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(1910-)
Ronald Harry Coase
 
: Philosophy of the Social Sciences, Mar98, Vol. 28 Issue 1, p5, 27p
Maki, Uskali
IS COASE A REALIST?
Ronald Coase has been a vigorous critic of mainstream economic theory, arguing that it is unrealistic and that a good theory is realistic The attributes "realistic" and "unrealistic" appear in three senses at least in Coase: one related to narrowness and breadth; another related to abstracting from particularities (and the issue of "blackboard economics"); and the third related to correspondence with the legal. This does not yet make Coase an advocate of realism. It is therefore separately argued that each of the three kinds of "realisticness" as a property of theories is consistent with realism as a theory of theories.
1. INTRODUCTION
Many winners of the Nobel Memorial Prize in economics have expressed their views about the proper aims and methods of economics as a science. Philosophers of economics thereby get raw materials for analyses of these views in terms of familiar philosophical categories. One of their pastimes has been to portray these economists by classifying their views under labels such as positivism, instrumentalism, conventionalism, descriptivism, falsificationism, and so forth. Thus, Milton Friedman has been characterized as an instrumentalist and as a pragmatist (e.g., Boland 1979; Hirsch and de Marchi 1989); Paul Samuelson as an operationist and descriptivist (e.g., Wong 1973; Cohen 1995); Friedrich Hayek as an ally of both infallibilist apriorists and of falsificationists (e.g., Hutchison 1981; Caldwell 1992). Few economists have been identified as realists through a systematic analysis. Among the exceptions are Kaldor (Lawson 1989) and, somewhat surprisingly perhaps, Friedman (Maki 1992b), and, among the economists of the 19th century, Menger (Maki 1990, 1997a).
Ronald Coase, winner of the Nobel Prize in 1991, is an example of an economist who has been active in speaking out his methodological views (for a collection of some of his more important papers on methodological issues, see Coase 1994). Coase's contributions to economics are unconventional enough to have inspired him to engage in some reconsideration of the conventional approaches to economic theorizing. This is evidenced by the two seminal articles that won him the Prize. "The Nature of the Firm" (1937) revolutionized (albeit with a considerable time lag) the theory of the firm, while "The Problem of Social Cost" (1960) launched (almost overnight) a new research field, law and economics. Both articles, while theoretical themselves, were preceded by extensive empirical case studies, an approach that was unpopular then--and has been ever since-among economists. Both articles argued for the incorporation into theory of a new factor that is nowadays called transaction costs. Coase pointed out that transaction costs are not just any costs that can be ignored at will, but that they amount to a powerful factor that brings with them whole institutional structures to the fore. Coase argues that conventional neoclassical theory is unduly unrealistic in ignoring these costs and structures and in being embedded in what he calls "blackboard economics" with no touch with what is really going on in the economy. Coase's methodological main message is that economics has to be made more realistic.
Thus, one of Coase's explicit methodological principles implies a call for realistic theories. This much is clear and evident. Two things are less clear and evident, and they constitute the problem that we address in this article. First, the precise import of the idea that theories should be realistic is not immediately obvious from what Coase has written. I will provide an interpretation of this idea by submitting three complementary readings. Second, it is not immediately obvious that Coase also adheres to realism as a philosophical theory of scientific theories. As I have pointed out elsewhere, for many purposes we had better take realism and (what I have proposed calling) realisticness as distinct notions (e.g., Maki 1989). Realism is a family of philosophical doctrines, while realisticness is a family of properties of theories and their constituent elements. Both families are large, and in many cases, their members don't mesh up easily. That is, the advocacy of realisticness does not always imply the advocacy of realism, nor is it always--that is, in all senses of "realistic"--a necessary condition for realism. But sometimes they do go together. I will argue that in Coase's case they do. Note that while it can be argued that Friedman, even if opposing realistic assumptions, is a realist (Maki 1992b), I am now going to argue that Coase, who strongly endorses realistic assumptions and theories, is also an advocate of realism.
The structure of my argument is simple. I will first identify three senses in which Coase seems to defend realisticness. I will then show that each of these three senses of realisticness is compatible with a realist view of scientific theorizing. My approach to reading Coase is a bottom-up approach. Instead of imposing some pre-fixed form of realist philosophy on Coase's views, I will, in a piecemeal way, employ (and adjust) philosophical concepts that help make sense of Coase's writings as we move ahead reading him. At the end, I make a few remarks on the character of Coase's overall realism in a broader context.
2. THE QUEST FOR REALISTICNESS
On a number of occasions, Coase has expressed the opinion that economic theories had better be realistic--or at least more realistic than the typical mainstream theories tend to be. He is strongly opposed to the view standardly attributed to Friedman, according to which the unrealisticness of assumptions does not matter or, more strongly, that unrealisticness is a virtue. This seems to have been one of his driving obsessions from the very beginning of his career:
My article ["The nature of the firm"] starts by making a methodological point: it is desirable that the assumptions we make in economics should be realistic. Most readers will pass over these opening sentences . . . and others will excuse what they read as a youthful mistake, believing, as so many modern economists do, that we should choose our theories on the basis of the accuracy of their predictions, the realism of their assumptions being utterly irrelevant. I did not believe this in the 1930s and, as it happens, I still do not. (Coase 1993c, 52)
A closer look at the ways in which he puts this general idea reveals that it is not at all perfectly clear what he means by his insistence on realisticness. The present section attempts to clarify some of the senses in which the idea seems to appear in his writing. I suggest to identify three such senses.
The identification of the first two of these three senses of realisticness is based on distinguishing two kinds of what I call theoretical isolation or abstraction and their reverse operations, forms of deisolation. Consider your table on which lie two books, one blue, the other yellow, a pencil, and a piece of paper. Horizontal isolation takes place if you focus on--include in your "model"--the blue book and the pencil only, to the exclusion of the other two items. Horizontal de-isolation takes place if you then add the piece of paper or the yellow book or both in your model. Vertical isolation is an operation whereby you move from the particular items on your table to colors and pencils in general and from your two books to bookhood; in short, from concrete to abstract, from tokens to types of various generality, in some cases from particulars to universals. The reverse operation is vertical de-isolation. Whatever level of generality you attain by these methods, you can then fix that level and again practice horizontal isolation and de-isolation among the types or tokens that belong to that level.(n1) Let us then move from your table to the realm of Coasean economics for more interesting illustrations.
2.1. Horizontal De-Isolation: Incorporating "Missing Elements"
Coase is critical of the narrowness of conventional mainline economics in the sense that it excludes from consideration factors in the social world that he thinks should be included in the analysis. We may say that he finds standard neoclassical theory too isolative; it isolates a few factors from a number of others, some of which Coase considers to be unduly neglected.
Some of the excluded factors are those that characterize the internal organization of the business firm, thus leading to a notion of the firm as a black box:(n2)
The concentration on the determination of prices has led to a narrowing of focus which has had as a result the neglect of other aspects of the economic system.... What happens in between the purchase of the factors of production and the sale of the goods that are produced by these factors is largely ignored.... The firm in mainstream economic theory has often been described as a "black box." And so it is. This is very extraordinary given that most resources in a modem economic system are employed within firms, with how these resources are used dependent on administrative decisions and not directly on the operation of a market. Consequently, the efficiency of the economic system depends to a very considerable extent on how these organisations conduct their affairs, particularly, of course, the modern corporation. Even more surprising, given their interest in the pricing system, is the neglect of the market or more specifically the institutional arrangements which govern the process of exchange. (Coase 1993a, 229)(n3, n4)
Coase puts some of the blame on the conception of economics as a theory of choice which has contributed to the exclusion of the human and institutional "substance" of the economy from theoretical consideration:
This preoccupation of economists with the logic of choice . . . has nonetheless had, in my view serious adverse effects on economics itself. One result of this divorce of the theory from its subject matter has been that the entities whose decisions economists are engaged in analyzing have not been made the subject of study and in consequence lack any substance. The consumer is not a human being but a consistent set of preferences. The firm to an economist . . . "is effectively defined as a cost curve and a demand curve...." Exchange takes place without any specification of its institutional setting. We have consumers without humanity, firms without organization, and even exchange without markets. (Coase 1988b, 3)(n5)
Coase's diagnosis of the flaws of conventional theory is based on the idea that this theory is overly isolative or narrow. More precisely, conventional mainline theory is based on horizontal isolations--isolations at a given level of abstraction--such that it excludes items that should not be so excluded. The remedy, then, is to horizontally de-isolate or broaden the picture by incorporating neglected elements into the theory. The most important neglected element that Coase identified--the identification of which helped win him the Nobel prize--was positive transaction costs. By incorporating positive transaction costs into his account, Coase was able to incorporate institutional structures that were previously neglected from systematic analysis. This operation required the relaxation of the assumption of zero transaction costs, which "is, of course, a very unrealistic assumption" (Coase 1960,15). "The solution was to realize that there were costs of making transactions in a market economy and that it was necessary to incorporate them in the analysis" (Coase 1993d, 46). Coase admits that he "had no such general aim in mind in these articles"--namely, the famous two, "The Nature of the Firm" (1937) and "The Problem of Social Cost" (1960 --even without such an aim, he came up with providing what he calls "the missing element" in economic models, to wit, the concept of transaction costs (Coase 1993b, 62). This is not the only missing element, however: "No doubt other factors should also be added" (Coase 1988b, 30).
Now economists have an amazing variety of grounds for thinking of a given theory as unrealistic, but a major one is certainly the perception of the theory as overly narrow or partial or, as we may also call it, horizontally isolative. This is also one of Coase's critical perceptions of standard neoclassical theory. His quest for realisticness here takes on the form of insisting on the horizontal de-isolation of the theoretical picture of the economy by incorporating missing elements into the theory. Thus, Coase's first meaning for "making economic theory more realistic" is "broadening economic theory," or, in other words, "horizontally de-isolating economic theory."
There seems to be a more general form in which the insistence on horizontal de-isolation appears in Coase. He is worried about the practice among economists to examine economic problems in separation from the complex context in which they are embedded. "Any actual situation is complex and a single economic problem does not exist in isolation. Consequently, confusion is liable to result because economists dealing with an actual situation are attempting to solve several problems at once" (Coase 1988e, 77). This is, of course, a major thread in his persistent critique of Pigovian welfare economics:
Analysis in terms of divergencies between private and social products concentrates attention on particular deficiencies in the system and tends to nourish the belief that any measure which will remove the deficiency is necessarily desirable. It diverts attention from those other changes in the system which are inevitably associated with the corrective measure, changes which may well produce more harm than the original deficiency.... But it is, of course, desirable that the choice among different social arrangements for the solution of economic problems should be carried out in broader terms than this and that the total effect of these arrangements in all spheres of life should be taken into account. (Coase 1960, 42-3)
This is a call for a more comprehensive, horizontally de-isolated, approach.
2.2. Vertical De Isolation: Case Study Versus "Blackboard Economics"
Narrowness is not the only sin of standard neoclassical economics against realisticness. Coase suggests that the excessively far-driven horizontal isolationist strategy of conventional economics is related to another feature in it, namely, to what he calls "blackboard economic." As we will soon find out, the interpretation of this notion is much harder than our task thus far. The following sentence will play an important role in our interpretive efforts: "This neglect of other aspects of the system has been made easier by another feature of modern economic theory--the growing abstraction of the analysis, which does not seem to call for a detailed knowledge of the actual economic system or, at any rate, has managed to proceed without it" (Coase 1993a, 228; emphasis added). Coase argues that much of the discussion in the conventional theory of the firm "is theory without any empirical basis." He goes on by saying that "what is studied is a system which lives in the minds of economists but not on earth. I have called the result `blackboard economics'" (p. 229).
Coase puts this approach in a historical context by tracing it back to Joan Robinson's Economics of Imperfect Competition (1933): "This new theoretical apparatus had the advantage that one could cover the blackboard with diagrams and fill the hour in one's lectures without the need to find out anything about what happened in the real world" (Coase 1993c, 51). Coase is not happy with the fact that "when economists find that they are unable to analyze what is happening in the real world, they invent an imaginary world which they are capable of handling. It was not a procedure that I wanted to follow in the 1930s. It explains why I tried to find the reason for the existence of the firm in factories and offices rather than in the writings of economists, which I irreverently labeled as `bilge'" (p. 52).
A closer inspection of such passages soon reveals that the notion of blackboard economics is far from a clear one. Coase characterizes blackboard economics variously in terms of "abstraction," neglect of "detailed knowledge" of the "actual" economy, lack of "empirical basis," "living in the minds of economists but not on earth," lack of "need to find out anything about what happened in the real world," "inventing an imaginary world," neglect of what is going on in "factories and offices," and "bilge." It is not obvious that these characterizations all mean the same thing. We need patience to sort out the major threads in this jungle. My strategy is to look for an interpretation of the notion of blackboard economics subject to two limiting constraints: first, Coase himself must not appear as a blackboard economist; second, Coase's claim that "this neglect of other aspects of the system has been made easier by another feature of modern economic theory" has to appear as true. In other words, we will be after an interpretation that satisfies these two constraints.
To begin, the notion of "an imaginary world" that "lives in the minds of economists" is ambiguous enough to permit several interpretations. First, we may say that an imaginary world is imaginary in that it is inhabited by creatures that do not exist in the real world; thus, an economist might invent a world with unicorns and centaurs that seek to maximize physical pain and obey the first but not the second law of thermodynamics. Such a world would be radically imaginary. Second, we might take an imaginary world to be one which lacks many of the inhabitants of the real world but contains some of them. This would be the case discussed in the previous section: pictures of the world based on theoretical horizontal isolation. Such a world would be only weakly imaginary, and also quite harmless, since all scientific theories "invent" such worlds. Indeed, this is what theoretical isolation is all about. It seems that Coase cannot have either of these senses of "an imaginary world" in mind. Economics certainly is not quite as radically "blackboardist" as the first interpretation suggests, and economics quite harmlessly is "blackboardist" in the second sense. Some qualifications are needed to defend the charge that blackboard economics in something like the second sense is harmful. Let us see if we can find clues to such qualifications in Coase.
We may first note that Coase himself practices blackboard economics in the second sense. He explains that in sections III and IV of "The Problem of Social Cost," he "examined what would happen in a world in which transaction costs were assumed to be zero. My aim in so doing was not to describe what life would be like in such a world but to provide a simple setting in which to develop the analysis and, what was even more important, to make clear the fundamental role which transaction costs do, and should, play in the fashioning of the institutions which make up the economic system" (Coase 1988b, 13; emphasis added). Now it seems obvious that Coase here admits having practiced "blackboard economics," as it were. "Providing a simple setting in which to develop the analysis" constitutes an important part of theoretical isolation in all of economics. Coase's strategy is not exceptional here. Or consider the following: "Let us start by assuming that we have an economic system without firms, difficult though it may be to conceive of such a thing.... In such a system, the allocation of resources would respond directly to the structure of prices" (Coase 1993b, 65). We may choose or not choose to call such counterfactual reasoning "blackboard economics," but this is what is taking place in all scientific disciplines, both social and natural.
In order to distinguish between blackboard economics as practiced by Coase and blackboard economics as denounced by him, the following qualification would seem inviting. Maybe Coase uses the label "blackboard economics" to refer to those cases of economic theorizing that exclude from consideration, at all stages of the analysis, items in economic reality that he regards as nonexcludable in the final analysis. Coase himself may exclude items such as transaction costs and business firms at early stages of the analysis, but only to introduce them at later stages; "The Problem of Social Cost" is an example of this. The use of the label would then boil down to the issue of rival conceptions of what is and what is not excludable from theoretical analysis at certain stages.
The problem with this suggestion is that it does not seem to satisfy the second constraint of our interpretation; it does not easily fit with what we found Coase saying about the relationship between narrowness and blackboard economics, namely, that narrowness is "made easier" by blackboardism: "This neglect of other aspects of the system has been made easier by another feature of modern economic theory--the growing abstraction of the analysis...." The suggestion we are considering implies that blackboard economics is narrow economics. The second constraint would now lead to the idea that narrowness is made easier by narrowness, in other words, that the neglect of some aspects--in particular transaction costs--is made easier by the neglect of some aspect--such as transaction costs. Since this does not make much sense, we have to go on looking for other qualifications.
Let us focus on Coase's idea of "growing abstraction." It is important to see that the notion of abstraction is used by economists and others in a large number of different senses, not all of them being quite legitimate. Two legitimate senses of the term denote what we are calling horizontal and vertical isolation or abstraction. Horizontal isolation or abstraction amounts to excluding from consideration items at the same level of vertical abstraction, such as in partial equilibrium analysis. This is precisely the notion with which we have operated in the foregoing. "Growing abstraction" in this horizontal sense is a matter of isolating a decreasing number of items for consideration and thereby excluding an increasing number of items from consideration. But this does not seem to be the idea that Coase has had in mind, provided we want to retain the idea that the "neglect of other aspects of the system has been made easier by the growing abstraction of the analysis," since this would lead to the odd claim that horizontal abstraction has been made easier by growing horizontal abstraction, as pointed out above.
Maybe Coase has in mind vertical abstraction when he talks about "growing abstraction." Vertical abstraction is a matter of isolating general or universal aspects of things from their particular features. Instead of talking about particular business firms, we start talking about firms in general; instead of talking about the market for peppers and professors, we talk about the market; instead of talking about the particular costs of a particular transaction, we talk about transaction costs in general. Some of Coase's characterizations of blackboard economics seem to have this connotation. For example, the reference to "factories and offices" might be taken to imply that blackboard economics neglects what takes place in particular factories and offices. The idea of blackboard economics neglecting "detailed knowledge of the actual economic system" is a little more ambiguous, since it seems possible to interpret it in terms of both vertical and horizontal isolation or abstraction: the details excluded may refer to either all particular features at a low level of vertical abstraction (such as the particular managerial routines of particular business firms), so that the level of vertical abstraction rises, or to features at any fixed level of vertical abstraction (such as transaction costs at a high level of vertical abstraction). In any case, here we have yet another interpretation of blackboard economics: it is economics that vertically abstracts from the particular details of particular factories and offices. Would this idea help us? Could it be that horizontal abstraction is "made easier" by growing vertical abstraction?
Once again, we confront the problem of distinguishing blackboard economics from Coase's economics. Namely, it is clear that Coase's most celebrated ideas are also vertically abstract. He did not write an article on "The nature of General Motors," or of Ford Motors or of Union Carbide, companies that he visited during his research tour in the United States in 1931-2, preparing the way for his 1937 article, but he wrote his celebrated article instead on "the nature of the firm," that is, on the firm in the abstract. The same applies to all of his other theoretical ideas. Vertical abstraction alone therefore cannot provide the dividing line. Maybe the secret lies in the idea of "growing" abstraction? Maybe blackboard economics is vertically more abstract than Coasian economics? This idea does not seem to provide a solution either, since it is hard to see that the conventional concept of the firm would be significantly more vertically abstract than the Coasean concept, even though the former is horizontally more abstract or isolative, as we have seen.
To find a solution, we have to acknowledge that the term "abstraction" in the vertical context designates two different concepts, namely, the level of abstraction and the process of abstraction. Once we make this distinction, one might argue that whereas there is no major difference between the levels of vertical abstraction of the theoretical ideas in conventional and Coasean economics, there is a major difference between the two in regard to the process of abstraction. The difference might be the following. While Coase has moved, by way of a process of vertical abstraction, from "detailed knowledge" of particular "factories and offices" to vertically abstract ideas of the firm and the market and the law, nothing like this takes place in conventional mainline economics. The Coasean research process involves changing levels of vertical abstraction, while Coase might argue that this does not happen in blackboard economics which sticks to a high level of vertical abstraction without an ongoing process of abstraction supporting the high-level theoretical abstractions.
There is a major element in the Coasean research strategy that would play a major role in this interpretation. This element is the emphasis on the importance of empirical case study. As is well known, Coase himself has performed a large number of case studies on industrial structure and behavior--an unpopular activity within the traditional neoclassical mainstream of economics. The key feature of case study is, of course, that it takes place at a low level of vertical abstraction; it focuses on particular cases. Now the idea is that there is no need for case studies in blackboard economics, since there is no process of abstraction from low to high levels. Blackboard economics is there already, at a high level of vertical abstraction.
This idea might also be able to accommodate Coase's remaining characterization that blackboard economics supports "theory without any empirical basis." Even though he would be using the concept of empirical basis in an unconventional way, he might be suggesting that lacking an empirical basis is equivalent to neglecting the level of empirical particularities in the process of vertical abstraction.
We may now be in a better position to understand and perhaps accept the idea that the "neglect of other aspects of the system has been made easier by the growing abstraction of the analysis." Maybe Coase meant that the harmful horizontal abstraction from important factors has been made easier by a growing level of vertical abstraction which is not supported by a careful process of vertical abstraction. Maybe Coase wanted to say that a deliberate process of vertical abstraction, involving the very concrete phases represented by empirical case studies, is something that alerts economists to important factors in the economy and helps them suggest horizontal de-isolations in order to incorporate those factors into the analysis. The discovery of appropriate boundaries of horizontal abstraction would be dependent on discoveries provided by research at low levels of vertical abstraction. On this interpretation, blackboard economics is economics at a high level of vertical abstraction unsupported by the process of vertical abstraction. Blackboard economics is unrealistic precisely in this sense: it is vertically abstract without being supported by a process of vertical abstraction.
It took some effort to find a plausible interpretation for the notion of blackboard economics. But we are not done yet. There seem to be two other yet related interpretations that suggest themselves. Both are concerned with Coase's view of how economic theory should be applied to policy issues, while the interpretation developed above is concerned with his views of theory formation. Yet, it is vertical de-isolation that is the key also to these two other interpretations related to the application of theory to policy.
At times it seems that what Coase has in mind when calling an approach "blackboard economics" is what has been called the "Nirvana approach," the procedure of comparing the actual economic situation to an ideal unattainable situation rather than comparing two or more actual or attainable situations to one another. In "The Problem of Social Cost" Coase argues that
the whole discussion is largely irrelevant for questions of economic policy since, whatever we may have in mind as our ideal world, it is clear that we have not yet discovered how to get to it from where we are. A better approach would seem to be to start our analysis with a situation approximating that which actually exists, to examine the effects of a proposed policy change, and to attempt to decide whether the new situation would be, in total, better or worse than the original one. In this way, conclusions for policy would have some relevance to the actual situation. (Coase 1960, 43)(n6)
In his recent characterization of marginal cost pricing, he makes a similar point, now explicitly linking it to the notion of blackboard economics. He says that this policy "is largely without merit" and asks,
How then can one explain the widespread support that it has enjoyed in the economics profession? I believe it is the result of economists using an approach which I have termed "blackboard economics." The policy under consideration is one which is implemented on the blackboard. All the information needed is assumed to be available and the teacher plays all the parts. He fixes prices, imposes taxes, and distributes subsidies (on the blackboard) to promote the general welfare. But there is no counterpart to the teacher within the real economic system. There is no one who is entrusted with the task that is performed on the blackboard.... Blackboard economics ... misdirects our attention when thinking about economic policy. For this we need to consider the way in which the economic system would work with alternative institutional structures. And this requires a different approach from that used by most modern economists. (Coase 1988b, 19-20)
The second policy-related sense of realisticness based on the idea of vertical de-isolation is implied by the requirement that one has to have one's initial conditions right if one hopes to have the policy conclusions of theoretical inferences right. The correct initial conditions can only be discovered by detailed empirical studies of particular situations. This is a recurring theme in Coase's writing. There is something paradigmatic about his lengthy discussion of whether it would be desirable that the railroad should be liable for the fires that are caused by sparks from railway engines. This discussion is concluded by the following statement: "Whether it is desirable or not depends on the particular circumstances" (Coase 1960, 34). And knowledge of particular circumstances can only be acquired by way of detailed case study, while Coase criticizes the Pigovians for pretending to reach such conclusions by purely theoretical means.(n7)
That horizontal de-isolation by way of incorporating transaction costs and institutions (such as legal rules) into theory is not enough but has to be supplemented with vertical de-isolation, detailed attention to the particular facts at hand, is evidenced by the following conclusion of another analysis: "What incentives will be lacking depends on what the law is, since this determines what contractual arrangements will have to be made to bring about those actions which maximize the value of production. The result brought about by different legal rules is not intuitively obvious and depends on the facts of each particular case" (Coase 1988c, 178).(n8)
We can see that while the first criticism of blackboard economics was in terms of horizontal de-isolation being facilitated by vertical de-isolation, here it is in terms of horizontal de-isolation teeing supplemented by vertical de-isolation. Combining the two gives us Coase's second sense of realisticness: realistic theorizing is systematically supported by vertical de-isolation, by case study in particular.
2.3. Correspondence With Legal Discourse
There is a third sense of realisticness that does not appear to be immediately related to the other two that we have examined so far. The third notion appears in Coase's "The Nature of the Firm." In the opening section, he states that a major goal of this article was to obtain a definition which is realistic; on a recent occasion, he repeats this idea: "My aim was to discover a `realistic assumption'" (Coase 1993c, 52). What does he mean by this? He opens the article by saying that "It is hoped to show in the following paper that a definition of a firm may be obtained which is... realistic in that it corresponds to what is meant by a firm in the real world" (Coase 1937,386). Note that he does not say that he pursues a definition that is realistic in that it corresponds to the firm in the real world, but one that corresponds to what is meant by a firm (or rather, by the term "firm") in the real world. This creates a puzzle that we have to try to resolve: what is the item to which the definition is supposed to correspond to? The closing section of the article returns to this question and would seem to give us a clue. "Only one task now remains: and that is, to see whether the concept of a firm which has been developed fits in with that existing in the real world" (Coase 1937,403). There is an ambiguity in this sentence; it is not quite obvious whether the correlate of "that" (in "that existing in the real world") is "the concept" or "a firm," whether it is a firm existing in the real world or the concept of a firm existing in the real world.
This sense of ambiguity concerning the correlate of Coase's concept of the firm is confirmed by other passages. The next sentence appears to explain what Coase means by the expression "in the real world": focusing on the latter part of the question just cited ("whether the concept of a firm which has been developed fits in with that existing in the real world"), he now talks about "the question of what constitutes a firm in practice" (Coase 1937,403; emphasis added). Coase then gives a clue of the kind of practice he has in mind by invoking "the legal relationship normally called that of `master and servant' or `employer and employee'" (p. 403; emphasis added). He concludes by saying that "we thus see that it is the fact of direction which is the essence of the legal concept of `employer' and `employee,' just as it was in the economic concept which was developed above.... We can therefore conclude that the definition we have given is one which closely approximates the firm as it is considered in the real world. Our definition is therefore realistic" (1937, 404; emphases added).
We may be splitting hairs, but I cannot avoid seeing three possible interpretations of what Coase may think is the proper correlate of his concept of the firm: (1) the "legal concept" of employer and employee, that is, "the firm as it is considered" in legal practice; (2) "the legal relationship" between employer and employee existing in business practice; and (3) "the fact of direction" "existing in the real world," that is, in business practice.
This means that we have three interpretations of why Coase thinks his concept of the firm is realistic. He may think that his concept is realistic in that it corresponds to some permutation of (1)-(3), that is, to any one of them singly or to some combination thereof, such as all of them. Most of these permutations imply privileging the legal.(n9) We will return to these ambiguities in section 3.3.
3. FROM REALISTICNESS TO REALISM
Since Coase says that he is in favor of "realism" in assumptions and theories, one might rush to the conclusion that he is a realist, or more particularly, that he espouses realism as a theory of scientific theories. Realism in this sense is a view opposed to such other views of the nature of scientific theories as instrumentalism and conventionalism, often claimed to enjoy wide popularity among economists (e.g., Boland 1982). The temptation to infer from an advocacy of "realism" in theories to an advocacy of realism as a theory of theories is due to the use of the same term "realism" to express two different ideas. This is unfortunate, since not all preferred forms of "realism" in theories imply realism as a theory of theories. To underline the difference between the two ideas, I have in the foregoing section talked about the realisticness of economic theories and their assumptions rather than their "realism." Once the terminological distinction between realisticness and realism has been made, it is easier to pose the question of whether or not this or that form of realisticness is conceptually linked to forms of realism. This question is the topic of the present section.(n10)
One simple way of formulating the idea of scientific realism as a theory of scientific theories says that scientific theories, if they succeed, refer to really existing entities and truthfully represent the objective order of things in the world.(n11) In contrast, instrumentalism says that scientific theories are "inference tickets" or instruments for organizing data or generating predictions or the like, but not for directly representing the way the world is.
I have pointed out that Coase's quest for realistic theories--that is, his quest for realisticness--appears in at least three forms: (1) his horizontal de-isolationism, (2) his opposition to "blackboard economics" or his vertical de-isolationism, and (3) his insistence on "correspondence" with legal discourse. We next discuss each of these notions in turn from the point of view of realism. It will be seen that each of these notions fits neatly with an espousal of realism as a theory of theories. Coase is not only in favor of realisticness but also in favor of realism.
3.1. Horizontal De-Isolationism
We have already cited Coase's complaint about economics which theorizes "consumers without humanity, firms without organization, and even exchange without markets" (Coase 1988b, 3). Let us try to see whether there are grounds for this complaint. Such grounds are far from intuitively obvious provided we have any respect for scientific theories that study planets without extension, planes without friction, and molecules without color.
Coase explains that rather than being evident from the start, it took him a long time to realize that "the whole of economic theory would be transformed by incorporating transaction costs into the analysis" (Coase 1993b, 62). The somewhat revolutionary tone of this judgment can only be understood as reflecting the idea that transaction costs constitute a major factor in economic reality and that its inclusion in theory has major consequences for economics.
The idea that transaction costs constitute a major factor that is not to be excluded in an analysis that purports to give an account of the real economic system can be given a quantitative interpretation. Coase himself appeals to the study of Wallis and North (1986) that "estimated that transaction costs are about 50 percent of the gross national product. Given that they are so large, their influence on the working of the economic system is bound to be pervasive" (Coase 1993b, 63). Largeness alone, however, cannot provide a basis for theoretical significance. What must ultimately matter is causal significance in the order of things in the real world. Coase has to hold the view that transaction costs not only constitute a major fraction of the GNP but are causally very powerful for the functioning of the economy. The causal powerfulness of transaction costs is due to a qualitative side of the matter. The introduction of positive transaction costs in the theory brings with it new kinds of entities, namely, institutions, such as legal rules and contractual structures. If it is held that such institutions play an indispensable and powerful role in the functioning of the economy, it would be inexcusable to exclude them from the analysis.
This argument is premised on a central idea that we can find repeatedly in Coase, namely, that it is the task of economic theory to provide "insight into how the system works" (Coase 1988c, 64). He argues that "realism [i.e., realisticness] of assumptions is needed if our theories are ever to help us understand why the system works in the way it does" (Coase 1988c, 65). Coase is well aware that "our assumptions should not be completely realistic. There are factors we leave out because we do not know how to handle them. There are others we exclude because we do not feel the benefits of a more complete theory would be worth the costs involved in including them.... Again, assumptions about other factors do not need to be realistic because they are completely irrelevant" (p. 66). In other words, Coase is comfortable with a theory being horizontally isolative or abstract in general, provided there are good reasons for this such as the ones he cites above.(n12) But there are limits to horizontal isolativeness; some items simply cannot be excluded, since their inclusion is necessary for understanding "how the economic system works."
The idea that there is a way in which "the economic system works" suggests that the complaint about a "missing element" in theory is in effect a complaint about an indispensable missing link in the working of the real system; without this link, the system would not function as it does--or would not function at all. Therefore, this link has to be theorized in order to understand how the system works.
This idea can be built upon the realist belief that there is a fact of the matter about the functioning of the economic system and that it is the task of theorizing to represent this objective circumstance as truly as possible. Coase might think that reality is objectively organized into causally relevant and irrelevant factors and that while it is quite permissible to leave out the irrelevant ones, it is necessary to include the relevant ones in the theory. Factors are causally relevant or irrelevant, or essential or inessential, for how the economic system works, and it would be inexcusable not to be realistic about the former. The point of theorizing is "to get to the essence of what [is] going on in the economic system," as he puts it (Coase 1988c, 68). The realist interpretation of this idea presupposes that "the essence" of how the economic system works is something objectively real rather than created by our theoretical endeavors.
It is illuminating to contrast this idea with the view that Richard Posner expressed in the context of his critique of Coase's views. Posner put forth what may be characterized, without much hesitation, as an instrumentalist claim, namely, that "a model can tee a useful tool of discovery even if it is unrealistic, just as Ptolemy's astronomical theory was a useful tool of navigation...even though its basic premise was false.... We should be pragmatic about theory. It is a tool, rather than a glimpse of ultimate truth, and the criterion of a tool is its utility" (Posner 1993a, 77).(n13) In other words, Posner is comfortable with an astronomical theory which represents the structure of the solar system as being diametrically opposite to what we have every reason to believe it in fact is. It is obvious that such a theory cannot tell us how the solar system works, even though it may, in some circumstances, be useful for predictive purposes. Given Coase's interest in how the system under study functions, he would not tee content with Ptolemyan theory. He would prefer Copernican heliocentrism to the false geocentrism, even if the Copernican theory has many minor details wrong and may therefore fail in predictions. As Coase says, "Faced with a choice between a theory which predicts well but gives us little insight into how the system works and one which gives us this insight but predicts badly, I would choose the latter" (Coase 1988c, 64).(n14)
Coase may think that just as it is part of the essence of the solar system that the planets revolve around the sun and not vice versa, it is part of the essence of the economic system that institutions are there to reduce transaction costs. Without having these essential core ideas right in one's theories, no understanding of how the respective systems work is forthcoming. The "essentialist" ingredient in this view is that such missing elements in Ptolemaiac and conventional neoclassical theories are essential elements. The realist ingredient is that such elements are objectively real, unconstituted by the respective theories. This is my realist interpretation of the first form of realisticness in Coase.(n15)
3.2. Vertical De-Isolationism
Let us then see if there is a plausible realist interpretation of Coase's critique of blackboard economics. To begin, we may note that, historically, the term "realism" was first used in medieval philosophy to characterize the Platonic and Aristotelean views that universals (such as properties and kinds) as opposed to particulars are real. Nominalists, on the other hand, were those who held that only particular objects are real, while universals are merely names invented by us. A nominalist about universals (or abstract objects, as the phrase now goes) would say that there is no such thing as the business firm, or the M-form firm; all there is are particular business firms such as the Nokia Corporation and Liza's Ice Cream Parlor next to your house. A realist would say that the firm in general may exist, and so may generic types of firm; a plausible form of realism about such abstract kinds would have it that such kinds exist as aspects of particular business firms. It would hold that firmness is a really existing universal shared by all particular firms just like redness is a property shared by all particular red objects. It is their firmness that would distinguish all particular firms from all particular markets just as it is their marketness that would distinguish all particular markets from all particular firms.(n16) The nominalist alternative would be to say that it is we who do the distinguishing by naming one set of objects by the term "firm" and another by the term "market" such that there is no ground for this naming activity in the real order of things.
It is easy to see that the issue here is related to the notion of vertical abstraction. Nominalists think that all there is is concrete or particular. This implies that linguistic representations involving vertically abstract concepts (such as that of the firm in "the theory of the firm") do not directly denote anything real; at most, they indirectly denote particular objects. Theories of the firm do not denote firmness but rather sets of particular firms. Realists about universals think that such vertically abstract concepts are able to denote real things directly, namely, abstract objects such as the employer-employee relationship constituting firmness.(n17)
Coase emphasizes the importance of case studies, that is, studies of particular cases at the lowest level of vertical abstraction. Let us consider how this emphasis can be combined with realism about universals. It is evident that Coase's "The Nature of the Firm" is about firmness. Firmness is the nature of the firm, it is whatever constitutes the firm; it is this feature that particular firms have to possess in order to count as firm instances. Now it appears that Coase does not explicitly say things that would help us firmly identify him as an advocate of a realist view of firmness and other universals. On the other hand, it would seem to me that nothing that Coase says excludes the possibility of firmness existing as a real aspect of particular firms; in other words, nothing that Coase says denies realism about firmness, understood as the universal of employer-employee relationship or some elaboration thereupon. He might--and, we might add, in the name of coherence, he should--think that it is the task of research to help vertically abstract or isolate this real aspect of particular firms from their other aspects. The notion of firmness is at a high level of vertical abstraction, and the role of case studies would be to help give the right direction to the process of vertical abstraction that aims at capturing the vertically abstract nature shared by all particular business firms.
In regard to the other roles played by vertical de-isolation in Coase's opposition to blackboard economics, everything he says about getting the initial conditions right is consistent with the realist idea that theories are attempted representations of the real order of things. The point is that since theories do not cover the particularities of actual situations, these have to be provided by empirical case studies in order to make theories applicable to those situations in an empirically informative way.
3.3. Privileging the Legal
We then turn to a brief discussion of the third form in which Coase's quest for realisticness appears. I pointed out that the ways in which Coase formulates the idea that his concept of the firm is realistic suggest three interpretations that can be held separately or jointly: Coase's concept of the firm corresponds to (1) the legal concept of employer and employee, (2) the legal relationship between employer and employee, and (3) the fact of direction between employer and employee.
Let us see what is required for a realist reading of these three options. Option (3) would seem to be the least problematic case. Coase's concept of the firm would be allegedly realistic in the sense that it successfully refers to and represents the fact of direction between employer and employee, a fact that is supposed to be an aspect of objective social reality. No legal content would appear here.
However, this cannot be the whole story, given the emphasis that Coase puts on the role of the legal. Option (2) introduces the legal in an "objectivist" way. The legal here appears as an important aspect of social reality. The point is that legal rules help constitute or establish the relationship between employer and employee; this relationship is partly a legal relationship.(n18) If an economic concept corresponds to this legal relationship, it is therefore realistic. Thus, (2) does not seem to pose any major problems for a realist interpretation either. (2) can also be conjoined with (3) in the following way: legal rules governing the employer-employee relation constitute an aspect of the fact of direction in social reality; therefore, the economic concept of the firm had better correspond to the legal relationship.
Option (1) introduces the legal in a "subjective" sense, namely, by bringing in legal concepts rather than legal relationships. This is the most problematic case from a realist point of view, since it seems to be based on concept-concept connections rather than concept-world connections. Correspondence in a realist sense would prevail between concepts or assumptions and the real world (such as in cases [2] and [3]) rather than between two or more concepts or assumptions. However, a realist interpretation seems to be able to accommodate (1), too.
Coase here privileges the legal in the following sense: realisticness is a virtue, and the degree to which an economic notion of the firm is realistic is measured in terms of how closely it corresponds to legal notions. The use of the term "realistic" here appears to presuppose that legal notions are realistic themselves; legal notions are privileged because they are realistic, and economic notions are realistic to the extent that they correspond to the legal notions. However, the legal concept has to be realistic in a different sense, namely, it has to correspond to the firm in the real world, not just to some other concept of the firm.
Take another look at the last quotation of section 2.3. Coase says that his definition "closely approximates the firm as it is considered in the real world." The last words can mean at least two things, either "as it is considered in legal practice," or "as it is considered to be in the real world." On the latter interpretation, "the real world" is irreducible to "legal practice"; we may therefore formulate it "as it is considered in legal practice to be in the real world." This last formulation is consistent with realism: the economic concept of the firm is supposed to correspond to a legal conception of the firm which is supposed to be adequate about the firm as it is in the real world. Coase might think that legal discourse is somehow closer to social reality than economic discourse, that it has a relatively privileged access to social realities. The realisticness of economic ideas can therefore be measured by comparing them to legal ideas.
Our earlier suggestions regarding isolation or abstraction can be used to make this idea more specific. Maybe Coase believes that legal discourse has been able to isolate the core aspect of what it is to be a firm, that is, firmness as a real element of the social world, as depicted by (2) and (3). And, if the economic theory of the firm is to satisfy the canons of realism, its isolations had better conform to those of legal discourse. The required correspondence should then be understood as that between two isolations: economic discourse should isolate the same aspect of business firms as their real "essence" as legal discourse has done. As we saw in section 2.3, Coase implies that "corresponds to" means "shares the essence of," in this case "the fact of direction" ("...it is the fact of direction which is the essence of the legal concept of `employer' and `employee,' just as it was in the economic concept which was developed above" [Coase 1937, 404]). Thus, a direct concept-concept correspondence would indirectly amount to a concept-world correspondence. To be sure, this idea exemplifies a form of realism. We may therefore conclude to have reached a realist interpretation that is able to accommodate all three options (1)-(3) at the same time.
4. CONCLUSION
It took some effort to show that somebody explicitly advocating realisticness as a property of theories is also an implicit advocate of realism as a theory of theories. This is how it should be. There is often no direct link between the two. In the case of Coase, we had to identify the three senses in which he thinks realisticness is a virtue, and could only then proceed to explore whether these virtues are realist virtues. Our conclusion was that they are.
We have interpreted Coase's metatheoretical position to be a version of realism. Our reading has been more in the spirit of following a bottom-up approach--letting Coase guide us in choosing and creating the relevant philosophical notions--than a top-down approach, imposing some pre-fixed form of realist philosophy on his less than fully elaborate pronouncements. The result of the endeavor is not that we have shown Coase's view to be an instance of some preconceived realism; we have rather developed a picture of Coase's realism which can be understood only in the context of his economics.
Coase's realism includes simple elements such as the following. There is an objective order of things in society, "the way the system works." In this order, more specifically, positive transaction costs play a prominent role in the constitution of the economy, important aspects of the social order have a legal character, and firmness is a social kind or universal that is as real as particular firms. We may conclude that there is some essentialist flavor in Coase's ontological realism. Insofar as the goals and ways of theorizing are concerned, his realism involves the ideas that a theory is sufficiently true if it captures those elements that are necessary for the functioning of the system, and that empirical work based on close case studies plays an indispensable role at all stages of theorizing, including the "discovery" phase. His epistemology thus seems to be rather empiricist. Beyond these conjectures, any suggestions and elaborations may become much more speculative than those of this article.(n19)
Received 29 May 1996
Comments by two anonymous referees are gratefully acknowledged. This article draws upon a larger work on Coase. Thanks for comments on this earlier work go to Stephan Boehm, Gregory Dow, Milton Friedman, Thomas Mayer, Bsther-Mirjam Sent, and Oliver Williamson. The major part of research for this article was done during a pleasant semester at the University of California at Berkeley, for which I wish to express my thanks.
NOTES
(n1.) For a more detailed account of the ideas of horizontal and vertical theoretical isolation and illustrations from economics, see Maki (1992a, 1993a).
(n2.) The exclusion of internal characteristics of the objects under study (such as the internal organization of business firms) amounts to what may be called "internal isolation" in contrast to "external isolation," which is a matter of excluding characteristics of the system surrounding the object (such as other markets in partial equilibrium analysis) (see Maki 1992a, for details).
(n3.) Given statements like this, it is not surprising that Coase is critical of what he finds as the dominance of price theory in microeconomics. Given this attitude, it is somewhat ironic that his "The Nature of the Firm" was reprinted in American Economic Association's Readings in Price Theory (1952). In this context, it should also be pointed out that Coase may be giving a somewhat misleading characterization of standard microeconomic theory by attributing "the concentration on the determination of prices" to it. Standard price theory, of course, never provided an account of the determination of relative prices, in the sense of the causal process whereby prices are formed.
(n4.) This last claim about the neglect of the institutional structure of the market in conventional economics appears to run against Posner's claim that "all economists believe that they are engaged in the study of institutions, the institutions of the economic system broadly or narrowly understood. Theorists of `perfect competition' think they are studying an institution called the price system or the marker' (Posner 1993a, 76). Now it is obvious that either there is a substantial disagreement between Coase and Posner on this question or they are wing the term "institution" in at least two different yet unspecified senses. If there is a legitimate sense in which Posner uses the term, he has to understand it "broadly," while Coase would understand it more "narrowly" or in a more specific sense. Of course, Coase might justifiably hold that such a broad or general notion of institution is either not legitimate or at least not helpful, and that conventional economics is flawed precisely because of neglecting institutions in the more specific sense. Unfortunately, Coase is not very consistent in his usage of the term or, alternatively, in his assessment of conventional economics. Elsewhere he says that "what economists study is the working of the social institutions which bind together the economic system: firms, markets for goods and services, labour markets, capital markets, the banking system, international trade, and so on. It is the common interest in these social institutions which distinguishes the economics profession" (Coase 197B, 206-7).
(n5.) Note that Coase says that economists have preoccupied themselves with the logic of choice and that this has had adverse effects on economics. This implies the denial of the popular definition of economics as the study of the logic of choice.
(n6.) By suggesting that analysis at a low level of vertical abstraction would yield relevant conclusions, Coase implies yet another sense in which theorizing can be said or required to be realistic Policy relevance is one of the common forms of realisticness regularly referred to by economists.
(n7.) Coase's article on the lighthouse example also has a paradigmatic flavor to it. This article is a long argument for realisticness in the special sense at hand. He accuses economists such as J. S. Mill, Sidgwick, Pigou, and Samuelson of not understanding that the particularities of the institutional organization of the lighthouse system make a decisive difference regarding whether lighthouse services should be provided by the government or by private enterprise (Coase 1974).
(n8.) Coase's "Industrial Organization: A Proposal for Research" is a call for detailed empirical studies addressed to the NBER, the National Bureau of Economic Research (Coase 1988d). Toward the end of his Nobel Lecture, he expresses the wish that the "greater availability of data and the encouragement given to all researchers working on the institutional structure of production by the award to me of the Nobel Prize should result in a reduction in that elegant but sterile theorizing so commonly found in the economics literature on industrial organization and should lead to studies which increase our understanding of how the real economic system works" (Coase 1993a, 235).
(n9.) On a later occasion, Coase makes some qualifications on the specific substance of his suggestion. "I consider that one of the main weaknesses of my article stems from the use of the employer-employee relationship as the archetype of the firm. It gives an incomplete picture of the nature of the firm. But more important it misdirects our attention.... The way I presented my ideas has, I believe, led to or encouraged an undue emphasis on the role of the firm as a purchaser of the services of factors of production and on the choice of the contractual arrangements which it makes with them. As a consequence of this concentration on the firm as a purchaser of the inputs it uses, economists have tended to neglect the main activity of a firm, running a business" (Coase 1993b, 64-5). The admission that "the fact of direction" does not exhaust the whole essence of the firm does not, however, seem to undermine the idea that assessments of realisticness involve privileging the legal. Another major example of privileging the legal is the idea that it is rights that are subject to exchange in the market. Coase says that "lawyers...habitually think of what is bought and sold as consisting of a bundle of rights.... I was led to adopt the same approach" (Coase 1988b, 11). Coase does not explicitly relate this idea to the issue of realisticness, but it is obvious that it can be so related.
(n10.) The proposal to distinguish between realism and realisticness (and between the variety of forms in which both of them appear in economics and in philosophy; and between the variety of ways in which these forms are or are not interrelated) was originally made in Maki (1989).
(n11.) For qualifications needed to accommodate the peculiar features of economics, see Maki (1996).
(n12.) For arguments that show why an economist espousing realism as a theory of theories is entitled or even required to use unrealistic assumptions, see Maki (1993a, 1993b, 1994a).
(n13.) If Posner thinks that the two options he mentions in characterizing a scientific theory, namely, "a false but useful tool" and "a glimpse of ultimate truth," exhaust the alternatives, he is mistaken. One can be a realist without "ultimate truths."
(n14.) Coase is quite unambiguous in his rejection of the instrumentalist conception of theories: "But a theory is not like an airline or bus tietable. We are not interested simply in the accuracy of its predictions. A theory also serves as a base of thinking. It helps us to understand what is going on" (Coase 1988c, 64). Coase's point is, quite obviously, that while bus timetables may help us predict the behavior of buses and thus to serve as "inference tickets," they fail to give us any idea about the mechanisms and processes that keep buses running as they do.
(n15.) For a elated detailed argument that links realism to a specific version of the idea of "how the system works," namely, a causal theory of the market process, see Maki (1992c).
(n16.) This should not be taken to imply that hybrid forms cannot exist. Particular economic organizations instantiate hybrid forms when they instantiate both firmness and marketness at the same time. We may say that it is their "hybridness" that distinguishes them from particular firms and particular markets.
(n17.) The issue of universals is one of the neglected topics in the recent work in the philosophy of economics. For an exception, see the analysis of the issue as it appeared in the context of the German Methodenstreit between Carl Menger and Gustav Schmoller in Maki (1997c). It is obvious that the themes of the Methodenstreit are still relevant in economics, not least in the debates around the new institutionalist economics, including Coase's controversial research strategy.
(n18.) Masten (1993, 200) puts the idea cautiously: the emphasis "in economics on the authority of management to direct the efforts of employees is at least nominally supported by the law governing employment transactions."
(n19.) Research on Coase's methodological views has started emerging. See Medema (1994), chap. 6; Maki (1994b, 1997b); Foss (1994). See also the highly critical papers by Posner (1993a, 1993b). For a critique of an aspect of Posner's account, see Maki (1997a).
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