Econ351 Lecture 8. Analysis of selected specific rules of property law

Lecture outline Main tradeoff in the analysis of laws of property Rule of first possession (RFP) Rule of tied ownership (RTO) Rules for verifying ownership Legal restraints on property rights

Main tradeoff Balancing the cost of maintaining the system of property rights with the benefits (mainly, incentives) it creates

Rule of first possession Fugitive property RFP and the tragedy of the commons Examples: overly fast extraction of oil; overfishing (refer to the Tragedy of the Commons example)

RFP (cont.) Another problem (sunken treasure example) Sunken ship with treasure of $1 mln. Cost of finding and lifting it: $0.1 mln. How many teams would compete? Common law solutions: first in pursuit; government gets ownership giving finder a share What if the treasure is cash? RFP is easy to administer, but creates incentives to overinvest in redistribution of wealth

Rule of tied ownership (RTO) RTO, the ownership of fugitive property (such as oil) is tied to settled property such as land (under which oil is located); see Hammonds v. Central Kentucky Natural Gas Co., 1934 Accession principle: “new” property is owned by the owner of proximate property (a calf born to a cow is owned by the owner of the cow)

Fugitive property Hammonds v. Central Kentucky Natural Gas Co. (commonly told and incorrect story): Central Kentucky leased tracts of land above natural gas deposits But geological dome lay partly under Hammonds’ land Hammonds sued, claiming some of the gas they were extracting was hers True story of Hammonds: The Co. stored its gas in an empty stratum under Hammonds land. She claimed tresspass., but the court rules that the gas was like wild animals and thus there was no trespass by the Co. (but then Hammonds could simply take it! For some reason she didn’t).

Rules for verifying ownership Real property: have registered title, need expensive title search to remove “clouds” from title Cars: have registered title, no title search is generally needed Pens, pencils, MP3 players: no registered titles Why such differences? Uncertain ownership reduces efficiency, but registration and title search are costly

What are the rules for inexpensive items? US rule: thief cannot pass good title; original owner still owns property that was stolen and resold Exceptions: Cash Purchase from established dealer (Most of) Europe: if the buyer purchased the good in good faith, he owns it even if it was stolen property

Incentives generated by the US and European rules US rule: risk is on the buyer  invest resources in verifying true ownership; reduces costs of guarding property European rule: risk is on the original owner  saves the buyer costly ownership verification but pushes original owner to invest in protecting and marking the property What might be the economics reasons for these differences?

Rule of adverse possession The law: the person who actively, openly, and continuously possesses property for a given term (usually 20 years), becomes its legitimate owner (formal list of conditions: actual, open & notorious, adverse, continuous, exclusive, pays taxes); more likely to be applied if adverse possession is accidental Economic benefits: saves on title search, transfers property from inactive to active owners Costs: owners are forced to monitor property

Estray statutes The law: if property is reasonably valuable, the finder needs to appear before court official and describe how he found the property; the court places an ad about the property; if the original owner does not appear (e.g., in 1 year), the finder becomes the new owner Benefits and costs: discourages theft, clears clouds from title, disseminates information about lost property, BUT generates administrative costs

Limits on what owners can do with their property Bequests and inheritances Efficiency requires that people are able to bequeath property to whomever they wish and limit its use as they wish However, limits on future use also limit future owners Rule against perpetuities (life-in-being + 21 years) Private necessity (Ploof [owner of boat] v. Putnum [owner or harbor], 1904) – in emergency, reasonable bargaining is infeasible  damages are used (liability rule) instead of injunction

Inalienability Some property rights cannot be transferred at all. Some can be transferred but only as a gift. Such property is called inalienable, for it cannot be alienated from its owner. Examples: prohibitions on the sale of blood, organs, sex, babies for adoption, illegal drugs, etc. Efficiency arguments for such prohibitions?

Takings The law: government may take private property when this property is needed for PUBLIC USE and as long as the state provides JUST COMPENSATION, which for practical purposes means "fair market value." 5th amendment to the US Constitution: “…nor shall private property be taken for public use, without just compensation. “

Pros and cons of takings facilitates land acquisition for public goods provision by preventing hold-up problems “public use” and “just compensation” clauses limit government interference in markets and corrupt redistribution “just compensation” clause reduces disincentive to invest in property and reduces randomness of state revenue collection (taxes are more efficient mechanisms for raising revenue)

Pros and cons of takings (cont.) to the extent compensation undervalues property, the potential for property to be taken results in weaker incentives to improve property to the extent compensation is substantial, it may create moral hazard whereby property is improved despite the possibility of it being taken

Regulations as takings Takings are accompanied by “just compensation” while regulations that reduce the value of somebody’s property are not When does regulation become a “taking”?