Of Coase Things Won't Change Much

 

“The NHS will be safe again in Labour’s hands” they tell us. “With Labour in charge, the NHS will now get proper funding”, they declare. But that’s not the right way to look at things. The NHS is not in so much trouble because of which party is in government – mark my words, when Labour has finished however long they are in office, the NHS is unlikely to be in a better state than it is now, and that’s because politicians are not allowed to be honest about the problems, and about how ill-equipped they are to deal with them. Don’t get me wrong, I really value the ‘free at the point of use’ element, and my experiences of NHS workers show that they do a fantastic job under extremely challenging conditions. But, alas, for several decades now, the NHS situation has been that politicians pretend that only their party has the solutions to make it better, and members of the public pretend to believe whichever party they happen to favour. If politicians brushed up on their economies, and were voluntarily injected with truth serum, what I’m now going to say is roughly what they’d concede is the truth.

For many complex reasons that are too broad for a short blog post, institutions like the NHS, the Civil Service, Central Government, the EU, etc have become so bloated that they fall victim to diseconomies of scale, where it’s prohibitively difficult to manage the system efficiently through the command economy model. The economist Ronald Coase explored the optimal size of institutions in his “The Nature of the Firm", although he wasn’t talking about institutions like the above. For Coase, a firm is a collection of individuals coordinated by a management structure to achieve specific economic goals – largely, organisations that engage in economic activities to produce goods or services with the goal of minimising transaction costs.

But such firms do simulate the above institutions in that they involve a hierarchical structure, where decisions are made to coordinate the allocation of resources. Looking at the trade-offs between market exchange mechanisms and top down central planning, the latter is frequently devoid of the important information signals that markets provide, and the former is sometimes devoid of the centralised initiatives that maintain a perspective on the bigger picture.

In The Nature of the Firm, Coase determined that a firm optimally undertakes transactions by having an efficient internal hierarchy, where firms expand their activities internally up to the point where the costs of internal hierarchy and command are balanced against the costs of conducting those transactions in the market (such as outsourcing to external suppliers). That’s why an efficient firm (and, by extension, institution) will attain the right internal mechanisms alongside the efficiencies of economies of scale when outsourcing production activities when it’s more efficient to do so.

Under the Coasian theory, this is what determines the equilibrium size of firms, and goes a long way to explaining why the organisations suffering from diseconomies of scale are so consistently underperforming. When the internal structure becomes too complex or burdensome, with excessive bureaucracy, rigid hierarchies and inadequate upward/downward/sideward communication structures, inefficiencies will arise, leading to increased costs and reduced effectiveness in service delivery. And politicians mired in structures that are constructed and sustained with exactly the same inefficiencies are unlikely to be sufficiently equipped or competent enough to significantly improve something like the NHS.