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Property law is the body of law that establishes the rules governing ownership rights over scarce resources. Ownership rights are multifaceted— often referred to as a “bundle of rights”—but in general such rights encompass three broad areas of control over a specific resource: the right to exclude (the ability of the owner to prevent others from using the resource), the right to use (the ability of the owner to use the resource in the manner he or she sees fit), and the right to transfer (the ability of the owner to assign ownership rights to the resource to another). The economic analysis of property law is primarily concerned with the effect of various property rules on the allocation of resources and whether such effects conform to the economic concept of efficiency.1 Equity issues are also addressed but to a lesser degree.
The Economics of the Right to Exclude
Ownership rights to a resource grant to the owner the ability to exclude others from using the resource. In contrast, an open-access resource, often labeled common property, is one that an individual has a right to use but cannot exclude others from using. The ability to exclude is probably the most commonly associated aspect of ownership—”that’s mine; you can’t use it.” A derivative power of the excludability right is that the owner can determine which other persons can use the property, either now or in the future, via some form of permission, such as a rental or licensing agreement.
The Minimization of Conflict Costs
Economists distinguish between goods and resources that are characterized by rival consumption (or use) and goods and resources that are characterized by nonrival consumption (or use). Rival consumption exists when consumption by one individual physically precludes consumption by another individual, such as the eating of an apple. Nonrival consumption exists when consumption by one person does not preclude consumption by others, such as the viewing of a fireworks display.
A world of scarce resources characterized by rival use will inevitably lead to disputes over the control of such resources. If ownership rights are uncertain, costly conflicts arise in an attempt to gain or defend use of the resource. Resources are expended (including lives lost) in the actual conflict as well as in preemptive protective measures against attack. Conflict costs are particularly detrimental in that they are unproductive from a societal standpoint. Nothing new is produced; worse yet, existing valuable resources are destroyed—a negative-sum game. Thomas Hobbes (1651/1963) was one of the earliest political philosophers to emphasize the costs of a lawless “state of nature,” where ownership rights were determined by the private use of force. A well-defined system of ownership rules can reduce the uncertainty and attendant conflict costs regarding who controls scarce resources. While it requires resources to establish and enforce a system of property rights, a state-enforced system has substantial economies of scale over a system where each individual is responsible for establishing and defending his or her ownership rights.
In contemporary society, most ownership rights are acquired via transfer from the (previous) legal owner of the resource. However, property law is regularly called upon to resolve ownership rights in resources that have no prior owner. Pierson v. Post (1805) is a legendary case on this issue. Post was leading a fox hunt. As the target was in sight, Pierson—not a member of the party—shot the fox and claimed the corpse. Post sued for ownership. The court awarded ownership to Pierson, establishing (or reinforcing) the legal rule that (with respect to wild animals) ownership rights are bestowed on the person who first “possesses” the animal.
The “rule of first possession” is a common rule for resolving ownership disputes over previously unowned resources (Rose, 1985). The rule has been defended on efficiency grounds as a low-cost method of establishing rights, in that possession is often an unambiguous phenomenon (as in Pierson v. Post), providing a clear demarcation for establishing who owns a specific resource. However, the cost-benefit calculus does not always favor first possession, as issues of difficulty in determining possession, wasteful expenditures in the race to first possession, and possible disincentives to productive efforts, among other issues, may favor more finely tuned rules for establishing ownership to previously unowned resources (Lueck, 1995). Economic analysis of alternative rules for establishing initial ownership claims has focused on the cost of establishing such claims versus the benefits from the right to exclude (for an example with respect to the whaling industry, see Ellickson, 1989).
The Prevention of Resource Depletion
It is a fundamental proposition in economics that an open-access resource will be used beyond the point of efficiency in the short run and quite likely to the point of depletion in the long run—the famous “tragedy of the commons” (Hardin, 1968). Hardin (1968) used the example of open grazing rights to village pastures that were a common arrangement in seventeenth-century England. The cost of using the pasture was zero to any individual herder; therefore, each herder had an incentive to graze his or her livestock as long as some return could be gained, that is, as long as some grass (or other grazing material) remained. This individual-maximizing behavior had two consequences. One, it reduced the current productivity of the pasture for other herders, as their livestock now had less grazing material. Two, it reduced the future productivity of the pasture, as it would be unable to regenerate itself.2 This outcome results from rational individuals following their own self-interest and maximizing their individual productivity, a behavioral characteristic that in the world of Adam Smith results in beneficial social outcomes. Furthermore, it is of no consequence if a specific individual user (e.g., a herder) recognizes the seeds of the tragedy and attempts to avert the outcome by refraining from using the resource. His or her place would be taken by another user following his or her own maximizing instincts, and the tragedy would continue to its inexorable conclusion.
The crux of the tragedy lies not in the self-interested maximizing behavior of individuals but rather in the institutional setting in which such behavior is allowed to operate. In order to defeat the tragedy, an institutional setting must be found so that access to the resource can be limited. One possibility is to establish private ownership rights in the resources, with the accompanying ability to exclude. If the commons can be privatized, then maximizing incentives for the private owner will be in line with the socially efficient condition for resource utilization, as the profit-maximizing private owner will use the resource to the point where marginal revenue product equals marginal (factor) cost.
The tragedy of the commons, unfortunately, is no mere theoretical construct; rather, its destructive outcome is characteristic of some of the more serious problems currently facing the world’s environment. Ocean fisheries serve as a textbook case of the tragedy of the commons in action, as open access has resulted in a state of near collapse for several species. The shrinking of tropical rain forests is another prominent example of the overexploitation of an open-access resource.
Securing Returns From Investment
The act of investment requires incurring costs today in order to earn a return in the future. Such acts are unlikely without confidence in the ability to claim a future return, that is, without the ability to exclude others from the return to the investment. “Open access is associated with depletion and disinvestment rather than with accumulation and economic growth” (Eggertsson, 2003, p. 77). A system of private property rights can ensure that an owner who undertakes an investment today can secure the gains from that investment, thus eliminating the disincentive to investment that exists with an open-access resource.
The grant of exclusive rights to the use of the product of investment activities is to grant a form of monopoly power—the owner is the sole seller of the product. Such a grant creates no efficiency issues when the product is sold in a competitive market. Thus, if a wheat farmer is granted exclusive rights to the crop produced in his or her field, there will be no inefficiency if the wheat is sold in a competitive wheat market. The ownership right provides an incentive for efficient investment, and competitive markets will guarantee the efficient level of wheat production and consumption.
However, the scope of ownership rights—the power to exclude—can raise serious efficiency issues when such rights result in the creation of substantial monopoly power in product markets. These issues arise most notably when rights of exclusion are granted to the inventors of new products and the authors of creative works. This is the realm of intellectual property rights—patents and copyrights. The efficient level of output occurs when price, a measure of the social benefit from additional units of the good, equals the marginal cost of production, a measure of the opportunity cost to society of producing an additional unit of the good. A monopolist will set price higher than marginal cost, thus denying access to the good for consumers whose benefit from additional units of the good (as indicated by the price they are willing to pay) exceeds the cost of producing additional units. Furthermore, monopoly prices will most likely result in extra-normal (monopoly) profits, resulting in a transfer of income from consumers to monopoly producers.
The economic justification for granting such monopoly power is that without the expectation of high returns, inventors and authors have little incentive to undertake the risky process of discovering and developing new products and expressive works. The benefits to society of having the new invention or creative work outweigh the costs of restricting its use. The specific provisions of patent and copyright law, such as the duration of the ownership rights and exceptions such as the “fair use” provision of the copyright law, attempt to strike a balance in the trade-off between incentives to create and monopoly inefficiencies. Changes in the parameters, which determine the magnitude of this trade-off, result in pressure to change the legal rules governing this area of property law.
Recently, a more fundamental challenge has been leveled against the degree of monopoly power granted by patents and copyrights. Rather than promoting the creation of new products and creative works, the web of legal restrictions established by patent and copyright law may actually hinder discovery, innovation, and creative expression by creating substantial barriers to using the knowledge and ideas contained in existing protected works to develop new products and expressive works— an example of the “tragedy of the anticommons.” The tragedy of the anticommons occurs when numerous individual property rights to a resource result in underutilization of that resource—the opposite outcome of the overutilization inherent in the tragedy of the commons (Heller, 1998).
The Economics of Use Rights
If resources are scarce, then a society must answer the question of how those resources will be used. In a society characterized by private property rights, individuals who hold the ownership rights to the resources control the answer to that question, subject to the laws governing the use of their property. This freedom granted to private resource owners—”ownership sovereignty,” if you will— reflects a fundamental tenet of economics—that individuals are the best judges of their own well-being and should be free to choose how to use their resources so as to maximize that well-being. Broad use rights conferred on individual owners are consistent with the underlying normative justification for a competitive market system—that the pursuit of individual self-interest in a competitive market system will result in a socially efficient allocation of resources.
Externality Problem: When Use Rights Conflict
However, user rights are not unlimited. The conclusion that the decisions of rational, self-interested utility maximizers will result in a socially efficient allocation of resources rests on several assumptions. One key assumption is the absence of negative externalities. A negative externality exists when the activity of Person A imposes costs on Person B, and such costs are not reflected in the price Person A must pay to undertake the activity. It is a well-established principle in economics that the existence of negative externalities can result in a suboptimal allocation of resources.4 Property law has likewise recognized the problems created by negative externalities, as perhaps best illustrated by the common law maxim “sic utere tuo ut alienum non laedas,” which translates to “use your own (property) in such a way that you do no harm to another’s.”
A straightforward example of the externality problem is presented by the case of Orchard View Farm v. Martin Marietta Aluminum (1980). The defendant’s aluminum plant had emitted fluoride into the atmosphere, which damaged the plaintiff’s orchards. From an economic standpoint, such emissions may be inefficient if the benefit from the emissions is less than the harm to the orchards (or, alternatively, the cost of reducing the emissions is less than the benefit to the orchard from reduced emissions). Assume that the harm to the orchards reduced the plaintiff’s profits by $500, an amount that represents the net benefit to society (price paid by consumers minus cost of production) of the lost output. Assume further that the defendant could reduce the emissions to a nonharmful level by reducing output, with an accompanying loss of profits (representing again the net benefit to society of the foregone output of aluminum) equal to $300. Under this scenario, the reduction in aluminum output and the resulting increase in the output of the orchard would represent a more efficient allocation of resources, as the increased orchard output is more valuable to society than the reduction in aluminum output. However, the aluminum producer has no incentive to reduce output unless some corrective action is taken to “internalize” the external cost imposed on the orchard.
Property law provides one method to internalize the external costs—the award of compensatory damages for the harm done, often in a complaint of nuisance or trespass. (The Orchard View Farms case was a trespass action.) In the above hypothetical, if the court found the defendant liable for damages of $500, then the defendant would have an incentive to reduce output to the nonharmful level, as the $300 in lost profits would be less than the $500 in damages it would have to pay if it did not reduce output. The externality would be internalized, and the allocation of resources would be more efficient. (If the numbers in the above hypothetical were reversed, then the defendant would continue to produce at the same level and pay the damages, which would be the efficient result.)
The award of compensatory damages was one of several mechanisms that property law provided to deal with negative externalities. This mechanism was in line with traditional economic theory, which most often suggested the imposition of taxes (or fines) on the negative externality-generating activity. However, the publication of Ronald Coase’s (1960) seminal article “The Problem of Social Cost” dramatically changed the way economists analyzed the question of negative externalities.
The Coase Theorem
Instead of viewing negative externalities as a situation where Person A’s activity imposed a cost on Person B, Coase (1960) recast the situation as one in which the two parties were vying over the use of a scarce resource in which no ownership rights had yet been established. If Person A were allowed to use the resource, then a cost would be imposed on Person B, who would not be able to use the resource. However, Coase argued that the converse was also true—if Person B were allowed to use the resource, a cost would be imposed on Person A, who would not be able to use the resource. In effect, externalities were reciprocal in nature, in that one party’s use of the resource precluded the other party’s use. In the Orchard View Farms case, the two parties were competing over the (incompatible) use of the atmosphere, to which neither (prior to the legal decision in the case) had an established property (use) right. The defendant’s emissions imposed a cost on the plaintiff, but if the plaintiff were successful in preventing the defendant from releasing emissions, a cost would be imposed on the defendant. The question of which party is harming the other—that is, which party is creating the negative externality—cannot be determined until it is decided who has the right to use the resource in question.
Drawing on this basic insight, Coase (1960) developed the famous Coase theorem: In the absence of transactions cost, the allocation of resources will be efficient regardless of the assignment of property rights. Placing the Orchard View Farms case in the idealized world of no transactions costs, the Coase theorem states that an efficient allocation of resources will result regardless of whether the plant is given the right to emit fluoride or whether the orchard is given the right to be free from fluoride emissions. To state the point more starkly, it does not matter, with respect to efficiency, what the court decides, as long as it decides something!
What is the logic behind this remarkable conclusion? It was concluded above that if the owners of the orchard were given the right to be free from harm from the emissions (via compensatory damages), the defendant would reduce output so as to avoid paying damages—the efficient outcome. If, instead, the owners of the plant were given the right to emit, then the orchard owners would have an incentive to offer the owners of the plant a payment, say $400, to reduce the emissions. The plant owners would agree to do so, as the $400 payment is greater than the $300 in decreased profit resulting from reducing emissions. As long as there are no obstacles to reaching this agreement—that is, there are no transactions costs—the efficient result is reached. The offer of payment by the orchard owners internalizes the cost of the emissions to the plant owners, as the refusal to accept the offer represents an opportunity cost to them.
This example illustrates the strong version of the Coase theorem, which states that allocation of resources will be identical (and efficient) regardless of the assignment of property rights. But identical allocational outcomes may not result, even in the absence of transactions costs. Efficiency requires that resources go to their most highly valued use. But “value” can be measured in two distinct ways—by how much one is willing to pay to acquire a resource (i.e., to buy) and by how much one is willing to accept to give up a resource (i.e., to sell). These two amounts may differ. It may require more to compensate a person for the loss of the right to a resource than the person would be willing to pay to acquire the right to that resource. For example, it may take $8,000 to compensate an individual who owns a beachfront cottage with beautiful sunset views to give up that right so that an oil well, which obstructs the view, can be drilled. However, that same individual, perhaps due to income constraints, may only be willing to pay $2,000 to prevent the oil well from being drilled. If there exists a divergence between willingness to pay and willingness to accept (i.e., if endowment effects exist), then the initial assignment (endowment) of the property right may result in a different allocation of resources.6 However, regardless of the outcome, the resultant allocation of resources will be efficient, given the property right assignment. In other words, the resource will go to the most highly valued use regardless of the assignment of the right, but the most highly valued use may differ due to endowment effects stemming from the different assignment of the right.7 This is the weak version of the Coase theorem: In the absence of transactions cost, the allocation of resources will be efficient (but not necessarily the same), regardless of the assignment of property rights.
The Coase theorem is a fascinating and provocative proposition. Despite the fact that transactions costs are likely never zero, it has several implications for property law. One, the law should strive to reduce transactions costs so as to facilitate private agreements to resolve externality conflicts. A clear delineation of property rights is a key step in this process. Negotiations are likely to be particularly acrimonious if the parties believe their rights are being violated. Two, in cases where transactions costs are low, the courts do not have to burden themselves unduly worrying about the efficiency effects of their (clear) assignment of the property right in question, as bargaining will eventually result in an efficient outcome. The courts can focus on other possibly important aspects of their decision, such as the distributional or “fairness” implications. Third, when transactions costs are high, the court should assign the resource in question to the most highly valued use. If transactions costs are high and the resource is assigned to the lower valued use, it is unlikely that a transfer to the more highly valued use will occur, thus resulting in an inefficient allocation of resources. This proposition is dependent on two key assumptions: one, that allocative efficiency is the primary objective of the legal system and, two, that the identification of the most highly valued use is clear and is not subject to possible endowment effects.
The Economics of the Right to Transfer
The rules of property law are part of the set of rules that determine how resources can be passed from one user to another, that is, the right of alienability.9 This transfer can include the transfer of all rights of use for all time or can be limited in both type of use and length of use. Full voluntary transference of rights can be done by sale, gift, or bequest. A partial transfer of rights can be done in a variety of legal forms, including licensing and leasing arrangements.
It is a bedrock principle of economics that a voluntary transfer of resources between two reasonably informed parties improves the well-being of both parties, thus representing a Pareto superior reallocation of resources. This is perhaps the fundamental justification for a market-based economy. One prominent role of property law is to facilitate such transfers, primarily by clearly specifying property rights so that uncertainty over ownership can be removed from the market transaction.
But in some instances, the legal system explicitly restricts rather than facilitates the transfer of a property right. The restriction may be complete, as in the case of the right to vote, which can neither be sold nor given away. More often, however, the restraint on alienability is in the form of a prohibition on the sale of the resource, that is, the transfer of the resource in exchange for compensation. For example, it is illegal in most countries to sell one’s bodily organs, such as a kidney, for purposes of transplantation, although the transfer of such via a donation is not only legal but often encouraged. Several economic justifications have been advanced in support of inalienability, among them the existence of negative externalities, poor information regarding the consequences of a sale, and myopic behavior (see Rose-Ackerman, 1985). While these justifications may be valid in certain situations, none address the fundamental question of why uncompensated transfers are allowed. The suspicion is that society fears that the offer of compensation will distort the owner’s valuation of the resource—that is, that the lure of financial compensation will tempt the owner to transfer the resource when such transfer is not really in the owner’s best interest. This is the classic paternalism argument. The argument is often applied most directly to lower income people, who may be particularly susceptible to an offer of financial compensation. Such temptation has been characterized in such adverse terms as “exploitation” of the poor, as if the provision of compensation is actually detrimental to the welfare of the poor. Paternalistic arguments violate the basic assumption in economics that individuals are the best judge of their own well-being, and thus restrictions on alienability based on such arguments are often criticized by economists as inefficient.
Questions have arisen as to exactly when and what ownership rights are given up in the process of a voluntary transaction, particularly when the transaction involves body tissue. In Moore v. Regents of the University of California (1990), the plaintiff agreed to the removal of his diseased spleen, which, unbeknownst to him, contained unique cells. Defendants, through genetic engineering, developed a highly lucrative line of pharmaceutical products based on the plaintiff’s cells, without informing plaintiff. The patient claimed ownership; the defendant argued that all ownership rights to the spleen and cells therein were voluntary transferred at the time of the operation. The court ruled that the patient had forfeited his ownership right in the spleen once it was voluntarily removed from his body.
Adverse Possession (Private Taking)
Adverse possession is the rule of law that transfers ownership of property from the current owner to another private party, without the permission of or compensation to the owner. Adverse possession can be invoked when the owner has not objected to the “open and notorious use” of his or her property by another. For example, if a person builds a garage that encroaches five feet onto the adjacent property of another, and if, over an extended period of time, the owner of the adjacent property makes no attempt to claim ownership, then ownership of that part of the property may pass to the person who built the garage under a claim of adverse possession. The economic justification for such involuntary transfers is twofold. One, the property is moving to the person who values it more highly, on the presumption that the lack of objection by the owner indicates a very low valuation of the property by the owner. Two, adverse possession can discourage ownership claims based on occurrences in the distant past.
Eminent Domain (Public Taking)
Eminent domain is the power of the government to take private property to pursue a government function. The Fifth Amendment of the U.S. Constitution states, “No property shall be taken for public use without just compensation.” Public works projects often require the acquisition of multiple parcels of private property, allowing the possibility of one or more owners to “hold out” in an attempt to capture a larger share of the gains from the project. Assume that the government plans on building a hospital, with estimated net benefits (excluding property acquisition costs) of $100 million. The hospital is to be built on 10 identical parcels of private property, each with a market value of $1 million. Thus, the project is economically efficient, with net social benefits of $90 million. Assume the government engages in voluntary market transactions to acquire 9 of the 10 parcels at their aggregate market value of $9 million. The last parcel is now worth up to $91 million to the government, although no other buyer would pay more than $1 million. The owner of the last parcel is in a position to extract an enormous gain by refusing to sell—”holding out”—unless the government pays a substantial premium over the market price. The government may refuse to pay the premium, thus scuttling the project. If more than one of the owners of the 10 parcels attempts to follow this strategy, the problem is confounded. The power of eminent domain eliminates such strategic behavior, allowing the government to acquire property at (preproject) market value, which presumably represents the true opportunity cost of the property to society. The owner is left no worse off, and efficient projects can go forward.
Actual compensation is in accordance with the Pareto test for efficiency but is not required under the more widely used Kaldor-Hicks potential compensation test. However, the “just compensation” requirement promotes efficiency by forcing the government to more explicitly weigh the benefits of a proposed project against the actual costs, an incentive that is not as great if the government can simply take property without compensation. On equity grounds, the compensation requirement results in no one citizen bearing an unduly large cost of providing a public benefit—the general public will bear the cost through the taxation necessary to pay the compensation.
In principle, as well as practice, “fair market value” is considered the standard measure of “just compensation.” However, market value—a willingness-to-pay measure of value—may not reflect the amount necessary to induce the owner to sell the property, that is, the amount necessary to fully compensate the owner for his or her loss. As discussed with respect to the Coase theorem, a property owner’s willingness to accept may be greater than his or her willingness to pay. This is not unusual when the property in question is the owner’s private residence—his or her home. In such a situation, the exercise of the power of eminent domain with “just compensation” based on fair market value may result in a reallocation that does not meet either the strict Pareto test for efficiency or even the weaker potential compensation test for efficiency.
The Fifth Amendment states that the government can acquire property for “public use.” If title to the acquired property is transferred to the government and the property is available for use by the public, such as a park or a highway, the public use requirement is clearly fulfilled. The question has arisen, however, concerning the limits on the public use requirement. In Kelo v. City of New London (2005), the plaintiff challenged the city government’s proposed taking of her house (with compensation at market value), the property to be converted to a parking lot for a private corporation in accordance with a comprehensive economic development plan formulated to reverse the city’s declining economic fortunes. In a 5—4 decision, the Supreme Court ruled that the “public use” requirement was fulfilled, as the proposed development plan could provide substantial benefits to the general public.
The police power of the state enables the government to pass laws and regulations to protect the “health, safety, and welfare”11 of the public. Such regulations may reduce the value of affected property, but the government is generally not required to compensate property owners for the reduced value. For example, the government can restrict the playing of outdoor music at a nightclub if the noise disturbs the peace and quiet of local residents without compensating the owner of the nightclub for any reduction in the value of his or her property resulting from reduced profits or even the closing of the business. Can such regulations so restrict the use of property that in effect the government has “taken” the property, even though title remains with the private owner? In Lucas v. South Carolina Coastal Council (1992), the defendant adopted a setback rule prohibiting construction on coastal property within a certain distance from the water, justifying the regulation as necessary to mitigate coastal erosion and to protect the coastal environment. The rule prevented the plaintiff from carrying out plans to build a house on each of his two coastline properties (purchased for $975,000). The plaintiff sought compensation for the significant reduction in the value of his properties, arguing that the regulation in effect constituted a “taking” under the Fifth Amendment. The Court held that if a new government regulation “deprived the owner of virtually all economic benefit” from his property and was not inherent “in the common law traditions of the state,” then the regulation resulted in a government taking, requiring compensation under the Fifth Amendment.
The legal issue of whether a government regulation is a legitimate use of the state’s police power with no compensation required for any resulting losses or whether the regulation is a taking requiring compensation remains unresolved. From an economic perspective, the analysis echoes the discussion above regarding the Coase theorem and the theory of externalities. As a logical proposition, it is equally correct to state, with reference to the Lucas case, that the property owner would harm the coastal environment if he built on the property (i.e., impose a negative externality) or, alternatively, that he would benefit the coastal environment if he did not build (i.e., confer a positive externality).12 As with the Coase theorem, the assignment of property right must be decided (presumably the role of the court) before the appropriate characterization of the externality can be determined.
Protecting Property Rights
The primary remedies for the protection of property rights are injunctions and damages. An injunction is a court order requiring the defendant to cease the behavior that violates the plaintiff’s property right in order to prevent “irreparable harm” to the plaintiff in the future. If the defendant violates the injunction, he or she can be held in contempt of court and face large fines or possible incarceration. The plaintiff can agree to have the injunction lifted if an agreement is reached with the offending party.
Damages are intended to compensate the holder of a property right for the damages that have resulted from the violation of his or her property right. As such, they are backward looking.13 Damages and injunctions are not mutually exclusive remedies—a court may grant an injunction against future harms while awarding damages for past harms.
In their seminal article, Calabresi and Melamed (1972) highlighted a key difference between injunctions and damages as remedies. An injunction prevents another party from using (harming) the property of the owner (assuming that large fines and the threat of incarceration are effective deterrents). Damages, on the other hand, allow the offending party to use (harm) the property of another, as long as compensation is paid. Returning to the Orchard View Farms case, an injunction against emissions from the plant would result in the orchard being free from emissions. If damages were awarded (without an injunction), emissions could continue as long as the orchard owners were compensated for their losses. Calabresi and Melamed classified this distinction as protection by a liability rule (damages) and protection by a property rule (injunction).
Following the logic of the Coase theorem, in a world of zero transactions cost, the type of remedy should not affect the allocation of resources. Reversing the numbers in the Orchard View Farm hypothetical above, assume that profits from the plant are increased by $500 if emissions are released while damage to the orchard from the emissions equals $300. If the court awards damages, the plant owners will continue to allow the emissions and pay damages of $300, thus gaining $200. (Note that this represents an efficient allocation of resources.) On the other hand, if the court issues an injunction prohibiting future emissions, the plant owners have an incentive to offer the orchard owner an amount between $300 and $500 (say, $400) to lift the injunction and allow the emissions (again, the efficient outcome), an offer that the orchard owner would presumably accept. The choice of remedy does not affect the allocation of resources, only the distribution of the resultant efficiency gain.
As with the Coase theorem, the equivalency result relies on the key assumption that transactions costs are sufficiently low so that the two parties are able to reach an agreement. If transactions costs are high, then granting an injunction against the plant owners will result in the plant being forced to eliminate emissions, an inefficient outcome. In this situation, the award of damages (a liability rule) would lead to the efficient result, as the plant owners would continue to emit and pay the damages. As a general proposition, if transactions costs are low, an injunction is the preferred solution, as the parties can negotiate their own (efficient) agreement without the court undertaking the costly task of determining actual damages. However, if transactions costs are high, damages are the preferred solution so as to allow for the resource to be used by the more highly valued user, if that user is not awarded the property right.
The above discussion has touched on certain issues that will challenge the established rules of property law. Some form of property-like exclusionary rights must be established to currently open-access natural resources, or else such resources will soon face extinction. As new life-saving pharmaceutical products are developed, the ability of patent holders to restrict access via monopoly prices will become ever more costly to society. Medical advances in organ transplantation practices combined with increasing life expectancies of a healthier population will make the inalienability of bodily organs increasingly inefficient. The broader issue of property rights in one’s bodily tissue, cell line, and genetic code will need to be addressed if the full benefits of scientific advances in biotechnology and genetic engineering are to be realized. In the area of government takings, the courts must decide how broadly the concept of “public use” will be defined and in what circumstances government regulations become so restrictive as to require compensation. But it should not be forgotten in the midst of these weighty national and global issues that one of the most important functions of property law is to decide conflicts over the appropriate uses of one’s property that constantly arise at the most local of levels— disputes between neighbors.
Economic efficiency requires that scarce resources are not exploited to the point of depletion, that they are employed in their most valuable use, and that productive investments are undertaken in order for the resource base to grow. Property law plays a key role in the successful obtainment of these objectives by establishing exclusion rights, use rights, and transfer rights to resources and then protecting those rights with appropriate remedies. Ownership rights grant to the owner of a resource the legal authority to exclude others from access (without permission) to the resource, thus providing an incentive against overutilization and depletion as well as for productive investment in the growth of the resource. An owner has broad discretion to put the resource to the use that he or she deems most utility enhancing, thus promoting efficiency. However, that use may impinge on another’s resource, and property law determines the extent to which an owner can use his or her resource in a manner that interferes with the property of another (the externality issue). By facilitating negotiations between the affected parties and, in situations in which negotiations are not feasible, by assigning use rights to the most highly valued use, the legal system can contribute to an efficient allocation of resources. A well-functioning system of property law will enable the voluntary transfer of resources between parties on mutually agreeable terms so that resources are moved to their most highly valued use. In situations where voluntary agreements may be difficult to achieve, the legal rules governing the involuntary transfer of ownership rights—adverse possession and government takings—can move resources to more highly valued uses, if properly structured. In a dynamic market economy, the effectiveness of established property law is constantly challenged by changing preferences of individuals, changing production technologies, and changes in the institutional arrangements governing society. The economic analysis of property law is aimed at evaluating how effective the current legal rules that govern ownership rights, as well as proposed changes to such, are in promoting an efficient and equitable allocation of resources in an ever-changing world.
- A&M Records v. Napster, 239 F. 3d 1004 (2001).
- Anderson, T. L., & McChesney, F. S. (Eds.). (2003). Property rights: Cooperation, conflict, and law. Princeton, NJ: Princeton University Press.
- Barzel, Y. (1997). Economic analysis of property rights (2nd ed.). New York: Cambridge University Press.
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