Property Rights

Mad Props 

Property rights are one of the fundamental concepts of economics.  The notion of private and public ownership is the very heart of the difference between capitalism and communism.  Posterity has shown that with the collapse of Soviet Union is that the former system is more sustainable than the latter.  Why is that?  

The idea of central planning is endemic to the communist form of government.   This means the government is inherently better informed to distribute the resources of the state.  To anyone with a hint of skepticism about them, this sounds ludicrous.  That’s because it is.

The field of knowledge management is relatively young, dating back only as far as the problem of information overload and solutions such as databases have necessarily become a part of our everyday lives.  The broad concept is fairly easy to comprehend, and it deals with the difference between general knowledge and specific knowledge.  

General knowledge is defined as information that is relatively cheap to transfer from one entity to another.  A recipe for apple pie posted on the Internet is virtually cost-free, save for the effort involved for someone to post the recipe and the time investment for someone to look it up on Google.   

Inversely, specific knowledge is relatively expensive to transfer.  The classic example is the time and training that go into becoming a brain surgeon.  You can’t aquire the vast wealth of knowledge to become a doctor through a few search engine queries.  You have to go to school for a long time, then you have to work as a resident, then you have to keep current with the constant influx of medical advances.  To say it’s expensive is not simply a matter of tuition.  Economics recognizes pecuniary costs (those that can be quantified in dollars and sense) almost as secondary to social costs.  

The most prominent of these social costs is opportunity cost, which is theoretically all the other different things an aspiring brain surgeon could do with all the time and money invested.  When someone chooses to become a brain surgeon, that means they can’t simultaneously become a stock broker.  The process is too time-intensive and too challenging physically and mentally.  There simply aren’t enough hours in the day.  In much the same breath, transaction costs are all the costs that go along with the sale or purchase of an asset that is not immediately attributable to the asset itself.  In the stock market, the spread between the buyer and the seller goes to the market maker, and this can be viewed as a transaction cost.  Likewise, the broker’s commission is also thought of as a transaction cost.

Central planning is predicated on the idea that a bureaucrat analyzing wheat prices in Moscow is somehow more qualified to set the current market price for wheat than both the farmer who grows the wheat and the baker who needs the wheat to make bread.  The farmer and the baker can theoretically get together and figure out a price that is best for both parties  In a commodities market in capitalist systems, they pretty much do.  Now imagine the same ridiculous scenario played out throughout each industry in a communist state.  There’s a lot of waste, and it’s more or less equivalent to all the work of all the bureaucrats deciding things that they have no specific knowledge to decide.    Maddeningly, those bureaucrats create little value, but inevitably end up getting paid the highest wages under the pretense that they’re “in charge” of something, and something similarly maddening happens, in admittedly a lesser degree, in practically every corporate headquarters in capitalist countries.

The idea of public ownership and private ownership are key to the concept of property rights, but the difference between the two is hardly as clear-cut as we might expect.  In both communist and capitalist systems, there are varying proportions of public and private ownership.  In capitalist systems, there are public parks that anyone can use for free.  Likewise, the United States, a capitalist state, has social programs such as unemployment, Social Security, Medicare, and Medicaid.  There is no pure capitalist state, nor a pure communist state.  Each is characterized by some degree of public ownership and private ownership.  

In capitalist states, the public sector is still entitled to private gains, and typically this takes the form of taxes.  In communist states, the more likely scenario is that the state owns everything, and that the private gains of individuals are subsidies from the government.  The notion of value creation and value capture are paramount in this discussion, and the underlying theme is how well property rights are defined.  

With well-defined rights, the owner of a property, whether physical or intellectual, has the right to sell that property and reap the gains of bulk of the property’s value (less taxes).  This concept is known as the alienability of property rights.  When property rights are not well-defined, it becomes the Wild West.  As soon as someone puts a fence around some land or makes a photocopy of someone else’s work, in a sense, they “own” it.  But in another much more real sense, they really don’t.  The state can usurp the individual’s ownership at any time, and they tend to back up that privledge with the police powers of the state.  Even in capitalist systems, if it deemed by the courts that the public interest in having a highway run through your front yard, the state can take your property and reimburse you the “fair value” of that property.  In the case of appropriation, the lines between socialist systems and a capitalist society are not so different.

The concept of externalities allow us to delineate the disparity between value capture and value creation in the discussion between private and public ownership.  There are negative externalities and there are positive externalities.  When a factory creates a widget, assuming they own the patent to that widget, they can sell and reap the profits from the widget sales.  But as a by-product, all the noxious smoke that the plant creates is dispersed into the atmosphere, and the whole of the surrounding area endures that cost.  When the private costs and social costs of creating a product or service are not completely aligned, then an externality exists.  The factory example is a negative externality.  

In the same sense, private benefits may spillover to benefit society on the whole.  A positive externality might include the tracking software that allows a stolen laptop or smartphone to be returned to its rightful owner.  The mere existence of this software has a benefit to society as a whole - Even people without the software can leave their laptop alone in Starbucks while they go to the bathroom and generally rest easy knowing that criminals everywhere are vaguely aware that technology has surpassed the point that nicking a laptop in broad daylight is pointedly more difficult than it was before the software existed.

So value capture and value creation aren’t completely on par with each other.  But there are still economic ramifications for property rights.    In 1991, Ronald Coase won a Nobel Prize for his theorem that, in the absense of transaction costs, bargaining will lead to an efficient outcome regardless of the initial property owner.  This seems to be much the same argument about the superiority of market-based systems over socialist systems where property rights are not well-defined.  If the free market is efficient, and there are not undue costs that burden the free-flow of information, goods, and services, then we would expect that resources flow to their highest valued use.  In effect, there are ways to rectify externalities and make things efficient: the quasi-Utopian state of being according to economists.

One example of the market corrections for the factory pollution example would be the cap and trade of carbon emissions.  Each country would be allocated a certain amount of pollution, and, assuming these emmssions can be measured, non-developed nations would be able to sell and accumulate wealth for their lack of pollution.  More industrialized nations would have to pay for their increased pollution.  This is a highly stylized solution, but the point is that solutions for difficult problems have roots in economic theory.

AE - 06.16.2011

The Ambidextrous Economist never leaves his laptop alone in Starbucks.  

He can be reached at AmbidextrousEconomist@gmail.com.