Demsetz: Competition, Property Rights, Nirvana Economics, and Barriers to Entry

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~ Frederic Sautet ~

We are mourning the passing of one of the greatest economists of all times who influenced me a great deal: Harold Demsetz. I met Demsetz at a Mt Pélerin’s meeting in 1992. He was a joyous fellow and was totally available to speak with me (a student at the time). I’ll never forget his smile when I explained to him how influential his work was. It is because of Demsetz, Kirzner and Alchian that I got interested in competition, firms and entrepreneurship. So I have a great intellectual debt!

As Pete explains in his post, Demsetz’s work is unique in the history of price theory and market process, as he offered responses to difficult questions and showed the relevance of his solutions. Just look at the number of key issues he addressed in his oeuvre: competition (monopolistic and otherwise); ownership, control, production and firms; property rights (theory of origin and role in economics); public goods (and their private provision); transaction costs; regulation (antitrust and other); contract theory; advertising; etc. The list is long! It’s fair to say that in every topic listed, his contribution was remarkable, top-notch; and it moved the needle. Economists and others gained insights about the real world. Demsetz also belonged to a generation of economists who was interested in theory and made, primarily, theoretical contributions. Today, economics has moved away from this approach: discussions are more about empirics than about theory. Demsetz also knew the legal field and was a pioneer in law and economics (following Ronald Coase and Armen Alchian). He often brought legal references into his work. In that sense, Demsetz belonged to a class of intellectuals who thought about the world, as much as confronted their views to the world.

Even though I listed him among those who influenced me along with Kirzner, Demsetz was not, ironically, a friend of the idea of entrepreneurship in economic theory. In his paper, “The Neglect of the Entrepreneur” (published in 1983 in a book entitled Entrepreneurship, Ronen ed.), he vigorously attacks Kirzner’s work. While I never agreed with this paper of his, I still think that, to this day, it represents the best critique of the idea of entrepreneurship in market theory. Yet, I think he implicitly recognized (in spite of his saying) the importance of entrepreneurship in the dynamics of markets. This is was, after all, a key theme of his view of competition!

If there is one or two papers from Demsetz to add to the Pantheon of econ papers (other than his famous Towards a Theory of Property Rights (1967) and Production, Information Costs, and Economic Organization (1972), the latter is co-authored with Alchian and on the list of the Top 20 articles published in the American Economic Review, both are exceptional papers), it would be: Information and Efficiency: Another Viewpoint (1969) and Barriers to Entry (1982). In his 1969 paper, Demsetz discusses what he calls the nirvana approach to economics, which implicitly assumes an ideal institutional arrangement in economic theory. He compares this to a comparative institution approach in “which relevant choice is between alternative real institutional arrangements.” This is an utterly important insight, one that Austrians, especially Hayek have also used in different ways, but that has been lost on the mainstream of economics for decades (probably less today than in 1969, Demsetz had some influence). This came to be a distinguishing mark of the law and economics movement in the 1960s, as Coase and others also pursued a similar line of thinking. His Barriers to Entry paper provides probably the best discussion of the notion in the economic literature. Demsetz carefully shows the limits of such notion and how it articulates with property rights for instance.

I learned so much about competition, firms and organizations, property rights, and comparative institutions analysis studying Dr. Demsetz’s oeuvre. So thank you, Harold, for your exceptional contributions to economics and social science. Requiescet in pace.

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Frederic Sautet

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