Why Have Property Rights?

The purpose of this essay is to flesh out some aspects and properties of property rights.  For many readers, this is probably redundant.  Nothing I will write here is original or particularly new.  However, following recent conversations I have had, I feel it is worth it to rehash some of these ideas.

Property rights, defined as the right to use resources*, exist to help resolve conflicts.  In a world of scarce resources with more than one person in it, conflicts will inevitably rise.  The prototypical Robinson Crusoe, who finds himself alone on a desert island, need not worry about conflicting uses of resources.  He can choose to eat the berries or plant them, and there will be no other objections to their use.

However, once Friday comes ashore, now there is the risk of conflict.  If Robinson wants to eat berries and Friday wants to plant them, then there is a conflict; doing one necessarily means the other cannot happen.  The clear delineation of property rights, who owns the berries, in this case, helps solve/prevent the conflict.  If Robinson and Friday agree that Robinson owns the berry bushes and Friday owns the fruit trees, then Friday can use the fruit trees and Robinson can use the berry bushes to their hearts’ content.  Indeed, they could even trade with one another!

But, what about if there are conflicts with the use of the resources?  Does Robinson have any right to object to Friday’s use?  In other words, are property rights absolute?  Let me be absolutely clear by what I mean by “absolute,” and here a very little mathematical formalism would be helpful: By “absolute,” I mean that the use of the resource will be determined by the resource owner with a probability of 1.  If Joe owns a resource, and its use is determined by Joe and Joe alone 100% of the time, then his ownership is absolute.  If the probability is less than 1 at any time, then the property right is not absolute.

Going back to Robinson and Friday, let’s say that one of Friday’s trees is a coconut tree.  I have already said above that Friday has the property right to the trees.  He can use the trees for his purposes.  But does Friday and only Friday determine how those resources are to be used?  Can we think of an example where his right might be restricted, that is its use would not be determined by Friday?  Yes: Friday may not use his coconuts to bash in Robinson’s skull.  One can think of many other examples.  Therefore, Friday’s property right is not absolute.

Another example: I own a crowbar.  I can use that crowbar for many things, but I cannot use that crowbar to pry open my neighbor’s door without his consent.  Therefore, the use of my crowbar is not 100% determined by me.  For a very select few set of cases, the use is determined by my neighbor.  The property right is not absolute.

The discussion of using property to harm another (whether intentionally or not) is of major importance in law and economics.  As Ronald Coase pointed out when property rights are ill-defined, that is to what extent their use is defined, then conflicts arise.  If rights are absolute, then conflicts are inevitable and cannot have a just resolution.

To be clear, just because property rights are not absolute does not mean they are arbitrary.  They cannot be revoked, renegotiated, or reneged without due cause.  But the glorious thing about common law is that it allows for the flexibility needed to address conflicts which are at the present unseen but may arise down the road without sacrificing the right itself.

This blog post is a little over 600 words.  I will not pretend to have done justice to the issue of property rights here.  For a more detailed discussion, I’d recommend the following readings:

The Property Right Paradigm, by Armen Alchian and Harold Demsetz

Toward a Theory of Property Rights, Part I and Part II by Harold Demsetz

The Problem of Social Costs, by Ronald Coase

*Source

Institutions Matter

While cruising around Facebook this morning, I came across this argument against immigration by one Jasen Tenney:

Illegal immigration is down over 50% with Trump and now to get legal immigration way down. Glad to see them go. Since these people are so good for an economy they can make their own crappy home country a better place to live.

Jasen’s argument is somewhat typical of many man-in-the-street arguments against illegal immigration (and immigration in general).  If immigration is good for the US, if specifically, these people are really a net benefit to the country) and not, as President Trump said infamously, criminals, rapists, and drug dealers, why don’t they stay in their own country and make it a better place?

The economist’s response to this question is simple: institutions matter.  Institutions like rule of law, secure property rights, impartial judiciary, individual rights, etc (in other words, classically liberal institutions) go a long way in producing economic growth.

A person is more likely to flourish, and help others flourish, in an area with institutions that encourage economic growth than s/he is in an area that discourages or predates upon economic growth.  Why produce in an area where property rights are insecure (eg, roving bandits can just steal your stuff, or government can appropriate anything at will)?  Even the best producer may not produce anything under such circumstances.  But, under a different institutional structure, s/he may thrive.

To return to Jasen’s question that motivated this post: why can’t these immigrants simply return to their “crappy” home country and make it a better place?  Quite possibly, because the institutional arrangements necessary to make the country a better place do not exist (or are sufficiently weaker compared to the country the immigrant was headed to)!

Coase, Transaction Costs, and Environmental Entreprenureship

Today’s Quote of the Day comes from pages 7-8 of Ronald Coase’s 1988 book The Firm, the Market, and the Law [emphasis added]:

Markets are institutions that exist to facilitate exchange, that is, they exist in order to reduce the cost of carrying out exchange transactions.  In an economic theory that assumes transaction costs are nonexistant, markets have no function to perform and it seems perfectly reasonable to develop the theory of exchange by an elaborate analysis of individuals exchanging nuts for apples on the edge of a forest or some similar fanciful example.

Many readers of Coase (including economists!) misunderstand him.  This is evident in the improperly named Coase Theorem (it’s improper in that it’s not a theorem).  In fact, Coase is so often misunderstood, he felt compelled to write the book this quote is from to clarify his point!  Coase is often understood to say that, absent transaction costs (or sufficiently low transaction costs), externality issues (eg pollution, noise, etc) can be solved by an allocation of property rights and, regardless of their initial allocation, will result in a Pareto-efficient outcome.  This is correct, but only a partial understanding of Coase.

Much of Coase’s work (and work that spun off from him, such as with Armin Alchian, Harold Demsetz, Gordon Tullock, and many others including my own) focus on the role of the market in addressing externality issues.  Detractors from Coase argue that his insights, that markets for externalities can exist only if there are no/low transaction costs, are not applicable to the “real world,” since transaction costs abound and, therefore, government intervention is necessary.  But this argument represents a misreading of Coase.  In a purely ideal world, there would be no transaction costs, but then no market would be necessary.  As Coase says in the above quote, it is in the world of transaction costs that the market is most useful!  The existence of transaction costs gives rise to firms and other means of human collaboration, which in turn reduce transaction costs, and increase the market exchange of individuals (see The Nature of the Firm (1937) for a more in-depth conversation on this point).

Expanding the idea of markets, firms, and transaction costs to environmental issues, we see the rise of “enviropreneurs” (to use the phrasing of PERC), that is people who seek out and find ways to mitigate these transaction costs in order to achieve desired environmental ends; in short, a market process of environmental concerns (for a detailed look at many different kinds of enviropreneurs, see Free Market Environmentalism for the Next Generation, especially Chapter 9).  The fact transaction costs exist is not a detriment to free market environmentalism, like the detractors of Coase argue, but rather what allows it to come about!

Like Coase (and Buchanan and many others) before me, I realize the market is not a panacea.  There may be conditions for government to get involved (namely where involvement by the firm or an individual are too costly).  But the work of Coase (and Alchian and Demsetz and Buchanan and Tullock and Anderson and many others) show us that the mere existence of an externality and transaction costs is not enough to justify intervention.

Reexamining the Case for Trade

My latest working paper reexamines the case for international trade.  Here is the abstract:

Since the time of Adam Smith, high tariffs have been decried by economists as counterproductive to a country’s economic growth. However, in recent years, this consensus has come under scrutiny, not just from the political sector but also the academic sector. Using GDP per Capita as a measure of economic well-being and the Economic Freedom of the World Index to measure freedom to trade, I find a distinct positive effect lower mean tariff rates have on GDP per capita. The size of the effect varies on the income of the country, with the strongest effect on the poorest nations and the weakest effect on the wealthiest nations.

As this is a working paper, any and all constructive comments are welcome!

Everyday Economics: Bioshock Edition

On my recent trek between Virginia and Massachusetts (and back), I listened to an audio version of the book Bioshock: Rapture by John Shirley (If you’re looking for something light to take your mind off of things, this is a good book).  The book details the rise and fall of Rapture, a massive underwater city built by Andrew Ryan (a not so subtle jab at Ayn Rand) to escape the “parasitic” governments of the world and build a society dedicated to freedom and free markets.  While the initial goal of Rapture may have been freedom and free markets, as the novel (and the video game that the novel is based on) details, Rapture becomes a totalitarian police state with an extremely wealthy (and often sadistic) upper class, and extremely poor low class, and no one in between.  Some see Bioshock as a refutation of Randian philosophy, however, I will not address that here as I am no expert in Ayn Rand (for an excellent discussion, see The Value of Art in Bioshock: Ayn Rand, Emotion, and Choice by Jason Rose).  I’ll leave that to people far smarter than I.  Rather, I want to address the economic situation of Rapture and discuss, briefly, how that contributed to the downfall.

A few quick disclaimers before I begin:

  1. As far as I know, Bioshock: Rapture is not canonical.  However, it is the only detailed source I can find thus far on the days of Rapture that take place before the video game (which is canon) so I will operate on the assumption that my source material is canonical knowing full well everything I write here could become completely worthless insofar as discussing canonical information (the lessons gleaned from this book are still important, however).
  2. Nothing in this essay should be taken as implying the rise or fall of Rapture is purely economic.  There are many other factors involved (social, political, medical, psychological, etc).  I skip or gloss over these not because I think they are unimportant (quite the opposite, really), but because I simply lack the expertise to discuss them with any confidence.
  3. I will be avoiding using direct quotes in this version of this essay.  The reason for this is simple: I have the audio book, not the book itself.  I can’t easily do verbatim quotes and attribute them to proper pages for citations.  Therefore, the reader should be aware that I am doing this partly out of memory (although I did scribble some notes) and further the reader should assume that whenever I describe what’s happening in Rapture, that is a reference to the work of Mr. Shirley.  The only original material will be my analysis.  Any inaccuracies, either to details or analysis, belong to me and me alone.

The short version of what follows: Rapture cannot be classified in any meaningful sense as a “free market.” It suffers from several deficiencies that prevent us from labeling Rapture as a free market: lack of property rights, lack of free trade (autarky), lack of labor mobility (autarky in the labor market), rejection of altruism, widespread and institutionalized fraud (this issue is speculative based off of interviews with characters within the book but not substantiated by details), and censorship (indirect at first, but more direct later).  In Andrew Ryan’s Rapture, “free market” and “laissez-faire” were not much more than dishonored buzzwords.  It can best be described, in the words of James Buchanan, as “moral anarchy,” (see Moral Science and Moral Order, especially page 190 and Limits of Liberty, especially Chapter 7).  These factors, coupled with other psychological, social, and other factors, lead to the decline, civil war, and eventual fall of Rapture.  Continue reading

Toward a Better World

According to the organizers of Earth Day: “Education is the key to advocacy and advocacy is the key to change.”  I agree.  Toward that end, allow me to explain why free markets, and in particular secure private property rights, help make the world a better, cleaner, and more environmentally friendly place.

Property rights are important because they encourage the owners of that property right to maximize the property’s uses.  Property rights do this by having the owners incur the costs of their property (its upkeep, its development, etc), but also confers the benefits onto its owner; in other words, the greater concentration of costs and benefits means each person’s success is dependent on his/her activities.  As such, the property owner is incentivized to minimize costs and maximize benefits over the life of the property.

While there are many kinds of property rights, the type of right matters for environmentalism.  Contrary to many popular claims, public ownership of natural resources (national parks, nature preserves, and the like) may be counter to the goals of environmentalism; in other words, state-produced environmental efforts may make the situation worse, not better!  The reason for this is the incentive may not be as strong to maximize effort on the part of the property owner.

Allow me to explain by way of paraphrasing an example Armen Alchian gives in his 1965 Il Politico article Some Economics of Property Rights:

Suppose there is a community with 100 people in it, and 10 enterprises.  Further suppose that each person, by devoting 1/10th of his time to some enterprise as an owner, he can generate a gain of $1,000 for the enterprise.  If ownership of each enterprise is divided equally among the populace (that is, all the enterprises are “publicly owned,”), then he will produce a gain of $100 for himself each day (1/100th part owner and 10 firms) and the rest of his product ($9,900) going to the other members of the community.  If the other 99 people in the community act the same way, he will get $9,900 from them, bringing his total wealth gain to $10,000.

Now suppose that each person owns 1/10th of a single enterprise.  The individual now works to produce $10,000, of which he keeps $1,000 and the other $9,000 goes to the other owners.  If the other owners do the same, all end up with $10,000.

If we go to the extreme end and each enterprise is owned by a single person, then he gets to keep all $10,000 of his own hard work.

As we can see, in each case above, the reward to the property owner depends partly on his own effort and partly on the effort of others (except the last option).  In the first of the cases, the incentive for him to maximize his efforts is minimal: no matter how hard he works, he’ll only get $100 direct benefit from it.  The other $9,900 must come from someone else who may or may not have the same work ethic as him.

So, if a person is most incentivized to act when s/he absorbs the costs and the benefits, how will that help the environment?  Well, it’ll help by incentivizing the person to keep their property in working order.  A person who owns a home will do her best to keep the house neat, to keep the fixed costs (heating, cooling, water, etc) low.  They may, if they have time and money, plant a garden or maintain a yard in order to keep the house pretty.  Larger groups with common goals could pool money to maintain a park.  Firms, seeking to minimize their costs, are constantly looking for ways to reduce waste and increase output.  Owners of farms, of mines, and the like are always looking for ways to extend the life of their sources of wealth.

In short, people will look to take care of their own little plot of the world.  Environmentalists often urge us to “think globally, act locally.”  I can’t think of anything better than property rights to accomplish this task.

There are objections some might raise to the above discussion, and those I will address in another post as this one, at nearly 700 words, is already too long.

Today’s Quote of the Day…

…is from pages 5-6 of Frederic Bastiat’s 1850 essay The Law (Mises Inst. Edition):

But [man] may live and enjoy, by seizing and appropriating the productions of the faculties of his fellow men.  This is the origin of plunder.

Now, labor being in itself a pain, and man being naturally included to avoid pain, it follows, and history proves it, that wherever plunder is less burdensome than labor, it prevails; and neither religion nor morality can, in this case, prevent it from prevailing.

When does plunder cease, then?  When it becomes more burdensome and more dangerous than labor.

As with anything, people will choose the least-costly option for their actions, in this case in the trade off between labor and plunder (Bastiat uses the phrase “plunder” here meaning the legal appropriation of one’s property by the state to transfer to another person).  As the cost of labor rises (or the cost of plunder drops), the attractiveness of plunder increases.  Things like occupational licenses, tariffs, and even progressive taxation all increase the costs of labor, and thus make plunder more attractive, which in turn leads to more lobbying and resources spent to get a share of the plunder.

Respect for the law cannot long be preserved when the law becomes a tool for plunder rather than preventing it.