Krishnan on Coase and Cultures

I just finished introducing the Coase Theorem to my first year undergraduate students at the Gokhale Institute, and my timing couldn't have been better. Have you read Rohit's excellent essay yet?

Life in India is a series of bilateral negotiations conducted a thousand times a day. And that drives the character of life here.

He uses the Coasean framework to explain why India, despite its growth and potential, remains stuck well below what it could potentially achieve. Rohit argues that the inefficiency is actually a Ridiculously Big Problem. It's rooted in the nature of Indian culture itself, where daily life is a never-ending series of bilateral negotiations.

For us students of econ, the phrase "series of bilateral negotiations" really means high transaction costs. In normal every day English, this simply is the time, effort, and energy spent on navigating India’s messy public systems. If a cop stops you by the side of the road to check your license, you know what high transactions costs are all about. Cheaper, you think, to pay the bribe and move on. From bribing officials to negotiating traffic norms to getting completion certificates out of a municipal corporation (and a million other things besides), every interaction comes with a hidden cost, and this is precisely the kind of problem Coase’s theory seeks to address. India is trapped in a Coasean world where transaction costs aren’t eliminated but are multiplied, fragmenting society into hajjar negotiations.

Every. Single. Minute. Of. Every. Single. Day.

Coase Giveth, Coase Taketh Away

I am an unabashed fan of Coasean thinking, and that makes it easy for me to agree with Rohit’s diagnosis wholeheartedly. But here's the thing: if you think about it, I think one can make the argument that what Coase giveth (the problem), he also taketh away (by providing the solution).

One of my all time favorite papers, The Nature of the Firm, offers a solution for high transaction costs when it comes to the world of business. If high transaction costs prevent efficient negotiation between individuals, then the answer is to internalize those costs. That's what firms are, in a Coasean world - machines to internalize transaction costs! If one can create firms that absorb the friction and reduce the complexity of multiple negotiations, one can get a lot of things done!

Firms exist, in Coase’s view, because they reduce transaction costs by creating centralized decision-making and reducing the need for constant negotiation in a market.

A blog is meant to be about wild, out-there ideas, so here's one for you—why shouldn't we think of a national culture as a firm? Instead of just dismissing culture as something intangible and amorphous, let’s think about it in terms of organizational logic. If firms exist to minimize transaction costs, could a national culture serve a similar purpose? Could shared values, norms, and expectations reduce the constant friction of negotiating social rules?

The Firm and Culture: An Analogy

The Theory of the Firm tells us that in a Coasean world, firms exist because they efficiently internalize transaction costs. Firms, to Coase, are the vaccines against the virus of transaction costs.

If we extend this analogy to culture, we can think of cultures as "firms"—not literal corporations, but organized responses to the inefficiencies of public administration. Just as a firm exists to minimize the costs of constant market negotiation, a culture can emerge to minimize the costs of constant social negotiation. Norms, values, and social structures within a culture serve to reduce the friction of daily life, providing predictability, coordination, and shared expectations.

Culture is much, much more than just something that minimizes the costs of constant market negotiation. It is also about social coordination, the creation and maintenance of identity, (somewhat) effective social control, the transmission of knowledge, and millions of other things. Culture helps define who we are, how we connect with others, and how we navigate the world around us. Which is why the analogy isn't, and cannot be perfect.

And so, like all analogies, this one holds up in some ways and not in others. Here’s three ways, if you ask me, in which firms are, indeed, like cultures. First, cultures internalize costs just like firms do. Just as firms minimize the transaction costs of markets, cultures develop norms to smooth over the inefficiencies of weak public administration. Communities create their own governance systems—customs, caste networks, or religious institutions—that provide the services a formal state should. Second, cultures are about coordination. Like a firm coordinates activity within its boundaries, cultures coordinate behavior across their members. And they use the carrot and the stick just as much as any other organizations! Third, cultures focus on local efficiency. Just as firms adapt to their environments to maximize productivity, cultures do the same—they evolve in response to local conditions. This evolution is contingent upon two things that are important for my argument here (although there are other things at play too, of course): a) what the culture is trying to optimize for and b) the local environment.

But the analogy also breaks down in some ways. I'll list two that come immediately to mind, although I am sure there are many others. First, firms have a top-down hierarchy to make decisions, whereas culture is largely organic and bottom-up, evolving through collective experience rather than being directed by a single authority. Second, unlike a firm that exists within a clear boundary, cultures in a diverse country like India are highly fragmented. There is no single culture or "firm"—instead, there are millions of small sub-cultures, each responding differently to the inefficiencies around them.

India’s Sub-Cultures as a Response to Inefficiency

India’s modern sub-cultures aren’t just arbitrary social formations—they’re, at least in part, responses to the failure of public administration. Where the state does not provide efficient health care, education, sanitation, or safety, local communities step in to fill the gap. Each of these sub-cultures functions as a mini-firm, internalizing the costs of weak administration through strong communal networks and social ties.

But here’s the real problem: These sub-cultures are also political processes. Local leaders rise within these groups, positioning themselves as intermediaries between the state and their community. Their political power depends on maintaining this role, so they have a vested interest in perpetuating weak administration. They need the inefficiency to exist so they can continue to act as brokers, strengthening their political base and keeping their constituents dependent on them.

In doing so, these leaders are invested in preserving sub-cultures rather than building a cohesive national culture. The opportunity cost of this equilibrium is the lack of demand for a scaled-up, more efficient public administration.

Here's Karthik Muralidharan, in Accelerating India's Development:

Weak state capacity and vote-bank politics can reinforce each other in a vicious cycle. Because weak states cannot credibly deliver services well to all citizens, voters often support politicians who can direct public resources to their group. Politicians, in turn, build their power base by representing the interests of specific groups—typically those with whom they share an identity—rather than the population at large. Reflecting the expectations of their voters, they use their time in office to reward their base voters rather than invest in improving broad-based governance. This underinvestment then perpetuates the cycle of weak state capacity and vote-bank politics. A good example of such a vicious cycle is seen in Lalu Prasad Yadav’s tenure as chief minister of Bihar in the 1990s. Multiple studies have documented widespread atrophy in governance during this period. Yet, what is perhaps less well-known is that programmes targeting the welfare of Yadavs and Muslims—his two main vote banks—functioned relatively well. Thus, by directing the limited resources of the state towards his loyal base voters, he could still get re-elected, despite poor overall performance.

The Bottom-Up Disequilibrium

In such a system, assuming I'm on to something here, the bottom-up demand is for sub-cultures to persist and grow, not for an overarching culture that demands better public services. Each sub-culture reinforces itself by creating its own informal governance. This, in turn, weakens the incentives on the formal state to improve. If your local networks can solve the problem, why bother asking for really "difficult to make happen" improvements in official public administration?

The opportunity cost of this self-reinforcing cycle is that a unified, efficient public system that could serve all citizens never gains momentum.

We can ask how other countries have solved this problem—how Japan or Switzerland managed to build strong institutions, for example—but this approach is, alas, not directly translatable to India. India’s scale, her mind-boggling diversity, and insane complexity make it fundamentally different. And that's putting it mildly! Other countries may provide insights, but they do not offer a straightforward Ctrl-C, Ctrl-V menu option, more's the pity.

So Doom and Gloom Then, Eh? Or Not?

One solution, then, is not to search for a single Coasean equilibrium, but for multiple local Coasean equilibriums. Instead of trying to force a one-size-fits-all national solution, we need to decentralize further. Politically, fiscally and administratively! This will, hopefully, have the effect of having local leaders be held locally accountable for local governance. This means giving local governments the ability to raise and spend revenue, providing them with the tools they need to improve services at the grassroots level.

Local accountability, I'd argue, has the potential to break the current self-reinforcing loop where political leaders benefit from the state’s inefficiency. Instead, they would be directly responsible for delivering services, and their success or failure would be clear to their constituents. I'm not asserting this as a fact, but this certainly has, I'd argue, a non-zero probability!

Rohit ends his essay by saying that "But the framework is clear, to move away from bilateral negotiations to a Coasian equilibrium. That’s the next cultural progress milestone we need to get to." My only change to that quote is to ask for many and localized Coasian equibriums.

Not every cultural firm needs to scale, and the solution to India’s inefficiency lies in recognizing that culture is bottom-up, not top-down. Imposing one from the top doesn't work, and not trying to build one (many, actually) would be disastrous.

Starting locally is almost always the better idea.