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Coase vs. the Neo-Progressives

Wednesday, October 28, 2009

Fifty years ago this month a seminal paper challenged the prevailing intellectual orthodoxy on markets, technology, and regulation. We would be wise to revisit it today.

In the United States no one may operate a broadcasting station unless he first obtains a license from the Federal Communications Commission. These licenses are not issued automatically but are granted or withheld at the discretion of the commission, which is thus in a position to choose those who shall operate radio and television stations. How did the commission come to acquire this power?
— Ronald H. Coase, “The Federal Communications Commission,” 1959

It is no accident that today’s liberals call themselves “Progressives.” For them, the Progressive Era is not just a nostalgic memory, it is a blueprint for the future. Like the Progressives of old, the Neo-Progressives see market failure as the source of most problems, and government as the centerpiece of most solutions. Healthcare costs rising? Create a “more efficient” government plan. Financial system in trouble? Pass off more control to the “independent” Federal Reserve. The Progressive Conceit—the notion that well-intended elected officials and dispassionate bureaucrats can systematically improve the workings of the marketplace and civil society—is firmly back on top in American politics.

Fifty years ago this month, writing in the Journal of Law and Economics,1 economist Ronald Coase directly challenged these foundational Progressive assumptions. In the process of explaining why government should not own and control the broadcast spectrum, he showed that where Progressives mistakenly had diagnosed market failure, the real problem was government’s failure to create enforceable property rights. And, where Progressives had promoted government control, Coase minced no words in demonstrating its failings. His work—expanded upon a year later in “The Problem of Social Cost”2 —ultimately won him the 1991 Nobel Prize in Economics, “for his discovery and clarification of the significance of transaction costs and property rights for the institutional structure and functioning of the economy.”3

Explaining why government should not own and control the broadcast spectrum, Ronald Coase showed that where Progressives mistakenly had diagnosed market failure, the real problem was government’s failure to create enforceable property rights.

Although considered heresy at the time, Coase’s article began a wholesale rethinking of the Progressive paradigm that had dominated political thought since the turn of the century. By the 1980s, Coase’s ideas had gone from radical to mainstream. Free market advocates, then in the ascendancy, embraced such Coasian principles as:

(1)    The existence of a market failure or externality does not in and of itself justify government intervention; indeed, government is often the underlying cause of the problem.

(2)    Government intervention is seldom either administratively efficient or politically neutral; to the contrary, it often results in what Coase called the “mal-allocation” of resources.

(3)    Government control of the economy is a threat to political liberty; for example, government control of the broadcast spectrum has consistently been used to limit free speech.

Today, these lessons are once again being challenged (or perhaps we should say ignored) by a new generation of “Neo-Progressives.” Hence, it is not only proper to salute Coase’s “The Federal Communications Commission” on its 50th anniversary, but timely to recall its lessons, as well.

In what follows, we discuss each of the three principles listed above, and then close with a brief summary of the impact Coase’s article had on its titled subject, the Federal Communications Commission.

Market Failure: Causes and Cures

At the time Coase wrote, many economists saw market failures as commonplace, and government action as the correct response. Specifically, externalities—such as sparks from a passing train setting fire to a farmer’s crops, or emissions from a radio transmitter interfering with another’s signal—were seen as evidence that the market was not able to allocate resources efficiently. Government regulation—or even, in the case of the broadcast spectrum, direct ownership and control—was seen as a sensible solution. These basic notions were central to Progressive governance: indeed, it was Herbert Hoover, in many ways a prototypical Progressive, who as Secretary of Commerce was responsible for expropriating the broadcast spectrum and placing it under the stewardship of the Federal Radio Commission, the precursor to the FCC.

The existence of a market failure or externality does not in and of itself justify government intervention; indeed, government is often the underlying cause of the problem.

In “The Federal Communications Commission,” Coase directly challenged the central tenets of Progressivism. So long as property rights were clearly defined and transactions costs were low, he explained, externalities could and would be addressed by the market itself, through private negotiations between the affected parties. Moreover, he explained, it did not matter to whom the property rights were initially assigned, as the parties would trade among themselves to achieve the most efficient economic outcome.

To understand how revolutionary the Coase Theorem really was, consider that it was initially rejected by none other than economists Milton Friedman and George Stigler. As Coase explained in a 1997 interview, those two (and several other leading lights of the Chicago School) were persuaded of his theory’s validity only after Friedman personally administered a lengthy grilling at the home of famed University of Chicago economics professor Aaron Director. Then, and only then, was Coase encouraged to expand on his arguments in the follow-on article, “The Problem of Social Cost.”4

From a legal and policy perspective, Coase’s thesis had two profound implications. First, and most obviously, Coase demonstrated that in many cases the only form of government intervention required to address an apparent externality was to create clear property rights and workable means of adjudication, and the market would do the rest. More intrusive forms of government intervention—whether in the form of tax incentives, regulations, or even (as in the case of the electromagnetic spectrum) expropriation—were simply not necessary.

Coase also recognized, however, that there are times when the costs of negotiating among multiple parties would make market solutions infeasible.

When the transfer of rights has to come about as a result of market transactions carried out between large numbers of people or organizations acting jointly, the process of negotiation may be so difficult and time-consuming as to make such transfers a practical impossibility … In these circumstances it may be preferable to impose special regulations (whether embodied in a statute or brought about as a result of the rulings of an administrative agency).5

But even where regulation is justified, Coase explained, the solution should be dictated by economics, not morality. And that was Coase’s second, less obvious but equally profound, contribution: He stripped the concept of externality of its moral trappings and, in so doing, de-legitimized absolutist solutions.

Coase demonstrated that in many cases the only form of government intervention required to address an apparent externality was to create clear property rights and workable means of adjudication, and the market would do the rest.

Until Coase, externalities were seen as bad acts, the willful imposition of harm by a wrongdoer on an innocent victim. Given this characterization, the appropriate policy objective was to stop the wrongdoer and make the victim whole. But Coase explained that the relationship between the party “imposing” the externality and the one “affected by” it was in fact reciprocal. For example, a rule prohibiting a locomotive from emitting sparks into the farmer’s fields imposed costs on the railroad that are no different, in kind, from the costs that would be borne by the farmer under a rule requiring crops to be planted further back from the tracks. The Coasian objective, then, is to determine which rule imposes the least costs on society overall—whether it is more efficient, that is, to retrofit the locomotive to stop producing sparks, to plant the crops further back from the tracks, or, perhaps, to simply let the crops burn.

Now as much as then, such thinking represents a profound challenge to the black versus white, good versus evil, oppressor versus victim mentality that so deeply pervades the Progressive Movement and upon which so much of its public policy agenda is based.

Regulatory Failure and ‘Mal-allocation’ of Resources

Coase turned next to a critique of Progressive methods, in particular the independent regulatory agency and its supposedly “scientifically” based, apolitical decision making. Making arguments we now associate more closely with Richard Posner and George Stigler (indeed, Stigler’s Nobel was awarded in part “for his seminal studies of [the] effects of public regulation”), Coase argued that “political pressures” on regulatory agencies would lead directly to “mal-allocations” of resources. He noted that, while many lawmakers bemoaned “the extent to which pressure is brought to bear on the commission by politicians and businessmen … that this should be happening is hardly surprising.”

When rights, worth millions of dollars, are awarded to one businessman and denied to others, it is no wonder if some applicants become overanxious and attempt to use whatever influence they have (political and otherwise), particularly as they can never be sure what pressure the other applicants may be exerting.6

Thus, Coase recognized the connection between the politicization of spectrum policy and the special interest politics and lobbying (later termed “rent seeking”) that would inevitably accompany it. Moreover, as Coase explained, “the problem … largely arises because of a failure to charge for the rights granted. If these rights were disposed of to the highest bidder, the main reason for these improper activities would disappear.”7 By replacing regulation with market mechanisms, in other words, government could reduce the favoritism and corruption that naturally accompanies the political allocation of wealth.

‘Economic’ Regulation as a Threat to Liberty

A third crucial insight of Coase’s piece was that the “public interest” standard for asymmetrical regulation of the broadcast spectrum was both hopelessly arbitrary and in conflict with the First Amendment rights of broadcasters. “This phrase, taken from public utility legislation, lacks any definite meaning,”8 Coase noted. “Furthermore, the many inconsistencies in commission decisions have made it impossible for the phrase to acquire a definite meaning in the process of regulation.”9

Where regulation is justified, Coase explained, the solution should be dictated by economics, not morality.

Coase showed that, despite a general prohibition against direct censorship found in the Radio Act, the FCC frequently used its regulatory powers to influence or curb speech on the broadcast airwaves. The so-called Fairness Doctrine was the most obvious manifestation of the commission’s speech-meddling ways, but hardly the only one.10 Coase noted that this regime would be legally intolerable if applied to any other media sector:

The situation in the American broadcasting industry is not essentially different in character from that which would be found if a commission appointed by the federal government had the task of selecting those who were to be allowed to publish newspapers and periodicals in each city, town, and village of the United States. A proposal to do this would, of course, be rejected out of hand as inconsistent with the doctrine of freedom of the press.11

Indeed, such a Federal Newspaper Commission proposal would have never passed constitutional muster. Building on Coase’s insight, subsequent communications policy scholars such as Harry Kalven Jr.,12 Thomas Hazlett,13 Matthew Spitzer,14 Thomas Krattenmaker, Lucas Powe,15  and others16 would demonstrate that there was an inherent conflict between modern broadcast regulation and America’s long-standing commitment to an unfettered press. It is one of the delicious ironies of Coase’s essay that it took a British-born economist to remind American lawmakers of the dangers of public interest regulation and its “clash with the doctrine of freedom of the press.”17

Even if one wanted to make the case for content control of the broadcast airwaves, Coase showed why better rationales were needed than those lawmakers had chosen:

If regulation of programming is desirable, it has to be advocated on its own merits; it cannot be justified simply as a by-product of particular economic arrangements. To say that resources should be used in the public interest does not settle the issue. Since it is generally agreed that the use of private property and the pricing system is in the public interest in other fields, why should it not also be in broadcasting?18

It’s a lesson many policy makers have yet to learn.

By replacing regulation with market mechanisms, government could reduce the favoritism and corruption that naturally accompanies the political allocation of wealth.

Coase closed his essay by noting that “it was indeed in the shadows cast by a mysterious technology that our views on broadcasting policy were formed.”19 As a result, “the belief that broadcasting industry is unique and requires regulation of a kind which would be unthinkable in the other media of communication is now so firmly held as perhaps to be beyond the reach of critical examination.”20 Thus, as he looked to the future, Coase seemed to hold out little hope that America’s experiment with command-and-control spectrum micromanagement would be reversed.

Coase’s Impact on the FCC

Coase was at least partly right to be pessimistic about prospects for reform. The FCC to this day, often urged on by Congress and various political interest groups, is no less inclined to ignore the First Amendment in its regulation of broadcasting than it was 50 years ago. Indeed, as the FCC contemplates “net neutrality” regulation—essentially a “fairness doctrine” for the Internet—it can be argued things have gotten worse.

On another front, however, Coase has had a profound effect. Literally dozens of articles and studies picked up on his arguments that spectrum could and should be allocated according to market incentives rather than administrative fiat, and by the early 1990s, a consensus had formed that the best way to license spectrum was, as Coase had proposed, through auctions. Beginning in 1994, the United States has allocated spectrum to the highest bidder, producing nearly $60 billion in revenues for the government and, more importantly, ensuring that access to this key economic resource is awarded to those who can put it to its highest valued use.

Conclusion

Like most seminal works, “The Federal Communications Commission” represents what happened when someone asked the right—that is, the fundamental—question. In Coase’s case, it was this: “How did the commission come to acquire this power?” All of the rest—the unmasking of misguided theories of market failure and naïve belief in an efficient bureaucracy, the damning assessment of the government’s overreaching intrusions into basic freedoms—emerged from Coase’s effort to answer that fundamental question. As today’s Neo-Progressives launch the next round of government expansion, it is a question that will be asked with increasing frequency, and growing regret, in the years ahead: how did the government come to acquire this power?

Jeffrey Eisenach is chairman and a managing partner at Empiris LLC and adjunct professor at George Mason University Law School. Adam Thierer is president of The Progress and Freedom Foundation.

Image by Darren Wamboldt/Bergman Group.

Endnotes

  1. R.H. Coase, The Federal Communications Commission, 2 Jour. of Law & Econ. 1 (Oct. 1959) [hereinafter “Coase, FCC”].
  2. R.H. Coase, The Problem of Social Cost, 3 Jour. of Law & Econ. (Oct. 1960).
  3. The Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel 1991, Press Release, Oct. 15, 1991, http://nobelprize.org/nobel_prizes/economics/laureates/1991/press.html.
  4. Another historical factoid worth pondering is this: Coase’s research was funded by the Ford Foundation, which today is a major funder of the liberal interest groups pushing for a bigger and more intrusive FCC.
  5. Coase, FCC at 29.
  6. Coase, FCC at 37.
  7. Coase, FCC at 37.
  8. Coase, FCC at 8.
  9. Coase, FCC at 8-9.
  10. See Brian Anderson & Adam Thierer, A Manifesto for Media Freedom (Encounter Books, 2008).
  11. Coase, FCC at 7.
  12. Harry Kalven, Jr., Broadcasting, Public Policy and the First Amendment, 10 Jour. of Law & Econ. 15 (Oct. 1967).
  13. Thomas Hazlett, The Rationality of U.S. Regulation of the Broadcast Spectrum, 33 Jour. of Law & Econ. 133 (April, 1990).
  14. Matthew L. Spitzer, The Constitutionality of Licensing Broadcasters, 64 N.Y. Law Rev 990 (1989).
  15. Thomas G. Krattenmaker and Lucas A. Powe, Regulating Broadcast Programming (1994).
  16. Jeffrey A. Eisenach and Randolph J. May, Comments of the Progress & Freedom Foundation in the Matter of Public Interest Obligations of TV Broadcast Licensees, Federal Communications Commission, MM Docket 99-360, March 27, 2000.
  17. Coase, FCC at 7.
  18. Coase, FCC at 39-40.
  19. Coase, FCC at 40.
  20. Coase, FCC at 40.

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