The effect of property on theory

Monday, March 21, 2005

Economic theory is broadly applicable. However, a society's property-rights structure influences how the theory will manifest itself. It's the same with the theory of gravity. While it, too, is broadly applicable, attaching a parachute to a falling object affects how the law of gravity manifests itself. The parachute doesn't nullify the law of gravity. Likewise, the property-rights structure doesn't nullify the laws of demand and supply.

Property rights refer to who has exclusive authority to determine how a resource is used. Property rights are said to be communal when government owns and determines the use of a resource. Property rights are private when it's an individual who owns and has the exclusive right to determine the legal uses of a resource and receive the benefit therefrom.

Property rights might be well defined or ill defined. They might be cheaply enforceable or costly to enforce. These and other factors play a significant role in the outcomes we observe. Let's look at a few of them.

A homeowner has a greater stake in the house's future value than a renter. Even though he won't be around 50 or 100 years from now, the house's future housing services figure into its current selling price. Thus, homeowners tend to have a greater concern for the care of a house than a renter. One of the ways homeowners get renters to share some of that interest is to require security deposits.

Here's a property-rights test question. Which entity is more likely to pay greater attention to wishes of its clientele and seek the most efficient methods of production? Is it an entity whose decision makers are allowed to keep for themselves the monetary gain from pleasing clientele and seeking efficient production methods, or is it entities whose decision makers have no claim on those monetary rewards? If you said it is the former, a for-profit entity, go to the head of the class.

While there are systemic differences between for-profit and not-for-profit entities, decision makers in both try to maximize returns. A decision maker for a not-for-profit will more likely seek in-kind gains such as plush carpets, leisurely work hours, long vacations and clientele favoritism. Why? He doesn't have property rights to take his gains. Also, since he can't capture for himself the gains and doesn't himself suffer the losses, there's reduced pressure to please clientele and seek least-cost production methods.

You say, "For-profit entities sometimes have plush carpets, have juicy expense accounts and behave in ways not unlike not-for-profits." You're right, and again, it's a property-rights issue. Taxes change the property-rights structure of earnings. If there's a tax on profits, then taking profits in money form becomes more costly. It becomes relatively less costly to take some of the gains in forms other than money.

It's not just businessmen who behave this way. Say you're on a business trip. Under which scenario would you more likely stay at a $50-a-night hotel and eat at Burger King? The first is where your employer gives you $1,000 and tells you to keep what's left over. The second is where he tells you to turn in an itemized list of your expenses and he'll reimburse you. In the first case, you capture for yourself the gains from finding the cheapest way of conducting the trip, and in the second, you don't.

These examples are merely the tip of the effect that property-rights structure has on resource allocation. It's one of the most important topics in the relatively new discipline of law and economics.

Walter E. Williams is a professor of economics at George Mason University.

Respond to this story

Posting a comment requires free registration: