yearly planning cycle. WalMart runs on a daily information cycle and a weekly planning cycle. Amazon is near real time.
China, interestingly, goes to the opposite extreme. China is now on the 13th 5-year plan since the Revolution.[1] It's a set of 32 general policy goals to be emphasized for the next five years. These seem general, but this overall guidance determines on what the government spends time and resources.
That's not the point. That information needs to be processed by a human being who then outputs decisions. If you have too much "big data", that data becomes useless because it overwhelms thereby making itself useless.
Only some of the information needs to be processed by a human being. How much inventory to carry of each item has been automated in retail for decades. Only unusual situations and new items need human attention.
Coase's internal vs external transaction costs is a really good way of framing lots of tradeoffs between internally production vs outsourcing trade-offs. Should the government run jails or pay contractors to? Should apple build its own components or ship them in from China? It depends on whether internal or external transaction costs are higher
Over time, various economists have argued for additional factors. For example, there's often a degree of path dependence to why a given firm might be structured in a particular way. But, yes, especially for a paper that's almost 80 years old, its core concepts hold up remarkably well and provide a useful framework to think about sourcing decisions.
And it's often very clear (at least in retrospect) that those outsourcing trends that fall out of fashion over time often do so because many transaction costs associated with the outsourcing turned out to be ignored or at least underestimated. Conversely, there are countless examples today of companies using external services for things because the transaction costs associated with doing so have been so dramatically reduced.
Coase also had some fundamental insights into regulatory economics (insights which have been often misunderstood by modern neo-liberals). Two other excellent papers to read:
Coase quotes Sir Arthur Salter: "The normal economic system works itself. For its current operation it is under no central control, it needs no central survey. Over the whole range of human activity and human need, supply is adjusted to demand, and production to consumption, by a process that is automatic, elastic and responsive." He's quoting Salter out of context. Salter was perhaps the first international central planner - he was in charge of Allied shipping during WWI.
Salter goes on to write, in his "Allied Shipping Control"[1], "By the exacting criteria of war conditions, this system proved to be, at least for those conditions, seriously inadequate and defective. By the new standards, it was blind and it was wasteful. It produced too little, it produced the wrong things, and it distributed them to the wrong people."
This is the fundamental critique of capitalism. The US produces about 4,000 Kcal of food per capita and still has hungry people. Even with huge productive capacity, the system doesn't deliver for the little guy.
Salter is describing economic socialism. Bertrand Russell once contrasted "Allied Shipping Control" with Marx's "Capital" as guides to the achievement of international socialism. Salter represents the bureaucrat's approach, as opposed to the politician's. Salter set things up so that the coal commission had to agree on coal policy across national boundaries, and the steel commission had to agree on steel policy, and then they'd go argue over shipping allocation. Arguments were by field, rather than by country. Marx is all about power - "Who tells whom what to do?", as Lenin put it.
Salter was one of the architects of the European Union, which started as the European Coal and Steel Commission, and a friend of Jean Monnet. He was influential in the design of the machinery of the Common Market. That's worked well; the EU's problems today are over immigration.
Coase and Salter were writing in an era when people considered these questions seriously. The Great Depression made it clear that unbridled capitalism could break down. All the productive capacity was still there, the workers still had their skills, yet people were starving. Something was fundamentally wrong with the system.
The Communists argued that their system was fundamentally better. (The failure mode of communism was that it centralized power so much that it encouraged tyranny. In retrospect, one can ask whether the problem was communism or just Russia. Since 1900, Russia has had a Czar with absolute power, a brief period of liberal communism that collapsed, dictatorial communism, bureaucratic communism, a brief period of liberal capitalism that collapsed, oligarchy, and now capitalist dictatorship. Russia without a strongman doesn't work. But that's another subject.)
The US coped with the Depression by trying to get capitalism under control, moving away from "greed is good, greed works". There was a lot of business opposition at the time. But not enough to stop it, for two reasons. One was that the Depression wasn't good for business, either. But the other was fear of communism as a competing economic system. It looked like communism was working - they weren't having a great depression. Capitalism had real ideological competition. This kept it honest.
This worked for a long time, from the 1930s to the 1970s. But by 1980, communism, as an economic system, wasn't working well. Nobody took it seriously any more. This freed up capitalism to go to its default "greed is good, greed works" mode, which is where we are today.
Now we have "secular stagnation" - plenty of excess productive capacity, but we can't deliver a good standard of living to everybody. The new thing is that we need far fewer people to make production go. For most of history, the problem was making enough stuff. Coase wrote in an era when making enough stuff was still a big problem. We're past that now. And we have no clue how to organize an economic system that deals with it.
[1] https://archive.org/details/alliedshippingco00saltuoft