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September 29, 2002
David Warsh, Proprietor


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Short Takes

1. Another charette is underway in New York City — an intense effort to solve an architectural problem in as limited period of time. Lower Manhattan Development Corp. last week chose a second set of six teams of architects and urban planners to submit competing plans to rebuild the World Trade center site. They are due at the end of November. An earlier competition produced yelps.

There’s still a good chance the city will make a serious mistake.

The new specification calls for office space, stores, transportation hubs and a suitable memorial to be erected on the 16-acre site. But New York City mayor Michael Bloomberg has been a vocal advocate of new housing to be included in the redevelopment, either on the site itself or nearby properties. Almost all of it would be expensive, naturally.

Wall Street Journal columnist Robert Bartley (subscription required) thinks this is a bad idea. He fears that “someone who made a fortune selling computer screens sees the future as telecommuting, and underrates face-to-face contact at the highest levels of world commerce.”

Quite the contrary. In pushing for housing, Bloomberg understands what Jane Jacobs was on to about forty years ago in The Death and Life of Great American Cities. People, perhaps rich people especially, often want to live near where they work. Take a look at the preference of Fidelity executives for Boston’s Beacon Hill.

American suburbs, at least in their present form, are aberrations, artifacts of the invention and rapid development of the railroad and the automobile. New York should take a cue from Boston and Chicago in pursuing mixed use development as the key to future of its core neighborhoods, starting with Wall Street.

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2. One of the most beguiling papers in all the literature of modern economics is titled simply, “The Lighthouse in Economics.” The reason that the lighthouse plays a prominent role in the writings of economists, wrote Ronald Coase in the Journal of Law and Economics in 1974, “because of the light it is supposed to throw on the question of the economic functions of government.” (The essay is reprinted in The Firm, the Market and the Law.)

Economists from John Stuart Mill to Paul Samuelson had confidently asserted that lighthouses by their very nature could not be supplied by private enterprise, Coase noted, there being no way to collect tolls from ship-owners who benefited from their warnings.

Samuelson in particular had argued that, even if it were possible to price the service, it was better that governments should provide it, as it were, “for free.” Why? Because once a lighthouse was in place, it would cost nothing extra to let one more ship avail itself of its warning. Any ship discouraged from entering local waters by the prospect of the price it would have to pay would represent an economic loss to society.

The implication was that, even if it were possible for private lighthouse operators to charge for their services, they should not be allowed to do so.

Then Coase proceeded to sketch the history of light houses in England and Wales.

He described how an institution known as Trinity House — today we would call it a quasi-non-governmental authority or “quango” — had evolved out of a medieval seaman’s guild whose objectives had included maritime safety. How Trinity House applied for a charter to regulate harbor pilots in 1513. How it gained the right to regulate seamarks and buoys in 1566 and built its first lighthouses early in the 17th century.

When Trinity House abruptly stopped building lighthouses in 1610, Coase noted, private developers stepped into the gap, financing at least 10 lighthouses during the next 65 years while Trinity built none. At the time, Sir Edward Coke told Parliament: “Projectours like watermen looke one waye and rowe another; they pretend publique profit, intend private.”

Instead of the government-sanctioned “light dues” charged by Trinity House, developers persuaded ship-owners to sign up in advance for voluntary tolls. Rather than go out of business, Trinity House finally returned to it, contracting out to private builders development rights for sites on which it held patents. In the 19th century, Trinity House purchased 14 of the 56 English lighthouses that remained in private hands, presumably in hopes of lowering light dues.

Even after Trinity discontinued the practice of supporting seamen’s retirement homes with its profits, the light dues remained in force, with a view to continuing to make improvements in maritime safety. But as they were paid by consumers of the service, a committee of ship-owners, insurance underwriters and shippers kept a close eye on its budget.

And rather than discourage frequent travel by keeping prices high, Trinity House capped its fees at ten voyages a year for “home-trade” ships and six for “foreign-going” vessels. A cross-channel ferry paid no dues for most of the year; a regular in the Australia trade would top out and sail for free only rarely. Ships whose operation ceased to be economic because of the light dues must have been few and far between.

Before Coase, no economist had ever made a systematic study of lighthouse finance and administration. (A pretty good journalistic account of what was once the frontier of high-technology in Scotland now can be had from The Lighthouse Stevensons.) The lighthouse, he said, had been simply “plucked out of the air to serve as an illustration,” he wrote — an unconvincing one at that.

“This seems to me to be the wrong approach,” wrote Coase. “I think we should try to develop generalizations which would give us guidance as to how various activities should best be organized and financed. But such generalizations are not likely to be helpful unless they are derived from studies of how such activities are actually carried out within different institutional frameworks.”

The effect of Coase’s lighthouse paper was dramatic. It led scores of young economists to see the point of the two more theoretical papers for which Coase in 1991 would be awarded the Nobel Prize — “The Nature of the Firm” and “The Problem of Social Cost.” A whole new wing of empirical economics grew up, concerned with the ways in which the legal, political and educational institutions of societies give rise to their economic systems.

Leaving aside the question of whether Coase fully appreciated the usefulness of the “blackboard economics” that led Paul Samuelson to his conclusions about why the government might finance the production of some kinds of goods, he had touched a nerve. There were, in fact, many different ways to skin an economic cat. Over the centuries clever, human beings had discovered many ingenious mechanisms for accomplishing their purposes. Theorists had dreamt of relatively few.

 

Coase had shined a spotlight on what came to be known as transaction costs — all the activities necessary before a single open market transaction could take place — search and information costs, bargaining and decision costs, policing and enforcement costs. Firms had been invented to organize these activities. Legal and political systems had been devised to make them possible. A comparison of alternative institutional possibilities and the incentives that they created was one of the main tasks of economics.

 

Coase’s  work became a standard starting point — perhaps the standard starting point — for the broad movement knows as “deregulation,” not just in the industrial democracies but in the formerly communist lands and newly-industrializing countries as well. With Douglas North and Oliver Williamson, two other pioneers in the study of institutional arrangements, Coase formed the International Society of New Institutional Economics.

ISNIE has been holding it annual meeting in Cambridge this last weekend in September. The breadth and depth of the papers was a testament to economics’ increased ability to find the interesting issue. The American dustbowl in the 1930s; the Icelandic fisheries zone; the appearance of Redcoats in the British Army in England after the Glorious Revolution of 1688; fragmented rights and sequential patenting strategies in the semiconductor industry; the ubiquity of money in politics; the neurobiology of trust; the complicated nature of incentives: all proved susceptible to the new approach.

True, the really interesting topics of the moment weren’t yet on the docket. What went wrong with electric power deregulation in California? How is privatization proceeding in Russia? What are the chances for real health care reform in the United States? ISNIE is one of the main venues in which questions like these they will be asked and answered. It is a door to the future of economics.

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