Economics and the Law
Lessons from a property rights perspective
A big point of emphasis here at Economic Forces is the role of exchange and the usefulness of supply and demand for thinking about exchange. Lurking in the background of this analysis is something quite important: property rights and the legal system.
A popular subfield of economics is called Law and Economics. People working in this field are often engaged in what we might call the economic analysis of the law. Some might examine the economic implications of a particular law or particular types of law. For example, these scholars might be interested in things like property law, criminal law, or torts. Economics as a field focuses on incentives. As a result, a lot of people working in Law and Economics are looking at the economic foundations of the law. In this post, I would like to take a different approach. I would like to think about the legal foundations of economic exchange and how this might structure our thinking around economic questions.
When we think about exchange, we often ignore what is going on in the background. In other words, when I purchase a new TV from the local electronics store, I might think of the exchange as one in which I get a TV and the store gets money. I am buying a TV. However, what I am really buying is the property right to the TV. When the store sells me the TV, they are transferring the property right to the TV to me.
In larger transactions, we recognize this explicitly. When I buy a house, I am giving the existing homeowner money and they are giving me the house. This process, however, requires title work. The legal title to the house and the property is put in my name.
In principle, there is really no difference between these transactions. In each case, the property right is being transferred from one party to another. In the case of the TV, the cost of drawing up a legal title to the TV at the point of sale would probably be too costly relative to the cost of the TV itself. In other cases, what I am purchasing might be perishable and there is no reason for why I might need a title for something that won’t last very long.
Focusing on the exchange of property rights is important for a number of reasons. Doing so clarifies that the very nature of exchange requires understanding exactly what property rights entail. It also makes clear that there must be some type of legal system in place that outlines the rules regarding property rights and the enforcement thereof.
Questions about the legal system are important, but I want to focus on property rights. When we think of property rights, we are referring to a bundle of rights. One of these rights is exclusivity, or the ability to exclude others from the benefits that one gets from the property. When I purchase the TV from the electronics store, this gives me the right to watch that TV. My neighbor does not have the right to watch my TV, although I do not have to enforce that at all times. Another important feature is alienability, or the ability to transfer the rights to the property to someone else. If I decide that I do not want the TV any longer, I can sell it to someone else or simply give it away.
It is important to think about these characteristics of property rights to clarify certain claims. Government officials, for example, like to tell taxpayers that things like public parks “belong” to the people. Yet, these parks are owned by the government. The government relaxes the exclusive right to these parks during certain hours. For example, they allow anyone to enjoy the park, but usually only from sunrise to sunset. The parks are not owned by the taxpayer in any meaningful sense. While the government can exclude people from the park, a single taxpayer cannot. Taxpayers similarly lack alienability. One cannot opt out of funding the park nor can one sell their “share” of the park. If you don’t believe me, I challenge you to go to the local park, take a picture of the slide, and offer it for sale on Facebook or Craiglist or whatever people are using these days. When the city protests, let them know that the slide is on your “share” of the park and you’d like to clear some space. Then let me know how that went.
Many of the microeconomic questions that we are interested in involve issues that prevent exclusivity, alienability, or other create other restrictions on the bundle of rights. Issues related to public goods, common resources, and externalities are really questions about property rights. I think that a lot of people recognize this point. Nevertheless, there are a lot of other examples from introductory economics courses that are fundamentally about restrictions on the bundle of rights.
Let’s think of some examples. Consider a world without any type of restriction on the bundle of rights. Now, suppose that you own some apartments or houses in a college town that you rent to students every year. You notice that female college students tend to take better care of rental properties and are otherwise less destructive than male college students. Without any restriction on the bundle of property rights, you could charge males higher rent than females. In the real world, however, this might not be possible. The local government might restrict the bundle of rights by prohibiting discrimination by gender. (It is left to the reader to determine the effect of this prohibition on rent in equilibrium.)
Thinking about these issues in terms of property rights leads to some important insights about the way that people might behave. For example, another type restriction on the property rights bundle would be to impose price controls. Thinking about the example of the property for rent, the local government might also impose a maximum amount of rent on the property.
Price ceilings lead to persistent shortages. Stipulating a maximum amount of rent below the going market rate would lead to an increase in the quantity demanded. In the short run, there is a fixed supply of property to be rented. In the long run, the quantity supplied of rental property will decline as a result of the price control. As a result, there are more people who want to rent the property than the amount of rental property available, and that problem gets worse over time.
An important point is that these two restrictions on the property rights bundle might not be compatible. Preventing discrimination based on gender ensures that both male and female college students pay the same price, but it does not ensure that they are equally likely to be able to rent an apartment. If there is a persistent shortage due to rent control, the landlord has more people who want to rent the properties than there are properties. The landlord then has some discretion regarding who gets the apartment. Given the price controls, the landlord might simply choose to rent the apartments/houses to the female students.
The importance of particular restrictions on the bundle of rights is also illustrated by an example that Harold Demsetz used to talk about. Demsetz once went back and looked at apartment rentals in Chicago before and after the price controls associated with World War II. Prior to World War II, he noted that among the apartments available to rent, some were furnished. These furnished apartments required a separate fee for the use of the furniture in addition to the rent. Following the imposition of rent control, the number of furnished apartments increased along with the fees charged for the use of the furniture.
This is easy to understand in the context of this essay. Rent control is a restriction on the bundle of property rights. However, there is no such restrictions on furnishing and the corresponding fees. As a result, the cost of renting the apartment is shifted to another margin to ensure that it is allocated to who values it most.
What all of this reveals is that while many scholars focus on the economic foundations of the law, it is just as important to focus on the legal foundations of economics, or exchange. This property rights perspective can be quite useful in addressing many economic questions.