John Mawdsley: BADM 545 wk4 13th Sept 09 Toward a Theory of Property Rights Harold Demsetz, (1967) American Economic Review, 57 (May): 347-359 John Mawdsley: BADM 545 wk4 13th Sept 09

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.

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

+ve change in the value of PR's How does it happen? +ve change in the value of PR's Internalization (Transaction costs)‏ Externalities Benefit / Harm

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.

Internalization: A person’s 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

Example: Development of Property Rights in land among American Indians Quebec: Development of fur trade > $ value of furs to Indians up > increased scale of hunting > 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 > 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.

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.

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.

Coalescence & Ownership of Property Rights Land 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

Communal land ownership

Private land ownership

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

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.

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.

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.