One size does not fit all – the Role of Private Property and Commons in a Market Economy

One size does not fit all –

the Role of Private Property and Commons in a Market Economy

Dirk Loehr

1. Introduction

In 2009, Oliver E. Williamson and Elinor Ostrom were awarded the Nobel Prize for Economics. This is a strong backing for the institutional approach.

However, Williamson and Ostrom represent different interpretations of institutionalism. Williamson’s focus is on transaction cost economics, whereas Ostrom mainly considers common goods. Williamson might be considered representative of the mainstream of the New Institutional Economics approach, which includes works in transaction costs, political economy, hierarchy and organization, public choice and property rights. Ostrom, who was mainly concerned with commons, represents the heterodox stream of the new institutional approach. In the following, the New Institutionalists’ view on property rights in particular will be described and critiqued. Some implications of a regulative policy approach will be discussed.

2. The orthodox approach: Market failure and external effects

2.1. Theoretical background

Economists are mainly focussed on the efficiency of allocation. Especially “market failure” is a matter of concern, due to a lack of allocative efficiency. Welfare economics defines market failure as a “too much” of disadvantageous goods or as a “not enough” of useful goods – in respect of the allocation optimum. “Too much” means: Economic activity is carried out up to a level where the social costs exceed the social benefits. This is due to “external costs”. External costs are borne not by those who cause the harmful production, but by other persons. In doing so, there is no compensation paid by those who cause the damage. “Not enough” means that economic activity is abandoned despite the fact that the social benefits significantly exceed the social costs. The reason for this relates to external benefits. External benefits are enjoyed by other persons who do not bear the costs of the production of the goods.

Although New Institutional Economics is critical of the concept of welfare optimization (Voigt 2009, pp. 212), it claims a close connection between “market efficiency” and the way property rights are designed. In this article, we want to make a distinction between “pure public goods” and “impure public goods”. Pure public goods might be characterized by “non excludability” (due to a lack of property rights) and “non rivalry” (the utility of consumption does not decrease by other users of the good). One example might be a street light: If pedestrian A gets light on his way through the night, pedestrian B normally does not fall into darkness (the criterion of rivalry may no longer apply if more and more people converge beneath the street light – hence rivalry is not pure in most cases). Pure public goods are one of the counterparts of pure private goods, which are characterized by excludability and rivalry. Pure public goods often suffer a lack of supply, because the external benefits are not adequately compensated. Private goods on the one hand and pure public goods on the other hand are extremes: The benefits of the use of pure private goods might be shared and are completely private; the benefits of pure public goods are indivisible and public (national defence, vaccination etc.) (Samuelson / Nordhaus 1998, p. 411). Between pure private and pure public goods is a continuum of positive external effects of different intensity. An example is the discussion about “merit goods”: Basically merit goods could be provided by the market. However, the supply is considered to be unsatisfactory in quality or quantity (e.g. education, health).

Pure private
goods

Intermediate forms

Pure public goods

Benefits:
–       Private

X

Positive external
effects

–       External

X

Costs:
–       Private

X

X

–       External

 Table 1: Private vs. public goods

 Another example relates to inventions: In the absence of any regime for the protection of the inventor’s achievement (e.g. intellectual property rights), the costs of research (time, money) are covered privately. However, people other than the inventor might commercialize the invention and make use of it. However, these beneficiaries probably probably behave like “free riders”: They use the invention without any contribution to covering the costs of the inventor. For the free riders this is a rational strategy, because otherwise the individual contribution would be comparatively small and other (opportunistic) users probably would refuse to contribute voluntarily. However, the free use by other actors will discourage the inventor. When he has further ideas he will think about spending more leisure time instead of producing external benefits if he does not get an adequate compensation. The result is a Nash equilibrium, which is probably below the social welfare optimum (Samuelson / Nordhaus 1998, p. 418, footnote 6).

Another important counterpart to “pure public goods” involves “impure public goods”, which are characterized by non-excludability, but – in contrast to pure public goods – also by rivalry (Handelsblatt Wirtschaftslexikon 2010). Rivalry exists due to the limited production elasticity and substitution elasticity (e.g. fish stocks, clean air, free public highways etc.) (Keynes 1997, pp. 230). The traditional problems with impure public goods are external costs and an overuse of resources. The costs of use are shifted onto the public (e.g. damage of the regeneration capability of fish stocks), whereas the benefits are privatized.

Pure private
goods

Intermediate forms

Pure public goods

Benefits:
–       Private

X

X

–       External
Costs:
–       Private

X

Negative external effects

–       External

X

 Table 2: Private goods vs. impure public goods

Even if an actor behaves cautiously and tries to conserve the resources, his competitors will not do the same. A pastoralist who recognizes the overuse of pasture land with open access may take away his cattle from the grazing land. However, the pasture land will only recover if the other pastoralists do not use the “free space” in order to send more cattle onto the grazing land. If they do so, the voluntary self-restraint will be in vain. Anticipating the behaviour of his competitors, our pastoralist will not change his behaviour despite his deeper insight. Again we get a Nash equilibrium, which is very far from a social optimum.

Between impure public goods and private goods, a continuum of external costs of different intensity also exists. Impure public goods and pure public goods differ due to a different intensity of rivalry. For instance, a public highway should be a public good. However, if too many people use the highway, traffic jams occur. Then we get temporary rivalry. The highway is overused.

Regarding impure public goods there is a lot of confusion in contemporary economics due to the famous article by Hardin. He called the problem of overuse of natural resources a “tragedy of the commons” (Hardin 1968). Hardin ignored the fact that many examples of commons existed that have been used sustainably over decades and even centuries (cf. Ostrom 1990). In fact, Hardin did not describe a “tragedy of the commons” but a “tragedy of open access” to limited resources (Lerch 1997). This is the reason why we emphasize in this article the difference between common property and impure public goods despite the fact that contemporary economics often confuses them. Lerch (1997, p. 130) complains (own translation): “According to the ‘Tragedy of the Commons’ the Property Rights Theory normally suggests an inefficient allocation of common goods and an efficient allocation of private goods – as a consequence a privatisation strategy is preferred in order to solve the problem of the ‘Tragedy of the Commons’.” This simplifying view regards private property as a superior system – without further differentiation. Alternative property rights regimes are looked upon critically. The consequence is an ideology of “one size fits all”.

2.2. Specification of property rights in order to internalize external effects

Market failure occurs due to external effects which are caused by different allocation of benefits and costs of economic activities. According to the Property Rights Theory (which is a variant of the New Institutionalism approach), such market failure can be prevented by means of an unambiguous allocation and specification of property rights. This holds true if the costs of the definition, specification and enforcement of the property rights regime are not prohibitively high (Schüller 1988, p. 169). This point of view has already been stressed by Coase (1960). Following his line, Posner (1986, p. 32), Demsetz (1967) and others framed the following criteria for an efficient economy:

–       universality (all scarce resources should be owned by somebody)

–       excludability (property rights are exclusive rights) and

–       transferability of the property rights (tradable property rights in order to ensure that resources can be allocated from low to high-yield uses).

This approach has spread widely, e.g. by Washington Consensus (Stiglitz 2006). It claims to be applied universally. However, we wish to illustrate below that this idea of “one size fits all” has all the features of an ideology.

2.3. Basic case: Land

Land is generally considered an asset of special importance. Property rights on land are often considered a basic right – without making a difference to other assets. It is not an exaggeration that property on land is often considered an “archetype” of property. It is possible that some reforms of property already emerged during the Neolithic Revolution some 10,000 years ago. Whenever the first enclosures were made, before setting up fences land was an impure public good. According to the Property Rights Theory, the rationale for the enclosure was the attempt to achieve higher efficiency. This argument refers to allocation (Lerch 1997, p. 131). Demsetz (1967), a prominent proponent of the Property Rights Theory, described the tribe of Montagnais Indians in Labrador und Quebec as proof of this theory. At the end of the 17th and beginning of the 18th century these native Indians did not know any constraints for hunting. Despite the free access, there were no problems of overuse due to the lack of benefits of an abundant number of killed animals. This situation changed with the white man’s demand for beaver furs. The intensification of beaver hunting caused a decrease in the beaver population. In economic terms, the benefits of the killed animals were privatized by the hunters while the costs of the declining beaver population were shifted onto the community (external costs). The hunters did not restrain themselves voluntarily due to the Nash equilibrium mentioned above (“tragedy of the commons”). The Indian community solved the problem by creating property rights: Territories were allotted to the various families of the tribe. By doing this, individual incentives were created to plan the beaver stock in a sustainable way. The costs and benefits of beaver hunting were allotted to the same persons. One could argue that Demsetz was not talking about property rights on land but about shooting rights. Below we will give more reasons why Demsetz’ explanation is anything but comprehensive.

Demsetz’ approach represents a so-called “optimistic theory” of the development of property rights. According to this theory, market forces are pushing the specification of property rights in order to save transaction costs (Demsetz 1967). Like Marx – but with a different direction – Demsetz asserts a historic law. Hence, Popper’s criticism of Marxism also holds true for Demsetz: According to this criticism the doctrine of historic determinism is nothing but superstition (Popper 1987). In order to recover the Neoinstitutional theorist’s honour, we have to add that the eschatological view held by Demsetz[1] goes too far for many of his companions (cf. Sugden 1989, North 1988). It may be that the mainstream of New Institutionalists nowadays has adapted the opinion of a neighbouring discipline, evolutionary economics. Evolutionary economists stress the historic conditionality of development paths, institutional arrangements and so on. Meanwhile it is broadly accepted that the evolution of institutional environment change toward economic efficiency often fails.

On the other hand, many representatives of the mainstream of New Institutionalism stress the connection between economic progress and the specification of property rights not as historic law, but as an economic blueprint. Representatives of evolutionary economics would hold against this that there is no such thing as “best solutions”, but only a variety of possible paths, which should be adapted based on the historical and cultural conditions.

Despite all critics, the property rights paradigm has influenced politics deeply. Just one of many examples can be studied in a common publication of FIG / UN-HABITAT / Global Landtool Network (International Federation of Surveyors et al. 2010). In this publication the authors assert a continuum of the design of property rights related to land (International Federation of Surveyors et al. 2010, p. 9):


Figure 1: Progress in the development of property rights for land?

According to figure 1, informal property rights on land are the initial point while registered freehold is the end of the development (International Federation of Surveyors et al. 2010, p. 9). This figure reflects the idea of the New Institutionalists mainstream: Although no historic determinism is asserted, progress in institution building is suggested. The apogee of the development is private property on land.

This view aspires to a final state of “one size fits all” – without regard for the cultural differences and different features of assets (see table 5). All the other forms of property rights are regarded as inferior pre-stages. This theoretical point of view has important practical implications. Assisted by Western development aid organizations, land reforms are carried out in developing countries according to a certain blueprint. The focus is on the registration of land, capacity building and allocation of individual property rights on land (de Soto 2000). The figure below illustrates the suggested “progress” (see the direction of the arrows):

Formalization of property rights

Not registered (no formal right)

Registered (formal right)

Individualization / Specification of property rights

Collective ownership (possession)

(1) Customary

(3) Group tenure

Individual ownership (possession)

(2) Occupancy

(4) Leases

Collective property

– – – – – – – – – – – – – – –

Individual property

(5) Registered freehold

Table 3: Progress in the development of property rights on land?

2.4. Further cases

This view is not only applied to land, but also to other kind of assets. According to the New Institutionalist mainstream, there is basically no area or asset that cannot be privatized. The assets mentioned below in table 4 are successively subject to privatization. The institutional framework differs, but it is very often based on WTO or on the Washington Consensus (cf. Stiglitz 2006). The following table provides only a short overview. We do not have enough space to discuss every asset in detail:

Asset Starting point Final state / legal base
Land Developing countries: Common property, overlapping customary rights, e.g. of pastoralists Registration of land, formalization and specification of property rights on land according the blueprint of Western industrialized countries
Pollution rights Atmosphere as impure public good Exclusive and tradable permits (e.g. EU emissions trading scheme)
Patent law / intellectual property rights Common generation of knowledge in various systems Private Intellectual Property Rights (foremost TRIPS)
Water Common good or impure public good Privatization of water sector (primarily driven by GATS), regarding the distribution network as well as water as a tradable good
Natural monopolies, distribution networks Primarily electricity, railways: State property Privatization, e.g. based on the Washington Consensus

Table 4: The privatization campaign

In contrast to the traditional “subjective privileges”, which in former times were given to certain persons, we wish to call these assets “objective privileges”. Although the owners of such assets may change (e.g. by trade), such assets basically cannot be contested by competition. A detailed rationale of why we call these assets “privileges” is provided in section 3.

2.5.      Reflection: A “map”

The specification of property rights is considered by New Institutionalism as an effective way of dealing with external effects. Private property rights are considered a guarantee for an efficient economy. It is regarded as a final point of an institutional development of property rights. In the following table 5 (cf. Löhr 2009, p. 69), we aim to sketch a typology of different types of assets and property rights (Löhr 2007, p. 13). In the lines we see different types of property: Private property, common property and open access. We are only considering pure types and discuss neither the large variety of intermediate forms nor state property (Löhr 2005, pp. 14). In the columns, we refer to Keynes’ distinction between assets with different degrees of elasticity of production and of elasticity of substitution (Keynes 1997, pp 230): Some assets can be easily reproduced or substituted, other assets cannot.


Assets
Difficult to reproduce or to substitute   Easy to reproduce or to substitute
Excludability:
Private property 

(1) “Objective privileges”: e.g. land, IPR, money, tradable CO2 allowances, water rights, other exploitation rights etc.

Also:

Natural monopolies: e.g. railway track, energy grid etc.

(2) “Normal assets”:

e.g. machines, cars, storehouses

 
No excludability, but clear rules for use and access: Commons (3) Common property resources (CPR) (4) Common property pool (CPP)
 
No excludability, no rules for use and access:Open access
(res nullius)

(5) Impure public goods: e.g. fish stocks, genetic pool (in as far as not yet privatized), water etc.

Problem:

Overuse (so-called “tragedy of the commons”)

(6) “Public goods”: e.g. knowledge, security, national defenceProblem:Insufficient production

 Table 5: Analytical framework and examples

The recommendations of the property rights theorists aim to specify private property rights on assets in fields (5) and (6) and to transfer them into field (1). By doing this, pure public goods and impure public goods are changed into private goods.

3.  A different paradigm – The error of Posner, Demsetz & colleagues

3.1.  The bias of contemporary economics

Like other economists, the New Institutionalist approach also stresses very heavily the importance of efficiency for society. However, particularly the Guiding Value Theory pointed out that other guiding values – such as provision, security etc. – are also of great importance for the functioning of any (social) system (Bossel 1998). Emphasizing certain guiding values too much while neglecting others may endanger any system. Hence, the “imperialism of economics”, which judges many aspects of society only in regard to efficiency, is a latent threat for the coherence of the social organism. This holds true particularly for some public services such as water distribution or railway tracks. For example, water is essential for life, and mobility is also essential in a modern society. If, for instance, the railway tracks are privatized, those tracks that cannot earn the required minimum profit will be closed. Particularly people in remote areas will suffer as a result. However, even if one engages with the contemporary stressing of efficiency, the New Institutional approach has some important shortcomings, as the following sections will show.

3.2. A lack of distinction

The basic argument of the Property Rights approach is based on a lack of distinction of assets in fields (1) and (2), regarding table 5. This is rather astonishing, because with regard to public goods, the aspect of reproduction and substitution of assets is included in the criterion of “rivalry”. According to orthodox theory, the criterion of “rivalry” is essential in order to distinguish pure public goods from impure public goods. However, regarding private goods this distinction was ignored by orthodox theory. In modern textbooks we often find the production factors categorized as “labour” and “capital” (2 factors), instead of the traditional labour, capital, land and similar assets (3-factor model). This is mainly due to the consideration of land and similar assets as a “fixed” asset, which is without importance in a marginal analysis. However, this point of view is very misleading (see also the following section). Reproducible assets (“capital”) and non-reproducible assets (“land”) are confused.

The highly acclaimed performance of the competition mechanism can only hold true for easily reproducible and substitutable assets (field (2)). These assets are contestable by competition, but not assets in field (1). One example: If a new demand emerges in an economy, an entrepreneur will discover this and record pioneer profits in his attempt to meet the needs. These pioneer profits will attract competitors, imitating his activities. In the end the new demand is met and the competition has reduced the pioneer profits to a customary level. The allocation of pioneer profits is due to property rights. Thus the competition mechanism has the function of limiting the economic power (of the pioneer).

However, the market mechanism described above does not work with assets that are difficult to reproduce or to substitute. Such assets are characterized by a relatively steep supply curve (in order to sketch the critical points, we use a simplified explanation based on Ricardo’s theory of ground rent; for a more comprehensive theory cf. Evans 2004). If demand rises, the effect is only higher (ground) rents. However, the supply of land will not increase. The higher rents are allotted to the owners of the land. The only consequence is a redistribution of income and wealth.

If assets in fields (1) and (2) are mixed up in one analytic category, the function of property is nebulized. At the same time it is suggested that the effects of increasable assets also take place with non-increasable assets.

It is worth noting that Marx made the same mistake, simply in reverse. He transferred the criticism by early socialists (that referred to the feudal system and was motivated by redistribution ideas) on property on land (field (1)) to many other assets in field (2) without making distinctions. The practical results are well known.[2]

3.3. Costs of a new kind of uncertainty

Furthermore, the allocation of exclusive property rights generates a new sort of external costs. The transfer of assets from fields (5) and (6) into field (1) creates real options, or more precisely, exclusive real options. Generally, options are defined as contracts which contain the rights but not the obligation to buy (call option) or to sell (put option) underlyings during a certain period of time (American option) or at a certain point in time (European option). In order to obtain the right, the buyer has to pay for the option. Options have two significant characteristics:

–          An option is the key to a sequential investment strategy. After a relatively cheap initial investment, the holder of the option may make the capital-intensive follow-up investment only if circumstances develop positively. For instance, the property on an unimproved plot gives the owner the possibility, but not the obligation, of a follow-up investment in a building. The owner of a water right may make commercial use of it but is not obliged to do so etc.

–          Because the buyer of the option has the right, but not the obligation, to exercise the option, we get an asymmetric opportunity /risk structure (Dixit / Pindyck 1996). The risk (in case of a bad performance of the underlying) is limited to the option premium, which is the cheap initial investment. However, the possibilities in case of a good performance of the underlying are basically unlimited (Liebler 1996, p. 102; Löhr / Rams 2000, pp. 1983).

The following table 6 illustrates the optional features of the different assets in field (1) of table 5:

The acquisition of … gives the owner the possibility, but not the obligation, to …
a reserve plot set up a building (as a follow-up investment) in case of a good business cycle
a right to oil exploitation make the exploitation during the termination of the right – if the oil price is high enough
a CO2 allowance save marginal damaging costs to an unlimited extent during the trade period
a water right exploit the source exclusively during the period of validity
a patent right make exclusive commercial use of an invention
a natural monopoly (e.g. a railway track) use the track exclusively (except in the case of access regulations, which are difficult to enforce)
money take the chance of a good investment (high net present value)

Table 6: Examples for options in field (1), table 5

An option is of high value in situations of uncertainty. The owner of an option may win due to uncertainties – however, his loss risks are limited. Due to the specification of property rights the options are exclusive. Because the rights can neither be reproduced nor substituted, they can be hardly contested by competition. Hence, investing in such real options is an adequate individual strategy to face insecurity. However, this individual rational strategy may push the economy as a whole into the rationality trap of a prisoner’s dilemma. In other words, the individual benefits mutate into a problem for the system as a whole. The reason is that if the owner of the option does not exercise it, he will block other actors. If, for instance, money is kept liquid instead of being invested, the consequence will be a loss of income for other actors.

The blockade (keeping the option) by… may manifest for other actors and the state …
… not using a plot … as higher pressure in order to develop new plots, e.g. in suburban areas
… not using an oil exploitation right … as the possibility to form a cartel (e.g. OPEC), to reduce the quantity and take higher prices
… keeping a CO2 allowance unused … in abusing the allowance for speculative purposes or to keep potential competitors out of the market
… not exploiting a water right … in stopping the provision of a certain area with water
… not using a patent right … in investments in “strategic patent portfolios” as “virtual large-scale land property”, in order to use patents only for change or to exert pressure
… abusing a natural monopoly (e.g. denying access to a competitor to a railway track) … in “integrated trusts” (e.g. rail network and operation in one hand) to deny access to potential competitors
… holding idle money (e.g. speculative balances) … in interruptions of the economic cycle (e.g. “liquidity trap”)

Table 7: Blockade possibilities by not exercising the option

The owner of the option may either block potential competitors or reduce the supply. In both cases the welfare of the economy is reduced. Hence, the individual risks do not simply disappear by making such investments; instead, they are shifted to society.

3.4. Exercising the option – as a monopolist

If the option is exercised, the commercial use is almost an exclusive one. We say “almost”, because although in most cases substitutes exist, they are inferior. The difference between using the inferior substitute and exercising the option is a kind of monopolistic rent (differential rent).

Asset Substitute Differential rent
Land Marginal land Yield of the land owned minus yield of the marginal land
Oil exploitation right Marginal oil in place Costs of exploitation of the marginal oil in place minus costs of exploitation of the acquired oil in place
CO2 allowance Saving by environmental technology or reducing production Costs of the marginal abatement (environmental technology or opportunity costs of reduced production) minus costs of the CO2 allowance
Water right Alternative water source or marginal water source Costs of exploitation of the marginal water source minus costs of exploitation of the licensed water source
Patent right Substitute invention Yield from the exclusive commercial use of the patent minus yield of the commercial use of the substitute invention
Natural monopoly (e.g. railway track) Substitute technologies, e.g. using roads Difference between monopoly price and the price of the alternatives
Money Substitutes such as cheques, bill of exchange Transaction costs of using such substitutes (barter, trade bills) minus transaction costs using cash

 Table 7: Exclusive commercial use of options

3.5. Additional costs for society

Real options are a ubiquitary phenomenon. Almost every investment strategy has some features of flexibility. The real option approach calculates an “extended present value” as the sum of the present value and the value of the flexibility advantage of an investment strategy. In contrast, the normal net present value calculation ignores the value of the flexibility advantage. Hence, the net present value calculation is nothing but a special case of the real option approach with a supposed value of the flexibility advantage of zero.

As a ubiquitary phenomenon, real options are not only limited to field (1) of table 5. Real options may also be discovered in field (2). However, the consequences of real options in fields (1) and (2) are completely different:

In field (2), the real options are not exclusive and might be contested by competitors. Furthermore, flexibility features are often required by the buyers of the asset. They offer benefits to them. On the other hand, the seller or producer has costs in creating these flexibility features. A firm, for instance, buys a truck and is willing to pay a mark-up for a base frame which makes it possible to install a crane if needed. The firm has additional costs, but also additional benefits. It is possible that the firm would not have made the investment without this flexibility advantage, because of uncertainty regarding the way in which the truck will be used in the future. In this regard the additional flexibility supports allocation efficiency. The additional flexibility is a sort of “lubricant” for the economy.

Exclusive options in field (1) have a completely different character. We wish to illustrate this by using the example of land (the same also holds true for other assets in field (1)). The value of unimproved land cannot be explained by the discounted ground rents alone.[3] In fact mark-ups are also paid to compensate the seller for his loss of flexibility.[4] In order to illustrate the problem, let us assume an efficient company as a potential investor. This potential purchaser wants to set up a building on a plot and expects a discounted cash flow of 1,000,000 $. The costs of the building including a usual profit margin of 100,000 $ is expected to be some 900,000 $. Hence, the willingness to pay for the plot is the residual value, in this case 1,000,000 $ – 900,000 $ = 100,000 $. We suppose our company is an efficient one, other actors could not earn more money with the property. Hence, the discounted land rent is some 100,000 $. However, although the presumptive seller of the land agrees with these data, he has a complete different idea of how to fix the price. If he sells the plot, he not only loses the future land rents (discounted: some 100,000 $) but also the value of flexibility (let us suppose that this value of flexibility is some 50,000 $) (Holland et al. 2000, p. 34). From an ethical point of view it might be relevant that the seller never created the flexibility advantage – in contrast to sellers in field (2).[5]

opt-Struc

Figure 2: Optional structure of unimproved land and inefficiencies (click and open)

Now let us take a look at the prospective investor: He wants to make an investment immediately (building), he already has a specific plan for the commercial use of the site. He has no interest at all in a “wait and see” approach. Hence, in contrast to his colleague in field (2), he does not have any benefit from the flexibility advantage! Nonetheless, he not only has to pay 100,000 $ for the discounted land rent, but another 50,000 $ for the useless flexibility. Although he does not want to have this flexibility advantage, he either gets the unimproved land with this advantage or he does not get it at all. Hence, the mark-up (50,000 $) is nothing but an additional hurdle for the profitability of his follow-up investment (the building). But that is not all: By setting up the building, the value of flexibility of the plot is lost (cf. Evans, p. 85). In our case the loss is 50,000 $. This is why the value of an unimproved site is higher than the value of an improved site (many valuers – at least in Germany – reduce the value of improved sites by 10 to 20%) (Sommer / Kröll 2005, pp. 209). In case of purchase, our investor has to pay capital costs of 950,000 $ (800,000 $ for the building, 150,000 $ for the land). His discounted cash flow is 1,000,000 $. This means that he cannot record his expected profit margin. It is only 50,000 $ instead of the required 100,000 $. Either the firm refrains from making the investment or it has to “squeeze it out”, e.g. by reducing wages, lowering the quality of the building etc.[6] This is the reason why many potential investors complain about “unrealistic” price demands by the owners of the sites. Whereas flexibility in field (2) was a lubricant for the economy, flexibility in field (1) is sand in the gearbox of the economy. The seller of the site as the potential creator of damage requires compensation for giving up the damaging act (blockade). This regime, which follows the victim-pays principle (instead of the causer-pays principle) is not only unfair, but also inefficient.

The consequences of such inefficient markets are far-reaching. For instance, in Germany (like in many industrialized countries) many plots are not used at all or underused, which in fact lowers the effective supply of plots on the market. On the other hand there is urban sprawl and a conversion of farmland into settlement areas at the rate of around 100 ha per day (depending on the business cycle, cf. Landusewatch 2010). Particularly young families are urged to settle in suburbia because they cannot afford to live in the expensive cities. Hence, in suburbia a parallel technical and social infrastructure has to be set up, whereas in the cities the infrastructure is operating at low capacity. The dimension of infrastructure in suburbia is set up according to maximal capacity, but with a shrinking, mobile and aging population, the infrastructure in suburbia is also running at low capacity. However, it has to be maintained and financed. Furthermore, living in suburbia causes additional traffic flows. Such sort of development is also not sustainable for a lot of different reasons which cannot be discussed here.

3.6.      Reflection: External effects and rent seeking

We have demonstrated that goods other than land in field (1) of table 5, such as (oil) exploitation rights, tradable water rights, CO2 allowances, intellectual property rights etc. also have similar features as land:

–          If the exclusive owner of the asset does not put it into commercial use, other actors are blocked. The owner gives up the blockade only in case of sufficient compensation. Such blockades create systemic risks, which are externalized to other actors, which – in contrast to the owners of such assets – are mostly poorly organized social groups.

–          The owner agrees not to block other actors only in case of sufficient compensation. Hence, the victim-pays principle is realized, not the causer-pays principle.

–          In case of commercial use the owner of the asset has a quasi-monopolistic position. This holds true because these assets cannot easily be reproduced or substituted. These assets cannot be contested by competition; they are a sort of privilege, which allow rent seeking. Such assets are aliens in a market economy.

–          All possible exchange gains cannot be exhausted (see the previous section), hence the allocation optimum cannot be achieved. Economic efficiency is impeded, not supported.

4.             “Commons”

4.1.      Four requirements

“Commons” could be an alternative to assets in field (1) of table 5, which we referred to as “aliens in a market economy”. Since Elinor Ostrom was awarded the Nobel Prize in Economics, “commons” are taken more seriously by economists. In table 5 we showed two types of commons: On the one hand “common property resources” (CPR) on goods which are difficult to reproduce and to substitute and have optional features (such as water or land, see field (3)). On the other hand we allow for a “common property pool” (CPP) for goods which are basically easy to reproduce or to substitute but nonetheless there is not enough supply due to a lack of economic incentives.

Considering the findings of the Guiding Value Theory (Bossel 1998), a specific institutional framework for commons has to take several dimensions into account. The following criteria seem to be important in this regard (cf. Löhr 2009):

–          Effectiveness / planning: Scale and structure of use of CPR (field (3)) has to be planned (access restrictions) in order to avoid overuse (e.g. land use planning). The same holds true for CPP (field (4)): For instance, society has to think about which areas of research should be focussed on and financed with priority.

–          Efficiency / allocation: Institutional conditions have to be provided in order to allocate the scarce resources to the best users. Possible blockades have to be impeded.

–          Distribution / access: The differential rents described in section 3.4. have to be distributed in a just way. The access to the assets, which nowadays are in field (1), has to be guaranteed.

–          Legitimization / justice: The members of society should have the feeling that the system is just.

There are several possibilities to meet these requirements. The analysis of such institutional arrangements is a major contribution made by Elinor Ostrom. Designing such arrangements always affects the way property rights are allocated. On the other hand, New Institutionalists deserve praise for their analysis of property rights: They identified a whole set of property rights which might be bundled and allotted to one person or unbundled and allotted to different persons. The table below is based on the description by Pejovich (1990), who was geared toward Roman law:

Exclusive rights, based on Value and rent Control and use
Asset (stock)
Right to sell the asset and to participate in its value (disposal, Latin: “ius abutendi”) Right to control and change the asset according to one’s need (Latin: “abusus”)
Utility (flow) Right to appropriate any returns on the asset (Latin: “usus fructus”) Right to use the asset (Latin: “usus”)

Table 8: The bundle of property rights

4.2.      The organization of commons – an example

On the basis of Berkes (1986) a regime is described by Ostrom in order to control the inshore fishing on the coast of Alanya, Turkey. The fishery is comparatively small in size (around 100 fishermen). They are fishing in boats with two or three people and use different kinds of fishing nets. Half of the fishers belong to a local producers’ cooperative. The initial point of the new system is a state of overuse of the fishing stock. Ostrom (1990, p. 19): “The economic viability of the fishery was threatened by two factors: First, unrestrained use of the fishery had led to hostility and, at times, violent conflict among the users. Second, competition among fishers for the better fishing spots had increased production costs, as well as the level of uncertainty regarding the harvest potential of any particular boat.
Early in the 1970s, members of the local cooperative began experimenting with an ingenious system for allotting fishing sites to local fishers. After more than a decade of trial-and-error efforts, the rules used by the Alanya inshore fishers are as follows:

–       Each September, a list of eligible fishers is prepared, consisting of all licensed fishers in Alanya, regardless of co-op membership.

–       Within the area normally used by Alanya fishers, all usable fishing locations are named and listed. These sites are spaced so that the nets set in one site will not block the fish that should be available at the adjacent sites.

–       These named fishing locations and their assignments are in effect from September to May.

–       In September, the eligible fishers draw lots and are assigned to the named fishing locations.

–       From September to January, each day each fisher moves east to the next location. After January, the fishers move west. This gives the fishers equal opportunities at the stocks that migrate from east to west between September and January and reverse their migration through the area from January to May …”

 A brief analysis shows some interesting features:

The arrangement deals with the regulation of user rights (“usus”) and yields (“usus fructus”) of an impure public good (originally: field (5) in table 5, now: transfer to field (3)). These rights are individualized. The rights to the stock (“ius abutendi”, “abusus”) are considered as being common property rights. Regarding the requirements mentioned above, we arrive at the following judgement:

–          Effectiveness / planning: There is a planning of the exploitation. The fishermen are located across the entire the fish stock area. The consequence is a careful exploitation of the fish resource without damaging the regeneration capability.

–          Efficiency / allocation: There is no waste of resources by competing for the best location. The rotation system is enforced by the fishermen themselves and also surveyed. The consequence might be minimal transaction and supervisory costs. However, it might be doubted that the most efficient fishermen get the best locations. The guiding value of efficiency is obviously weighted less than the guiding values of distribution, access and justice.

–       Distribution / access: Using the rotation system, equal opportunities are put in place to have access to the best fishing locations. The aspect of redistributing resource rents is obviously of minor importance in this example.

–          Legitimization / justice: The arrangement is neither based on private property nor on state property – the example deals with the administration of common property. However, the agents of the cooperative are backed by legislation, because the responsibility for arrangements is delegated to the local level by law. The legitimization is supported by an annual check of the arrangements, carried out by officials. The participants are supporting the arrangement. It would not make sense to create an arrangement by the central government which is not complied with and which cannot be enforced.

4.3.      A CPR blueprint

Another model – as a sort of blueprint – was designed independently by P. Barnes (skytrust, cf. Barnes / Pomerance 2000), the geo-justice movement of J. Smith and descendants of the German Free Economy movement (F. Andres, E. Behrens and D. Löhr):

–       Effectiveness / planning: This aspect was mainly stressed by the German supporters of the model. Considering possible trade-offs between effectiveness and efficiency, the guiding value of effectiveness should get priority if ecological systems could be damaged otherwise. A “safe minimum standard” (SMS) has to be guaranteed, even if the protection of environment, health etc. is cost intensive. In order to avoid overuse, objective, spatial, subjective, and temporal pollution or exploitation limits should be defined. This means that the “abuse” right should be kept by the community. One aspect is of particular significance: Not only the scale of use of CPR has to be planned, but also the structure! This could be done by fixing use quotas.

–       Efficiency / allocation: The plans (scale and structure of use) have to be achieved with minimal costs. Moreover, the best user should get prior access. Auction is a good mechanism in order to achieve this target. However, not all property rights should be leased out to the privates, but mainly the right to use the asset (“usus”). As a precondition all property rights should be owned by the community. More accurately, the property rights at the CPR should be placed in a first step into the hands of an independent trust. This is not necessarily the same as “state property”. However, the trust should not be in charge of exploitation and operation. Instead it organizes the auction of temporary user rights to the private users. Already Silvio Gesell suggested auctioning leasing rights for land (Gesell 1958, pp. 87; Hugler / Diefenbacher 2005, p. 113). The land rents and other resource rents are collected by the trust.
As mentioned above, the German supporters of the system stress that the structure of use also has to be planned. Trade schemes often cannot support the planning of structures of use or pollution. Making use of the efficiency potential of a trade scheme requires a large scaled system (in terms of space, time, objects and subjects). Where marginal abatement costs are high, pollution hotspots also have to be accepted. However, a control of the structure of use and pollution often requires narrow schemes (e.g. for a certain gas in a certain region at a certain time). According to the SMS, pollution hotspots can be only tolerated if no serious impact on the resilience of ecological systems has to be expected (Löhr 2008). Hence, in contrast e.g. to P. Barnes and the New Institutional mainstream, the German supporters of the system stress the application of auction schemes as a contrast to trade schemes.

–       Distribution / justice: There is an obvious argument against the auction of temporary user rights: Those with the highest ability to pay will get the rights.[7] This argument might be invalidated by introducing a redistribution scheme: The revenues (after subtracting administration costs) should be redistributed to the citizens in equal shares. Hence, the distribution position of an actor depends on his intensity of use of the CPR. If an actor has a high use, he has to pay a large amount to the trust within the auction. If he has a low use, he has to pay less money.

A high consumption of the CPR causes payments into the trust and vice versa. For instance, with regard to climate protection this means (without considering administration costs):

–          If some actors use the CPR “atmosphere” more intensively or extensively than the average, they pay more into the trust than the average user. On the other hand, they will get back money, but only an average payment. On balance such “overuse” actors pay more than they get.

–          Other actors have lower emissions than the average. On balance they get more money back than they pay.

–          If an actor has average emissions, he gets as much back as he pays. His position is the same as if such a regulatory system did not exist.

Every actor has an incentive to get the position of a net beneficiary. Hence, there is a built-in mechanism to use the common good efficiently. In the ideal case[8] the redistribution system would give every human the necessary budget in order to participate in equal shares in the CPR.[9] If the price for the user rights is rising (e.g. rising demand for the allowances due to economic growth or due to a reduction of the allowances), the bidding prices in the auction will also rise. On the other hand, the redistribution payments will also rise. Hence, there will be no negative income effect for the average user.

According to a basic idea of the land reform movement, every human should have the same rights to land (in the broad understanding of Henry George (1879), including also natural resources other than land; cf. Backhaus 1999, pp. 28-29).[10] J. S. Mill (1909, section II, § 6): “No man made the land”. This applies to all assets that are actually in field (1) of table 5 except the natural monopolies. On this basis Andres (2001, pp. 24) asks for the access to such resources to be a human right.

4.4.      Reflection: CPR blueprint as another “one size fits all”?

Maybe the institutional design described in section 4.2. is not an optimal one in an economic sense. The rents of the fish stock (“usus fructus”) are individualized and privatized, which runs counter to the system redistribution blueprint design described in section 4.3. On the other hand, this deviation from the redistribution blueprint design is not a problem at all, because these rents are of minor significance. For the community of fishermen the aspect of legitimization and justice was of higher importance. The criteria described in section 4.1. are reflecting guiding values (Bossel 1998) which every system has to meet to a certain extent. However, depending on the actual situation it may be adequate to stress some guiding values more and other less. Hence, there is no “one size fits all” design for common goods; otherwise the protagonists of the commons would fall into the same trap as the orthodox New Institutionalists. Against this background the redistribution blueprint (section 4.3.) might be interpreted as a “pure type” that has to be modified according to the specific situation in place. It has to be stressed that the blueprint in section 4.3. is also not applicable for all situations. Particularly the aspect of “justice”, which refers to the cultural background, suggests looking for adapted designs in different countries and regions, even if the problem is the same.

5.             Final remark: One size does not fit all

The idea of the New Institutionalists is that a far-reaching specification of property rights is a precondition for an efficient economy. This idea can be criticized from many viewpoints: First, efficiency is only one guiding value among a magnitude of guiding values. For example, the idea of “sustainability” refers to at least three dimensions (economy/efficiency, ecology/effectiveness and social aspects/distribution). Even if one accepts the narrow view of efficiency, property in field (1) of table 5 is completely different from property in field (2). Private property in field (1) is the basis for privileges, which are aliens in a competitive economic order. This is an argument to transfer the impure public goods (field (5)) and the pure public goods (field (6)) not into field (1) but into field (3) (CPRs) and pure public goods into field (4) (CPPs) of table 5. This might happen differently according to the differences in situation, culture and society. The desirable result would be a society with a variety of forms of property rights. It should be noted that this implies another role of the state. Today, the state is captured by well-organized groups and is protecting the privileges in field (1). The costs of using these privileges are shifted to poorly organized groups or to society as a whole (Olson 1971).


References

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[1] Eschatology means “study of the last things.

[2]  This was not Marx’ original mistake, because he adapted the wrong theory of Moses Heß (cf. von Berg 1986, pp. 66).

[3] This is another shortcoming of the usual theory which is based on Ricardo (1821).

[4] Maybe the most general reason for the mark-up is the available option to use land in a different way. For instance, agricultural land which might be converted into a settlement area also has such an intrinsic option value. Every plot might be considered as an option regarding competing land use, if the uncertainty about the future is taken into account.

[5] Basically this is what Oppenheimer (1909) called the “absolute rent”.

[6] This means that the hurdle rate of capital costs is even increased by the costs of the value of flexibility.

[7] The “willingness to pay” depends not only on the preferences but also on the budget – this is the “ability to pay”. Cf. Endres 2000, p. 41.

[8] This means also no administration costs and low costs of exploitation of the resources.

[9] In order to achieve this it would be helpful to complete the system by a credit mechanism (e.g. charging the previous period of use in the following period, within the auction).

[10] The idea of equal participation is also central to the concept of environmental space of Opschoor et al. (1992).

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