Coase and the Logic of Institutional Economics

Why did aristocrats in pre-modern Britain spend lavishly on Latin, music, and gardens, yet still grow wealthier? Why were army commissions bought and sold, but not naval ones? Why did some judges own their offices, and why were prisons and police virtually absent from society until the 19th century? These and other puzzling institutional features of the period 1500–1850 invite a deeper examination of the organizational logic behind them. The starting point lies in Ronald Coase’s insight on the nature of transaction costs. Coase famously argued that when these costs are zero, the allocation of resources is unaffected by legal rules or institutional structures—hence the so-called Coase theorem. But this was never meant as a descriptive claim about the real world. Instead, it reveals the emptiness of traditional economic models in explaining how real-world institutions evolve. Once transaction costs are positive, then laws, norms, and property rights do matter. They are not exogenous constraints but endogenous outcomes of efforts to reduce those very costs. Institutions and organizations, then, are not arbitrary or inefficient relics of the past, but adaptive responses—arrangements that survive because they maximize wealth net of the frictions they must overcome. This Coasean logic reframes historical institutions not as puzzles, but as solutions to the problem of organizing production and minimizing social cost. It renders unnecessary any reliance on hidden preferences or risk assumptions: understanding transaction costs is both necessary and sufficient for explaining institutional form.

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