Economics of Law: Ownership and Property Rights

1. Econ 522Economics of Law Dan Quint Fall 2010 Lecture 8

2. Logistics • First homework back today • Second homework due next Monday (Oct 11) • First midterm next Wednesday (Oct 13) – in Bascom 272

3. More on: what can be privately owned?

4. Organizations • Most organizations are not owned by anyone • churches, clubs, cooperatives, charities, etc. • But many corporationsare owned • can be bought and sold like property • General principle: • Organizations whose primary purpose is to earn profits should be owned • Organizations whose primary purpose is something else should not • Ownership leads to a principal-agent problem

5. Multiple forms of public ownership • Open Access • Anyone free to use the resource • Leads to overutilization (Tragedy of the Commons) • Example: oyster beds • Unanimous Consent • Opposite of open access – multiple owners must all agree to any use of the resource • Leads to underutilization • Example: empty storefronts in post-Communist Moscow • Political Control/Regulation

6. Third form of public ownership: political control/regulation Dividing the mountain pasture among individual owners would require fencing it, which is prohibitively expensive. Instead, the highland pasture is held in common, with each village owning different pastures that are separated by natural features such as lakes and mountain peaks. If each person in the village could place as many sheep as he or she wanted in the common pasture, the meadows might be destroyed and eroded by overuse.

7. Third form of public ownership: political control/regulation In fact, the common pastures in the mountains of Iceland have not been overused and destroyed, because the villages have effective systems of governance. They have adopted rules to protect and preserve the common pasture. The sheep are grazed in common pasture in the mountains during the summer and then returned to individual farms in the valleys during the winter. The total number of sheep allowed in the mountain pasture during the summer is adjusted to its carrying capacity. Each member of the village receives a share of the total in proportion to the amount of farmland where he or she raises hay to feed the sheep in the winter.

8. How are property rights established/verified?

9. Fugitive property • Hammonds v. Central Kentucky Natural Gas Co. • Central Kentucky leased tracts of land above natural gas deposits • But geological dome lay partly under Hammonds’ land • Hammonds sued, claiming some of the gas they were extracting was his • (Anybody see “There Will Be Blood”?)

10. Two principles for establishing ownership • First Possession • fugitive property belongs to nobody until someone extracts it, establishing ownership • Central Kentucky would own all the gas, since they were first to actually possess it • Tied Ownership • ownership of fugitive property is tied to something else which is easier to establish – in this case, surface of the land • Hammonds would own some of the gas, since it was located under his land • principle of accession – a new thing is owned by the owner of the proximate or prominent property

11. First Possession versus Tied Ownership • First Possession • generally simpler to apply – easy to determine who possessed property first • but, incentive to invest too much to early in order to establish ownership

12. First Possession versus Tied Ownership • First Possession • generally simpler to apply – easy to determine who possessed property first • but, incentive to invest too much to early in order to establish ownership • Tied Ownership • encourages efficient use of the resource (no need to extract quickly) • but, difficulty of establishing and verifying ownership rights

13. This brings us to the following tradeoff: Rules that link ownership to possession have the advantage of being easy to administer, and the disadvantage of providing incentives for uneconomic investment in possessory acts. Rules that allow ownership without possession have the advantage of avoiding preemptive investment and the disadvantage of being costly to administer.

14. A nice historical example: the Homestead Act of 1862 • Meant to encourage settlement of the Western U.S. • Citizens could acquire 160 acres of land for free, provided • head of a family or 21 years old • “for the purpose of actual cultivation, and not… for the use or benefit of someone else” • had to live on the claim for 6 months and make “suitable” improvements • Basically a first possession rule for land – by living on the land, you gained ownership of it • Friedman: caused people to spend inefficiently much to gain ownership of the land

15. Friedman on the Homestead Act of 1862 “The year is 1862; the piece of land we are considering is… too far from railroads, feed stores, and other people to be cultivated at a profit. …The efficient rule would be to start farming the land the first year that doing so becomes profitable, say 1890. But if you set out to homestead the land in 1890, you will get an unpleasant surprise: someone else is already there. …If you want to get the land you will have to come early. By farming it at a loss for a few years you can acquire the right to farm it thereafter at a profit.

16. Friedman on the Homestead Act of 1862 How early will you have to come? Assume the value of the land in 1890 is going to be $20,000, representing the present value of the profit that can be made by farming it from then on. Further assume that the loss from farming it earlier than that is $1,000 a year. If you try to homestead it in 1880, you again find the land already taken. Someone who homesteads in 1880 pays $10,000 in losses for $20,000 in real estate – not as good as getting it for free, but still an attractive deal. …The land will be claimed about 1870, just early enough so that the losses in the early years balance the later gains. It follows that the effect of the Homestead Act was to wipe out, in costs of premature farming, a large part of the land value of the United States.”

17. When should resources become privately owned? • First Possession and Tied Ownership are doctrines for how ownership rights are determined • Next question: when should a resource become privately owned? • Cost of private ownership: owners must take steps to make the resource excludable – boundary maintenance • Cost of public ownership: congestion and overuse • An economically rational society will privatize a resource at the point in time where boundary maintenance costs less than the waste from overuse of the resource.

18. When should resources become privately owned? • First Possession and Tied Ownership are doctrines for how ownership rights are determined • Next question: when should a resource become privately owned? • Cost of private ownership: owners must take steps to make the resource excludable – boundary maintenance • Cost of public ownership: congestion and overuse • An economically rational society will privatize a resource at the point in time where boundary maintenance costs less than the waste from overuse of the resource. • (either because congestion got worse… • or because boundary maintenance became cheaper)

19. What can be done to prove ownership of something? • Branding cattle • Vehicle ID numberson cars • States grant deeds for property, and keepregistry of legal owner

20. What can be done to prove ownership of something? • Branding cattle • Vehicle ID numberson cars • States grant deeds forproperty, and keepregistry of legal owner • No such system for apples • Too many apples – high cost of maintaining a registry • Apples inexpensive – not much of a problem

21. Remedies

22. Remedies (review) • Maximum liberty: owner can do whatever he/she wants, as long as it doesn’t interfere with another’s property • When it does interfere, externality, or nuisance • Affects small number: private externality, or private bad • Transaction costs low injunctions preferable • Affects large number: public externality, or public bad • Transaction costs high  damages preferable

23. Types of damages • Compensatory Damages • intended to “make the victim whole” • compensate for actual harm done • make victim as well off as before • Can be… • Temporary – compensate for harms that have already occurred • Permanent – also cover present value of anticipated future harm

24. Temporary versus permanent damages • Temporary damages • Require victim to keep returning to court if harm continues • Create an incentive to reduce harm in the future • Permanent damages • One-time, permanent fix • No incentive to reduce harm as technology makes it easier

25. Efficient nuisance remedies • If a nuisance affects a small number of people (private nuisance), an injunction is more efficient • If a nuisance affects a large number of people (public nuisance), damages are more efficient • If damages are easy to measure and innovation occurs rapidly, temporary damages are more efficient • If damages are difficult/costly to measure and innovation occurs slowly, permanent damages are more efficient • What’s done in practice for public nuisances? • temporary damages and injunction against future harm • but…

26. Boomer v Atlantic Cement Co(NY Ct of Appeals, 1970) • Atlantic owned large cement plant near Albany • dirt, smoke, vibration • neighbors sued • plant was found to be a nuisance, court awarded damages • neighbors appealed, requesting an injunction • Court ruled that… • yes, this was a valid nuisance case • and yes, nuisances are generally remedied with injunctions • but harm of closing the plant was so much bigger than level of damage done that court would not issue an injunction • ordered permanent damages, paid “as servitude to the land”

27. Boomer v Atlantic Cement Co(NY Ct of Appeals, 1970) • Atlantic owned large cement plant near Albany • dirt, smoke, vibration • neighbors sued • plant was found to be a nuisance, court awarded damages • neighbors appealed, requesting an injunction • Court ruled that… • yes, this was a valid nuisance case • and yes, nuisances are generally remedied with injunctions • but harm of closing the plant was so much bigger than level of damage done that court would not issue an injunction • ordered permanent damages, paid “as servitude to the land”

28. Limitations/Exceptions toProperty Rights

29. One limitation: ways to give up (or lose) property rights • Adverse Possession (“squatter’s rights”) • If you occupy someone else’s property for long enough, you become the legal owner, provided: • 1. the occupation was adverse to the owner’s interests, and • 2. the owner did not object or take legal action

30. One limitation: ways to give up (or lose) property rights • Adverse Possession (“squatter’s rights”) • If you occupy someone else’s property for long enough, you become the legal owner, provided: • 1. the occupation was adverse to the owner’s interests, and • 2. the owner did not object or take legal action

31. One limitation: ways to give up (or lose) property rights • Adverse Possession (“squatter’s rights”) • If you occupy someone else’s property for long enough, you become the legal owner, provided: • 1. the occupation was adverse to the owner’s interests, and • 2. the owner did not object or take legal action • Estray statutes – laws governing lost and found property

32. Another limitation: determining what happens to your stuff after you die • Owners today control who inherits their property • Wasn’t always the case • Limitations on who inherits lead to… • Circumvention costs

33. Another limitation: determining what happens to your stuff after you die • Owners today control who inherits their property • Wasn’t always the case • Limitations on who inherits lead to… • Circumvention costs • Depletion costs

34. Another limitation: determining what happens to your stuff after you die • Owners today control who inherits their property • Wasn’t always the case • Limitations on who inherits lead to… • Circumvention costs • Depletion costs • Restrictions I place on how they can use it • Impossible  circumvention and depletion costs • Allowed  difficult to maintain efficiency in changing circumstances

35. Another limitation: determining what happens to your stuff after you die • Owners today control who inherits their property • Wasn’t always the case • Limitations on who inherits lead to… • Circumvention costs • Depletion costs • Restrictions I place on how they can use it • Impossible  circumvention and depletion costs • Allowed  difficult to maintain efficiency in changing circumstances • “Restraints on alienation” • Common law generally prohibits perpetuities • Restrictions limited to “lives-in-being plus 21 years”

36. Another limitation: Private Necessity • Property rights generally protected by injunctive relief, BUT… • Ploof v. Putnam (Sup. Ct. of Vermont, 1908) • Ploof sailing with family on Lake Champlain, storm came up • Tied up to pier on island owned by Putnam • Putnam’s employee cut the boat loose, Ploof sued • Court sided with Ploof: private necessity is an exception to the general rule of trespass • In an emergency, OK to violate someone else’s property rights; still must reimburse them for any damage done

37. Another limitation: Private Necessity • Property rights generally protected by injunctive relief, BUT… • Ploof v. Putnam (Sup. Ct. of Vermont, 1908) • Ploof sailing with family on Lake Champlain, storm came up • Tied up to pier on island owned by Putnam • Putnam’s employee cut the boat loose, Ploof sued • Court sided with Ploof: private necessity is an exception to the general rule of trespass • In an emergency, OK to violate someone else’s property rights; still must reimburse them for any damage done

38. Another limitation: Inalienability • Three ways to protect an entitlement: • as property (through injunction) • by liability rule (through damages) • through inalienability • Lots of things that can’t be bought/sold: • organs • sex • heroin • Arguments in favor of inalienability… • children • atomic weapons • human rights