Chapter 14
Challenge To Market Effectiveness 4:
Inadequate Property Rights
McGraw-Hill/Irwin
Copyright © 2009 by The McGraw-Hill Companies, Inc. All Rights Reserved.
Learning Objectives
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What are property rights?
How do property rights create wealth?
What is the tragedy of the commons?
What are different categories of goods?
What is a public good?
Why does the market fail to produce public
goods?
• What is intellectual property?
• How do real estate property rights help people?
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Property Rights
• To have property rights in a good means
one can use the good oneself, sell it to
others or prevent others from using the
good.
• A prime reason for widespread devastating
poverty is the lack of adequate property
rights.
• When property rights aren’t secure,
markets have difficulty creating wealth.
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Pain Before Pleasure
• Businesspeople must invest their time and
resources before earning a profit.
• Without property rights, the initial pain of
investment often leads to disappointment rather
than to pleasurable profits.
• People without property rights often have no
incentive to suffer the initial pain that investment
requires.
• For example, because it lacked secure property
rights, few people invested in Russia.
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Securing Property Rights
• Creating secure property rights is difficult.
• For property rights to be secure, they must be
respected at many levels of society.
• The central as well as local governments must
refrain from arbitrary confiscation.
• In addition, secure property rights require honest
courts that can adjudicate disputes among
businesspeople and honest police who prevent
criminal gangs from seizing property.
• Secure property rights also require families to
respect the individually owned property of their
members.
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Property Rights
• For property rights to create wealth, they must belong to
individuals, not groups.
• The wealth-creating superiority of individual over
collective property rights was well shown by Soviet
agriculture.
• Peasants had to farm the communal land without the
right to keep what was grown on it. Consequently,
peasants often did a shoddy job of farming the
collectively owned land.
• The small, privately owned plots, which accounted for
only 1% of the farm land in the Soviet Union, produced
one-third of all the food grown in the country.
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Dr. Seuss’ The Lorax
• The Once-ler discovers that he could use the soft tuft of
a Truffula tree to make Thneeds.
• To increase his profit, the Once-ler soon cuts down more
and more Truffula trees.
• Without property rights, the Once-ler cares only about
the short term, because he knows that the Truffula trees
would never survive in the long run.
• Property rights would have caused the Once-ler to take a
long-term view of the Truffula trees. He would have
managed his Truffula forest so that it would continually
renew itself.
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Tragedy of the Commons
• A resource is rival if one person’s use of it reduces the
amount left for other people to consume.
• A resource is excludable if people can be prevented, or
excluded, from using it.
• A non-excludable resource will continue to be used as
long as some people benefit from it. But, if the resource
is rival, then each person’s use harms other people.
• So, resources that are rival but non-excludable will
(tragically) tend to be used until they are depleted or
destroyed.
• A tragedy of the commons arises when a resource is
rival but non-excludable.
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Tragedy of the Commons
The Buffalo Tragedy:
• In 19th century, any American had the
right to kill buffalo.
• Consequently, American buffaloes were
almost hunted to extinction.
Lake Commons:
• Fish are a rival resource. If anyone has
the right to fish in the lake, people will
continue to fish this lake until no fish
survive to spawn new fish.
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Tragedy of the Commons
• When a common resource is owned by no one, each
user can benefit from using the resource.
• But, because the resource is rival, each person’s use of
the resource creates negative externalities on everyone
else.
• People tend to overuse goods that have negative
externalities.
• The tragedy of the commons problem arises because
absent some corrective measure, common resources
are frequently used until depletion.
• Property rights make a resource excludable and solve
the tragedy of the commons problem.
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Public Good
• A public good is any product or service that is
non-rival and non-excludable.
• Because it’s non-rival, one person’s use of a
public good doesn’t harm other people.
• Because it’s non-excludable, anyone can benefit
from a public good regardless of whether they
have contributed to creating it.
• Consequently, people have an incentive to freeride off of others’ expenditures on public goods.
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Public Good
• Because public goods are non-excludable, their
creators can’t acquire property rights in them.
• The free market does not induce self-interested
people to engage in producing public goods
because they would receive only a tiny fraction
of the benefits of their efforts.
• Adam Smith’s invisible hand of the marketplace
does not push people to take socially beneficial
actions.
• Through compulsory taxes, the government can
prevent people from free riding off others and
provide public goods.
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Charlie and the Chocolate Factory
• Using the information gathered by their spies,
other chocolate firms started selling the exact
same products that Willy Wonka produces.
• Because of the widespread theft of his
chocolate innovations, Willy Wonka has to
shut down his factory.
• Insufficient property rights cause Wonka to
stop making candy since he cannot recover
his innovation costs.
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Intellectual Property
• Intellectual property is information rather than physical
goods, e.g. the formula for making Everlasting
Gobstoppers, the code behind a software program, the
composition of notes making up a song.
• To have secure property rights in intellectual property
means that no one can use the proprietary information
without the innovator’s permission.
• Intellectual property can sometimes be defended without
governmental help. French chefs protect their intellectual
property by ostracizing those who steal.
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Internet Piracy
• Internet piracy has eroded intellectual property
rights in music and movies.
• The Internet has made music and movies far
less excludable.
• Such theft of property poses a significant threat
to the for-profit production of movies and music.
• Although Internet piracy is illegal in most
countries, the laws are not seriously enforced.
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Solutions to the Internet Piracy
Problem
• Increase the Moral Cost of Theft: Use of advertising to convince
people that theft of intellectual property is wrong.
• Action Figures/Concerts: Creators of intellectual property could
still profit even if everyone freely took their property by selling
products based on their intellectual property .
• Advertising: Movies, music, and books could incorporate
commercials into their plots.
• Tips: Intellectual property creators could ask for tips from
consumers.
• Self-Enforcement: Intellectual property holders could use virtual
weapons to protect their stuff.
• Not-For-Profit Production: Even with rampant intellectual property
theft, amateurs will still produce movies, music, and books for
pleasure and fame.
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Real Estate Property Rights
• The ownership of every home, building, and piece of
land in most rich countries is diligently recorded by the
government.
• Banks readily make collateral-backed loans because of
such careful records.
• Collateralized property loans allow many people in rich
countries to buy homes or start small businesses.
• Unfortunately, most of the real estate owned by poor
people in poor nations is not publicly recorded. They are
consequently denied the benefits of collateral-backed
loans that benefit citizens of rich nations.
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Property in Poor Countries
• Most of the property possessed by poor people in poor
countries is only informally owned.
• Because no one officially owns the land, the property
legally belongs to the government.
• According to Hernando De Soto, informally owned
property is “dead capital.” Dead capital refers to assets
that can’t be used to create new wealth.
• Banks are extremely reluctant to give loans to people
with dead capital as collateral.
• Similarly, lack of individual property rights, which creates
dead capital, is a prime reason for Native American
poverty.
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The Story of Srey Neth
• Srey Neth was a Cambodian teenage prostitute/sex-slave. New York
Times columnist, Nicholas Kristof, purchased her freedom for $150.
• With Kristof’s help, Srey Neth started a small shop but it failed
because she lacked property rights. She could not stop her family
from taking the goods from her shop.
• Using money donated by some New York Times readers, Srey Neth
attended school to become a beautician.
• Srey Neth’s family likely possessed only dead capital that couldn’t
be used as collateral for a loan. So without charitable assistance,
Srey Neth would not have been able to pay for her education.
• Many people in poor countries have the skills to run small
businesses, but their lack of property rights and dead capital often
makes this impossible.
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Where Property Rights Are Not Needed
• The free software movement purposefully rejects
property rights to deliberately create public goods, e.g.
the computer operating system Linux and the online
encyclopedia Wikipedia.
• Both of these free software products are built by
volunteers and are freely and legally accessible to
everyone.
• Since Wikipedia and Linux deliberately forsake property
rights, their tremendous success poses a challenge to
the worldview of those who believe in the importance of
property rights for wealth creation.
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Do You Know?
 Why does collective ownership discourage wealth
creation?
Collective ownership of resources does not provide
individual property rights. People without property rights
often have no incentive to suffer the initial pain that
investment requires and hence to create wealth.
 What is the “tragedy of the commons”?
The tragedy of the commons is a problem that arises
when common resources are frequently used until
depletion.
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Do You Know?
 Why doesn’t Adam Smith’s invisible hand cause selfinterested people to provide public goods?
A public good is any product or service that is non-rival
and non-excludable. Adam Smith’s invisible hand fails to
push self-interested people to engage in producing
public goods because they would receive only a tiny
fraction of the benefits of their efforts.
 What is the problem with dead capital?
Dead capital refers to property that is informally owned
without any official records. These assets can not be
used to create new wealth as banks are extremely
reluctant to give loans to people with dead capital as
collateral.
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Summary
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To have property rights in a good means one can use the good
oneself, sell it to others or prevent others from using the good.
Without secure property rights people have no incentives to invest
and create wealth.
The tragedy of the commons problem arises because rival but nonexcludable resources are frequently used until depletion.
A resource is rival if one person’s use of it reduces the amount left
for other people to consume.
A resource is excludable if people can be prevented, or excluded,
from using it.
A public good is any product or service that is non-rival and nonexcludable.
Market fails to produce public goods because people have an
incentive to free-ride off of others’ expenditures on public goods.
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Summary
• To have secure property rights in intellectual property
means that no one can use the proprietary information
without the innovator’s permission.
• Theft of intellectual property poses a significant threat to
the for-profit production of movies and music.
• Because of lack of real estate property rights, many
people in poor nations are denied the benefits of
collateral-backed loans that so benefit citizens of rich
nations.
• The free software movement that purposefully rejects
property rights to deliberately create public goods has
been tremendously successful.
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Coming Up
What is incomplete information?
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