Property Rights

by Armen A. Alchian

One of the most fundamental requirements of a capitalist economic system—and one of the most
misunderstood concepts—is a strong system of property rights. For decades social critics in the United
States and throughout the Western world have complained that “property” rights too often take
precedence over “human” rights, with the result that people are treated unequally and have unequal
opportunities. Inequality exists in any society. But the purported conflict between property rights and
human rights is a mirage. Property rights are human rights.

The definition, allocation, and protection of property rights comprise one of the most complex and
difficult sets of issues that any society has to resolve, but one that must be resolved in some fashion. For
the most part, social critics of “property” rights do not want to abolish those rights. Rather, they want to
transfer them from private ownership to government ownership. Some transfers to public ownership (or
control, which is similar) make an economy more effective. Others make it less effective. The worst
outcome by far occurs when property rights really are abolished (see tragedy of the commons).

A property right is the exclusive authority to determine how a resource is used, whether that resource is
owned by government or by individuals. Society approves the uses selected by the holder of the
property right with governmental administered force and with social ostracism. If the resource is owned
by the government, the agent who determines its use has to operate under a set of rules determined, in
the United States, by Congress or by executive agencies it has charged with that role.

Private property rights have two other attributes in addition to determining the use of a resource. One is
the exclusive right to the services of the resource. Thus, for example, the owner of an apartment with
complete property rights to the apartment has the right to determine whether to rent it out and, if so,
which tenant to rent to; to live in it himself; or to use it in any other peaceful way. That is the right to
determine the use. If the owner rents out the apartment, he also has the right to all the rental income
from the property. That is the right to the services of the resources (the rent).

Finally, a private property right includes the right to delegate, rent, or sell any portion of the rights by
exchange or gift at whatever price the owner determines (provided someone is willing to pay that price).
If I am not allowed to buy some rights from you and you therefore are not allowed to sell rights to me,
private property rights are reduced. Thus, the three basic elements of private property are (1) exclusivity
of rights to choose the use of a resource, (2) exclusivity of rights to the services of a resource, and (3)
rights to exchange the resource at mutually agreeable terms.

The U.S. Supreme Court has vacillated about this third aspect of property rights. But no matter what
words the justices use to rationalize such decisions, the fact is that such limitations as price controls and
restrictions on the right to sell at mutually agreeable terms are reductions of private property rights.
Many economists (myself included) believe that most such restrictions on property rights are
detrimental to society. Here are some of the reasons why.

Under a private property system the market values of property reflect the preferences and demands of
the rest of society. No matter who the owner is, the use of the resource is influenced by what the rest of
the public thinks is the most valuable use. The reason is that an owner who chooses some other use
must forsake that highest-valued use—and the price others would pay him for the resource or for the
use of it. This creates an interesting paradox: although property is called “private,” private decisions are
based on public, or social, evaluation.

The fundamental purpose of property rights, and their fundamental accomplishment, is that they
eliminate destructive competition for control of economic resources. Well-defined and well-protected
property rights replace competition by violence with competition by peaceful means.

The extent and degree of private property rights fundamentally affect the ways people compete for
control of resources. With more complete private property rights, market exchange values become
more influential. The personal status and personal attributes of people competing for a resource matter
less because their influence can be offset by adjusting the price. In other words, more complete
property rights make discrimination more costly. Consider the case of a black woman who wants to rent
an apartment from a white landlord. She is better able to do so when the landlord has the right to set
the rent at whatever level he wants. Even if the landlord would prefer a white tenant, the black woman
can offset her disadvantage by offering a higher rent. A landlord who takes the white tenant at a lower
rent anyway pays for discriminating.

But if the government imposes rent controls that keep the rent below the free-market level, the price
the landlord pays to discriminate falls, possibly to zero. The rent control does not magically reduce the
demand for apartments. Instead, it reduces every potential tenant’s ability to compete by offering more
money. The landlord, now unable to receive the full money price, will discriminate in favor of tenants
whose personal characteristics—such as age, sex, ethnicity, and religion—he favors. Now the black
woman seeking an apartment cannot offset the disadvantage of her skin color by offering to pay a
higher rent.

Competition for apartments is not eliminated by rent controls. What changes is the “coinage” of
competition. The restriction on private property rights reduces competition based on monetary
exchanges for goods and services and increases competition based on personal characteristics. More
generally, weakening private property rights increases the role of personal characteristics in inducing
sellers to discriminate among competing buyers and buyers to discriminate among sellers.

The two extremes in weakened private property rights are socialism and “commonly owned” resources.
Under socialism, government agents—those whom the government assigns—exercise control over
resources. The rights of these agents to make decisions about the property they control are highly
restricted. People who think they can put the resources to more valuable uses cannot do so by
purchasing the rights because the rights are not for sale at any price. Because socialist managers do not
gain when the values of the resources they manage increase, and do not lose when the values fall, they
have little incentive to heed changes in market-revealed values. The uses of resources are therefore
more influenced by the personal characteristics and features of the officials who control them. Consider
the socialist manager of a collective farm under the old Soviet communist system. By working every
night for one week, he could have made, say, one million rubles of additional profit for the farm by
arranging to transport the farm’s wheat to Moscow before it rotted. But because neither the manager
nor those who worked on the farm were entitled to keep even a portion of this additional profit, the
manager was more likely than the manager of a capitalist farm to go home early and let the crops rot.

Similarly, common ownership of resources—whether in the former Soviet Union or in the United States
—gives no one a strong incentive to preserve the resource. A fishery that no one owns, for example, will
be overfished. The reason is that a fisherman who throws back small fish to wait until they grow is
unlikely to get any benefit from his waiting. Instead, some other fisherman will catch the fish. The same
holds true for other common resources whether they be herds of buffalo, oil in the ground, or clean air.
All will be overused.

Indeed, a main reason for the spectacular failure of the 1980s and early 1990s economic reforms in the
former Soviet Union is that resources were shifted from ownership by government to de facto common
ownership. How? By making the Soviet government’s revenues de facto into a common resource.
Harvard economist Jeffrey Sachs, who advised the Soviet government, once pointed out that when
Soviet managers of socialist enterprises were allowed to open their own businesses but still were left as
managers of the government’s businesses, they siphoned out the profits of the government’s business
into their private corporations. Thousands of managers doing this caused a large budget deficit for the
Soviet government. In this case the resource that no manager had an incentive to conserve was the
Soviet government’s revenues. Similarly, improperly set premiums for U.S. deposit insurance gave banks
and S&Ls (see savings and loan crisis) an incentive to make excessively risky loans and to treat the
deposit insurance fund as a “common” resource.

Private property rights to a resource need not be held by a single person. They can be shared, with each
person sharing in a specified fraction of the market value while decisions about uses are made in
whatever process the sharing group deems desirable. A major example of such shared property rights is
the corporation. In a limited liability corporation, shares are specified and the rights to decide how to
use the corporation’s resources are delegated to its management. Each shareholder has the
unrestrained right to sell his or her share. Limited liability insulates each shareholder’s wealth from the
liabilities of other shareholders, and thereby facilitates anonymous sale and purchase of shares.

In other types of enterprises, especially where each member’s wealth will become uniquely dependent
on each other member’s behavior, property rights in the group endeavor are usually salable only if
existing members approve of the buyer. This is typical for what are often called joint ventures,
“mutuals,” and partnerships.

While more complete property rights are preferable to less complete rights, any system of property
rights entails considerable complexity and many issues that are difficult to resolve. If I operate a factory
that emits smoke, foul smells, or airborne acids over your land, am I using your land without your
permission? This is difficult to answer.

The cost of establishing private property rights—so that I could pay you a mutually agreeable price to
pollute your air—may be too high. Air, underground water, and electromagnetic radiation, for example,
are expensive to monitor and control. Therefore, a person does not effectively have enforceable private
property rights to the quality and condition of some parcel of air. The inability to cost-effectively
monitor and police uses of your resources means “your” property rights over “your” land are not as
extensive and strong as they are over some other resources such as furniture, shoes, or automobiles.
When private property rights are unavailable or too costly to establish and enforce, substitute means of
control are sought. Government authority, expressed by government agents, is one very common such
means. Hence the creation of environmental laws.

Depending on circumstances, certain actions may be considered invasions of privacy, trespass, or torts.
If I seek refuge and safety for my boat at your dock during a sudden severe storm on a lake, have I
invaded “your” property rights, or do your rights not include the right to prevent that use? The
complexities and varieties of circumstances render impossible a bright-line definition of a person’s set of
property rights with respect to resources.

Similarly, the set of resources over which property rights may be held is not well defined and
demarcated. Ideas, melodies, and procedures, for example, are almost costless to replicate explicitly
(near-zero cost of production) and implicitly (no forsaken other uses of the inputs). As a result, they
typically are not protected as private property except for a fixed term of years under a patent or
copyright.

Private property rights are not absolute. The rule against the “dead hand,” or perpetuities, is an
example. I cannot specify how resources that I own will be used in the indefinitely distant future. Under
our legal system, I can specify the use only for a limited number of years after my death or the deaths of
currently living people. I cannot insulate a resource’s use from the influence of market values of all
future generations. Society recognizes market prices as measures of the relative desirability of resource
uses. Only to the extent that rights are salable are those values most fully revealed.

Accompanying and conflicting with the desire to secure private property rights for oneself is the desire
to acquire more wealth by “taking” from others. This is done by military conquest and by forcible
reallocation of rights to resources (also known as stealing). But such coercion is antithetical to—rather
than characteristic of—a system of private property rights. Forcible reallocation means that the existing
rights have not been adequately protected.

Private property rights do not conflict with human rights. They are human rights. Private property rights
are the rights of humans to use specified goods and to exchange them. Any restraint on private property
rights shifts the balance of power from impersonal attributes toward personal attributes and toward
behavior that political authorities approve. That is a fundamental reason for preference of a system of
strong private property rights: private property rights protect individual liberty.