Sunday, September 04, 2005

It's the Economics, Stupid!

I'm not sure just what it is about people in my Property Law class. So far, we've been covering some basic economic issues, and today we touched on the topic of the tragedy of the commons. Despite some of the utilitarian thinkers whose names we were introduced to in the text, the ideas shouldn't be so hard to grasp.

"Tragedy of the commons" may be a term of economics, but the idea is very basic. Let's say you've got a communal pasture, which everyone can access, and which nobody has rights to. What happens, then, in a community of herders? You'll get overgrazing, because when nobody owns the rights to the common pasture, and anybody can use it, nobody has an incentive to stop somebody else's herd from grazing. It's a recipe for environmental disaster. The basic economic idea underlying this is that, when there is open access, and no exclusive rights, resources will be consumed faster, resulting in underproduction or shortage. To prevent overgrazing in the commons, then, the community could either ban herding (which has the advantage of negating the entire scenario, but the disadvantage of being unrealistic and avoiding the question), or the community could create private property by dividing the commons into small parcels. Each property owner then has a vested interest in the productivity of his piece of pasture, and so will not only limit his own consumption, but invoke his right, guaranteed by the law, to prevent others from grazing on his part of the pasture by any reasonable means, such as by building a fence. Simple enough, right?

Well, in class, we were discussing externalities in combination with the tragedy of commons. In the hypothetical scenario, a recycling plant is churning out large quantities of pollutants, upsetting a nearby residential area with 1000 properties. What remedies are available in property law to reduce the effects of pollution? Some answers include creating property rights to the airspace directly above each property, or, innovatively, envisioning airspace in a new dimension, and creating the property right of emissions quotas. For example, given a town of 1100 acres of private property, suppose a commission determines that an acceptable level of pollution is 100 parts per million (ppm).

(The unit of "parts per million" is used to refer to densities in gases, which is what air is. I'm not specialized in that field of science, so the usage here is simply to conform to scientific usage rather than to set out policy proposals. Think of parts per million in terms of percentages of volume: One part per million simply means 0.01% of volume. The denominator gives the actual volume. So 1ppm over an acre is twice as much actual pollutants as 1ppm over half an acre, but represents the same level of pollution.)

Suppose that each individual home in this fictional town is one acre, while the recycling plant takes up 100 acres (the town produces a lot of recyclables). The recycling plant would thus be entitled in its property to produce 100 times more pollutants than any individual home. Assuming that few if any homes ever reach 100ppm on any given day, much less throughout the entire year, it is conceivable that a homeowner might be willing to create a rent in his emissions property right, which the recycling plant might be able to pay for. If, say, ten households decide that they really don't like to barbecue all that much, and are thus willing to rent out half of their emissions right, then, for a certain price, the recycling plant would be able to purchase an additional 500ppm (50ppm from 10 homes). The level of pollution over the 1100 acres remains constant to or below the recommended level of 100ppm, so the homeowners are generally happy; and the recycling plant can continue to do its work unimpeded.

If, on the other hand, a law was enacted forbidding the creation of rent in emissions properties, then the recycling plant would be forced either to pay a fine (if that is provided for under the property law), or to change its modus operandi, meaning its equipment, its technology, or its business model.

In any event, by creating the property right, the plant is forced to internalize pollution. Getting to the point of the class is the relation of the discussion above to externalities. An externality is defined as a side cost or benefit that a producer need not (and usually does not) take into account. Creation of property rights is one way of internalizing an externality. For example, the risk of overgrazing, or the levels of pollution, are externalities that become internalized with the creation of, respectively, private grazing grounds and emissions quotas.

This is by no means the only way of internalization, of course. One suggestion provided in class last Friday was the role of group action. In the pollution example, this means that the residents could get together and offer to give the polluter some money in exchange for changing his modus operandi. Once the offer has been made, it internalizes the pollution. The polluter may decide to refuse the offer, but his planning will be affected by the fact that his refusal has implications for his costs and revenues.

The problem, though, with a group of significant size, such as 1000 households, is that there are high costs of getting everyone together for collective action. These are referred to as transaction costs. Contributing to transaction costs, particularly as the group grows larger in size, is the problem of freeriding, or people thinking that they can get away with less contributions because "someone else" will contribute, and that enough "others" will contribute that the program, which benefits the freerider, will be successful. In short, it's a bit of the "tragedy of the commons" unto itself.

The creation of property rights, on the other hand, engages a certain transaction cost that has already been paid: Government. Even without buying into Locke's formulation of government as a social contract, government is an entity that already exacts a transactional cost, in the form of taxes (where applicable) and manpower diverted from private production. By leveraging a "sunk" transaction cost to create new property rights, then, the community can avoid a subordinate tragedy of the commons, as well as force an internalization on the part of the polluter.

But people in class don't seem to get it. Nor did they get the idea of the "tragedy of the anti-commons". There were two examples given by the professor.

  • Building a laptop
    Suppose you had to build a laptop. There are 100 parts, without any one of which the laptop will not work. Each part is held by a different person. Suppose all 100 people (you are one) are in the same classroom (eliminating the transaction cost of having to find each holder). Assume no other one of them is interested in building a laptop. You begin soliciting for parts. Well, now, what happens as people realize what you're doing? It takes just one jerk to charge you $1000 for, say, the letter "m", to make the plan of putting together a laptop cost-prohibitive.
  • Saving the owls
    Suppose you owned a large parcel of land, which includes a large wooded area, home to an endanger species of owl. As a card-carrying member of the Sierra Club, you love the species, but you're forced by high property taxes to consider getting rid of the property. The very real danger exists that a logging company is going to try to buy it from you, and there's no way you could be sure that whomever you sold the property to would not turn around and sell it to the logging company, or even a front company for the loggers, because of economic pressures. What you might want to do, then, is to carve your land up into parcels, without any one of which a logging company could not utilize the forest. This is not as far-fetched as it might seem to reflexive anti-loggers: A logging company has to build a road to a piece of land in order to harvest the trees. If each piece of land were small enough, it would not make economic sense for the logging company to build, say, a five-mile road from the main highway to get to just one piece of the forest. That is, if it cost the company $1000 for each acre, $1,000,000 for the entire road, $5000-8,000 of expenditures on equipment and wages (depending on volume, or total acreage) to fell each acre's total number of trees, but an acre of forest only yields $10,000 of revenues at most, then it would not make sense for the logger to buy any less than 250 acres. That is, assuming this acreage would depress capital and wage expenditures to $5000 per acre, and assuming each acre yields the maximum of $10,000, each acre thus produces $4,000 of profit. To break even with the cost of the $1,000,000 road would require 250 units of $4,000 profit each. (Note: These numbers are purely speculative. I was never involved in the logging industry except for a Christmas tree I helped pick out for a family friend as a child twenty years ago, so I am not familiar with the actual numbers.) Anything less than 250 acres means that, barring downward revisions of costs, it is uneconomical for the logger to harvest from the total parcel. And all it takes is for one proprietor to ask for any amount over $1000 per acre to force an upward revision of the logger's cost factor.

What bothered me wasn't that it took a while for many students to grasp this, even though the example in the textbook, in which Moscow storefronts stood empty while street vendors flourished after the demise of the communist economy, because too many parties had different rights in the storefronts, without any one of which it was impossible to actually utilize the storefronts, should have prepared them for this. Instead, what many students resorted to was invoking government action.

It seems that we have reared a generation that is dependent on government for every conceivable social goal. One of the things that we must learn in law school, regardless of political ideology, is that in order to policy to be advanced, it must have a foundation, and applied policy entails consequences. Even in criminal law, arguably the area most receptive to liberal views, we are taught that the law must be based on something. Sure, if we feel that an outcome is unfair, that's probably because it is, but we must examine the factors that lead to such outcomes. In such examination, we often find that original intent often differs from application. In Bowers v. Hardwick, for example, we find in the dissenting opinion a discussion of original intent, wherein the dissenting justice claimed that sodomy laws were not originally enacted for the purpose of prohibiting homosexuality, but for convicting rapists and child molestors. If this is, in fact, true, then we can see that the outcome of a strict interpretation (to which all law is potentially subject to, depending on the way the case is argued, and, sometimes, on the perspective of an appeals court justice) stemming from a poorly written rule can have undesirable consequences.

So it wouldn't do simply for government to ban polluting properties, for example, because we may end up banning recycling plants which, while polluting, may create more social wealth than environmental pollution. (Consider the fact that recycling plants not only increase the lifespan of trash dumps and junk yards, but also provide jobs, all of which entail supporting service jobs, as well as profit for the operator, which the operator can then reinvest in the form of more jobs, a new plant, or better technologies, not to mention private consumption.) But it might make sense for government to regulate things a bit. Again, it is the leveraging of the social contract, which is a "sunk" transaction cost. That law students at a top-100 law school are having problems grasping these concepts does not bode well.

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