Property Law What can be privately owned 093009

Property Law What can be privately owned? 09/30/09 Prop_C 1

What can be privately owned? Public and private goods Pure Private Good - one person’s use precludes the use of the same good by another person – rivalry in use - it is relatively cheap to enforce property rights over private goods – excludability Pure Public Good - one person’s use does not preclude the use of the same good by another person – no rivalry in use - it is relatively expensive to enforce property rights over public goods – non-excludability 09/30/09 Prop_C 2

Examples: private or public ? 09/30/09 can of coke car DVD movie shown at a theatre movie rented from Blockbuster movie distributed over the internet police protection radio/TV broadcasting protection against nuclear attack ozone protection health care education Prop_C 3

Some considerations Degrees of ‘publicness’ Role of ‘technology’ - excludability Role of ‘congestion’ (free good and ‘open access’ versus scarce good) – rivalry in use The status of a commodity or service can change from being private to being public (music/entertainment), or from being public to being private (open range/landing space) Because the government supplies a good does not imply that it is a public good (then why do governments get involved? – equity/distribution, paternalism) 09/30/09 Prop_C 4

What should be privately owned? Privately owned – high? degree of rivalry in use - high? degree of excludability Efficiency requires that: - person who values the property most should own the property - the person who owns the property can exclude others from its use (at relatively low cost) If the person who values the property most does not currently own it then private bargaining should result in an efficient re-allocation – trading Further, the good will continue to be produced as long as MB=MC 09/30/09 Prop_C 5

Publicly owned - low degree of rivalry in use - low degree of excludability Private bargaining cannot achieve efficient resource allocation – no excludability – why should I pay for it if I can consume it without paying? Insufficient resources will be allocated to public goods – why should I produce it if I can’t make users pay for it? Too little of the good will be produced if private bargaining is relied on – markets do not work – ‘a market failure’ 09/30/09 Prop_C 6

Example: The lake There there are many cottages surrounding a local lake which happens to be polluted by a foul smell 09/30/09 Prop_C 7

If the lake is cleaned-up each cottager can enjoy the fresh air (and all property values will increase) The cottagers meet and agree to contract with a firm to clean up the lake It will cost $100, 000 to clean up the lake - there are 20 cottages each of which will increase in value by $10, 000 ($200, 000 in total) Each cottager is expected to pay his or her share of the clean up cost - $5, 000 GREAT PLAN! 09/30/09 Prop_C 8

BUT – each cottager can enjoy the fresh air without interfering with the fresh air enjoyment of her neighbours (non-rivalrous use) – no cottager can be stopped from breathing the fresh air (non-excludability) (all cottages will increase in value once the lake is cleanedup) What if some cottagers refuse to pay? These ‘free riders’ will enjoy all the benefits as long as the remaining cottagers are willing to pay to have the lake cleaned-up If this ‘free riding’ sentiment spreads there will be less money available for the cleanup so that less of the pollution will be eliminated - the entire clean-up plan will likely fail 09/30/09 Prop_C 9

If each cottager could be forced to pay for the fresh air they would presumably do so and more ‘fresh air’ could be produced Possible solution: The local government could be asked to pay for cleaning up the lake and then it could impose a special levy (property tax) on all the cottagers to fund the clean up This action treats fresh air as a public good Other examples: Airport security tax (revenue used to produce airport security) Tax on blank CD’s and DVD’s (revenue used to pay artists for their music – an acknowledgement that recorded music is a public good) 09/30/09 Prop_C 10

Another possible solution: What if one individual bought all the cottages at the relatively low ‘polluted air’ prices? The clean up (or fresh air) would no longer be a public good, the one individual being the sole beneficiary of any clean up. Would the sole owner clean up the lake? Yes, to the extent that the resulting increase in property values warrants the clean up. In this aside, the formerly public good (clean air) has been turned into a private good (clean air). Now the fresh air is an excludable item. What about the Coase Theorem? Enforcement costs – ‘free riding’ 09/30/09 Prop_C 11

Summary: Property such as urban land or cars exhibit rivalry and excludability - private markets for these types of property emerge, they are privately owned and traded into their most valuable use Property such uncongested air space or uncongested waterways do not exhibit rivalrous consumption and are therefore treated as public goods - no markets emerge (no scarcity – marginal cost of zero) Property such as clean air in urban environments or national defence exhibit non-excludabilty and are treated as public goods – no markets emerge (scarcity, marginal cost > 0 but not possible to set a price > 0) 09/30/09 Prop_C 12

Public ownership of private goods: de-regulation (private versus public transaction costs) - privatization and de-regulation Governments at times retain ownership over what are essentially private goods (virgin forest, mineral rights) - an historic artefact - vast stretches of uninhabited (uninhabited by Europeans) land water at the time of European settlement (What about aboriginal land claims? ) Governments also create property rights and then distribute these rights (trucking licenses, airline licenses, taxi cab permits, agricultural production quotas, liquor licenses, licenses for stripping and many of the communication licenses, radio, TV, cable, satellite, etc. ) - the creation of these publicly dispensed property rights often goes beyond any underlying technological or economic rationale (rivalry and excludability) - pure public goods not an issue at this point 09/30/09 Prop_C 13

Public transaction cost The public administration of property can sometimes result in misallocation - too few licenses granted (protect profits of existing firms) - licenses are often not granted to the highest bidder (party that values it the most) but on some political basis - licensing conditions (regulations) contain wasteful (inefficient) restrictions or requirements - more legitimate bureaucratic mistakes are made since decisions makers are not ‘playing with their own chips’ 09/30/09 Prop_C 14

Privatization - at times ‘public transaction costs’ can exceed whatever ‘private transaction costs’ might arise if the goods were simply treated as private goods - in such cases there is an economic argument for selling off the ‘public’ good to private owners and allowing it to become private property (mineral or broadcast rights simply sold to the highest bidder at auction with re-sale allowed) De-regulation - the more artificial property rights could be done away with entirely and the market opened up to competition (trucking goods between Windsor and Toronto, operating a bus company or airline) 09/30/09 Prop_C 15

Note some government ownership and regulation results for reasons unrelated to market failure – morality, paternalism, fairness, politics Social values change, notions of equity change, politics change and some privatization and de-regulation occurs for these reasons also Conclusion: Considering efficiency alone, goods that exhibit rivalry and excludability should be privately owned goods that exhibit non-rivalry and non-excludability should be public goods 09/30/09 Prop_C 16

What resources should be protected by property rights? A clear allocation of property rights facilitates private bargaining and cooperative behaviour - the law should set out clear property rights and be willing to enforce these rights However, allocation and enforcement of property rights can be costly, since resources are required by the government or private parties in order to develop and enforce property rights How should the law deal with this trade-off between the desire for a complete set of enforceable property rights and the cost of such a system? Where should the line be drawn? 09/30/09 Prop_C 17

Should the law help to enforce the property rights of retailers who sell CD’s or DVD’s? Should the law help to enforce the property rights of copyright owners of the music or movies ‘shared’ over the internet? It is a matter of the cost of exclusion and the cost of enforcement of property rights. Can owners of property for which the cost of exclusion is relatively high (the good has a high degree of ‘publicness’) be allowed to simply shift this cost of exclusion to legal authorities? What are the public goals? Other solutions in the face of this market failure: Tax on blank CD’s or DVD’s but much music is not even copied in hard form? 09/30/09 Prop_C 18

Fugitive property and the rule of first possession Fugitive property: property which moves around (oil in a common pool, wild animals, fish, weather balloons, a beekeeper’s bees) or has poorly defined boundaries (a person’s reputation? ) Settled property: property which is immobile and has well defined boundaries (your home). (In the common pool oil example - the oil can be considered as fugitive property) But who actually owns the oil and when? What if one of the surface land owners does not extract oil. Can he or she claim ownership of some of the oil extracted by his or her neighbours? 09/30/09 Prop_C 19

Two possible rules: ‘Rule of first possession’: the oil is not the property of anyone until it is actually extracted and taken into their possession. This rule implies ‘first in time, first in right’. A very old principle used in the assignment of property rights to tangible property (unpossessed land, water or other natural resources) In modern times more commonly used in the assignment of property rights to intangible property (inventions, scientific discoveries, computer software, internet addresses, brand names, etc. ) 09/30/09 Prop_C 20

Major advantage of the rule of first possession: relatively inexpensive to apply - there is usually some form of material evidence to establish ‘first in time’ Major disadvantage of the rule of first possession: it encourages an inefficient amount of ‘possession’ individuals take possession of property not only because it is productive to take possession but also because they are hoping to sell the property at some future date - the oil firm extracts oil to store in large tank farms, simply to get it out of the ground and into its possession before anyone else does so - a whole industry was created by individuals who began using internet site names (G&M Friday, July 11, 1997) 09/30/09 Prop_C 21

These are speculative, unproductive attempts to scoop ‘economic rents’ (wealth transfer) The oil extractor does not create value added by pumping the oil to the surface prematurely and storing it in a tank farm – in fact this results in wasteful storage costs (pre-emptive investment) The pre-emptive investment (extraction, harvesting) is what leads to the over-harvesting of renewable resources such as whales, fish or buffalo. In the case of non-renewable resources such as oil, gas or other minerals (and perhaps old growth forests) it leads to an inefficiently high rate of depletion. 09/30/09 Prop_C 22

Second possible rule for ownership of fugitive property ‘tied ownership’ : owner of the surface land has exclusive right to any oil which lays beneath it - Under this rules the ownership of fugitive property is tied to the ownership of settled property. (the mineral rights are tied to the ownership of the surface land - wild animals are owned by the owner of the land they are found on - fish are owned by the owner of the sea bed, or coastline, or stream they were spawned in) 09/30/09 Prop_C 23

Major advantage of the rule of tied ownership: it will not encourage inefficient investment or harvesting (inefficient attempts to establish ownership through possession) Major disadvantage of the rule of tied ownership: it is often difficult to establish ownership rights if the property is truly fugitive (although technological advances can help) (What oil lays under which plot of surface land? Which fish came from which stream? Who has prior claim to the use of the words TIME, COKE, GOLF, GLAMOUR or SPORT as part of an internet site name) - difficult technical and costly problems to solve - who owns the rights to fugitive property will be to a some extent arbitrary 09/30/09 Prop_C 24

Conclusion on fugititve property A trade off exist between ease of administration and the resulting inefficient pre-emptive investment (rule of first possession) and costly administration but no incentives to make inefficient pre-emptive investment (rule of tied ownership) 09/30/09 Prop_C 25

An Example: Fishing from a ‘common pool’ (B and H, from Libecap and Wiggins AER 75(1985): 368 -385 and JPE 93(1985) This example applies to a wide range of ‘common property resources’ such as fish stocks, scenic views, extinction of the buffalo, etc. It is sometimes referred to as the ‘tragedy of the commons’ - a number of private individuals draw oil from a common underground oil pool - each firm owns drilling rights attached to the land on which their extraction rigs sit - but they are all drawing from a common pool 09/30/09 Prop_C of oil 26

Picture this Firm A Firm B Firm C Common Pool 09/30/09 Prop_C 27

The faster a firm pumps oil the more oil that firm will get from the ‘common pool’ Each firm appears to have the incentive to extract oil as fast as is possible But what is the ‘efficient’ rate of extraction? That depends on: - the current rate of oil consumption - the cost of storage - the extent to which oil prices will be depressed as oil is dumped on the spot market - etc. 09/30/09 Prop_C 28

Generally it is much cheaper to store oil underground in the natural pools than it is to bring oil to the surface and store it - but what will the firms do in such a situation? - can we predict? Yes, and a little game theory helps. 09/30/09 Prop_C 29

An oil extraction game There are two firms each facing the following outcomes: - if I extract oil at the lower cooperative joint-profit maximizing (JPM) rate and my neighbour also extracts oil at the lower JPM rate then we will both earn $100 in profit. - if I extract oil at the lower JPM rate and my neighbour extracts oil at the higher non-cooperative, individual-profit maximizing (IPM) rate then I will earn $25 in profit and she will earn $150 in profit. - if I extract oil at the higher IPM rate and my neighbour extracts oil at the lower JPM then I will earn $150 in profit and she will earn $25 in profit. - if we both extract oil at the higher IPM rate then we will each earn $50 in profits. 09/30/09 Prop_C 30

The Oil Extraction Payoff Matrix Firm 1 Firm 2 Extract at lower rate Extract at higher rate 09/30/09 Extract at lower rate Extract at higher rate ($100, $100) ($25, $150) cooperative solution ($150, $25) Prop_C ($50, $50) non-cooperative solution 31

The extensive form – no-cooperation If private bargaining fails - what will each firm do? Consider Firm 1 first: Firm 1's payoff If Firm 2 extracts at lower rate - Firm 1 extracts at higher rate - Firm 1 extracts at lower rate $150 $100 If Firm 2 extracts at higher rate - Firm 1 extracts at lower rate $50 $25 09/30/09 Prop_C 32

Each firm’s dominant strategy will be to extract at the higher rate – they will each earn $50 – non-cooperative solution The efficient (socially optimal) strategy would be for each firm to extract at the lower JPM rate – they would each earn $100, the co-operative solution In the real world there are generally 15 or so firms involved in these oil fields - the courts in the United States are willing to enforce such agreements - the U. S. government encourages these types of agreements Nonetheless, relatively few such agreements are made, implying that non-cooperative, or individual profit maximizing, behaviour persist 09/30/09 Prop_C 33

Why would the Government encouraged collusion? How can this lead to a socially optimal (efficient) outcome? Note that this is a bargaining over how to minimize costs. Oil market prices are set in the larger world market for oil. We want the oil companies to agree on the ‘cost minimizing’ JPM rate of pumping in each oil field - this should generally have little or no effect on the price of oil (it will not affect consumers). 09/30/09 Prop_C 34

Why no Coasian bargain on the division of the cooperative surplus? In this particular case two reasons have been identified. - firms bargain very aggressively in the hope of getting a larger share of the joint profits - overreaching - there is not enough information about the actual size of the oil pool (reserves) and the location of those reserves with respect to each firms’ property (not enough information to determine threat values, the total social surplus or the division of the surplus) 09/30/09 Prop_C 35

Is there a legal (regulatory) solution to this failure of private bargaining? How should the government parcel out new oil leases? - grant all the leases for a given pool to one bidder? - mandate joint management among all of the successful bidders in a given pool? 09/30/09 Prop_C 36

The ‘fishing from a common pool’ problem is a very common problem It helps explain the exhaustion of fish stocks in Canada - the government attempted to control the harvest of fish through licensing of Canadian fisher persons (the Federal Government acted as the joint profit maximizer) Two problems arose 1. Too many licenses were granted - because it had inaccurate information on the size of the stocks (it could not determine the joint profit maximizing size of the catch)? - political pressure (it gave up trying to profit maximize) 09/30/09 Prop_C 37

2. Foreigners have the right to fish in international waters in which the same fish stocks migrate - it has not been possible to reach Coasian bargains with these foreign fisheries What incentive do the individual foreign fishing vessels have to limit their catches? It appears that no one can actually predict the longer term size of the fish stocks under alternative harvesting arrangements? There isn't even agreement on the current size of the stocks This problem exist in almost every major international fishery 09/30/09 Prop_C 38

Why no Coasian bargain? Oil field - the information necessary to determine the cooperative surplus and sharing of that surplus is too costly to acquire and too unreliable Fishing example - the cost of bringing all the parties together and determining the extent how to allocate the catch - the property rights held by each party are not known - the extent to which international courts would enforce an agreement across two countries, many states and provinces is unknown 09/30/09 Prop_C 39

This problem is referred to as the ‘the tragedy of the commons’ When you consider that in most cases ‘common’ resources are (or were) exploited by many individuals, firms or nations (ie. fish stocks, whales, buffalo, trees, clean water) it is easy to understand why parties could not reach a cooperative solution. As a result, many of these stocks were depleted at an inefficiently high rate - ‘rule of first possession’ applied Remember, as the number of parties increases transaction costs increase We will consider possible solutions to the above ‘problem of the commons’ later in the course 09/30/09 Prop_C 40

When to privatize open-access resources NOTE we are not dealing with government provided public goods! Consider a ‘state of nature’ (nomadic families roaming the pre -historic landscape) in which nothing is owned – we can ask, what will become owned and when? ‘Rule of open access’: ‘rule of first possession’ - anyone can compete for the possession of the resource ‘Rule of private property rights’: ‘tied ownership’ - owner of the resource has the right to exclude others from its use Based on the previous section - a rule of open access causes excessive exploitation of a resource (over use), while a rule of private ownership gives rise to a cost of excluding others from the use of the resource 09/30/09 Prop_C 41

What is the economically efficient rule? It depends on the situation ‘Open access’ is preferred if: - the resource is uncongested (little risk of over exploitation or premature extraction – price is zero, or near zero) - exclusion of others (boundary maintenance in the broadest sense) is expensive (air space for aircraft or satellite communications, ocean shipping lanes) 09/30/09 Prop_C 42

‘private ownership’ is preferred if: - the resource is congested - cost of exclusion of others is relatively low (farm land, old growth forest) OLD GROWTH FOREST! 09/30/09 Prop_C 43

Level of congestion can change over time, generally, but not always, increasing (use of western ranges and water resources, radio wavebands, landing slots at airports) Cost of boundary enforcement (exclusion) changes over time, generally decreasing, largely due to technical change (the invention of barbed wire, remote sensing, enhanced knowledge of the migratory patterns of wild animals, etc. ) Society might decide to alter the legal status of a resource from ‘open access’ to ‘private property’ Previously ‘open access’: landing slots at airports, the electromagnetic spectrum used by broadcasters, fishing and hunting rights, timber harvesting rights, grazing rights, the right to discharge household sewage, etc. Previously ‘private property’: railway right-of-way from Windsor to Leamington, the New York State Barge Canal, any others? ? 09/30/09 Prop_C 44

How are property rights established and verified? How do you know that you are dealing with the true owner of property (unencumbered right to sell the property)? Individuals efforts: receipts, recording serial numbers, branding cattle, securing a collar to your pet, taking a photograph of the object, writing our name on the object Public systems of registration of ownership: motor vehicles or real estate Uncertainty concerning ownership impedes trade - formal recording of ownership encourages trade - formal recording of ownership is costly - this results in the formal registration of costly items (real estate, motor vehicles, financial securities) - if not formally registered the law will not protect the transfer of ownership 09/30/09 Prop_C 45

Can a thief give good title? You buy a watch from someone at a local pub after listening to a sad story about how the ‘owner’ just lost his job. A few minutes later another patron claims that the watch is his and it was just stolen. He is able to recite the serial number recorded on the back of the watch. Should you be allowed to keep the watch, or, should you be required to return the watch? In Canada you would be forced to relinquish the watch, since sellers can only ‘give title’ to property they own - onus is on the buyer to ensure that the seller has good title In many European (Civil Code) countries you would be allowed to keep the watch, if you bought it in ‘good faith’ (truly believed that the seller owned it) - the onus is on the original owner to protect his property from theft 09/30/09 Prop_C 46

Which rule is more efficient? As always, it depends - if the cost of verifying ownership is less than the cost of protecting against theft, then the Canadian rule is most efficient - if the cost of protecting against theft is less than the cost of verifying ownership, then the European rule is most efficient 09/30/09 Prop_C 47

Breaks in the chain of title Uncertain ownership reduces private trade Adverse possession: if a non-owner takes possession of someone else’s property (trespasses) and that possession is ‘adverse’ to the interest of the owner, then after a sufficiently long time period, the ownership of that property could pass to the trespasser if the original owner does not assert her property rights (collect $1 in rent each year to assert her property rights) Adverse possession is efficient for two reasons: - it removes the uncertainty of ownership - it encourages the use of resources by those who value them most (discourages resource owners from leaving valuable resources in disuse and requires them to monitor their property) 09/30/09 Prop_C 48

Estray statutes: determine the conditions under which a finder of lost or abandoned property can assert ownership of that property - they might require that the finder make reasonable efforts to find the owner (by reporting the find to the police or a court, or by placing a public notice) - whatever the conditions, once these are met the finder can keep the property Estray statutes - help in distinguishing a true ‘finder’ from a ‘thief’ - eliminate uncertainty of ownership - encourage owners to protect their property - provide incentives for finders to disseminate information concerning lost articles, thereby reducing search costs 09/30/09 Prop_C 49