In Chapter 3, I pointed out that in order to cooperate, resource owners must cede to each other control over some of the attributes of their resources. Since it is too costly to price every attribute, their use will be sub-optimal, and some potential gains will be forsaken as a result. Sole ownership of all of the resources involved would eliminate the deadweight loss associated with cooperation. However, sole ownership may result in yet a greater loss due to reduced specialization; if this is the case, it will not be chosen. It might appear that in the case of commodities or assets that consist of single physical entities rather than those that are more complex, sole ownership would be routinely adopted. But because most, if not all, transacted commodities have many attributes, multiple ownership of commodities may be preferred to sole ownership. In this chapter, I shall suggest sources of potential gains from multiple ownership, offer hypotheses regarding the form the division of ownership will take, and discuss the organizations that are expected to emerge to handle relations among the owners.

The physical entities I consider to be commodities or assets typically consist of many attributes, and often different subsets of asset-attributes are owned by different individuals. For instance, the economic and legal ownership of every asset subject to guarantee (or to liability) is divided between its holder and its guarantor; similarly, the ownership of every rented asset is divided between the nominal owner and the renter.

Since the publication of the first edition of this book I have continued to conduct research regarding economic organization and political economy. This work is reflected primarily in Chapters 5 and 6 of the current edition. I have also separated the discussion of divided ownership from that of the firm. The former now occupies Chapter 4, whereas in Chapter 5 I offer new thoughts on the latter. In Chapter 6 I briefly speculate on the emergence of property rights and the state.

Teaching property rights courses over the last few years has led me to discover in the first edition some errors, many ambiguities, and several instances that call for elaboration. I have attempted to correct the mistakes, clarify the exposition, and elaborate when necessary. I have also added a number of illustrations, some of which derive from new research on property rights.

I wish to thank Dean Lueck, who read the entire manuscript, for his helpful comments; my daughter Tamar, for enlivening the presentation and protecting the English language; and the Earhart Foundation for its generous financial support.

By the beginning of the twentieth century, slavery had largely disappeared. Although the institution is extinct, comparing slaves and free laborers and exploring the forces that permitted slavery to flourish under certain circumstances can shed light on present-day institutions. It is particularly illuminating with respect to the understanding of the evolution of the status of women and general policing and ownership practices.

THE SLAVE CONTRACT

Labor services, routinely exchanged in the market, are subject to contract. The typical contract for the services of a free worker transfers a rather narrow, usually short-term set of attributes from the labor owner to its buyer. Slavery, too, may be viewed as a labor contract – one, however, that gave slave owners extensive rights over their slaves. In the case of forced slavery, the contract extended over the slave's lifetime. The voluntary slave contract typically specified a shorter duration and gave the owner fewer rights over the slave than did the forced slave contract.

Forced slavery was initiated by theft – free people were captured and, as the term suggests, were forced into slavery. Voluntary slavery was the result of an explicit contract – a contract to which both parties agreed, presumably in the belief that signing the contract would be beneficial to each. In some cases voluntary slavery resulted when people who had posted themselves as loan collateral defaulted on their contract and lenders assumed ownership over them. Indentured servitude, a form of voluntary slavery, was a direct method of repaying loans.

In the slave societies of the American South and the West Indies, as well as in others, slaves consistently – albeit rarely – bought their contracts from their owners in order to redeem themselves from slavery. In these societies the law afforded owners virtually absolute rights over their slaves, only seldom granting any legal rights to the slaves themselves; consequently slaves were not legally entitled to own the property necessary for self-purchase. There was no legal barrier or authority to stand in the way of owners' retaining both slave and freedom money. Nevertheless self-purchase, whereby slaves acquired legal rights to their own labor, did occur.

As will be elaborated upon in Chapter 7, the study of property rights and of the costs of transacting can yield an explanation as to why slaves were able to buy their freedom; such explanations can be tested against the facts. The property rights model I develop in this book can provide explanations of an array of such phenomena, which standard economic theory cannot successfully address. These explanations range from identifying the reasons behind the choice between wage and piece-rate contracts to pinpointing the conditions under which charity is more efficient than profit-seeking behavior.

In the following chapter, I shall define “property rights” and introduce some of the central ideas of this book. In Chapter 2, the examination of the gasoline shortage of the 1970s illustrates the usefulness and importance of the property rights framework and familiarizes the reader with its mechanics.

In previous chapters I demonstrated the expediency of using the property rights approach to explain various aspects of such specific phenomena as gasoline price controls and slavery, and to develop a general approach to, among other things, non-market allocation, the maximizing role of restrictions on private property rights, and, in the context of farm tenancy, the choice among various forms of control. The property rights framework can be applied to other problems as well. I shall now briefly consider several of these problems, beginning with an analysis of the individuals' ability to protect themselves against losses to monopoly, proceeding to a discussion of the relationship between property rights and theft and of property rights in relation to innovation and to price information, and concluding with an exploration of property rights as they relate to wildlife.

PROTECTION AGAINST LOSSES TO MONOPOLY

Monopolies are said to result in resource misallocation, which takes two forms. The first and better-known type of misallocation arises because monopolies produce “too little,” charging prices that exceed marginal costs, whereas the second type arises in the process of creating monopolies. Would-be monopolists spend resources in order to attain monopoly positions, and such expenditures are dissipating. The magnitude of these capture costs is comparable to that of the expected profits of the monopoly. Naturally, monopolists have economic rights to whatever gains they obtain. Since monopolists' gains exceed their contributions, their gains occur, in part, at the expense of others; thus, they also seem to have the right to harm other people.

Having analyzed the causes that allow properties to be kept in the public domain, I can now address the issue of the formation of economic (though not necessarily legal) rights. It might be tempting to trace the pattern of currently existing property rights holdings to its point of origin to determine how and why it came about, yet such an effort would be futile. The ability to consume commodities, including those necessary to sustain life, implies the possession of rights over them. Once this is understood, it becomes clear that one cannot expect to discover any evidence of a pre–property rights state, since it is not possible to endow a pre–property rights state of affairs with meaning. In order to gain a toehold on the evolution of property rights, one must start with the simultaneous emergence of life and property rights and then consider a world where some rights are already in place. One must resort to something less dramatic than, but similar to, the physicist's big-bang theory. Once some rights are already in existence, it is possible to explore their evolution with respect to changes in economic conditions and legal constraints.

Inferences about the creation of property rights may be drawn by studying instances of anarchy or violent upheaval that necessitated radical acts of rights redefinition. A spectacular example is that of the California gold rush, described and analyzed in detail by Umbeck (1977).

People have discretion over how to delineate rights, and as part of their maximization effort they do so to whatever degree they desire. Rights are never perfectly delineated, however, because the fact that commodities are not uniform and are expensive to measure makes perfect delineation prohibitively costly. Nevertheless, since people do what they deem “best,” rights may be said to be always well delineated.

Those properties that people choose not to delineate are in the public domain. Such properties include much of the world's oceans; they also include the cool air in air-conditioned shopping malls, which is not charged for on the margin. Properties in the public domain can be augmented or diminished. As the values of commodities and of commodity attributes change, and as the costs of delineation and of protection change, people's decisions regarding what to leave in, what to relinquish, and what to reclaim from the public domain change correspondingly.

The public domain is ubiquitous; innumerable commodity attributes are placed in it. Any service not fully charged for on the margin is at least partly relinquished to the public domain. Owners could charge for such services, but the extra returns often do not justify the extra costs. For instance, concert-hall owners relinquish to the public domain the differential in valuation among equally priced seats. When the value of concert-hall seats falls – which might happen when the hall is used by a local choir rather than a famous opera star – seats are expected to be priced in lesser detail.

The property rights approach to the study of economics has been promoted by market-oriented economists, who have used it occasionally to demonstrate the superiority of the market. Contrary to the perception that property rights tools may best be used to analyze the market economy, where allocation is performed largely if not entirely by prices, these tools seem to be uniquely well suited to analyzing resource allocation in non-market settings. Under the Walrasian approach, where rights are perfectly defined, nothing is lost by quickly dispensing with the topic of property rights, for there is little to say about them within that model, where prices determine everything. Indeed, the Walrasian model may provide satisfactory answers to many problems in capitalist economies, where prices play a vital role in economic life.

Those economists who have contributed most to the study of property rights tend to be strong advocates of unregulated markets. They contend that people and the economy thrive when left to their own devices, and that government intervention tends to reduce wealth. In the market, the argument goes, prices move resources to their highest-value uses; when prices are not given the opportunity to perform their function, misallocation results. Government intervention is deemed acceptable in such areas as national defense, police, the courts, and the money supply; such intervention is said to be desirable only inasmuch as it facilitates the functioning of markets. Despite the prevalence of this reasoning, government regulations cannot be dismissed on a priori grounds.

The intellectual content of “property rights,” a term that has enchanted and occasionally mesmerized economists, seems to lie within the jurisdiction of the legal profession. Consistent with their imperialist tendencies, however, economists have also attempted to appropriate it. Both disciplines can justify their claims, since the term is given different meanings on different occasions. Perhaps economists should initially have coined a term distinct from the one used for legal purposes, but by now the cost of doing so is too high. I attempt, however, to make clear the meaning I give to “property rights” and to demonstrate why property rights so defined are an appropriate subject for economic analysis.

The material of the book is at the heart of a course I have taught in recent years. Undergraduate students take my approach in stride. Graduate students often vigorously resist my dissatisfaction with the zero transaction costs model; converting them is, however, rewarding. This book is influenced by the diverse classroom reactions. It is an attempt to appeal both to those with little training in economics and to specialists.

I am grateful to my former students Douglas Allen and Dean Lueck and to my colleague Paul Heyne, who read early drafts of the book and forced me to reformulate many of my ideas and to clarify their presentation. Douglass North, who supported the project from its infancy, also read the entire manuscript and made numerous valuable suggestions. Victor Goldberg and Levis Kochin provided useful comments as well. I also thank Elizabeth Case and my daughter Tamar for excellent editing; they demonstrated that clear writing enhances clear thinking. Finally, I wish to thank the Earhart Foundation for financial support.

At the heart of the study of property rights lies the study of contracts. Contracts, whether formal or informal, reallocate rights among contracting parties. I will focus here on private contracts that are enforceable by the courts and the police. The tenancy contract between tenant and landlord – between the owner of labor and the owner of land – is relatively simple and is thus a suitable point from which to begin the study of contracts.

On a family farm, a single operator or a single family – the owner of labor – undertakes the bulk of farm activities. Family farming is common and relatively simply organized. By studying tenancy contracts in the context of family farming, it is possible to isolate some basic contracting problems that may be obscured in more complex organizations. As a background to the analysis of the tenancy contract I offer a critical review of the traditional approach to the relationship between tenant and landlord.

THE SHARE CONTRACT AND CHEUNG'S CONTRIBUTION

Price theory textbooks routinely introduce the notion of a production function and discuss the marginal product of a factor such as labor for given levels of such other factors as capital and land. Given the productivity of the factors and the market prices of factors and products, it is easy to determine both the optimum amounts and the values of the contributions of each factor.

In the following discussion an elaboration of a single example – the gasoline price controls of the 1970s – serves to illustrate the usefulness and power of the property rights framework. It also introduces tools that are useful in analyzing situations not subject to government intervention, in which the price of a commodity (or a commodity-attribute) differs from the (supposed) market clearing price.

Chapter 1 presented a property rights proposition central to this book: Given that property rights are never perfectly delineated, some valued properties will always be in the public domain. In the present chapter the nature of maximization, as affected by properties in the public domain, will be examined and the actual resolutions of several public domain issues will be analyzed. Because an analysis of rationing by waiting offers a convenient introduction to the subject of property rights, I will briefly concentrate on such an analysis; subsequent discussion will provide a more detailed analysis of maximization under price controls, which will highlight major features of the substance and the mechanics of property rights.

RATIONING BY WAITING

The rationing by waiting model used here, which is stripped of many real-world features, is most elementary. Using this model makes it easy to concentrate on the public domain issue while ignoring peripheral problems. I will use the results of this basic analysis in my subsequent analysis of the price controls placed on gasoline in the early 1970s.

The economists who first adopted the property rights framework in their analyses often considered any government restrictions on those rights (“attenuation of rights”) to be undesirable. A person's ability to realize the potential value of his or her property depends on the extent of his or her property rights, which consists of the ability to use (and exclude), to alienate, and to derive income from the property. The ability, or power, to exclude prevents the property from becoming common property, and the ability to alienate and to derive income permits the realization of gains from exchange. Since restrictions generally reduce freedom of action, restrictions on a person's property rights reduce the value of the property to its owner. Thus it would appear that such restrictions are harmful. In this section I will demonstrate that restrictions that seem to attenuate rights in fact often help to delineate rights more clearly.

Restrictions, that is, non-price allocations, can have no useful role in the Walrasian model. According to that model prices alone can direct all resources into their highest-value uses and will yield efficient allocation, since price adjustments are costless and rights are well defined. Restrictions, then, are at best superfluous and may well result in lower output. The unfavorable attitude by economists toward restrictions on, or attenuation of, rights may reflect the implicit application of the Walrasian, costless-transacting model.

In spite of the Walrasian model, restrictions on individuals' freedom to do what they wish with “their” property are widespread even in capitalist market economies.

For many years the theory of economic organization was nearly synonymous with the theory of the firm. Standard economics textbooks occasionally referred to other forms of organization, such as the family and government, but the firm was the only organization consistently and systematically discussed. Nevertheless, the exact function of the firm remained unclear. Knight's (1921) attempt to add substance to the construct called the “firm” did not fare very well, and Coase's (1937) revolutionary approach to organization required several decades, as well as his own work on social cost, to begin to influence economists. Both of these efforts focused on the firm. In more recent years, Coase's transaction cost ideas have been exploited by economists attempting to generate a theory of the firm, as well as by others who question the usefulness of such a theory. The insights gained through these efforts have been considerable, yet our understanding of organization is only in its infancy. In this chapter the transaction cost approach to organization will be extended.

In order to appreciate the need for the transaction cost approach and its contribution, one must first examine the received model of the firm extensively and critically. I attempt to show that as a description of real firms the received model is untenable, and that under conditions that would allow a textbook firm to exist, its function would become inconsequential. Turning to general problems of organization, I first consider the distinction between market and firm transactions and the significance of Coase's discussion of liability.

The Cambridge Series on the Political Economy of Institutions and Decisions is built around attempts to answer two central questions: How do institutions evolve in response to individual incentives, strategies, and choices? How do institutions affect the performance of political and economic systems? The scope of the series is comparative and historical rather than international or specifically American, and the focus is positive rather than normative.

The first edition of this work has become the classic statement of the property rights paradigm. In this second edition Yoram Barzel clarifies, elaborates, and extends the argument. Clarifications consist of more straightforward writing and making effective use of diagrams to illustrate complex theoretical points. Elaboration takes the form of greater depth of analysis in various sections of the study; for example, the old chapter “The Old Firm and the New Organization” has been divided into two chapters that now include new sections on divided ownership and on insurance. Barzel extends the argument to the role of the state in the formation of rights, the role of government in lowering transaction costs, and property rights to wildlife.

The property rights model developed in this book is an important extension and modification of economic theory, explaining an array of phenomena that standard theory cannot successfully address.

THE DEFINITION OF ECONOMIC AND LEGAL RIGHTS

What are property rights? The term “property rights” carries two distinct meanings in the economic literature. One, primarily developed by Alchian (1965, 1987) and Cheung (1969), is essentially the ability to enjoy a piece of property. The other, much more prevalent and much older, is essentially what the state assigns to a person. I designate the first “economic (property) rights” and the second “legal (property) rights.” Economic rights are the end (that is, what people ultimately seek), whereas legal rights are the means to achieve the end. In this book I am concerned primarily with economic rights. Legal rights play a primarily supporting role – a very prominent one, however, for they are easier to observe than economic rights.

I define the economic property rights an individual has over a commodity (or an asset) to be the individual's ability, in expected terms, to consume the good (or the services of the asset) directly or to consume it indirectly through exchange. According to this definition, an individual has fewer rights over a commodity that is prone to theft or restrictions on its exchange.

The notion of rights is closely related to that of residual claimancy. The residual claimant to, say, an apartment house is its economic owner in that he is able to gain (here by exchange) from an increase in the value of the building, whereas he loses from a reduction in that value.

A RETURN TO FREE MARKET CONCEPTIONS: WHY?

The conceptions about the self-regulating mechanisms associated with markets have undergone the equivalent of a long wave. During the Great Depression of the 1930s, a majority of economists were critical of the institutional impediments to the free functioning of markets. Only a minority argued that it was in the very nature of free markets to trigger large instabilities and/or stagnation (Weir and Skocpol, 1985). After World War II, the Keynesian heterodoxy became the core of significant revolution concerning the respective roles that the state and market should play in the long run social and economic reproduction of capitalism: Adequate public regulation and fine tuning of monetary and fiscal policies could promote quasifull employment, along a steady growth path. Basically market mechanisms had to be tamed by a series of legislation, regulation, and collective agreements, as well as built-in stabilizers in the tax system and/or in the reaction functions of central banks. As Joan Robinson recurrently pointed out, markets were efficient for allocating scarce resources between alternative goals via the formation of relative prices. But one major drawback resulted from the fact that pure market mechanisms were generally unable to provide full employment and macroeconomic stability. In fact during the fifties and sixties this view was widely shared by almost all governments, including the most conservative ones. Did not Richard Nixon declare, “Now we are all Keynesians”?