Unit 2: Property Law
What are property rights?
Property is a bundle of rights describing what people may and may not do with things that they own. Property rights are not absolute and they never have been. For example, dumping nuclear waste onto your yard is not part of your property rights. In a simple sense, property law is about what kinds of rights should be included in the bundle and how to enforce violations of property rights.
In this unit, we will address questions like:
• How does a person acquire ownership? For example, if property is unowned, does the first person to possess it acquire ownership?
• What kinds of things can be owned? For example, do I have the right to take water out of a stream that runs through my property? Can I own the rights to digital content?
• What may owners do with their property? For example, can you keep cows on your property that make a bad smell for your neighbors? Can the government force you not to develop on environmentally sensitive areas?
• What are the remedies for a violation of property rights? For example, what if your house encroaches a bit on my land?
Why do we have property rights?
It’s worth noting right away that many different societies across many cultures, locations and time periods have institutionalized some kind of private property rights. Pure collectivism is almost nonexistent. Typically when some institution arises independently across so many places and peoples, it must make sense somehow. Why do we have private property rights?
The traditional answer is that is that, if there were no property rights, people would waste resources protecting their property – resources that could be productive. Thus, there is a net surplus to society from protecting property rights. We save all of the time and resources that people would have invested in protecting their property.
Classical Coase Theorem
Let’s start right away with an example.
A cattle rancher lives next to a farmer and his cows sometimes damage the farmer’s corn. The rancher’s profit is $300. The farmer’s profit is also $300, but damage from the cows reduces his profit by $100. The rancher could build a fence around his ranch for $75 that would prevent his cows from damaging the farmer’s crop. The farmer could build a fence around his farm for $50 that would also prevent any damage from occurring.
Clearly, the efficient solution is for the farmer to build the fence.
In this problem, we will consider the effect of two different legal rules.
1. The rancher can do whatever he wants (rancher has property rights) 2. The rancher is ordered to build a fence (farmer has property rights)
Let’s first describe the outcome if there is no negotiation possible.
Rancher has property rights
The farmer will build a fence because the $50 fence is cheaper than $100 in damages.
Π𝑓𝑓𝑓𝑓𝑓𝑓𝑓𝑓𝑓𝑓𝑓𝑓 = 300−50 = 250 Π𝑓𝑓𝑓𝑓𝑟𝑟𝑟𝑟ℎ𝑓𝑓𝑓𝑓= 300
Farmer has property rights
The rancher will build the fence as ordered
Π𝑓𝑓𝑓𝑓𝑓𝑓𝑓𝑓𝑓𝑓𝑓𝑓 = 300
Π𝑓𝑓𝑓𝑓𝑟𝑟𝑟𝑟ℎ𝑓𝑓𝑓𝑓= 300−75 = 225
Notice that the total profit is $550 when the farmer builds the fence, but only $525 when the rancher is forced to build the fence. Thus, in the second case there is a $25 surplus if the farmer and the rancher can negotiate a better solution. The $25 surplus comes from their ability to solve the problem by having the farmer build the fence (cost of $50) rather than the rancher (at a cost of $75).
Let’s now describe what happens if there is easy negotiation
Rancher has property rights
Nothing else happens – This is already the efficient solution. The farmer will continue to build the fence.
Π𝑓𝑓𝑓𝑓𝑓𝑓𝑓𝑓𝑓𝑓𝑓𝑓 = 300−50 = 250 Π𝑓𝑓𝑓𝑓𝑟𝑟𝑟𝑟ℎ𝑓𝑓𝑓𝑓= 300
Farmer has property rights
The farmer and the rancher will realize that it is $25 cheaper to solve the problem by having the farmer build the fence. In the reasonable solution, the two split the surplus. Therefore, the rancher will pay the farmer $62.50 to build the fence – the $50 cost of the fence plus half of the surplus.
Π𝑓𝑓𝑓𝑓𝑓𝑓𝑓𝑓𝑓𝑓𝑓𝑓 = 300−50 + 62.50 = 312.50 Π𝑓𝑓𝑓𝑓𝑟𝑟𝑟𝑟ℎ𝑓𝑓𝑓𝑓= 300−62.50 = 237.50
One way to check your answer here is to notice that both the farmer and the rancher have $12.50 more profit under this legal rule than they had when they didn’t negotiate. They divided the $25 surplus.
As applied to private property rights, the Classical Coase Theorem states that, as long as transactions costs are zero, then an efficient use of resources results from private bargaining regardless of the legal assignment of property rights.
outcome is that he ends up building the fence anyway, after the rancher pays him to do so. A lawyer might argue that one or the other is more “fair” (e.g. that the rancher “should” pay the farmer to build the fence), but that is not an economic argument. Economically, both outcomes are equally efficient. The difference is distributional.
To summarize, when transactions costs are zero, the final outcome is efficient regardless of the legal rule regarding the property rights. The legal rule may, however, impact distribution.
Transactions Costs – Coase vs. Hobbes
The Coase Theorem says that, as long as there are no transactions costs that impede private negotiations, then private bargaining will always lead to an efficient solution, regardless of the legal allocation of property rights.
But what if there are some transactions costs? A corollary to the Coase Theorem states that the efficient use of resources may depend on how property rights are assigned if transactions costs are high enough to prevent bargaining.
Go back to the example from the previous section. If the rancher and the farmer can’t negotiate then the legal rule matters. The legal rule favoring the rancher led to the farmer building the fence, which is the efficient outcome. But the legal rule favoring the farmer led to the rancher building the fence, which is not the efficient outcome, if the two were unable to negotiate with each other.
How high is too high for transactions costs? The negotiation creates a $25 surplus in the latter case. Transactions costs (e.g. legal fees for fashioning an agreement) in excess of $25 would mean that the negotiation isn’t worth it. Transactions costs that exceed the surplus from cooperative negotiations will prevent bargaining from taking place.
To summarize one more time – When transactions costs are zero, private bargaining will always
result in an efficient use of resources, no matter what the legal rule is. But when transactions costs are high enough to prevent bargaining, then an efficient use of resources may depend on the legal rule.
This leads to two different schools of thought about how the legal system should ideally operate.
• Coasian legal theory – The primary goal of the legal system should be to make private bargaining as easy as possible.
Coasian legal theory emphasizes that private negotiation always leads to an efficient solution as long as bargaining is easy. By contrast, Hobbesian legal theory assumes that bargaining may, in fact, be costly, and thus stresses the importance of getting the initial decision right so that efficiency doesn’t potentially rely on more negotiations.
For our example, a Coasian scholar would say that the system should be set up in a way that minimizes transactions costs and makes it easy for the farmer and the rancher to negotiate on their own; he wouldn’t be concerned about the initial decision. A Hobbesian scholar would emphasize that the court should do the work to uncover the efficient solution, and should rule in favor of the rancher; he would recognize that negotiation might not be easy, and that negotiation isn’t needed if the initial decision leads to an efficient outcome in the first place.
Which should be our priority? The choice between these two competing theories is essentially about a choice between information costs – how easy it is for the court to get the information to make efficient decisions, versus transactions costs – how easy it is for the parties to negotiate with each other.
• If Information costs > Transactions costs, then Coasian reasoning makes more sense. The court should just make a simple decision quickly, not worry about whether it leads to an efficient solution, and then let the parties bargain privately.
• If Transactions costs > Information costs, then Hobbesian reasoning makes more sense. The court should seek out the efficient solution and render a judgment that implements this solution. Private bargaining to “undo” inefficient rulings is too expensive.
What are transactions costs?
What, exactly, are these sinister transactions costs that get in the way of bargaining to reach an efficient solution? We usually sort them into two categories.
1. Bargaining costs are the costs associated with coming to an agreement
2. Enforcement costs are the costs associated with monitoring performance and punishing violations
Here are a few examples of things that tend to create high bargaining costs.
• Bargaining costs are high when the parties are hostile towards each other. For example, a divorcing couple may have trouble coming to cooperative agreements, even efficient ones. • Bargaining costs are high when the number of parties involved is very large.
perhaps the farmer in the example above can fence in his property at extremely low cost. He might not want to tell the rancher this right away because he’s “tipping his hand” by telling the rancher that it wouldn’t cost him much to solve the problem. He might want to let the rancher believe that his cost of building the fence is high, to force the rancher to pay him more money. Bargaining is easier when all information is public and known.
Overall, bargaining works best when information about outside options and the cooperative solution is public and common to both parties. It’s much easier to make deals when everyone is starting with the same information.
There is one critical implication of this principle for the law. Property law should favor criteria that are clear and simple in order to keep bargaining costs as low as possible. Economists vastly prefer simple, obvious rules that are easy to litigate (even if they seem “unfair”) because they facilitate bargaining. Again, bargaining works best when everyone knows where we’re starting.
The second piece is enforcement of bargains that are reached. Here are a few examples of things that tend to create high enforcement costs.
• Enforcement costs are high for complex transactions that involve many elements. • Enforcement costs are high for transactions that will take a long time to satisfy.
• Enforcement costs are high when extensive monitoring is required to determine whether obligations are satisfied.
• Enforcement costs are high when it is costly to punish violations if they do occur.
If parties anticipate high enforcement costs upon a bargain being struck, cooperative agreements become more and more costly to fashion.
Question: Indoor smoking laws are a property rights issue – the right to smoke versus the right to breathe
clean air. Using Coasian reasoning, explain why it makes sense for the government to ban smoking in public areas (e.g. shopping malls) but not in private residences.
Answer: Bargaining costs are too high to assume that parties will reach an efficient solution on their own
in the case of smoking in public areas, mainly because the number of people involved is so large. A Hobbesian solution makes more sense here. By contrast, in a private residence, the residents will probably be able to talk it out and fashion the most efficient solution. A Coasian solution makes more sense here.
Question: Paul claims that his neighbor Al is taking too much water out of an underground well that runs
under both of their properties. Do you see any barriers to Paul and Al negotiating privately?
Answer: Enforcement could be an issue. Even if Paul and Al make an agreement about water usage, the
fact that the well is underground might make it difficult to monitor for compliance.
Remedies
What are the legal remedies when someone violates your property rights? They come in two forms.
• Compensatory – A monetary award for losses sustained (referred to as legal damages by lawyers)
• Injunction – Ordering the defendant to do something or not to do something (referred to as equitable relief by lawyers)
Basically, compensatory damages are backwards-looking and compensate for past harm. Injunctions are forward-looking and prevent future harm.
It’s important to note that an injunction does not necessarily prevent the act completely, but it prevents the act without the consent of the plaintiff. In other words, injunctions do not prevent future negotiation. If a judge orders me to get rid of my dog because it bothers my neighbor, I can still keep the dog, but only as long as the neighbor agrees.
How can we compare the efficiency of injunctions and damages? Let’s examine another farmer/rancher problem, with some different numbers.
A cattle rancher lives next to a farmer and his cows sometimes damage the farmer’s corn. The rancher’s profit is $300. The farmer’s profit is also $300, but damage from the cows reduces his profit by $100. The rancher could build a fence around his ranch for $125 that would prevent his cows from damaging the farmer’s crop. The farmer could build a fence around his farm for $75 that would also prevent any damage from occurring.
Again, the efficient solution is for the farmer to build a fence. In this problem, we will consider the effect of three different legal rules.
1. The rancher can do whatever he wants
2. The rancher is ordered to build a fence (injunction)
3. The rancher has to pay damages if his cattle stray onto the farmer’s property (damages)
Let’s first think about the outcome without negotiation
No relief
The farmer will build a fence because a $75 fence is cheaper than suffering damages.
Π𝑓𝑓𝑓𝑓𝑓𝑓𝑓𝑓𝑓𝑓𝑓𝑓= 300−75 = 225
Π𝑓𝑓𝑓𝑓𝑟𝑟𝑟𝑟ℎ𝑓𝑓𝑓𝑓= 300
Injunction
The rancher is forced to build the fence.
Π𝑓𝑓𝑓𝑓𝑓𝑓𝑓𝑓𝑓𝑓𝑓𝑓= 300
Π𝑓𝑓𝑓𝑓𝑟𝑟𝑟𝑟ℎ𝑓𝑓𝑓𝑓= 300−125 = 175
Damages
The rancher will pay the farmer’s $100 damages rather than spending $125 for a fence.
Π𝑓𝑓𝑓𝑓𝑓𝑓𝑓𝑓𝑓𝑓𝑓𝑓= 300−100 + 100 = 300
Π𝑓𝑓𝑓𝑓𝑟𝑟𝑟𝑟ℎ𝑓𝑓𝑓𝑓= 300−100 = 200
Clearly, there is a surplus from cooperatively negotiating a solution under either the injunction or damages.
• Injunction: Total profit is $525 when the farmer builds the fence, but only $475 with the injunction. There is a $50 surplus from coming to a deal where the farmer builds the fence. The $50 comes from the farmer building the fence ($75) versus the rancher building it ($125).
With this in mind, let us find the reasonable solution. Remember that the reasonable solution provides each party with the profit he started with plus half of the surplus. The reasonable solution has to be a better deal for both parties – the profits have to be at least the profits when there is no negotiation (the threat
values) and sweeten the deal with some of the surplus. Here is the outcome with easy negotiation.
No relief
Nothing else happens – The farmer builds the fence.
Π𝑓𝑓𝑓𝑓𝑓𝑓𝑓𝑓𝑓𝑓𝑓𝑓= 300−50 = 250
Π𝑓𝑓𝑓𝑓𝑟𝑟𝑟𝑟ℎ𝑓𝑓𝑓𝑓= 300
Injunction
The rancher pays the farmer $100 to build a fence. This compensates the farmer for the fence construction and gives him half the surplus
Π𝑓𝑓𝑓𝑓𝑓𝑓𝑓𝑓𝑓𝑓𝑓𝑓= 300−75 + 100 = 325
Π𝑓𝑓𝑓𝑓𝑟𝑟𝑟𝑟ℎ𝑓𝑓𝑓𝑓= 300−100 = 200
Damages
The rancher pays the farmer $87.50 to build a fence. This compensates the farmer for the fence construction and gives him half the surplus.
Π𝑓𝑓𝑓𝑓𝑓𝑓𝑓𝑓𝑓𝑓𝑓𝑓= 300−75 + 87.50 = 312.50
Π𝑓𝑓𝑓𝑓𝑟𝑟𝑟𝑟ℎ𝑓𝑓𝑓𝑓= 300−87.50 = 212.50
This example illustrates several important principles.
1. If there are no transactions costs and parties can easily negotiate, then damages and injunctions both produce efficient outcomes. This is just an application of the Coase Theorem.
2. However, even with easy negotiation, there is a distributional difference. The plaintiff (farmer) prefers the injunction because it gives him more leverage; his payoff is $325 instead of $312.50. The defendant (rancher) prefers the damages because it gives him more options – build the fence to prevent damages from occurring or pay for the damages. 3. If transactions costs prevent bargaining, then damages are a more efficient remedy than
injunctions. The plaintiff (farmer) is the same either way – he’s either not damaged or is being compensated fully for the damages. But the defendant (rancher) has more options with damages – with an injunction he has to build a fence, but with a damages remedy he can choose to build the fence or can choose just to pay the damages.
Overall, the Coase Theorem says that any legal rule is equally efficient if parties can easily negotiate. As usual, there may be a distributional difference – plaintiffs prefer injunctions whereas defendants prefer the option to pay damages.
However, if bargaining is not possible, then the legal rule can impact the efficiency of the outcome. In this case, damages are a more efficient remedy than injunctions. The plaintiff is the same either way, but the defendant has more options with damages than with injunctions.
There are some clear normative implications for the structure of the law. Clearly, when there are high transactions costs, the damages remedy is preferred because it leads to more efficient outcomes.
straightforward starting point for bargaining. If the court issues an injunction, the starting point for the negotiations is that the rancher is going to have to build the fence, period. If the rancher has the option to pay damages, there might be some disagreement about the amount of damages or parties might try to conceal the truth. Bargaining is easier with a clear, simple starting point. Summarizing, when there are no (or low) transactions costs, an injunction is the preferred remedy because it provides a cleaner starting point for bargaining.
This principle is consistent with the law in many respect. For small numbers of property owners, courts normally order injunctive relief – this makes sense, because bargaining is easier when the number of parties involved is small. For disputes with a large number of people, like air pollution, the remedy is typically damages. Again, this makes sense because bargaining is likely difficult in these cases, and so damages is the more efficient remedy.
Public Goods
Having covered the basic theory of property law, we turn now to some special areas of property law that create thorny economic issues. The first is public goods.
Remember that a public good is nonrival (it costs nothing for an additional person to use it) and nonexcludable (no practical way to exclude non-payers from using it). Public goods create a special problem for establishing property rights. The big problem is that the nonexcludability property means that it is difficult or prohibitively costly to enforce private property rights. For example, a company cannot go into business to clean the air and possess property rights over the service – there’s no way to charge people for breathing clean air.
Now, efficiency in property law means that property should be allocated to individuals who place the highest value on it. Thus, private goods should be privately owned – clear and simple property rights make exchanges and bargaining easy. It is fairly straightforward in the market for apples that the price system will allocate apples from farmers to the consumers who value them the most.
As a result, economists have traditionally said that private ownership is preferred when it is feasible. The benefits of public ownership always have to be balanced against the drawbacks. It’s only worth considering this option when private ownership is clearly infeasible.
Question: Some US states lease areas of the sea to various harvesters for oyster harvesting. Other states
maintain open access. Which do you think is more efficient?
Answer: Oyster harvesting is totally separable, with no real public goods problem. As a result, private
property rights make more sense. Evidence suggests that this is correct. Harvesting income is about 50% higher in states with private ownership / leasing versus open access.
Question: The land in Iceland is very mountainous. Most villages are small and scattered, and the people
living in them have common interests. What does this imply about ownership of land?
Answer: Public ownership probably makes sense. The fact that the land is mountainous means that
separating and fencing the land is prohibitively costly; private property rights are hard to establish. Collective decision-making is easy in Iceland, as well, since the number of people in each village is small and the villagers have common interests.
Note that there is no US parallel. We have lots of land, easily fenced in, and many potential users with competing interests. Market allocation makes more sense.
Externalities
In using property rights as a framework to understand externalities, economists usually distinguish between private externalities and public externalities. Private externalities involve only a few people suffering (e.g. a dog barking). Public externalities involve many people who suffer (e.g. air pollution from a factory).
How should the law address private and public externalities? Let’s apply the theory we developed earlier on optimal remedies.
• For private externalities, private negotiation can work well. Our theory on optimal remedies says that injunctions are the better legal solution here. They’re simple – no need to compute any damages – and the parties can use this as a starting point to negotiate an efficient solution.
• For public externalities, negotiation can be difficult. Our theory on optimal remedies says that damages are the better legal solution here. Because bargaining is difficult, an inefficient injunctive order could be very costly and hard to bargain away. It’s better to give the defendant the option to pay damages.
one-time award that compensates the plaintiff for all future damages. Upon an award of permanent damages, the plaintiff can never pursue any further legal action.1
We can outline some advantages and disadvantages of each.
• Temporary damages encourage the defendant to stop injuring the plaintiff in the future, so that he won’t get sued anymore. On the other hand, there is a high transaction cost of continuing to come back to court.
• Permanent damages involve low litigation costs because the damages are awarded on a one-time basis. On the other hand, they provide no incentive for the defendant to stop injuring the plaintiff, even if the defendant has an easy way to do so.
Thus, temporary damages are better in situations where there is rapid innovation – the defendant has an incentive to cease the externality so that he won’t get sued for damages anymore. Permanent damages are better in the case where there is no foreseeable way to abate the externality and where continuing to come to court is expensive.
Question: Sara owns a shoe factory with noisy machines. The noise from the machines disturbs her
neighbor George. The factory’s profit is $100,000. Sara could run the factory silently, but it would be much more costly and her profit would fall to $40,000. George’s happiness from living in his house is $30,000, but it falls to $20,000 if he has to endure the noise from Sara’s factory.
a. What is the efficient outcome – for the factory to shut down, to run silently or to run loudly? b. Suppose that George is granted an injunction to stop the factory from making noise.
i. What are the threat value payoffs if there is no negotiation? ii. What is the surplus from cooperative negotiations? iii. Describe what happens in the reasonable solution.
iv. What are the payoffs to each party in the reasonable solution?
c. Suppose instead that Sara is required to pay George’s damages if she wants to make noise.
i. What are the threat value payoffs if there is no negotiation? ii. What is the surplus from cooperative negotiations? iii. Describe what happens in the reasonable solution.
iv. What are the payoffs to each party in the reasonable solution?
d. What does the Coase theorem say about the two remedies when there are no transactions costs? e. Which remedy is more efficient when transactions costs are high and bargaining is impossible? f. Suppose that transactions costs are too high to allow bargaining. As time goes on and technology
improves, the problem can be cheaply solved either by Sara buying quieter machines or by George soundproofing his house.
i. Which solution is more likely if the judge awards permanent damages? ii. Which solution is more likely if the judge awards temporary damages?
1 Typically, permanent damages are even a “servitude on the land”, meaning that they are attached to the property
Answer:
a. The efficient solution is for the factory to run loudly. The noisy machines create a $60,000 benefit for Sara but impose a cost of only $10,000 on George.
b. Injunction
i. Sara is forced to run the machines quietly – Π𝑠𝑠𝑓𝑓𝑓𝑓𝑓𝑓= 40,000 and Π𝑔𝑔𝑓𝑓𝑔𝑔𝑓𝑓𝑔𝑔𝑓𝑓= 30,000 ii. $50,000 – Running quietly costs Sara $60,000 but only benefits George by $10,000. iii. Sara pays George $35,000 to agree to let her run the machines loudly. This compensates
George for his $10,000 costs plus gives him half the surplus.
iv. Π𝑠𝑠𝑓𝑓𝑓𝑓𝑓𝑓= 100,000−35,000 = 65,000 and Π𝑔𝑔𝑓𝑓𝑔𝑔𝑓𝑓𝑔𝑔𝑓𝑓= 20,000 + 35,000 = 55,000. Notice that both parties are $25,000 better off than they were with no deal.
c. Damages
i. Sara simply pays George’s $10,000 damages – Π𝑠𝑠𝑓𝑓𝑓𝑓𝑓𝑓= 100,000−10,000 = 90,000 and Π𝑔𝑔𝑓𝑓𝑔𝑔𝑓𝑓𝑔𝑔𝑓𝑓= 20,000 + 10,000 = 30,000
ii. Nothing – This is already the efficient solution. iii. No additional negotiations.
iv. Π𝑠𝑠𝑓𝑓𝑓𝑓𝑓𝑓= 90,000 and Π𝑔𝑔𝑓𝑓𝑔𝑔𝑓𝑓𝑔𝑔𝑓𝑓= 30,000
d. According to the Coase Theorem, all legal rules are equally efficient when there are no transactions costs are bargaining is easy.
e. Damages are more efficient when there are transactions costs. The injunction forces Sara to inefficiently run quiet machines if she and George cannot negotiate.
f. Temporary and permanent damages.
i. George is more likely to soundproof his house if the judge uses permanent damages. George can’t take Sara to court again, so he has to soundproof is house if he doesn’t want to hear the noise anymore.
ii. Sara is more likely to buy quieter machines if the judge uses temporary damages. Sara will want to avoid continuing to pay damages if she can solve the problem cheaply.
Fugitive Property
Fugitive property involves things like animals or natural gas deposits that do not obey clear spatial boundaries (unlike land or houses). There are two basic principles of ownership that the law can use for fugitive property.
• First possession – Fugitive property belongs to whoever is the first to control it. • Tied ownership – Ownership of fugitive property is somehow tied to settled property.
Which rule is better? It turns out that there are advantages and disadvantages to both in terms of efficient allocation of resources.
The disadvantage of first possession rules is that they create an incentive to over-invest early on just to become the first owner of something. For example, frontiersmen in the US would often put fake houses on land that they did not need in order to stake an ownership claim – just to make sure that they got the property before someone else did. This is clearly a waste of resources, especially if someone else could have used the property productively. Another example is sleeper patents. Companies sometimes buy up patents that they have no use for and for which they have no plan to develop or license any product simply to make sure that they grab it before someone else does. In economic language, first possession rules create incentives to use resources for transfer of property rather than for productive purposes. This is an inefficient waste of resources.
By contrast, tied ownership links ownership of fugitive property to settled property. Under the Common Law principle of accession, a new thing is owned by the owner of the most proximate property. For example, a newborn calf belongs to the mother of a cow. As another more recent example, the owner of a trademarked brand name has a right to use this name for an Internet domain name.
Tied ownership prevents the over-investment problem. The big problem is that the claim to the tied resource itself may not be settled, so tied ownership can be difficult to litigate. As an example, natural gas deposits are theoretically owned by whoever owns the surface land. But the way natural gas is dispersed underground makes it difficult to figure out whose property it lies under.
In summary, there is no simple answer about which rule is better. First possession is easy to administer but it provides incentives for wasteful use of resources for transfer. Tied ownership removes these incentives but can be unclear and more difficult to administer.
Collective Property
Collective property implicitly applies the principle of first possession. For example, fish in an ocean are owned by whoever catches them first. Public grazing lands are grazed by whichever rancher brings his cattle there first.
Our analysis above would predict overuse and overdepletion –each person races to become the first possessor of the property before anyone else can get it. This is exactly the tragedy of the commons – the problem of overdepletion of common resources, which has been known to economists for a long time. Law and economics gives us a different framework to understand it.
Open access is better when congestion is not a problem and when boundary maintenance would be expensive. Land in the American West in the early 1800’s was essentially open access. Privatizing makes sense when congestion is high and when it is easy to maintain boundaries. American history scholars have said for a long time that the invention of barbed wire was a turning point in US history, for exactly this reason – a cheap way to create boundaries and privatize land ownership.
Question: Traditional riparian rights (old law) specified that owners of land containing flowing bodies of
water were not allowed to use the water in a way that reduced flow downstream. Under today’s law, the owner can use as much water as he wants as long as nobody downstream is using it. Assume that transaction costs are zero.
a. What does the Coase Theorem say about the importance of how initial property rights are assigned to the efficiency of the outcome?
b. Is the difference between the old law and the new law purely a matter of how to assign initial property rights, or is there more than that?
c. Does the law appear to be moving in the direction of greater efficiency?
Answer:
a. According to the Coase Theorem, as long as negotiation is easy, the final outcome is efficient regardless of the initial assignment of property rights.
b. No – The problem here is more than simply the initial assignment of property rights. The resource (intensive use of the water) is actually unavailable under the old law.
c. Yes – The Coase Theorem says that property is allocated efficiently when parties have the opportunity to bargain over its use.
Stolen Property
Anna owns a lamp. Bob steals it from her and sells it to Cassie. Cassie did not know that the lamp was stolen when she bought it.2 Who owns the lamp?
• Under US Common Law, Anna gets the lamp back. Good luck to Cassie trying to recover damages from Bob.
• Under English Common Law, Cassie can keep the lamp as long as she acted “in good faith.” Good luck to Anna trying to recover damages from Bob.
Which law is better? Again, there is a tradeoff and no simple answer.
The US system passes the risk to buyers and encourages buyers to verify ownership. If verifying ownership is cheap and protecting property is difficult, then the US system is better.
2 If Cassie knew about it, she would be a conspirator in a crime, which is a different issue. The law sometimes requires
The English system passes the risk to owners and encourages owners to protect their property from theft. If protecting property is cheap but verifying ownership is difficult for buyers, then the English system is better.
Adverse Possession
Anna builds a house that encroaches a small amount on Bob’s land. For 10 years, Bob does not complain about the encroachment. Under the Common Law principle of adverse possession, Anna becomes the owner of the property as long as:
1. The possession is obvious.
2. The possession is adverse to the owner.3 3. The owner does not contest for some period.4
Adverse possession has been around for a long time and is a pillar of property law in many countries. Why does it make sense? Two big reasons.
• Adverse possession makes transferring property easier. When you buy a piece of land, you only have to look back ten years to make sure that the title is legitimate. Imagine if someone from a century ago could resurrect a claim. It would be nearly impossible to ever trade property.
• Adverse possession prevents resources from being left idle for a long time. If an owner is doing nothing with his property and someone else comes to use it without the owner even noticing, then obviously it’s more efficient for the user of the property to control it.
The main disadvantage of adverse possession rules is that they force owners to expend resources monitoring their property for trespass and ejecting trespassers.
Question: The time required in Common Law to invoke an adverse possession is 10 years. Consider the
two legal rules below. Which do you prefer on efficiency grounds?
• Discontinuous rule: Before 10 years, trespassers have no rights to the property. After 10 years elapses, all of the property rights transfer to the trespasser.
• Continuous rule: The property rights are lost gradually over time. For example, after 1 year the trespassers owns 10% of the property, after two years he owns 20%, etc…
Answer: The discontinuous rule is better because it’s simple and easy to litigate. We like simple because
it makes property rights clear and provides a good starting point for bargaining.
3 The possession does indeed have to be adverse. You can’t do someone a favor (e.g. help him landscape his property)
and then claim that you own the property.
4 Some people have suggested that this is a main reason for the persistence of the Israeli – Palestinian conflict.
Registration and Transfers
Public registration of property ownership reduces transactions costs significantly because certainty about ownership makes it much easier to buy and sell property. On the downside, there are costs associated with maintaining these registries.
As a result, most countries typically maintain registries only for high-value property like cars and land. While a registration system for lower-valued property would reduce transactions costs, the cost of maintaining the system is too high to justify the benefit.
Lost Property
Estray property is abandoned or lost. Who owns estray property? Under Common Law, a finder of lost property is required to follow reasonable procedures to locate its owner.5 If the owner is not located in a reasonable amount of time, then finders keepers – the person who found it becomes the owner.
Estray provisions have been enshrined in Common Law for a long time. They enhance efficiency for a few reasons.
• Estray provisions discourage theft. A thief cannot claim that he acquired property by finding it.
• Estray provisions establish a clear chain of ownership. The lost property can subsequently be transferred to the most efficient owner without any question about legal ownership. • Estray provisions provide an incentive for owners to monitor their property.
• Estray provisions increase public dissemination of information, since the finder is required to follow procedures to locate the owner, which reduces search costs.
Bequests and Inheritances
Should property owners be able to restrict what happens to their property after they die? For example, can I leave my property to my son in my will but stipulate that it can never be used for commercial purposes? There are tradeoffs associated with either rule.
Why not allow these restrictions? Because it can lead to property being used in inefficient ways. Current owners surely know more about efficient use of their property than prior owners. Restricting the use of property because of someone’s decision generations ago might prevent the property from being used in the most efficient way today.
That being the case, are there any arguments in favor of allowing such restrictions? One concern is circumvention costs. Owners, while they are alive, might waste resources trying to control what happens to their property after they die if they are not allowed to easily make restrictions in their wills. Another concern is depletion costs. Owners, while they are alive, might inefficiently deplete their property while alive in order to prevent it from being used in ways they don’t like after they die.
Where does Common Law stand on the issue? Halfway, it turns out. Property owners can restrict bequested or gifted properties for one generation after they die, but no longer than this. The logic is that an owner might want to protect his property against one foolish heir, but there probably won’t be a succession of multiple fools.
Private Necessity
In general, you may not use someone else’s property without permission. However, Common Law allows for an exception in the case of private necessity. In an emergency, you can legally use someone’s property as long as you compensate him for it later on. Think about a lost hiker becoming ill after a pharmacy is closed or a boater who needs to secure his boat to a private dock when there is a storm imminent.
What’s the logic for this exception? Remember, we’re looking for efficiency-oriented explanations. In an emergency, it’s difficult to bargain over efficient use of resources. In other words, the dock owner would almost surely agree to the use of his property in the case of the boater’s emergency. The benefits are surely greater than the costs, meaning that they would theoretically be able to strike a deal. The problem is that, in an emergency, there is no time for this negotiation to actually take place. Thus, it enhances efficiency to carve out an exception and let the boat owner use the private dock in high-value emergency cases.
Inalienability
If something is inalienable, then it can’t be legally transacted in certain ways. Organs and sex are inalienable by sale. Votes in an election are inalienable by gift or by sale. Human rights are inalienable by any means. Inalienability is the ultimate restriction on property rights. It prevents a transfer altogether.
correlated with health. As another example, anthropologists claim that markets have destroyed traditional gift-giving and charity in tribal economies.
Nevertheless, the argument that outlawing a mutually beneficial trade cannot – by definition – enhance efficiency is rather convincing. Ultimately, the most convincing arguments for inalienability are moral, not economic.
Unbundling of Property Rights
An owner owns rights A and B over his property. He wants to sell A but retain B. For example, he might want to sell his land but preserve his ownership of the mineral rights. Should property law allow such unbundling?
The advantage of unbundling is that property might have higher value if different people are the efficient owners of different pieces of the property rights. For example, a piece of land might be more productive if a farmer owns the surface land but an engineer controls the mineral deposits – an arrangement that is impossible if property rights must be bundled.
The disadvantage of unbundling is that it makes commerce difficult. Uniformity makes commerce easier. If property rights are required to be bundled, then any person purchasing land has the same rights associated with the land. If unbundling is allowed, you have to be careful when you purchase a piece of land that someone else might own some of the rights.
Overall, economists tend to support unbundling because of the potential for efficiency improvements as long as we make sure there is a clear way for buyers to understand what they are buying.
How does the law deal with this issue? Common Law tends to allow unbundling, at least for some fixed period of time. Civil law tends not to allow unbundling – there is a set of rights that are attached to the property, not to the person. Anyone who owns property has the same rights.
Taxation and Redistribution
A central, though controversial, function of government has traditionally been to redistribute wealth.6 Economists sharply disagree about the extent to which the government should redistribute wealth. However, economists do agree that taxation is a far more efficient way to redistribute wealth than shuffling around property rights. Astoundingly, lawyers still have not accepted this proposition and regularly make property rights arguments based on fairness / distribution rather than based on efficiency.
There are a number of problems with using property rights as a mechanism for redistributing wealth.
1. If courts favor poor people in their decisions for fairness reasons, people might avoid doing business with the poor at all. For example, who would sell a house to a poor person if the government is going to favor the poor person in disputes for fairness reasons?
2. Property rights can only target overall averages, whereas taxation is specific to each individual. For example, imagine that ranchers tend to be richer than farmers, and so courts start favoring farmers over ranchers for fairness reasons. Well, there are surely some rich farmers and some poor ranchers.
3. Reshuffling property rights can bring unintended consequences. For example, favoring tenants over landlords will surely increase rents.
4. Most importantly, bad property law encourages inefficient use of resources. Favoring farmers over ranchers encourages moving resources into farming, which is a distortion of the efficient market outcome.
Overall, it does not make economic sense to move economic resources to a less productive use in order to help the poor. It’s better to leave resources in their most productive use (determined by the market), tax the rich owners of the resources, and use the money to help the poor directly.7
Takings
A taking occurs when the state seizes private property for some social project. The principle is known as eminent domain in Common Law.
The social loss from eminent domain is obvious – it reduces the certainty of property rights, which makes negotiations more difficult and potentially reduces efficiency. The argument in favor of eminent domain is that it may be the only feasible way to produce certain public goods.
6 Many people have a knee-jerk reaction against “redistributing wealth”, but virtually every government program has
some redistributive aspect. Taxing to build roads and schools “redistributes” wealth from non-users of roads and schools towards users.
7 A profound example of this kind of inefficiency is Venezuela. The government there has been transferring land from
Economists almost always prefer voluntary transfer to takings when it is possible, but the economic rationale for eminent domain is to prevent the holdout problem. If property from many people is required to complete some high-value project, like building a road, the last person whose property is needed could demand an outrageous sum of money, knowing that the project can’t be completed without his property. In economic language, we would say that the transactions costs are very high for negotiating with such a person because he is trying to use his private information to game the system. Economists support takings only when the transactions costs are so high as to make it impossible to purchase the property with the agreement of the owner.
How does the law deal with this issue? A few centuries ago, Common Law allowed for takings and did not even require compensation for the property owner. This is clearly an inefficient way to finance the government because it interferes with private property rights. Nowadays, the government is required to compensate property owners for takings at fair market value. It’s even in the fifth amendment to the US constitution.
An alternative to takings is regulation, where the government does not take ownership of the property but instead restricts its use, e.g. for environmental reasons. Under Common Law, governments are not generally required to compensate owners for regulations. This lack of compensation creates the danger that governments might overuse regulation because takings require compensation to property owners but regulations do not.
Zoning Laws
A particular kind of regulation is zoning laws, which specify the type of establishment that can be built at a particular location.
Case Study
The text below is from a court decision in the case Boomer v. Atlantic Cement Co. It contains excerpts both from the majority opinion and a dissenting opinion.8 Read the opinions and answer the following questions.
a. Is the externality in this case public or private?
b. Suppose the court grants an injunction against any further pollution. Would you expect transactions costs from bargaining over the injunction to be low or high?
c. Explain the remedy given by the majority and summarize the economics behind the majority’s argument that this is the proper remedy.
d. What objection to the remedy is raised in the dissent?
e. Do you agree with the dissenting opinion that the firm’s benefits should not be weighed against the neighbors’ costs because these benefits are private to the firm?
f. Contrast the difference between temporary and permanent damages on the incentives of people to build new houses near the cement factory. Be sure to consider the fact that the damages are permanent and a servitude on the land.
Majority Opinion (Bergan, J.)
The defendant operates a large cement plant near Albany. These are actions for injunction and damages by neighboring land owners alleging injury to property from dirt, smoke and vibration emanating from the plant.
At the trial court and on appeal, the defendant’s cement-making operations were found to be a nuisance to the plaintiff neighbors. Temporary damages were awarded, but an injunction against future dirt, smoke and vibration from the plant was denied. Plaintiffs have brought this appeal in order to receive the traditional remedy against a nuisance – an injunction.
The trial court’s grounds for the denial of injunction is a large disparity in economic consequences of the nuisance and of the injunction.9 This theory,
however, cannot be sustained without overruling a doctrine which has been consistently reaffirmed in several leading cases in this court: where a nuisance has been found and where there has been any substantial damage shown by the party complaining, an injunction will be granted. The rule in New York has been such that an injunction will be issued against a nuisance even if a marked disparity be shown in the economic consequences between the effect of the injunction and the effect of the nuisance.
The trial court also found the amount of permanent damage attributable to each plaintiff, for the guidance of the parties in the event both sides agreed to the payment and acceptance of permanent damages as a settlement of all the
8 When a panel of judges makes a decision, the majority opinion controls the ruling. Judges who disagree with the
majority opinion can issue dissenting opinions that explain their reasoning.
controversies among the parties. The total of permanent damages to all plaintiffs was found to be $185,000.
The trial court’s result is a departure from a rule that has become settled; but to follow the rule literally would be to close down the plant at once. The court is fully agreed to avoid that drastic remedy; the difference in view is how best to avoid it.
If the injunction were to be granted, and unless the nuisance were abated by improved techniques in a short time, there would inevitably be applications to the court for extensions of time to find such techniques.
Moreover, techniques to eliminate dust and other annoying by-products of cement making are unlikely to be developed by any research the defendant can undertake within any short period, but will depend on the cement industry throughout the world. For obvious reasons, the date of this research is beyond the control of the defendant. If, at the end of 18 months, the industry has not found a solution, a court would again be hard-pressed to close down the cement plant completely.
On the other hand, to grant the injunction unless the defendant pays plaintiffs such permanent damages as may be fixed by the court seems to do justice between the contending parties. All of the attributions of economic loss to the properties on which the plaintiffs’ complaints are based will have been redressed.
It seems reasonable to think that the risk of being required to pay permanent damages to injured property owners by cement plant owners would itself be a reasonably effective spur to research for improved techniques to minimize nuisance. Thus, it seems fair to both sides to grant permanent damages to plaintiffs which will terminate this private litigation. The judgment, by imposing a servitude on the land, would preclude future recovery by plaintiffs.10
The case will be remitted to the Supreme Court of Albany County to grant an injunction which shall be vacated on payment by defendant of permanent damages.
Dissenting Opinion (Jasen, J.)
I agree with the majority that a reversal is required here, but I do not subscribe to the newly enunciated doctrine of assessment of permanent damages, in lieu of an injunction, where substantial property rights have been impaired by the creation of a nuisance.
I see grave danger in overruling our long-established rule of granting an injunction where a nuisance results in substantial continued damage. In permitting the injunction to be cancelled on payment of permanent damages, the
10 A servitude on the land is a perpetual restriction on a piece of property. The servitude “runs with the land”, meaning
majority is in effect licensing a continued wrong. It is the same as saying to the cement company that you may continue to do harm to your neighbors so long as you pay a fee for it. Furthermore, once such permanent damages are assessed and paid, the incentive to alleviate the wrong would be eliminated, thereby continuing air pollution without abatement.
It is true that some courts have sanctioned the remedy proposed by the majority in a number of cases, but none of these cases is analogous to the situation before us. In those cases, the courts, in denying an injunction and awarding money damages, grounded their decision on a showing that the use to which the property was intended to be put was primarily for public benefit. Here, on the other hand, it is clearly established that the cement company is creating a continuing nuisance primarily for its own private interest with no public benefit. The promotion of the interests of the polluting cement company has, in my opinion, no public use or benefit.
