PROPERTY RIGHTS

Lecture 2: Establishing Property Rights, Defining Their Meaning and Defending Them

Introduction

In the first lecture we learned that in economies where private property rights are present, better specified, and better protected, prosperity and growth are stronger also. When resources are privately owned, resource users and resource suppliers compete for one another's business. This competition leads to more productive and less fractious dealings, while wasteful and destructive activities are penalized and thus minimized. Resource users who pay for what they use are more careful about what they use � they purchase less and work to reduce the waste materials (the materials that can become pollution). Citizens reap substantial gains from the presence and protection of property rights partly because they produce resource conservation and less pollution. Such a system of rights, however, is not given by nature to an economy. Property rights must be produced at a cost.

Where do property rights come from? Why do some economies have stronger institutions to support property rights than others have? What explains opposition to property rights? This lecture will describe how property rights systems have evolved in various places and how, in some of those places, the early, pre-governmental forms of property rights were formalized and supported by governments. Established and formalized property rights systems have been shown to provide many benefits for citizens who have access to them, but there are 3 elements or dimensions of property rights that must be present in order for those benefits to be fully realized. These three dimensions � which I call �3-D� elements � and the benefits of each will be described and explained, along with how those benefits are generated.

The lecture will also discuss why � in the face of all the evidence of their high value to any economy � property rights are often poorly formulated and poorly defended in most nations around the world. Political-economy problems help to explain these problems and thus can help us to predict or even to better promote the use of these �3-D� rights.

The Evolution of Property Rights Systems

Like other human activities, the delineation and defense of property rights respond to changes in the costs and the benefits of doing so. Harold Demsetz, in a well-known and pioneering 1967 article, 1 pointed this out. Drawing on the existing literature of history and anthropology, Demsets showed how various native American tribes developed property rights in earlier centuries. 2

Demsetz pointed to the example of the Montagnais Indians on the Labrador Peninsula of Canada, who were hunters subsisting on large game such as caribou and small fur-bearers such as beaver. Until trade developed with Europeans, there was little pressure on the hunted animals. In the early 1600s however, the fur trade arose, increasing the value of the beaver harvest. Hunters took more beaver, and beaver populations became depleted. The Montagnais were experiencing �the tragedy of the commons.� That is, many hunters sought the beaver, even though taking more beaver meant that there would be a smaller breeding population for the next year. Each hunter knew that saving some beavers would provide more beavers for the future, but the hunter who held back � saving a beaver � would bear all the cost of losing the beaver. In contrast, if the hunter took the beaver, the benefit of obtaining the beaver would be immediate and all his. The benefit gained by saving more beavers for next year would be shared among all hunters in the territory with access to the same beavers. When all hunters had access to the entire territory owned in common, the incentive of each hunter was to take more now even though the total result � now and in the future � was detrimental to entire group of hunters.

As awareness of this looming tragedy spread among hunters, exclusive ownership by individual families emerged. The tribe agreed that specific families would have the sole right to take beavers from a specified section of a stream where beavers lived. Each hunter (or family) was an owner. The family's hunters would gain the benefit later of saving beaver now, and thus had the incentive always to leave enough beavers in the territory they controlled to assure a supply of beaver in the future. The territories of the beaver, previously a common-pool resource that came under pressure when the value of the resource rose, were made privately owned. Both the costs and the benefits of conservation accrued to the family who conserved. By the early-to-middle part of the next century, the transition to private hunting grounds was nearly complete. Beavers were were being managed on a sustained yield basis.

The Montagnais system of property rights to beaver territories lasted until the European trappers arrived. Unfortunately, these trappers ignored the Montagnais' hunting territories and invaded them. Once the Indians recognized that they could not defend their property rights well against the Europeans, they abandoned their conservation methods and took beavers quickly, before Europeans could get there first. They did this even though they knew that doing so would virtually wipe out the beaver- trapping potential in the area.

The story of the Montagnais and the beavers is one of several cases where the property rights institutions (that is, the customs, traditions, and laws) of Native American tribes were responsive to changing costs and benefits, and were more advanced in regard to wildlife than the institutions of the Europeans who began to displace them. In some situations, however, the tribes were themselves unable to establish and defend property rights. even when the value of doing so grew larger. 3

In contrast to the situation on the Labrador peninsula with its beaver is the situation of the Great Plains with its bison. Beavers were sedentary � they stayed in the local area where they settled � but the Great Plains bison (often known as the American buffalo) roamed widely in herds. Because of their movement across large territories, they were a classic �fugitive resource� when they were hunted. Several Plains Indian tribes who lived by hunting them also moved to follow the buffalo herds. The tribes did not take large numbers of bison until the horse and the gun became available to them in the late 1700s. As bison became easier to kill, far more of them were killed. Because the bison herds ranged far and wide across the plains, individual tribes were unable to establish and defend property rights to a specific herd. Unlike the beavers in the Labrador peninsula, which could be �owned,� bison could not be �owned.� Indians at that time had no technology that would allow them to establish property rights to a resource that was not sedentary and not tied to a specific, defendable location.

As a result, all hunters had access to this fugitive resource. According to historian Francis Haines, by 1840 Indians themselves had driven buffalo from portions of the Great Plains. 4 As Indians obtained access to the eastern U.S. market for buffalo skins, and white hunters began shooting them as well, the bison faced possible extinction.

Even though property rights in buffalo herds or hunting territories were not feasible for Plains Indians at that time, these Indians did employ property rights to good advantage on a smaller scale. Economist Terry Anderson, in a highly readable article available on the Web (http://www.perc.org/publications/policyseries/conservation.html), cites the work of several historians to provide many examples of Indians' use of property rights to prevent disputes and improve incentives in fishing and hunting, among other activities. 5

For example, Anderson points out that although buffalo hunts were communal, ownership of the dead animal and its parts was specified by tribal agreements, and hunters owned their own bows and arrows.. Hunters �marked their arrows distinctively, so after the hunt, the arrows in the dead bison indicated which hunters had been successful.� The man whose arrow killed the bison would claim the largest share of the animal--the hide and one side. Helpers were rewarded in the order that they arrived. The first received a hind quarter, the second got most of the organ meats, and the third claimed the ribs. These and other arrangements for establishing property rights made each hunt a more productive and less acrimonious event. Using property rights this way avoided arguments and fights and encouraged the development of hunting skills that would earn the skilled hunter better payoffs, thus making life better for everyone in the tribe. Stories with similar outcomes are recounted by Anderson for fishing rights along certain important streams.

The experience of American Indians shows that property rights go back to aboriginal cultures. The existence of property rights avoided the �tragedy of the commons.� When white settlers arrived in America, they too relied on property rights � even though they didn't have a government that supported property rights.

A recent book by Anderson and Laura Huggins (2003) 6 provides an overview of how property rights have developed historically in various situations. For example, when cattlemen (that is, ranchers) first started grazing cattle on the grass ranges in what are now the western states of the United States, range land was plentiful. A cattleman finding one part of the range already in use by another would simply move on to other, unused range land. Over the years, cattlemen thought of the range they used, recognized by others as not available, as their own property. As more people came west, and unclaimed land became more scarce, cattlemen banded together in associations to defend their claims to property rights � rights in both the cattle and the land. They hired cowboys to patrol the boundaries of their land claims. In other words, they all understood that someone owned the land, and the boundaries were generally understood. This form of property rights formation was common in the American West. Later, when state and federal government agencies arrived, these privately established rights were usually recognized, recorded officially, and enforced.

As Anderson and Huggins point out, rules which are developed by participants over time tend both to minimize the cost of forming the rules, and to maximize the net benefits of the resulting rules. That is because those involved in the development are paying the development costs and, at the same time, are capturing a large share of the net benefits of better results. Participants will carefully consider the costs and the benefits of alternative possible approaches, and the choices they make will vary with circumstances across time and place.

The Essentials of Property Rights

It is important to remember this: Property rights generally are not something that government �grants� to people. They usually develop on their own.

Whatever the process of their formation, property rights are effective in producing good results for society to the degree that they are "3-D." There are three dimensions, or three characteristics that effective property rights share.

1.) Rights must be defined . Most goods and services that we deal with from day to day are well-defined. In fact, a lot of effort goes into making sure they are clearly defined. Before purchase, land is often surveyed and the boundaries of property are recorded in a local government office so that any dispute about where one person's property ends and another's begins can be easily settled.

But what does ownership mean, exactly? What rights go with owning the land? How much noise is allowed there? Is burning wood in a fireplace okay? A potential buyer would be unwilling to spend much money on a new home, farm, or business if ownership and ownership rights were not clearly defined.

2.) Rights must be defendable. Usually in the United States, property rights are readily defended. Courts will back an owner's property rights. However, if for any reason rights to a resource are difficult to defend against theft, harm, use by others or trespass, the value of the resource falls.

A farmer's land that is too easily accessible to others can be robbed of its produce. The smell from a new hog feeding operation upwind may invade an owner's property, or the land may have become contaminated by hazardous waste from an unknown source. In these cases, if the owner is unable to fully defend his or her ownership rights�for example by going to court to obtain compensation and a court order to cease the rights violation--the property is worth less than it would be otherwise.

3.) Rights must be freely divestible. If the property rights to a resource are not freely divestible , meaning that the owner is not free to sell (or rent or lease) the resource to any willing buyer, the resource is not likely to be well used. In normal day-to-day living, we can usually sell what we own. The classified sections of most newspapers are filled with property being sold by its owners, everything from used furniture to automobiles and boats. Most people take this ability to buy and sell property for granted. But there are important exceptions to some owners' ability to divest their land or resources.

In the recent past, it was common for people to save on inheritance taxes by providing property to a son or daughter, but holding it in trust for the grandchildren. The son or daughter could only obtain the income from it, not the full value of selling the property. This tended to distort decisions about how to use and care for the property. The middle generation had an incentive to increase their income by overusing the land, thus decreasing its long term value to its owner and to the economy.

The Role of Government

As we have seen, even without government, property rights can and do exist. Although the white settlers who followed the Indians in the American West are known for their gunfights (especially in American movies), such fights were actually rare. Even without formal government, the value of property rights was so great that only the threat of force was needed in most cases to protect the rights. But when government helps to protect the rights of ownership, the costs of defending rights can fall.

In most situations today, the government has a key role in the protection of property rights. A person owning land usually has a deed (a paper stating that he or she owns the land) that is recorded by a government agency. If anyone trespasses (that is, enters the land without permission), the owner has a right to seek the help of the government to get the trespasser off the land or, as an American western movie might say, to �send in the sheriff� to help enforce ownership rights.

Owning property backed by a legal deed (or title) has another advantage. People can use their property as collateral. That is, they can borrow money from a bank with the promise that if they pay off the loan, the bank will be able to have the land instead. Using the land to back a loan also signals to the bank and other potential investors that the owner is willing to put ownership of the land up as a hostage to the success of the venture. Having something valuable at stake this way provides both some insurance for lenders and, for other investors, confidence in the land owner's commitment to the success of the venture to be financed.

But in many parts of the world, this use of property is not possible. That is because many people do not have a genuine property right to what they own � or think they own�in the eyes of the government. Hernando DeSoto has written a poignant and compelling book, The Mystery of Capital , 7 which contends that the great majority�perhaps four fifths--of the people of the world are outside the realm of protected and recorded ownership of private property. In some cases, they are �squatters� � people who have invaded an area and begun to use (and typically to improve) the property or live in the property, even though they don't have a government-sanctioned right to do so.

Others have taken land that belonged to no one and made use of it �they have taken it from the commons and improved it � but they can't get a deed from the government. There are more bureaucratic rules and requirements than they can fulfill and more bribes to government officials than they can pay. As DeSoto says, �They have houses but not titles; crops but not deeds; businesses but not statutes of incorporation� (DeSoto, p. 7) When governments clearly are in control, but do not recognize or help to protect certain property rights, those rights are not worth as much and are not as productive in the economy.

Establishing strong property rights can increase efficiency and create wealth in an economy. Yet governments do not always work for this goal. Thrainn Eggertson 8 reviews the literature that provides some reasons for this. One reason is that it is costly for a government to create and maintain a property rights regime. The process of discovering or establishing the rights, recording them (and exchanging them), and enforcing them requires time and effort. Until a resource becomes sufficiently valuable to overcome the burden of cost, a government may logically avoid establishing and protecting property rights for a resource.

A second, perhaps less obvious, reason that governments sometimes pass up opportunities to strengthen property rights is political opposition. Organized interests that lobby government are typically interested in protecting and building their own wealth, not necessarily doing what is best for the country.

When one resource is more efficiently used due to better property rights delineation and defense, that inevitably changes the supply and/or demand in many other markets that are linked to that resource. Consider the case of offshore U.S. fisheries in general, and the Alaska halibut fishery in particular.

During the twentieth century, competition for Alaskan halibut created a tragedy of the commons. Regulators stepped in to specify an allowable annual catch for the fish. Access was allowed to an unlimited number of fishers and vessels, but the regulators then shortened the season until the allowable catch was met. That season grew shorter and shorter, until in the 1980s it lasted only a few days each year. In that time, each vessel owner had to get as many fish as possible. Property rights to the fish were only established by legally catching them. The very short season meant that vessels had to fish almost without regard to bad weather, and the entire catch had to be brought to market. With such a short season, most of the fish had to be processed or frozen, reducing its value compared with its value when fresh. Owners of fishing vessels bought costly, high-technology boats and equipment in order to catch more fish during the short and frenzied season. The costly vessels were of little use the rest of the year.

Meanwhile, other fisheries, including the Canadian halibut fishery, began to adopt a property rights approach to fishing called. �Individually Tradeable Quotas� or ITQs for short. Each fisherman had a legal right to a specific portion of the total allowable catch for that season. This radically changed the fishing situation � for the better. As Donald Leal shows, 9 beginning in 1991, when the Canadians allocated the ITQs among the existing vessel owners, the season began to lengthen � going from 6 to 245 days. Ultimately, this meant that 94 percent of the catch was sold on the fresh market, greatly increasing its value. Safety was increased and fishing costs fell. The number of vessels declined dramatically, as less efficient fishers gained by selling their quota to others. The United States learned from the Canadian experience and Alaskan halibut fishery regulators issued similar property rights quotas in 1995, with similar results.

Yet soon after the Alaska halibut fishery adopted ITQs, the U. S. Congress placed a moratorium on additional use of ITQs in Alaska. Why? Some opposition to ITQs comes from the owners and workers of businesses that process and sell frozen Alaska fish. The spread of the ITQ system would harm their business, at least in the short run, and they successfully fought against it. This opposition illustrates that progress � even when it brings more efficiency and increases wealth � normally harms some market participants, at least temporarily. Those participants can be expected to fight progress. That may mean fighting against the establishment of property rights.

In the next lecture, we will examine the importance of property rights in producing and distributing information in a market economy. Stay tuned.

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1Harold Demsetz, �Toward a Theory of Property Rights,� American Economic Review (May 1967).

2The importance of the costs, as well as the benefits, of property rights creation, and the role of costs in delaying the formation of rights, was make more rigorously and extended in Anderson, Terry L. and Peter J. Hill, �The Evolution of Property Rights: A Study of the American West,� Journal of Law and Economics, 18 (No. 1, April 1975): pp. 163-179.

3 An early bibliographic review of this and other elements of property rights development and their importance in the context of natural resources is found in Richard L. Stroup and John Baden, "Property Rights and Natural Resources Management." Literature of Liberty 2(4), (October/December 1979), pp. 5-44. See also John a. Baden, Richard L. Stroup, and Walter N. Thurman, "Myths, Admonitions and Rationality: The American Indian as a Resource Manager." Economic Inquiry 19. (January 1981), pp 132-142. The

4Francis Haines, The Buffalo , (New York: Thomas Y. Crowell Co., 1970), pp. 156-159.

5Terry L. Anderson, Conservation�Native American Style , (Bozeman: PERC, 1996)

6Anderson, Terry L. and Laura E. Huggins, Property Rights: A Practical Guide to Freedom and Prosperity , (Stanford CA: Hoover Institution Press, 2003).

7 Hernando Desoto, The Mystery of Capital: Why Capitalism Triumphs in the West, but Fails Elsewhere ,(New York: Basic Books, 2000).

8See Thrainn Eggertson, Economic Behavior and Institutions , (Cambridge: Cambridge University Press, 1990) and especially chapter 8 on �The Emergence of Property Rights.�

9Donald Leal, Fencing the Fishery: A Primer on Ending the Race for Fish , (Bozeman: PERC, 2002); available also at: http://www.perc.org/publications/guidespractical/fence_fishery.html.