Toward a Theory of Property Rights Harold Demsetz, (1967) American Economic Review, 57 (May): 347-359

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Toward a Theory of Property RightsHarold
Demsetz, (1967) American Economic Review, 57
(May) 347-359

• John Mawdsley BADM 545 wk4 13th Sept 09

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Property Rights

• Property rights are an instrument of Society
• Help individuals form expectations which they can
  reasonably hold in dealings with others
• Property rights specify how persons may be
  benefited and harmed
• Determine who must pay whom to modify actions
  between persons.

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Role of Property Rights

• Primary role of property rights is that of
  guiding incentives to achieve greater
  internalisation of externalities.
• Property rights arise when it becomes economic
  for those affected by externalities to
  internalize benefits and costs.
• Allocation of property rights are a pre-condition
  for the efficient functioning of markets

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How does it happen?

• ve change in the value of PR's

Internalization (Transaction costs)?
Externalities
Benefit / Harm
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Increased internalization

• Changes in knowledge lead to new techniques,
  which provides new ways of doing the same thing.
• New and emerging property rights will be in
  response to changes in technology and relative
  prices.
• Long-term viability depends upon how well Society
  modifies behaviour to accommodate externalities.

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Internalization A persons right to freedom

• If a person is a 'freeman', then the cost to the
  firm of paying for the use of labor is considered
  in the decision of the firm.
• If a person is a slave, then the slave-owner will
  take into account the sum of money the slave is
  willing to pay for their freedom.
• Hence, these costs become internalized

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Example Development of Property Rights

in land among American Indians

• Quebec Development of fur trade gt value of
  furs to Indians up gt increased scale of hunting gt
  development of private, allotted hunting
  territories and animal husbandry.
• So, property rights system changed in response to
  the economic effects of fur trade and the
  increased importance of externalities.
• SW Territory Animals graze over large areas of
  land gt value of establishing boundaries reduced
  by high costs of preventing animals crossing
  boundaries.
• Therefore the importance of the externalities not
  sufficient enough to warrant changes.

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Forms of property rights ownership

• Communal Property Rights
• Rights are exercised by the 'community'.
• The State or an individual cannot deny right a
  person the right to exercise community owned
  property rights.
• Costs of any abuse to communal rights are borne
  by each member of the community.
• Negotiating costs can be high difficult to
  reach mutual agreement with a large group. Plus
  likelihood of future re-negotiations.
• High policing costs.
• Cannot have a pay-to-use / pay-not-to-use system.

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Forms of property rights ownership

• Private Ownership
• Owner can exclude the community from exercising
  owner's private property rights
• Seek to maximize value of property by taking
  account of alternative streams of benefits and
  costs
• But...may not take into account the effects upon
  others.
• Can have a pay-to-use / pay-not-to-use system.

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Coalescence Ownership of Property RightsLand
Ownership Example
Communal Ownership Private Ownership
Over hunt and overwork land because some of the costs are borne by others Attempts to maximize present value by taking into account alternative future time streams of benefits and costs
Negotiation cost high, many people Negotiation cost low, one owner
Not possible to bring full expected benefits costs of future generations to bear on current users Acts as a broker whose wealth depends on how well he takes into account the competing claims of present and future
Great number of externalities Internalizes many of external costs associated with communal
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Communal land ownership
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Private land ownership
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Publicly-owned companies ?

• Legal modifications to Partnership Law effect
  on property rights
• Executive management become de facto owners of
  company
• Reduces negotiation costs / expedites decision
  making
• Limited liability for shareholders
• Protects shareholders financially from the
  external effects brought upon the de facto
  management
• Reduces transaction costs of trading shares

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Property Rights for 'inventions'

• If communal rights apply to 'new ideas' then
  incentives to develop new ideas are lacking as
  benefits will not be concentrated on the
  inventor.
• By patenting, PR rights become private, and
  therefore new ideas will be rapidly forthcoming.

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But.......

• New idea makes an old one obsolete (-ve) but
  sometimes another old one more valuable (ve)?
• Can bring about market negotiations or legal
  cases.

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Recap

• Demsetz (1967) sees property rights as a
  mechanism towards economic efficiency.
• Close relationship between property rights and
  externalities.
• Changing of property rights can have beneficial
  and harmful effects.
• Society must adapt to changes.