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Property Rights and Tragedy of The Commons
Property Rights and Tragedy of The Commons
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economic way of thinking, we can and will take a giant step toward a better
understanding of business management.
Economists also study broad macroeconomic subdivisions of the economy, such
as the total output of all firms that produce goods and services. Instead of concentrating on how many bicycles or PDAs are sold, macroeconomists watch overall
production level and overall price level. These and similar issues are of more than
academic interest, as the dramatic downturn in the world economy in 2008 demonstrated once again. But we hasten to repeat that this book and course are devoted
primarily to microeconomic theory and applications, although you will find that
our study will not avoid addressing the microeconomic foundations of the macroeconomic debacle of 2008 and beyond.
We make microeconomics our focus because we are firmly convinced that an
understanding of the macroeconomy is necessarily dependent on an understanding of the microeconomy. Many of the microeconomic concepts developed in this
book supply and demand, adverse selection and moral hazard, risk aversion, and
incentives will speak to the worlds economic problems of the early 2000s, which
originated with a credit binge in the 1990s, if not 1980s, that quickly morphed into a
stock-market bubble (and bust) in the late 1990s and a housing-market bubble (and
bust) in the early 2000s.
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depend upon the choices of others. We start with a discussion of the emergence of
property rights in a game-theoretic setting in part because property rights are
necessary for trade to flourish and in part to ease students into familiarity with
game theory to which we will return throughout the textbook.
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the soil, to mine the soil, to offer those rights for sale, etc., but not to have the right to
throw soil at a passerby, to use it to change the course of a stream, or to force
someone to buy it. What are owned are socially recognized rights of action (Alchian
and Demsetz 1973).
Property rights are not necessarily distributed equally, meaning that people do
not always have the same rights to use the same resources. Students may have the
right to use their voices (i.e. a resource) to speak with friends in casual conversation
in the hallways of classroom buildings, but they do not, generally speaking, have the
right to disrupt an organizational behavior class with a harangue on their political
views. In other words, property rights can be recast in terms of the behavioral rules,
which effectively limit and restrict our behavior. Behavioral rules determine what
rights we have with regard to the use of resources, goods, and services. The rights we
have may be the product of the legislative process and may be enforced by a third
party, usually the government or, more properly, the agents of government. In this
case, property rights emerge from legislation.
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If Fred and Harry find stealing a reasonable course to take, each will have to divert
resources into protecting that which he has produced (or stolen). Presumably, their
attacks and counterattacks will lead them toward a social equilibrium in which each
is applying resources to predation and defense and neither finds any further movement of resources into those lines of activity profitable (Bush 1972, 58). This is not
an equilibrium in the sense that the state of affairs is a desirable or stable one; in
fact, it may be characterized as a Hobbesean jungle in which every man is Enemy
to every man (Hobbes 1968, first published in 1651).
In an economic sense, resources diverted into predatory and defensive behavior
are wasted; they are taken away from productive processes. If these resources are
applied to production, total production can rise, and both Fred and Harry can be
better off both can have more than if they try to steal from each other. Only
through winding up in a state of anarchy, or seeing the potential for ending up
there, do they question the rationality of continued plundering and unrestricted
behavior; and it is because of the prospects of individual improvement that there
exists a potential for a social contract that spells out legally defined property
rights. Through a social contract they may agree to restrict their own behavior,
but they will do away with the relatively more costly restraints that, through
predation and required defense, each imposes on the other. The fear of being
attacked on the streets at night can be far more confining than laws that restrict
people from attacking one another. This is what John Locke meant when he wrote,
The end of law is not to abolish or restrain but to preserve and enlarge freedom
(Locke 1690, 23).
Once the benefits from the social contract are recognized, there may still be, as in
the case of voluntary behavioral norms, an incentive for Fred or Harry to chisel
(cheat) on the contract. Fred may find that although he is better off materially by
agreeing to property rights than he is by remaining in a state of anarchy, he may be
even better off by violating the agreed-upon rights of the other. Through stealing,
or violating Harrys rights in other ways, Fred can redistribute the total wealth of the
community toward himself.
Consider table 1.1, which illustrates the kind of games involving actions and
reactions of individual players we and other economists use to draw out strategies
people will (or should) use to deal with given situations. Table 1.1 contains a chart or
matrix of Fred and Harrys utility (or satisfaction) levels if either respects or fails to
respect the rights established for each as a part of the contract. (The actual utility
levels are hypothetical, but serve the purpose of illustrating a basic point.) There are
four cells in the matrix, representing the four combinations of actions that Fred and
Harry can take. They can both respect the agreed-upon rights of the other (cell 1), or
they can both violate each others rights (cell 4). Alternatively, Harry can respect
Freds rights while Fred violates Harrys rights (cell 3), or vice versa (cell 2).
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Table 1.1 The games Fred and Harry can play with property rights
Harry respects Freds rights
Cell 1
Fred
15 utils
Harry
10 utils
Cell 2
Fred
8 utils
Harry
16 utils
Cell 3
Fred
18 utils
Harry
5 utils
Cell 4
Fred
10 utils
Harry
7 utils
The payoffs (measured in util terms) from Fred and/or Harry either respecting or violating the others
rights are indicated in the four cells of the matrix. Each has an incentive to violate the others rights. If
they do violate each others rights, they will end up in cell 4, the worst of all possible states for both of
them. The productivity of the social contract can be measured by the increase in Fred and Harrys
utility resulting from their moving from cell 4, the state of nature, to cell 1, a state in which a social
contract is agreed upon.
Clearly, by the utility levels indicated in cells 1 and 4, Fred and Harry are both
better off by respecting each others rights than by violating them. However, if Harry
respects Freds rights and Fred fails to reciprocate, Fred has a utility level of 18 utils,
which is greater than he will receive in cell 1 that is, by going along with Harry and
respecting his rights. Harry is similarly better off if he violates Freds rights while
Fred respects Harrys rights: Harry has a utility level of 16, whereas he will have a
utility level of 10 utils if he and Fred respect each others rights. The lesson to be
learned is that inherent in an agreement over property rights is the possibility for
each person to gain by violating the rights of the other. If both follow this course,
they both will end up in cell 4 that is, back in the state of anarchy.
There are two reasons why this may happen. First, as we stated above, both Fred
and Harry may violate each others rights in order to improve their own positions;
the action may be strictly offensive. By the same token, each must consider what the
other will do. Neither would want to be caught upholding the agreement while the
other one violates it. If Fred thinks that Harry may violate his rights, Fred may
follow suit and violate Harrys rights: he will be better off in cell 4, i.e. anarchy, than
in cell 2. Thus, Fred and Harry can wind up in anarchy for purely defensive reasons.
Many wars and battles, at both the street and international levels, have been
fought because one party was afraid that the other would attack first in order to get
the upper hand. The same problem is basically involved in our analysis of the fragile
nature of Fred and Harrys social contract. The problem of contract violation can
grow as the community grows in number because individual persons violations are
more difficult (and more costly) to detect.
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to the same thing, the cost of 1 coconut is 2 papayas. Fred would be better off if he
could trade 1 coconut for more than 2 papayas, because that is what he has to give
up in order to produce the coconut. To determine whether there is a basis for trade,
we must explore the cost of coconuts and papayas to Harry. We note that the cost of
1 coconut to Harry is 4 papayas; this is because he has to give up 24 papayas to
produce 6 coconuts. If Harry could give up fewer than 4 papayas for a coconut, he
would be better off. He could produce the 4 papayas, and if he has to give up fewer
than that for a coconut, he will have papayas left over to eat, which he would not
have had without the opportunity to trade.
To summarize: Fred would be better off if he could get more than 2 papayas for a
coconut; Harry would be better off if he could give up fewer than 4 papayas for a
coconut. If, for example, they agree to trade at the exchange rate of 1 coconut for 3
papayas, both would be better off. Fred will produce 1 coconut, giving up 2 papayas,
but he can get 3 papayas for the coconut. Hence, he is better off. Harry can produce 4
papayas, giving up 1 coconut, and trade 3 of the papayas for a coconut. He has the
same number of coconuts, but has an additional papaya. Harry is better off.
Although relatively simple, the above example of exchange is one of economists
most important contributions to discussions of social interaction. So many people
seem to think that when people trade, one person must gain at the expense of
another. If people in the United States trade with people in Japan, someone must be
made worse off in the process, or so the argument goes. We will deal with such
arguments in more detail in chapter 5 in which we take up international trade. For
now, we wish to emphasize that we have demonstrated that, through trade, both
Harry and Fred can be better off. This was demonstrated even though we postulated
that Harry was more efficient than Fred in the production of both fruits!
[See online Video Module 1.3 Comparative advantage]
Trades that emerge from exploitation of comparative advantages among traders
can have even more profound effects than those already indicated. This is because
of the efficiency benefits of specialization of labor (or any other resource). By
specializing in the production of papayas, Harry can become more skilled in their
production, producing more papayas in a given time period because of the greater
skills and because less time will be wasted moving back and forth between the
production of coconuts and papayas. The same can be said for Fred because of his
specialization in coconuts. The result is that their joint production can increase for
two reasons:
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First, both Harry and Fred can produce the good in which they are relatively more
efficient in production and, thus, have a relatively lower cost of production.
Second, both can achieve an even greater production because of the economies of
specialization of resource use.
Restrictions on market trades (tariffs and quotas, for example) can have two adverse
effects: They can reduce the ability of traders to exploit their comparative advantages in production. Second, they can narrow the scope of markets, thereby reducing
the potential specialization in resource use and economies that could flow from the
missed specialization (points economists as far back as the venerable Adam Smith,
author of The Wealth of Nations [1776], have had in mind when they have opposed
trade restrictions).
While this argument has been couched in terms of two independent persons trade
of coconuts and papayas, we stress that the gains to be had from exploitation of
peoples comparative advantages and specialized talents are fully evident within
business firms. CEOs might be more talented and productive in accounting, law, and
advertising than the assistants they hire. However, they hire assistants to exploit
their relatively greater comparative advantage in running entire firms. Accountants
hire bookkeepers not because their bookkeepers are more talented and productive in
recording transactions but because they have comparative advantages in understanding what summary accounting statistics convey about the overall operation of
their firms. Firms are full of people with specialized talents who are exploiting those
talents at a higher level than would be possible if all sought to be jacks of all
trades. Indeed, firms very survival depends upon their understanding the gains
from trades and resource specialization.
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The same can be said for all other resources whose owner does not exercise the
right to exclude cattlemen.
Communal property rights can be employed with tolerably efficient results so
long as one of two conditions holds:
1 there is more of the resource than can be effectively used for all intended purposes
(in other words, there is no cost to its use), or
2 people within the community fully account for the effects that their own use of
the resources has on others.
Without the presence of one of these conditions, the resources will tend to be
overused.
The biologist Garrett Hardin (1968) characterized the problem of overused (and
abused) communal resources as the tragedy of the commons and considered why a
pasture might be overgrazed if cattle ranchers access to the pasture were unimpeded
by property rights. In deciding on how many cattle to add, each cattleman likely will
be compelled to reason that the addition of his cattle and his cattle alone to the
pasture will make no difference to the amount of feed available to the cattle of other
herdsmen. One persons cattle just dont eat that much, given the size of the pasture,
but the grass eaten by one ranchers cattle is grass that cant be eaten by the cattle of
other ranchers. This means that he can impose a portion of the costs of his cattle
grazing on the pasture on other ranchers, which is justification enough for all
ranchers to put more cattle on the pasture than they would if they individually
incurred the full grazing costs of their cattle. The result is that the cattlemen can
collectively face an outcome a tragedy in the form of overly thin cattle that
none of them would want:
Therein is the tragedy. Each man is locked into a system that compels him to increase his herd
without limit in a world that is limited. Ruin is the destination toward which all men rush,
each pursuing his own best interest in a society that believes in the freedom of the commons.
Freedom of the commons brings ruin to all. (Hardin 1968)
The prospect of the emergence of a tragedy under communal ownership has been a
very powerful argument for conversion of communal rights to private property
rights, which is an institutional setting under which the owners simultaneously have
both usage and exclusion rights.
Under communal ownership, if the resource is not presently being used by
someone else, no one can be excluded from the use of it. Consequently, once in
use, the resource becomes, for that period of time, the private property of the user.
The people who drive their cars onto the freeway take up space on the road that is
not in use; no one else (they hope!) can then use that space at the same time. Unless
the drivers violate the rules of the road, they cannot be excluded from that
space; and if they are rational, they will continue to use the resource until their
cost of a little additional use equals their benefits from that additional use. They
may consider most of the costs involved in their use of the road, but one that
they may overlook, especially as it applies to themselves personally, is that their
space may have had some alternative use, that is, by others. Their presence also
increases highway congestion and the discomfort of the other drivers (potentially nontrivial costs). As a result, they may overextend the use of their
resource, meaning that they may continue to drive as long as the additional
benefits they, themselves, get from driving additional miles is greater than the
additional cost.
The state can make the driver consider the social costs of driving in an
indirect way by imposing a tax on the drivers use of the road (through either
a tax on gasoline or a tax on the miles driven, as determined by GSP-based
monitoring devices that several states were considering deploying at the time of
this revision), causing less driving, and fewer costs that drivers impose on
others. This is called internalizing the social cost. Once the state does this
and it is commonly done through gasoline taxes and/or tolls the rights to the
freeway are no longer communal; the rights have been effectively attenuated
by the state.
There are two additional ways that social costs can be internalized.
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First, people can be considerate of others and account for the social cost in their
behavior.
Second, the right to the road can be turned into private property, meaning that
individuals are given the right to exclude others from the use of the resource (i.e.
the road). This may seem to be a totally undesirable turn of events unless we
recognize that private owners can then charge for the use of the road: they can
sell use rights, in which case the marginal cost of driving will rise, resulting in
an increase in the cost that individual drivers incur from traffic congestion (a
form of the tragedy of the commons all too familiar to MBA students commuting
to work or class).
The prime difference between this private ownership and government taxation is
that, with private ownership, the revenues collected go into the coffers of individuals rather than those of the state; this is either good or bad, depending upon
your attitude toward government versus private uses of the funds. Furthermore,
under private ownership and without viable competitors (and we have an example
in which competition may not be practical), the owners may attempt to charge an
amount that is greater than the social costs in table 1.1; they may attempt, in the
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Pollution
Pollution of streams, rivers, air, etc. can be described as a logical consequence of
communal property rights. The state and federal governments, by right of eminent
domain, have always held rights to these resources; but until very recently they have
inadequately asserted their right to exclude people and firms from their use. As a
result, the resources have been subject to communal use and to overuse, in the same
sense as that discussed above.
By dumping waste into the rivers, people, firms, and local governments have been
able to acquire ownership to portions of the communal resource they use it and
pollute it. Furthermore, because of the absence of exclusion, those people doing the
polluting do not have to pay to draw the resource away from its alternative uses
(such as beautiful scenery) or to reimburse the people harmed by the pollution for
the damage done. Under communal ownership, in which government does not
exercise its control, the firm with smoke billowing from its stacks does not have
to compensate the people who live around the plant for the eye irritation they
experience or the extra number of times they have to paint their homes.
Pollution is often thought to be the product of antisocial behavior, as indeed it
often is. Many who pollute simply do not care about what they do to others.
However, much pollution results from the behavior of people who do not have
devious motives. People may view their behavior as having an inconsequential
effect on the environment. The person who throws a cigarette butt on the ground
may reason that if this cigarette butt is the only one on the ground, it will not
materially affect anyones sensibilities, and in fact it may not. However, if everyone
follows the same line of reasoning, the cigarette butts will accumulate and an
eyesore will develop. Even then, there may be little incentive for people to stop
throwing their butts on the ground. Again, a person may reason on the basis of the
effects of his own individual action: If I do not throw my butt on the ground here
with all the others, will my behavior materially affect the environmental quality,
given the fact that other butts are already there? This type of reasoning can lead to a
very powerful argument for conversion of communal rights to private or state
rights, with the implied power for someone to exclude some or all of this kind of
use. (More will be said on the economics of pollution in chapter 5.)
Theft
The prevalence of theft can affect peoples willingness to create, invest in, and
enhance property. This is because theft reduces the rewards from property. Theft can
come in forms that quickly come to mind, muggings and break-ins, but it can also
come in other more widespread forms, such as customer shoplifting and employee
pilferage. The greater the prevalence of theft of property, the less people can be
expected to willingly invest in and build up their property. That rule is transparent
in the bicycles people ride in Amsterdam, the Netherlands. While bikes are everywhere present, few bikes are less than thirty years old. Bikes without gears (or with
no more than three gears) are common, and most show signs of wear. The reason is
that bike theft is common. As residents of Amsterdam will freely admit, it simply
doesnt pay to buy a modern bike. Indeed, parking a new bike on the side streets and
alleys of Amsterdam is an invitation to thieves. The working rule among bike
owners in Amsterdam is that the amount spent on bike locks should be greater
than the amount spent on a bike.
It also very likely follows that the higher the cost of theft detection, the greater the
theft problems business will have. If the cost of monitoring customer shoplifting and
employee pilferage goes down, then more monitoring and less shoplifting and
pilferage can be expected. Both honest customers and honest employees can have
good reason to want at least some monitoring of the thieves among them. The
penalties can abate a tragedy of the commons in business added costs of doing
business. The meted out penalties imposed on thieves can contain the prices of
products customers buy and increase the potential pay and job security of
employees.
However, in closing this section, we add a note of caution. While the assignment
of property rights is important to the efficient use of resources and the smooth
functioning of a market economy, there is a case to be made for the development of
some balance in the assignment of property rights. If there are too many rights
claimants, resources can be underutilized, giving rise to the tragedy of the anticommons, or so legal scholar Lawrence Lessig (2001) has argued, especially with
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regard to copyrights, which are a form of property right for intellectual property.
You can read more about this tragedy in Perspective 1 on the publishers website
for this book.