Sunday, September 08, 2013

Ronald Coase, R.I.P. - And A Coasian Course for the FCC

Ronald Coase, a Nobel Prize winner in 1991 for his major contributions in the field of "law and economics," died on Labor Day at age 102. Indeed, Coase, one of the two or three most important economists of the twentieth century, was the father of the Chicago-school "law and economics" movement. 
And, as you will see below, Coase's ideas have direct relevance to the way the FCC conducts its activities today, including with respect to two very topical issues – net neutrality regulation and the incentive spectrum auction. 
With the University of Chicago Law School as his long-time home, Professor Coase labored away at his teaching and writing well into his 90s. So perhaps it is fitting that he passed away on Labor Day. I bet Coase would have thought so. 
Thankfully, Coase lived long enough to see his most important ideas widely, if not universally, accepted – although the acceptance often came decades after his fellow academics initially expressed much skepticism, if not downright ridicule. Coase frequently joked – well, at least half-joked – that he had some of his best ideas in his 20s, but it took another half century for them to be accepted. 
Coase's ideas, including the so-called Coase Theorem, are applicable to the FCC's regulatory activities. I don't think Coase would mind at all for his passing to be used as a "teachable moment;" in fact, I rather suspect he would regret if it were not. So, I want to suggest the FCC should pay more attention to adopting a Coasian course. 
But first, by way of brief introduction to Coase's ideas, here are two pieces published in the Wall Street Journal on the day after Coase's death, "The Wisdom of Ronald Coase," and "The Man Who Resisted 'Blackboard Economics.'" And here is the Wikipedia entry for Coase with links to his major works. 
The Coase Theorem – which was not called such by Coase himself but by his University of Chicago colleague George Stigler – is derived from the insights in his seminal work, "The Problem of Social Costs", published in 1960. One formulation might be that posited by Donald L. Regan: "That in a world of perfect competition, perfect information, and zero transaction costs, the allocation of resources in the economy will be efficient and will be unaffected by legal rules regarding the initial impact of costs resulting from externalities." An even simpler statement might be: "If there are zero transaction costs, the efficient outcome will occur regardless of the choice of legal rule." 
But Coase recognized in "The Problem of Social Costs" that the proposition that there are no costs in carrying out market transactions "is, of course, a very unrealistic assumption." Thus, in considering its practical application, it is useful to restate the Coase Theorem, as A. Mitchell Polinsky has, this way: "If there are positive transaction costs, the efficient outcome may not occur under every legal rule. In these circumstances, the preferred legal rule is the rule that minimizes the effects of transaction costs. These effects include actually incurring transaction costs as well as the inefficient choices induced by a desire to avoid transaction costs." 
Here's my own further reductionist simplification deduced from the Coase Theorem: The choice of legal rules, including the assignment of property rights, matters as to whether transaction costs are minimized, and whether transaction costs are minimized matters as to whether economic efficiency is maximized. 
Let's now briefly apply Coasian thinking to two current communications policy issues. 
First, the FCC's order adopting net neutrality regulations – the oral argument challenging the lawfulness of the FCC's action in the D.C. Circuit just happens to be on Monday, September 9. The FCC's net neutrality regulations are highly problematical from a Coasian perspective if for no other reason than that the vagueness of the rules adopted almost certainly increases the transaction costs incurred in offering Internet access services. The ambiguity inherent in the prohibition against "discrimination," as malleable as such a vague prohibition is, necessarily creates legal uncertainties that translate into increased transaction costs. 
For example, suppose an Internet services provider wishes to consider a new offering or business model. The ISP must consider the direct costs incurred for the lawyers (and possibly the lobbyists too) that must be engaged in order to assess the feasibility of moving forward in the face of the uncertain application of the rule's scope. And the effects of the ill-defined legal rule include not only the actual direct transaction costs incurred, but also indirect costs that lead to inefficient business choices. These inefficient choices prevent, or inhibit, what otherwise would be the emergence of more efficient voluntary negotiated agreements among participants in the Internet marketplace. In other words, a new offering or business model that may benefit consumers and increase overall consumer welfare may not be implemented at all in order to avoid the transaction costs induced by the net neutrality rule adopted by the FCC. 
The second topical issue that would benefit from Coasian thinking is the FCC's incentive auction proceeding. In 1959, Coase published his famous article simply titled "The Federal Communications Commission," in which he proposed that spectrum rights should be auctioned to the highest bidder rather than assigned by the FCC in its discretion under the public interest standard. Coase argued that spectrum is not unique as a "scarce" good, and "there is no reason there should not be private property in frequencies." At the time, the idea was widely ridiculed by his fellow economists, not to mention by those at the FCC doling out spectrum licenses. 
Coase's auction idea eventually won acceptance some quarter century after publication of his FCC article, and with the exception of broadcast frequencies – on which his article primarily focused – for the most part spectrum rights now are auctioned. But the FCC, with its ingrained pro-regulatory, interventionist proclivities, is often tempted to encumber spectrum auctions with various use or eligibility restrictions in ways that necessarily impact bidding outcomes and prevent the maximization of revenues realized from the auction. For example, imposing a net neutrality restriction in the 700 MHz auction, by most accounts, diminished the revenues realized. 
So, today, the FCC apparently is considering encumbering the proposed incentive spectrum auction by imposing some form of eligibility restriction that would prevent Verizon and AT&T, in one way or another, from bidding on the offered spectrum. Consistent with the Coase Theorem, this is certainly a case in which the legal rules adopted will determine whether the most economically efficient outcome occurs. I'm pretty sure that Ronald Coase, who, after all, proposed spectrum auctions, would frown on imposition of conditions that derogate from conducting a clean auction. In the face of what, in any event, necessarily will be a complex undertaking in auction design, a prime Commission goal should be to reduce, to the extent possible, the transaction costs associated with the auction. 
A final note: As I pointed out, many of Coase's ideas were not accepted until decades after he first propounded them, but, in the end, they did achieve widespread acceptance. In the Free State Foundation's tag line, we say, "Because Ideas Matter." They do. It's just that in the think tank world in which FSF operates, sometimes it takes a while before the ideas win out. Remembering Coase helps provide us with steadfastness. 
So, we remember Ronald Coase for many reasons. To promote overall consumer welfare and benefit the nation's economic productivity, the FCC would do well to be attentive to Coase's teachings, and to much more frequently adopt a Coasian course.
Ronald Coase, R.I.P.