Monday, June 29, 2009

Economic Analysis of Property Rights

Here’s an historical puzzle: slaves cannot own property, they are property. Yet slaves did, on occasion, buy their own freedom. How can someone not legally entitled to own anything assemble enough wealth to buy their own freedom?

Because there is a difference between property rights recognised by law and property rights in the sense of the ability to use or control something. If this was not so, there would be no point to theft.

The puzzle of slaves buying their own freedom is how Prof. Yoram Barzel (fulsome tribute here) introduces the reader to the Economic Analysis of Property Rights. (He expands on the economics of slavery later in the book.)

There is shift underway in economics from the analysis of decision-makers (firms, consumers, workers, etc) to the analysis of transactions and groups of transactions, based on Ronald Coase’s development of transaction cost analysis. Barzel’s work is very much part of that shift. Thus, for example, he has a nice critique of the production function analysis of firms (pp 66-67).

His book is a difficult read, partly because his language is somewhat technical (the book could do with a glossary) and partly because what he is trying to explain is a different way of looking at transactions, one that is comfortable with complexity. It is a sufficiently difficult, yet revealing, read that, having finished it, I immediately went back to the beginning and read it through again.
Barzel is very comfortable with the notion of agents as maximisers—provided we take into account all the constraints they are acting under. Consider cognition (not an example he uses). Simple concepts of humans-as-maximisers analyse behaviour as if every decision will be fully considered on every occasion—that is, cognition and information are costless. But they are not. Thinking takes time and effort, as does gathering information. So, given such constraints, genuine maximisers will use habits and routines, saving on time and effort.

Barzel’s first basic point is that the characteristics of the transaction are crucial to understanding how folk will behave. So, for example, as wages rise, workers will tend to move towards self-employment since they will be more able to cope with income variability (p.151). (I will discuss some applications of Barzel on transaction costs in my next post.)

Property rights

Barzel’s other basic point is that property rights are pervasive. Particularly if one realise the commodities are typically bundles of attributes that can be allocated in various ways. I was particularly taken with his analysis of insurance and warranties as methods of transferring ownership (pp 60-62). A fire insurer is someone paid to own the fire occurrence attribute of a building (which has negative value, hence the insurer has to be paid to own it). Insurance contracts make sense as ways of allocating attributes to those who are best able to efficiently deal with them. As do warranties. The manufacturer is the most efficient owner of, for example, the coolant-leak attribute of a fridge. Warranties assume ownership of such attributes with restrictions taking into account comparative risks to the parties and the likely behaviour of the other (similarly with insurance contracts).

Another striking Barzel example is property rights in wildlife (Pp145-7). In the UK, farms tend to be larger than habitats, so property rights to wildlife are largely held privately as habitats are largely encompassed within private holdings. In Canada and the US, farms tend to be smaller than habitats, so the state assumes much more control over wildlife, as habitats generally extend across several, or even many, holdings.

A central question with property rights is what rights are left in the public domain (and so often subject to wastage problems) and what are captured by private users. Such capture is not costless, so the more valuable the attribute and the easier rights are delineated, the more likely it is to be captured. The more attributes are allocated to their efficient owners, the more productive the social system is likely to be.

One of the general features of mainstream economics is that it typically has much more sophisticated analysis of public-private boundaries than what passes for such analysis in much of the (non-economic) Left. Barzel raises that sophistication to another level again. Thus, he explains how government-imposed restrictions can increase the value of an attribute against the presumption of many economists that all restrictions by government on property impede efficient allocation. For example, government restrictions on how water rights can be used in arid Western States of the US increases the value of the water rights held (Pp 118-121). But that is essentially an expansion on Barzel’s discussion of restrictions in contracts generally.

The application of Barzel’s analysis to prudential financial regulation seems likely to be fruitful, perhaps even urgent.

On restrictions increasing value, consider the difference between what Paul Krugman calls Zoned Zone, where land use is highly controlled, and Flatland where it is not. If official permission is required to use some plot of land for housing, then control of the attribute “suitable for housing” is shared between the landowner and an official. Clearly this, of itself, can only reduce the amount of land used for housing, it cannot increase it. Reducing supply raises prices, which makes incumbent housing more valuable, pleasing many voters; increases property and transaction taxes, increasing official revenue; and generates income for political parties from developers needing official access making donations. So officials have many reasons to be restrictive in approving housing construction. This creates a one-way bet in house values. Houses thereby become inflation-beating assets (which is by no means an automatic feature of them). Such apparent one-way bets in asset values being the classic basis of asset bubbles.

Barzel notes ironically that “command” economies were less able to keep air and water out of the public domain (i.e. region not controlled by anyone) than capitalist states, hence they were reduced to much lower value (i.e. suffered much worse pollution) than in capitalist states (p.135). But this is easily explained by applying his analysis.

Socialism pools attributes together. This is useful for the functional holder of the attributes—officials—as they are subject to much less restrictions and have much wider ambit of action thereby. (Barzel in his analysis rejects the notion that there is a nebulous “state” which acts, focusing instead on decision-makers. In his analysis, bureaucrats, like workers, have property rights—attributes they can control use of.) But socialism (in the sense of government ownership) pools together producing and regulating. So producers will clearly be subject to far less regulatory restraint and so capture far more of the public domain for their own benefit (e.g. pollute more thoroughly, produce lower quality goods, be less efficient in production, etc.). Though, as Barzel points out, they own (i.e. control) the public vocabulary, which helps obscure the effect (a phenomenon hardly unknown in Western society). Allocating the production and regulatory attributes to different bodies delineates rights much more clearly leading to public domain being less used for private purposes and hence better overall performance.

Barzel claims that, given constraints, all production is efficient (p.138): but efficient for the decision-makers, not necessarily for the wider society. The problem with socialism is precisely that its pooling of attributes impedes their efficient allocation for the wider society.

Barzel has a particularly striking analysis of equity capital (pp80-84). Equity capital is analysed as “guarantee capital”, providing the final guarantee for variability in income (since it is the owner who covers any shortfall in revenue: up to the point of the firm going bankrupt). A firm is defined by the scope of its equity guarantees. Since there is no definitive answer to which transactions will be market/priced and will be non-market/“in house" due to the variable circumstances of specific transactions, Barzel holds that it is better to concentrate on forms of organisations and allocation of attributes.

Taking that point further, government ownership makes taxpayers the residual claimants (the guarantors of income variability). But their ability to control the relevant attributes is extremely tenuous, as Victorian and South Australian taxpayers found to their cost with the Tricontinental, VEDC and State Bank of South Australia debacles. Hence it is generally better than such attributes be allocated to private shareholders with greater control (such as being able to exit by selling). Though Murray Horn’s analysis does suggest that—in cases where officials just cannot stop meddling—it might be better for the taxpayer’s to assume the ownership rather than forcing the costs thereof on private shareholders. (Telstra™ shareholders may have a view on this.)

To take another example of applying Barzel’s analytical structure, consider the tendency of large corporations to pay higher wages and salaries than small businesses. Large corporations are less able to determine attributes of workers and monitor their direct contribution to output than small businesses. They are also better able to absorb the risk of error and variability in attribution. Paying workers more means the workers have more to risk from loss of position, so are more self-policing than they would otherwise be. (Of course, on the imbalance-of-power analysis of exchange relations, corporations should typically pay less than smaller businesses, just as large supermarkets should price higher than corner shops. Which is clearly contradicted by how things actually work.)

Barzel is seeking to create a structure of analysis that can cope usefully with a complex world. It is one that seeks to focus careful attention on the actual characteristics of transactions, commodities, attributes and so forth. He is particularly interested in criticising economic analyses that either assume costless transactions (the simple Walrasian model, though he acknowledges its power in dealing with many aspects of capitalist economies) or which fail to specify where the costs of transactions lie.

But, as I will discuss further in my next post, Barzel’s analysis is even more powerful in undermining other forms of simplicity in analysis. Particularly policy preferences that have much less to do with the characteristics of the problems they are alleged solutions to and much more to do with the typical characteristics of the advocates (providers of easily or already politicised intellectual capital). Hence, whatever the purpose—helping workers, the poor, third world development, indigenous development or environmental protection—the solution advocated by the possessors of such capital is typically versions of the same—the government should do it since that maximises the ambit of action of such intellectual capital (and its status).

Which has not proved to be a notably successful path. Consider third world development. Typically, the most corrupt, exploitative and disfunctional element in developing countries is the state. Indeed, that is the largest single reason why they are poor countries. So, naturally, the advice has been that the state should do a whole lot more—and hasn’t that worked well? Systems which permit much more efficient allocation of attributes have worked much better in achieving increases in prosperity. But such systems do not give any particular premium to such forms of intellectual capital. Barzel’s approach of accepting a complex world and trying to carefully understand that while presuming folk are folk (that is, officials are people too, not magical purveyors of public purposes) is much more useful.

Barzel manages to cover a wide range of phenomenon, with many engaging examples which provoke one to extend his analysis to new examples. It is a powerful and striking structure of analysis.


  1. Oooh, an analysis of ownership in animals! I think I need to read this book.

  2. Yes you do. For the analysis of warranties and insurance contracts alone.

  3. This is such a great post.

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