The Competitiveness of Nations in a Global Knowledge-Based Economy
Armen A. Alchian, Harold Demsetz
The Property Right Paradigm
Journal of Economic
History 33 (1
The Tasks of Economic History
March 1973,
16-27.
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Content
The Social Consequences of the Structure of
Rights |
ECONOMICS textbooks invariably describe the important
economic choices that all societies must make by the following three questions:
What goods are to be produced?
How are these goods to be produced?
Who is to get what is produced?
This way of stating social choice
problems is misleading. Economic
organizations necessarily do resolve these issues in one fashion or another, but
even the most centralized societies do not and cannot specify the answer
to these questions in advance and in detail. It is more useful and nearer to the truth
to view a social system as relying on techniques, rules, or customs to resolve
conflicts that arise in the use of scarce resources rather than imagining that
societies specify the particular uses to which resources will be
put.
Since the same resource cannot simultaneously be used to
satisfy competing demands, conflicts of interest will be resolved one way or the
other. The arrangements for doing
this run the full gamut of human experience and include war, strikes, elections,
religious authority, legal arbitration, exchange, and gambling. Each society employs a mix of such
devices, and the difference between social organizations consists largely in the
emphasis they give to particular methods for resolving the social problems
associated with resource scarcity.
Capitalism relies heavily on markets and private
property rights to resolve conflicts over the use of scarce resources. These fundamental characteristics of an
idealized capitalistic system have been taken for granted by most mainstream
economists even though the discipline of economics developed contemporaneously
with Western style capitalism. It
is unfortunate that the study of the underpinnings of capitalism has been left
by default to its critics on the left.
But recent years have witnessed increasing attention to
the subject of property rights and to the beginning of a somewhat different
approach to the analysis of social problems that find their source
in
Grateful acknowledgement for aid is made to the E. Lilly
Endowment Inc. grant to the Economics Department, U.C.L.A. for research on
behavioral effects of different property rights.
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scarcity. Three questions are suggested by this
growing literature: (1) What is the structure of property rights in a society at
some point of time? (2) What consequences for social interaction flow from a
particular structure of property rights? and, (3) How has this property right
structure come into being? Economic
historians can contribute very much to overcoming our ignorance about the
answers to these questions, and our purpose here is to facilitate historical
research on these problems by clarifying somewhat the content of these
questions.
In common speech, we frequently speak of someone owning
this land, that house, or these bonds. This conversational style undoubtedly is
economical from the viewpoint of quick communication, but it masks the variety
and complexity of the ownership relationship. What is owned are rights to use
resources, including one’s body and mind, and these rights are always
circumscribed, often by the prohibition of certain actions. To “own land” usually means to have the
right to till (or not to till) the soil, to mine the soil, to offer those
rights for sale, etc., but not to have the right to throw soil at a passerby, to
use it to change the course of a stream, or to force someone to buy it.
What are owned are socially
recognized rights of action.
The strength with which rights are owned can be defined
by the extent to which an owner’s decision about how a resource will be used
actually determines the use. If the
probability is “1” that an owner’s choice of how a particular right should be
exercised actually dominates the decision process that governs actual use, then
that owner can be said to own absolutely the particular right under
consideration. For example, a
person may have an absolute right to pick apples off a tree, but not to prune
the tree.
The domain of demarcated uses of a resource can be
partitioned among several people. More than one party can claim some
ownership interest in the same resource. One party may own the right to till the
land, while another, perhaps the state, may own an easement to traverse or
otherwise use the land for specific purposes. It is not the resource itself
which is owned; it is a bundle, or a portion, of rights to use a resource
that is owned. In its original
meaning, property referred solely to a right, title, or interest, and resources
could not be identified as property any more than they could be identified as
right, title, or interest.
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Distinct from the partitioning of the domain of uses to
which a resource may be put is the decision process that may be relied upon to
determine that use: The exercise of
a particular right may depend on a decision process in which many individuals
share, such as in the use of majority voting. The right to vote may be exercised
individually, but it is the pattern of votes by many individuals that determines
the way in which a right to use a resource will be
exercised.
There are two important questions that can be asked
about the structure of property rights in a society. The first asks which property rights
exist. There may exist a particular
right of use in a society that did not exist earlier or that does not exist in
other societies. For example, early
in the history of radio, users of frequencies did not own the right to prevent
members of the community from broadcasting on these same radio frequencies.
Any person who wished to could
broadcast on any frequency, and that is still true today for certain bands of
radio frequencies. The right to
offer heroin for sale on the open market does not exist in the
The second question calls attention to the fact that the
identity of right owners may vary. Perhaps the most important ownership
distinction is between state (public) ownership and private ownership. An easement right may be owned by the
state or by an individual. The
right to deliver first class mail is owned by the state, whereas the right to
board troops without permission is not. Needless to say, the classification of
social systems according to the degree of centralization of control is closely
related to the degree to which property rights are owned exclusively by the
state.
There is some ambiguity in the notion of state or
private ownership of a resource, because the bundle of property rights
associated with a resource is divisible. There can and does exist much confusion
about whether a resource or “property” is state or privately owned. Some rights to some uses of the resource
may be state owned and others privately owned. While it is true that the degree of
private control is increased when additional rights of use become privately
owned, it is somewhat arbitrary to pass judgment on when the conversion to
private control can be said to change the ownership of the
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bundle of rights from public to private. The classification of owners can be
carried beyond the important state and private dichotomy. Corporate, school, and church owners of
property are also of interest. The
structure of rights can have important consequences for the allocation of
resources, some of which we now illustrate.
THE SOCIAL CONSEQUENCES OF THE
STRUCTURE OF RIGHTS
The significance of which rights exist can be
appreciated by contrasting situations in which there is and is not a right to
exclude. We shall use the phrase
“communal rights” to describe a bundle of rights which includes the right to use
a scarce resource but fails to include the right of an “absentee owner” to
exclude others from using the resource. Operationally this means that the use of
a scarce resource is determined on a first-come, first-serve basis and persists
for as long as a person continues to use the resource. The use of a city sidewalk or a “public”
road is communal, and the rights to till or hunt the land have been subjected to
this form of ownership frequently. Often communal ownership is technically
associated with state ownership, as in the case of public parks, wherein the
state technically has the capability of excluding persons from using its
property. If this right is
exercised by the state frequently, as it is on military reservations, then the
property right is more properly identified as state owned, but if the right to
exclude is seldom exercised by the state, as in public parks or thoroughfares,
then as a practical matter the users of the resource will treat it as
communal. Communal rights mean that
the working arrangement for the use of a resource is such that neither the state
nor individual citizens can exclude others from using the resource except by
prior and continuing use of the resource. The first driver to enter the public road
has a right of use that continues for as long as he uses the road. A second driver can follow the first but
cannot displace or exclude him.
The difficulty with a communal right is that it is not
conducive to the accurate measurement of the cost that will be associated with
any person’s use of the resource. Persons who own communal rights will tend
to exercise these rights in ways that ignore the full consequences of their
actions. For example, one of the
costs of hunting animals, if they are not superabundant, is the resulting
depletion in the subsequent stock of animals. This cost will be taken into account only
if it is in someone’s interest to do so. This interest is
provided
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if someone can lay claim to or benefit from the increase
in the stock of animals that results from a curtailment in his hunting
activities. Under a communal right
system anyone who refrains from hunting does so not to his benefit but to the
benefit of others who will continue to exercise their communal right to hunt.
Each person, therefore, will tend
to hunt the land too intensively and deplete the stock of animals too
rapidly.
Often the exercise of communal rights forces persons to
behave in ways that are thought to be immoral. In 1970, the newspapers carried stories
of the barbaric and cruel annual slaughter of baby seals on the ice floes off
The problems posed by communal rights are abundantly
clear when we analyze the causes of pollution. Since the state has invited its citizens
to treat lakes and waterways as if they are free goods, that is, since the state
generally has failed to exclude persons from exercising communal rights in the
use of these resources, many of these resources have been overutilized to the
point where pollution poses a severe threat to the productivity of the
resource.
An attenuation in the bundle of rights that disallows
exchange at market clearing prices will also alter the allocation of resources.
The interests pursued by men are
both varied and many. If a price
ceiling or price floor prevents owners from catering to their desires for
greater wealth, they will yield more to the pursuit of other goals. For example, effective rent control
encourages owners of apartments to lease them to childless adults who are less
likely to damage their
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living quarters. Effective rent control also prompts
landlords to lease their apartments to persons possessing personal
characteristics that landlords favor. In a Chicago newspaper, the percentage of
apartment for rent advertisements specifying that the apartment was for rent
only on a “restricted” basis or only if the renter purchased the furniture rose
from a pro-war low of 10 percent to a wartime high of 90 percent during the
period of World War II when rent control effectively created queues of
prospective renters. Attenuations
in the right to offer for sale or purchase at market clearing prices can be
expected to give greater advantages to those who possess more appealing racial
or personal attributes.
The reallocation of resources associated with the
absence of a right to exclude and the inability to exchange at market clearing
prices is attributable to the increase in the cost of transacting brought about
by these modifications in the property right bundle. A price fixing law raises the cost of
allocating resources vis-á-vis the price mechanism and, therefore, forces
transactors to place greater reliance on non-price allocation methods. This is obvious; but not equally obvious
is the role played by transaction cost when the right to exclude is
absent.
Consider the problem of congestion during certain hours
in the use of freeways. No one
exercises the right to exclude drivers from using freeways during these hours.
The right to drive on freeways is a
communal right. But drivers who
desire less congestion are not legally prohibited from paying others to use
alternative routes during these hours. This right system, however, encourages
drivers to let someone else pay persons to use alternative routes, since those
who do not pay cannot be excluded from the use of the freeway under a communal
right system. The communal right
system raises transaction cost by creating a free rider problem. Moreover, even if some temporary
reduction in congestion is purchased, there may be many persons not now using
the freeway who are attracted to it by the temporary reduction in congestion.
The supply of freeway space is very
likely to create a demand for its use under the communal right system because
these new users cannot be excluded. They also must be paid to return to
alternative routes, and this burdens the allocation system with additional
costly transactions. A right system
that includes the right to exclude nonpayers, such as is possible with
tollroads, eliminates both these sources of high transaction cost. Persons not now using the road can use it
only if they value the route
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enough to pay the toll, and the owner of the toll road
is not handicapped by the psychology of a freeloader.
The social consequences of the identity of right owners
also can have allocative effects. At the more obvious level, government and
private owners, respectively, will respond in greater degree to political and
market incentives, and this can be expected to yield differing resource uses.
But the effect on resource
allocation of altering the identity of owners, all of whom are private owners,
is not so obvious. As a first
approximation, each and all private owners can be expected to respond to market
incentives in the same way so that the particular identity of owners will not
alter the uses to which resources are put. All private owners have strong incentives
to use their property rights in the most valuable way. Under certain conditions, this
approximation can be expected to be very good. The most important of these conditions is
that the cost of transactions be negligible; in this case, it will be easy for
those who can put resources to their most valuable uses to contact and negotiate
with those persons presently owning the rights to these resources. If the cost of transactions is not
negligible, then an alteration in the identity of right owners can have
allocative effects because negotiations toward a unique utilization of resources
may be inhibited by positive transaction costs.
The most important effect of alterations in
institutional arrangements may well be the impact of such reorganizations on the
cost of transacting. The enclosure
movement, for example, may have significantly reduced the cost of carrying on
transactions among those possessing rights of use, and this may have eased the
task of putting resources to their most productive uses. Perhaps some new insights about the
consequences of the enclosure movement can be obtained if the researcher focuses
his attention on the cost of transacting.
THE DEVELOPMENT OF PROPERTY RIGHT
STRUCTURES
Under a communal right system each person has the
private right to the use of a resource once it is captured or taken, but
only a communal right to the same resource before it is taken. This incongruity between ownership
opportunities prompts men to convert their rights into the most valuable form;
they will convert the resources owned under communal arrangements into resources
owned privately, that is, they will hunt in order to establish private rights
over
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the animals. The problem can be resolved either by
converting the communal right to a private right, in which case there will be no
overriding need to hunt the animals in order to establish a private claim, or
the incentive to convert communal rights to private rights can be restrained
through regulation.
There is a basic instability in an arrangement which
provides for communal rights over a resource when that resource takes one form
and private rights when it takes another form. The private right form will displace the
communal right form. In itself this
has important consequences only if the conversion of communal ownership
into private ownership is costly. Thus, if unbranded animals are held to be
communal property while branded animals are private, there will be a rush to
place brands on the animals. This
would not be very costly, especially since branding would be desirable for
identification purposes anyway. There would be no need to kill the
animals in order to establish private rights, so that these animals can be
husbanded appropriately once the cost of branding is incurred. But a conversion process that requires
that the animals be killed in order to establish private rights must incur the
larger social cost of depleting the stock of animals.
If the social adjustment to the incongruity between
communal and private rights is resolved in favor of eliminating the private
right, then the immediate problem is replaced by another - the problem of
providing incentives to work. Thus,
if we suppose that the communal right to hunt is supplemented by the stipulation
that killed animals belong to the community, in which all citizens can share
according to custom, and do not belong exclusively to the hunter, then the
incentive to hunt will be diminished. This may cure the overhunting problem by
creating an underhunting problem in which the able-bodied wait for others to do
the hunting, the results of which will be shared by all. In order to reduce the severity of the
shirking problem that is thereby created, it is necessary for societies which
fail to establish private rights to move ever closer to a social organization in
which the behavior of individuals is directly regulated by the state or
indirectly influenced by cultural indoctrination. The option to hunt or not to hunt cannot
be left with the individual who, unable to claim the fruit of his effort, will
tend to shirk. Instead, the state
will find it increasingly necessary to order the hunt, to insist on
participation in it, and to regulate more closely the sharing of the kill. Or, possibly, the community can invest in
cultural
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indoctrination that leads to an increase in the
willingness to hunt. This is in
fact the course that events have taken among many primitive peoples. The animals they hunt are “free” to all
on a first-come, first-serve basis, but the kill must be shared according to
detailed ritual procedures, and the question of participating in the hunt is not
left open to individuals. The
attempt to resolve scarcity-created problems by reducing the scope of private
rights must inevitably result in a more centrally regulated or indoctrinated
society. One need not go so far
afield to find this process at work. Our public schools are offered on a
“free” right to use basis. As good
schools attract increasing numbers of students, the community either must expand
its resource commitment to public schools, in order to offset what it views as
overutilization, or it must somehow regulate the flow of newcomers. Zoning restrictions and building codes
frequently have been used to restrict the rate of immigration into such
communities.
If private rights can be policed easily, it is
practicable to resolve the problem by converting communal rights into private
rights. 1 Contrary
to some popular notions, it can be seen that private rights can be
socially useful precisely because they encourage persons to take account of
social costs. The
identification of private rights with anti-social behavior is a doctrine as
mischievous as it is popular.
The instability inherent in a communal right system will
become especially acute when changes in technology or demands make the resource
which is owned communally more valuable than it has been. Such changes are likely to bring with
them harmful and beneficial effects which can be measured and taken account of
only by incurring large transaction costs under the existing property right
structure. In such situations, we
expect to observe modifications in the structure of rights which allow persons
to respond more fully and appropriately to these new costs and benefits. The coming of the fur trade to the New
Continent had two consequences. The
value of furs to the Indians increased and so did the scale of hunting
activities. Before the coming of
the fur trade, the Indians could tolerate a social arrangement that allowed free
hunting, for the scale of hunting activities must have been too small to
seriously deplete the stock
1. Alternatively, of course, the communal right can be
converted to a state right in which the state seeks to exclude, perhaps by
adopting a price mechanism, the issue raised by state vs. private
ownership is not so much one of what can be done but one of what will be done by state
owners.
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of animals. But after the fur trade, it became
necessary to economize on the scale of hunting. The control system adopted by the Indians
in the Northeastern part of the continent was to substitute private rights in
land for free access to hunting lands. By owning the right to exclude others
from their land, Indian families were provided with an incentive to inventory
their animals. Under a free access
arrangement, such inventories would have been depleted by other hunters. With private rights to hunt the land
these inventories could be maintained at levels more consistent with the growing
market for furs.
Similarly, Professor North notes that twelfth-century
The relaying of radio signals between nations in
2. D. North and R. Thomas, “The Rise and Fall of
the Manorial System: A Theoretical Model,” Journal of Economic History,
XXXI (December 1971), pp. 777-803
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We have merely touched on a few cases of evolving
structures of property rights to which some contemporary thought has been given.
There exist very many property
right phenomena that could benefit from thoughtful attention. Consider the problem of the capital
structure of corporations. The
well-known Modigliani-Miller theorem that the value of an enterprise is
independent of its capital structure is a special application of the assumption
that the cost of transacting is zero. Titles of various kinds are assigned to
parts of an enterprise’s wealth and the value of these titles are no more nor
less than the present value of the enterprise’s wealth potential, at least so
long as entitlements are well defined, partitionable, and transferable at zero
cost. Further, they will be revised
and exchanged in ways that maximize the utility of their owner subject only to
the constraint imposed by the wealth potential of the
enterprise.
But, in fact, these bundles of rights are not costlessly
transferable or revisable, so that a question remains as to what bundles of
rights are most appropriate for an enterprise to issue intially. Bonds, common stocks, preferreds,
convertibles, warrants? Given the
cost of transacting and of revising these bundles of rights, are there any
factors that would explain the initial mix? We conjecture that differences in
beliefs by investors about the potential performance of the enterprise can
account for differences in the initial mix. An enterprise that desires to maximize
the sum it raises from the sale of ownership claims would find it desirable to
offer different bundles of rights; a warrant, for example, to optimistic
investors and a bond to pessimistic investors, given that markets do not
function costlessly. If the market
could produce these different bundles costlessly, there would be no need for the
firm to be concerned with different financial instruments. For, then, financial intermediaries could
supplement and convert any financial instrument issued by the firm into the mix
of financial instruments preferred by optimistic and pessimistic investors who
hold different expectations about the firm’s prospects.
Although articles dealing with property rights and
transaction costs are accumulating at a rapid pace, they tend to be primarily of
the “speculative theory” variety. Only a handful of empirical studies have
been concluded, a few of which are concerned with phenomena old enough to be
historical. But economic historians
have much
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more to contribute, and we hope that we have made some
of you curious enough to examine the partial bibliography appended to this
paper.
ARMEN A. ALCHIAN AND HAROLD
DEMSETZ,
1. A. A. Aichian, “Unemployment and the Cost of
Information,” Western Economic Journal, VII (June 1969), pp.
109-128.
2. ----------------, “Some Economics of Property
Rights,” Ii Politico, XXX (1965), pp. 816-829.
3. A. Aichian and H. Demsetz, “Production, Information
Cost, and Economic Organization,” American Economic Review, LXII
(December 1972).
4. A. Bottomley, “The Effect of the Common Ownership of
Land Upon Resources Allocation in
5. K. Brunner and A. Meltzer, “Studies in Money and
Monetary Policy,” Journal of Finance (May 1964).
6. S. Cheung, The Theory of Share Tenancy
(Chicago: Univ. of Chicago, 1969).
7. R. H. Coase, “The Nature of the Firm,” Reprinted in
AEA
8. --------------, “The Problem of Social Cost,”
Journal of Law and Economics, III (October 1960), pp.
1-40.
9. T. D. Crocker, “Extenalities, Property Rights, and
Transaction Costs,” Journal of Law and Economics, XIV (October 1971), pp.
451-464.
10.
H. Demsetz, “Toward a Theory of Property Rights,” AEA Papers and
Proceedings, May 1967, pp. 253-257.
11. --------------, ‘When Does the Rule of Liability
Matter?,” Journal of Legal Studies, I (January 1972), pp.
13-28.
12. --------------, “The Private Production of Public
Goods,” Journal of Law and Economics, XIII (October 1970), pp.
293-306.
13. --------------, “The Cost of Transacting,”
Quarterly Journal of Economics, LXXXII (February 1968), pp.
33-53.
14. A. S. Devany, R. D. Eckert, C. J. Meyers, D. J.
O’Hara, and R. C. Scott, “A Property System for Market Allocation of
Electro-Magnetic Spectrum: A Legal-Economic-Engineering Study,” Stanford Law
Review, XXX (June 1969), pp. 1499-1561.
15. E. Furubotn and S. Pejovich, ‘Property Rights and
the Behavior of the Firm in a
16. S. MacCauley, “Non-Contractual Relations in
Business: A Preliminary Study,” American Sociological Review, XXVIII
(February 1963), pp. 55-67.
17. R. N. McKean, “Products Liability: Implications of
Some Changing Property Rights,” Quarterly Journal of Economics, LXXXII
(November 1970), pp. 611-626.
18. D. North and R. Thomas, “The Rise and Fall of the
Manorial System: A Theoretical Model,” Journal of Economic History,
XXXI (December 1971), pp. 777-803.
19. S. Pejovich, “Liberman’s Reforms and Property Rights
in the
20. -------------, “The Firm, Monetary Policy and
Property Rights in a Planned Economy,” Western Economic Journal, VII
(September 1969), pp. 193-200.
21. S. Rottenberg, ‘Property in Work,” Industrial
Labor Relations Review, II (April, 1962), pp. 402-05.
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