Harold Demsetz (1930-2019)

By Peter Klein

Harold Demsetz, the inaugural recipient of SIOE's Elinor Ostrom Lifetime Achievement Award, passed away January 4, 2019. Few scholars did more to advance the field of institutional and organizational economics. Demsetz taught at the University of Michigan (1958-60) and the University of Chicago (1963-71), but spent most his career at UCLA (1960-63 and 1971-95) where, along with his friend and colleague Armen Alchian, he established the “UCLA School” of institutional and organizational economics.

Demsetz made seminal contributions to three key areas of institutional and organizational economics: the theory of the firm, the theory of property rights, and the theory of regulation. His 1972 AER article with Alchian, “Production, Information Costs, and Economic Organization,” offered a team-production theory of the firm that built on previous work by Ronald Coase and Oliver Williamson, while advancing the novel idea that the firm is best understood as a “nexus of contracts” among individuals contributing inputs to the team. Virtually all the subsequent work on the theory of the firm, from the agency-theoretic, transaction cost, evolutionary, and property-rights perspectives, frames the key arguments relative to the ideas of Alchian and Demsetz.

Demsetz’s 1967 AER paper, “Toward a Theory of Property Rights,” helped establish the field of property-rights economics and is second only to Coase’s “Problem of Social Cost” in influence in that field. Coase had argued that property rights are valuable economic goods and, as such, can be priced and traded in markets. Demsetz went beyond Coase in pointing out that property rights must be defined and enforced to constitute valuable economic goods, and that the emergence of a particular property right as a tradable commodity is endogenous to the costs of definition and enforcement. Demsetz framed his argument mainly in terms of land and other natural resources, but his arguments continue to play a strong role in current debates, particularly about intellectual property.

Beyond his contributions in these areas, Demsetz was also a pioneer in the theory of regulation. His “Industry Structure, Market Rivalry, and Public Policy” (JLE, 1973) was critical in helping overturn the structure-conduct-performance paradigm in industrial organization and regulatory economics, arguing that market power is typically the consequence of prior profitability (and hence efficiency), not its cause. His paper “Why Regulate Utilities?” (JLE, 1968) argued that, in the absence of transaction costs, regulators could achieve competitive outcomes even with a single provider, as long as the monopoly license could be auctioned ex ante among competitive bidders. (It was Demsetz’s argument, along with a related one offered by Richard Posner, that inspired Williamson to develop his theory of the “fundamental transformation,” in which competition ex ante does not translate into competitive outcomes ex post if there are significant relationship-specific investments.)

Beyond these three key intellectual contributions, Demsetz has also done highly influential work on corporate governance and ownership (“The Structure of Corporate Ownership: Causes and Consequences,” JPE 1975, with Ken Lehn), the nature of transaction costs (“The Cost of Transacting,” QJE 1968), and the proper use of comparative institutional analysis (“Information and Efficiency: Another Viewpoint,” JLE 1969).

Demsetz was on the inaugural board of SIOE's predecessor organization, the International Society for New Institutional Economics and was a regular participant at several ISNIE/SIOE meetings (including, most recently, the 2012 conference in Los Angeles where he spoke on "Transaction Cost Confusions"). He will be missed.