Implications of Property Law on Nations’ Resources and Economic Development

 

Greg Mennerick


 

            In a world dominated by cutting edge technology, affluent nations, and brilliant scholars, many nations fail to “run with the pack” so to speak.  These lagging countries remain impoverished and economically underdeveloped in a society driven by markets.  In an effort to boost these nations’ financial status and quality of life, many of the 1st world countries like the United States have offered monetary support and ideas for economic reform, so that they can join the rest of the world in the economic game.  Some believed that economic policies alone were enough to lift the third world countries to financial stability.  Essentially, underdeveloped nations received the message that more participation in global markets equated to economic development and success. 

            However, this notion possesses a caveat.  The exception to this idea is best voiced in a Wall Street Journal article entitled “If Economists Are So Smart, Why is Africa So Poor?”  In this article, authors Stephen Haber, Douglass North, and Barry Weingast explain why a third world nation’s participation does not necessarily translate into prosperity.  They point to Africa and state that since 1980, only two nations – Botswana and Uganda – have grown economically at rates higher than 3% per year.  In addition, 2/3 of the African continent has either remained economically stagnant or shrunk since 1960.  The reason for Africa’s inability to rise out of poverty does not fall on the shoulders of its economic policy reform.  In fact, the true reason transcends a commitment to markets and lies in the basis of political institutions.  More specifically, the economic problem these nations face begin with the law.  In a society without a strong political institution in place to enforce property law and protect the individual rights of the people, an economy will never develop.  Think of a nation’s development as a chain of events:

Ø      Stable political/legal environment and structure leads to:

Ø      Free market system that allows:

Ø      Individual accumulation of property (wealth) and:

Ø      Individual increase in savings and:

Ø      Individual increase in income, therefore:

Ø      The production possibilities curve for that nation expands outward.

Bypassing the first link in the chain of events proves catastrophic for the remaining aspect of the sequence.  Each link builds on the previous one.  When the United States injected the notion of free markets to the impoverished African nations, they were doomed to failure at the onset.  The Washington Consensus “assumed that economic reforms can create efficient markets without simultaneous reform of the political institutions” (Haber).  Yet, as the chain of events illustrates, it can be seen that “without a limit on government and a guarantee of property rights and individual liberty, efficient markets cannot exist” (Haber).  While the finest and most brilliant economic scholars of our time may possess an excellent vision of the potential of the global economy, they must remember that “five minutes of despotism can undo the finest economic theory” (Haber).

Keeping in mind the theme Haber, North, and Weingast maintained throughout their article, one must turn to the task at hand and assert what implications property law inflicts upon a nation’s resources and economic development.  In order to dive into the complexities of this issue, two basic questions first arise and must be addressed:

Ø      What exactly is the definition of property law?

Ø      What are the origins of property law?

The answer to the first question is best characterized in Harold Demsetz essay “Toward a Theory of Property Rights.”  Demsetz states that property rights “are an instrument of society and derive their significance from the fact that they help a man [or woman] form those expectations which he [or she] can reasonably hold in his dealings with others … These expectations find expression in the laws, customs, and mores of a society” (Wahl - Demsetz 173).  In layman’s terms, property rights are one’s claim to an object or asset to which they believe to own.  For example, if one owns a 1999 Toyota Celica GT, they assume that their property rights and the property law governing society will help protect that asset from others. 

When delving into the complexities of the second question, one must take into consideration more than one point of view.  For the purpose of this paper, an examination of John Locke, Adam Smith, Jeremy Bentham, and John Stuart Mill’s ideas surrounding the origins of property rights and law shed sufficient light on this issue.

 

Origins of Property Law

Turning first to John Locke, the Lockean state of nature and belief in natural rights is central.  According to Locke, his state of nature was a state before the presence of an organized government and governing rules.  Yet, even without rules, this state of nature was not a state of war like earlier philosophers, particularly Thomas Hobbes, had stated.  No, Locke believed that because “men became acquainted with the law of nature through their reason” they inherently know and feel a sense of natural rights (Anderson – West 21).  Locke believed that natural rights were rights bestowed by the creator. Thus, they transcended the scope of authority afforded to the crown.  However, even in this state of nature filled with people “divinely inspired by natural law” Locke envisioned mistakes being made (Spreng 36).  Dangers exist when “each and all individuals [are left] to do their own policing of their individual property rights” (Anderson – West 21).  In Locke’s own words, “every Man hath a right to punish the Offender, and be Executioner [of this law]” (Locke qtd in Anderson – West 21).  Because of these inevitable mistakes and potential pitfalls, Locke believes a government must be instated.  Throughout all of Locke’s lengthy and brilliant literature regarding the role and function of the government, the crux of his belief stemmed from his notion that “it is practical to consent to a social contract forming a government that is primarily a trustee for its citizens” (Anderson – West 21).  Essentially, Locke says that because of the potential problems that will arise in the state of nature, it is necessary for people to “take sanctuary under the established laws of government, and therein seek the preservation of their property” (Locke qtd in Spreng 40).  From an economic standpoint, the marginal benefit received from autonomy in the state of nature is less than the marginal benefit derived from a state of nature in which people enjoy a social contract with their government (Spreng 41).

Coming full circle, before John Locke’s Two Treatises of Government in the 1690’s, “property had been viewed as something exclusively created by the government” (Anderson – West 20).  Yet, as ascertained in the previous paragraph, Locke maintained that property was the source of government.  Reason tells us that Locke’s message is correct:  property rights pre-date government because they are grounded in the doctrine of natural law which existed in the state of nature before organized government.  Thus, Locke concludes that the “government has no other end but the preservation of property” (Anderson – West 20).

Turning next to Adam Smith, the father of economics and author of The Wealth of Nations, one can draw several key parallels and one major distinction between his ideas and John Locke’s literature.  Like Locke, Smith insists that “to hinder a man from employing his labor how so ever he desires without injury to his neighbor is a violation of the most sacred property … the property which ever man has in his own labor, as it is the original foundation of all other property, so it is the most sacred and inviolable” (Smith qtd. in Anderson – West 24).  These words echo the writings of Locke in the sense that Adam Smith seems to assign a similar weight or importance to one’s property.  To both men, one’s property embodied one’s self because it was one’s labor and hard work which allowed them to accumulate property in the form of assets and wealth.  Thus, the preservation of one’s property is a crucial aspect for a just and economically efficient society. 

Edwin G. West contends that Adam Smith did make one key distinction between himself and John Locke.  Even though what Smith called “natural liberty” in The Wealth of Nations parallels Locke’s natural rights, Adam Smith modified Locke’s categorization significantly (Anderson – West 24).  In a series of lectures given at Glasgow University in the early 1760’s, Smith “confined natural rights to the rights of liberty and life, whereas the right to property was an acquired right depending on the current disposition of society” (Anderson – West 24).  Essentially, Smith broke up the famous Lockean summary of natural rights as being the right to life, liberty, and property.  Smith saw the right to property as peripheral to the others, though it still carried the weight of equal importance.  In the midst of this modification or evolution of Locke’s original ideas, Adam Smith’s theory on the origin of property does not stray far from Locke’s original message.  Smith still maintains that “till there be property there can be no government, the very end of which is to secure wealth and to defend the rich from the poor” (Smith qtd. in Anderson – West 25).  Although the wording may differ, Smith’s message echoes Locke’s – property pre-dates organized government and the government’s primary responsibility lay in the preservation of its citizen’s property rights.

Contrary to both John Locke and Adam Smith, Jeremy Bentham poses another way to analyze the origins of property law.  In Bentham’s Theory of Legislation in 1795, he rejected natural law and stated that “advocates of natural law and natural rights had advanced no proof” (Anderson – West 29).  In fact, Bentham went to on insist that “natural rights were dangerous metaphors – nonsense on stilts – based on capricious and subjective feelings” (Anderson – West 29).  Bentham felt that true property rights were creatures of the law.  In his eyes, property did not and “cannot exist before laws and the government” (Anderson – West 29).    With the view that “property and law are born together and die together,” Bentham began to expand upon his utilitarian beliefs (Anderson – West 29).  In short, he maintained a pleasure principle.  Simply, an individual or the government should indulge in actions which would eventually yield the greatest happiness or greatest good for the greatest number.  (This parallels the Kaldor-Hicks Criterion in a way.) 

However, even though Bentham’s theory flies in the face of the Locke and Smith’s literature regarding natural rights, the notion of the greatest good for the greatest number pervades the overall idea of the function of the government.  From a Benthamite point of view, it is in the best interest of the greatest number for the government to preserve its citizen’s property.  Bentham states this idea in The Theory of Legislation by saying, “Labeour, and I will assure to you the enjoyment of the fruits of your labeour – that natural and sufficient recompense which without me you cannot preserve; I will insure it by arresting the hand which may seek to ravish it form you” (Bentham qtd. in Spreng 57).

John Stuart Mill, a follower of Bentham’s utilitarian thinking, placed another twist on the issue of property.  He particularly took issue with Adam Smith’s assumption that “invisible hand” theory provided the most efficient and productive economy.  As a utilitarian concerned with the pleasure principle, Mill felt that there were some aspects in society which should be publicly dealt with instead of privately owned.  In essence, this is a public vs. private goods debate, and Mill favored public goods.  Furthermore, Mill maintained that the preservation of property was indeed an essential part of civil society, but asserted many complaints regarding the distribution of wealth.  It was here in which “Mill began to inject his Utilitarian value judgments as to how the wealth of recently deceased persons should be disposed of” (Anderson – West 34).

Looking at these three great thinkers, Locke, Smith, Bentham, and Mill, one can see a spectrum of parallels and stark contrast.  Yet, the one common thread uniting all four is the notion that property and law are intrinsically intertwined so that an organized government is essential protecting private property.

Theory of First Possession

After examining the origins of property law and theory, one must now turn and look at how property possession can be assessed and why property rights are an essential part of the legal structure. 

Different methods exist which determine how a society may assign initial property rights.  Looking at the theory of first possession and the labor theory of value exemplify the variations which exist.  First of all, the notion of first possession is a theory recently advocated by Professor Richard A. Epstein and emphasized in the famed Pierson v. Post decision in 1805 (Spreng 47 and Wahl 159-165).  Specifically, in Pierson v. Post, the facts of this case showed that Post labored in the hunt for the fox, but Pierson was the one who killed it and took possession. The court “considered the possession, and hence ownership of a wild fox … Further, the court ruled that possession required physical capture and not simply wild pursuit” (Anderson – Lueck 213).  Another example of first possession occurs in the whaling industry.  While the possession of the whale in the whaling industry has not undergone strict state scrutiny, Robert C. Ellickson of Yale contends that “property rights may emerge from sources other than the state - in particular, from the workings of nonhierarchal social forces (Wahl – Ellickson 187).  In this instance, the network of whalers communicated an understanding that the “iron holds the whale” (Wahl – Ellickson 198).  Whichever boat harpooned the whale first and showed intent to maintain the hunt had earned possession.

Alternatively, John Locke proposed a different method of ownership based on a labor theory of value.  Rooted in his belief that individuals were in possession of their labor, Locke would have ruled in favor of Post in the 1805 case.  In Locke’s eyes, the labor involved in the pursuit of the hunt qualified Post for ownership of the fox.  Perhaps the best example of this Lockean idea manifests itself in the children’s story of The Little Red Hen.  In the story, the little red hen labors to make the bread all by herself.  Thus, in the end, she asserted sole ownership of the bread (Spreng 45-46).

Regardless of which method one favors in deciding initial property ownership, the key is to step back and acknowledge that at least a legal-based property rights system exists.  Both Milton Freedman and Frederick Hayek point out that “economic freedom, including private property is a critical precondition for political and personal freedom” (Spreng 21-22).  Hayek goes so far as to state that “private property is the most important guarantee of freedom, not only for those who own property, but scarcely for those who do not” (Hayek qtd. in Spreng 21).  Thus, one must contend that while the different methods of assuming ownership remain intriguing and vexing issues, reverting back to Freidman and Hayek’s message that property rights preserve personal freedoms is essential.  As long as a society possesses a legal structure dedicated to the preservation of property rights, the methods unto which individuals are allocated ownership will take care of itself and find legitimacy in the fact that the legal structure is legitimate.

 

Coase Theorem

Next, it is necessary to analyze economically why property rights need to be a pillar in a society’s legal structure.  Economics simply defined looks at how one allocates scarce resources over a variety of choices.  Ultimately, the goal lies in the pursuit of maximizing efficiency from the world’s resources. 

When looking at property law in this context, property, in every sense of the word, can be categorized as a scarce resource.  Thus, it should not be a stretch to think of economic efficiency as a legal principle.  In a legal structure that emphasizes the prudent allocation of its resources, “efficiency might constitute a guiding light for a judge” (Mattei 52).  In fact, Ugo Mattei in his book Basic Principles of Property Law asserts that “efficiency … takes into account fundamental notions of justice and fairness” (Mattei 53).  If this is true, then the concepts of economics and justice parallel each other, economic theory can be a valuable tool in the pursuit of justice. 

In fact Ronald H. Coase of the University of Chicago School of Law went a step farther in his 1960 article “The Problem of Social Cost.”  He believed that whenever “parties are left free to negotiate and have the possibility to do so without being restricted by excessive costs, they will reach efficient solutions independently of the legal rules” (Mattei 54).  This became the basis for the famed Coase theorem.  Essentially, Coase argued that the legal rules did not matter when individuals wanted to bargain and the transaction costs were low.  This bargaining translated into Pareto optimality and maximum efficiency.  Thus, when applying the Coase theorem to property law, Coase argues that “the structure of the law which assigns property rights … does not matter so long as the transaction costs are nil” because any form of bargaining will produce an efficient outcome (Katz – Cooter 150).  The only thing that does matter is that the structure of the property law must suppress excessive transactions costs.  Otherwise, as Coase stated, efficiency will take precedence over the law.  Thus, the legal system must be explicit in protecting each person’s property so that they can participate in any bargaining they wish.  If this occurs, table 1illustrates the crux of the Coase theorem with supply and demand curves. 

 

Tragedy of the Commons

The legal structure must be prudent when taking into consideration the issue of private and public goods.  For the most part, privatization of goods reduce outside costs and create the efficiency which Coase desires, and “economists have a tendency to see private law as creating property rights and public law as … lowering their value” (Mattei 44).  However, it may be more appropriate to find the balance between private and public goods because there may be some aspects in which costs may be less if the state took control of some property.  A lighthouse, for example, may be a piece of property best left to the state to control because the cost would be too great for an individual to own and operate and be left with the impossible task of trying to collect money for its services.  “Lawyers see private and public law as cooperating in defining property rights” (Mattei 44).  Perhaps, this is the best way to address this issue.

However, problems do arise when a public good, or common good, is left for the people to consume at their convenience.  In the instance of the tragedy of the commons, some believe that a common piece of property left to be used by the community will spell disaster for that asset.  The best example of this comes from Garret Hardin’s 1968 article entitled “Tragedy of the Commons.”  Hardin “discusses open access and its consequences” by using an example of a pasture and cattle (Anderson – Eggertson 75).  In Hardin’s example, the pasture is open to everyone.  Thus, every person owning cattle allows their cattle to graze in the common pasture.  This arrangement eventually leads to the cattle owners to attempt to maximize their benefit.  Adding one cow to their herd increases the owner’s marginal benefit while the cost to that owner remains the same because the commons inherits the marginal cost of adding one more cow.  Therefore, after a while, the rational actions taken by each individual to maximize individual benefit causes the commons to experience depletion (Spreng 26-29 and Anderson – Eggertson 74-89).

The marginal cost and benefit curves in table 2 illustrate the tragedy of the commons graphically.

Taking into consideration the efficiency ideas of Coase and the notion of the tragedy of the commons, the legal structure faces significant challenges.  First, it must ensure that transaction costs are low, so that the law is not circumvented for the goal of efficiency.  Secondly, the law cannot pursue low transaction costs by placing the state in charge of all property, like in the instance of the commons.  Again, a balance between private and public goods, private and public law, is essential to keeping transaction costs as low as possible while keeping the economics of the tragedy of the commons to a minimum.  Simply, the legal structure must be a system in which the law is self-enforcing and promotes economic efficiency.  The best way to do this is to go back to the original theme behind Locke, Smith, Bentham, Mill, Friedman, and Hayek.  The system must preserve individual freedoms and provide security for people’s property.  Once this has been achieved, a community is ripe for economic development, growth, and efficiency, thus, enabling the law to be self-enforcing.  Individuals will adhere to the property law standards not because laws are laws, but because these laws add to their wealth.

 

Property Law and the Production Possibilities Curve

Thus, the last item to look at is how the legalities of property law contribute to economic development.  In Kevin E. Davis and Michael J. Trebilcock’s article “Legal Reforms and Development,” they both state that “the evidence … suggests that … the integrity, competence, and independence of the formal and criminal courts systems … is a major problem for developing countries” (Davis 33).  In addition, they believe that the biggest challenge for these nations lies in their ability to upgrade the “quality of their legal systems” (Davis 33).  If the quality can be bolstered along with the integrity of the formal legal system, then Davis and Trebilcock believe that the nation has a better opportunity to develop economically.  Davis and Trebilcock concede that the “legal institutions do not play a wholly autonomous role in development; their effectiveness is contingent upon the effectiveness of a number of other intuitions” like an honorable government and free market practices (Davis 33).  The easiest way to envision what Davis and Trebilcock and so many other economists believe when they say that an adequate legal system is a prerequisite for development is through an example.  Perhaps, there is diamond mine in an underdeveloped nation.  If no formal property law or legal system existed, the owners of the mine would have to pay substantial external costs in protecting their assets from theft.  However, if a strong legal system was in place and people recognized this system as legitimate, the external costs would decrease and the Coase theorem would come into play – reduced transaction costs lead to efficiency.  In effect, more diamonds would be harvested and wealth would accumulate.  Taking a step back, one sees that the formal legal structure made this nation ripe to become efficient, accumulate wealth, and develop economically.  Essentially, this nation’s production possibility curve moved from one being somewhat restricted because of high transaction costs and lack of rules to another curve pushed farther out because of the economic growth.  The production possibilities curve in table 3.

 

In closing, from John Locke to John Stuart Mill, and from Adam Smith to Milton Friedman, most philosophers and definitely most notable economists believe in the concept of property rights and law.  While some may differ regarding the origins and the public/private distinction, this does not change the fact that property laws preserve individual freedoms.  And, one cannot forget what the famed Coase theorem brings to the table.  Coases’ notion of efficiency when applied to property provides the basis for the argument that a formal legal system built around the preservation of property allows for an efficient allocation of resources and provides the foundations for economic growth. 

 

 

Works Cited

 

Anderson, Terry L. and Fred S. McChesney, eds. Property Rights: Cooperation, Conflict, and Law. Princeton: Princeton University Press, 2003.

 

            Eggertson, Thrainn. “Open Access Versus Common Property.” p. 73-89.

           

            Lueck, Dean. “First Possession as the Basis of Property.” p. 200-226.

 

            West, Edwin G. “Property Rights in the History of Economic Thought.” p. 20-42.

 

Davis, Kevin E., and Michael J. Trebilcock. “Legal Reforms and Development.” Third World Quarterly. Vol. 22. Issue 1. Feb 2001. p21-37.

 

Haber, Stephen, Douglass C. North, and Barry R. Weingast. “If Economists Are So Smart, Why Is Africa So Poor?” Wall Street Journal. July 30, 2003. p. A12.

 

Katz, Avery Wiener, ed. Foundations of the Economic Approach to Law. Oxford: Oxford University Press, 1998.

 

            Cooter, Robert. “The Cost of Coase.” p. 150-154.

 

Mattei, Ugo. Basic Principles of Property Law: A Comparative Legal and Economic Introduction. Westport, Connecticut: Greenwood Press, 2000.

 

Spreng, Frank. “Property I: It’s Importance and Origin: A Market Perspective.” p 1-69.

 

Wahl, Jenny B., ed. Overview and Economic Analysis of Property and Criminal Law. New York: Garland Publishing Inc., 1998

 

Demsetz. Harold. “Toward a Theory of Property Rights.” p. 173-186.

 

Ellickson, Robert C. “A Hypothesis of Wealth Maximizing Norms.” p. 187-202.