Property Rights and Contracts

Posted by PITHOCRATES - March 26th, 2012

Economics 101

We put a lot of Money and Time into Maintaining Property we Own so we can Enjoy it Exclusively

Have you ever bought the Brooklyn Bridge?  I hope not.  For if you have someone probably conned you.  Unless you bought it from the New York City Department of Transportation (DOT).  Because they currently own the Brooklyn Bridge.  And are the only ones who can sell it.  But the last I checked they weren’t selling.  So I doubt they sold it to you.  If you are about to enter into negotiations to buy the Brooklyn Bridge I suggest you do a title search first.  To verify that the seller in fact owns the property.  Has the right to sell the property.  And that the seller is selling the property ‘free and clear’.  To make sure you don’t have to pay any outstanding construction bills for work completed on the bridge that the DOT didn’t pay.  Then and only then should you buy your bridge.  So you can enjoy the pride of bridge ownership.  While charging tolls.  And getting rich.

This illustrates a central point about buying and selling things.  Property rights.  Which lets us buy things.  And sell them.  For to sell something we must first own it.  And to buy something we must know that we can own it.  Because if we’re not sure we can own it we’re not going to exchange our hard-earned money for it.  And once we own something we’re going to use it however we wish to use it.  At least that’s what we expect to do.  If we buy a house with a pool in the yard we’re going to want to use that pool exclusively.  Because we paid for it.  And keep it clean.  By maintaining the pool filters and pumps.  Adding chlorine.  Vacuuming the bottom.  We’re going to put a lot of money and time into maintaining that pool so we can enjoy it.  Our little tropical paradise in our own backyard.  But we’re not going to do all of that if just anyone can walk into our yard and use our pool whenever they damn well please.  For if that were the case we wouldn’t spend the time and money in the first place.  We’d look for a pool we could use for free.  Like everyone else who thought they could walk into our yard and use our pool whenever they damn well please.

Or would we?  Let’s say someone in your neighborhood just moved in.  They put in a nice in-the-ground pool.  Spent a fortune on it.  Kept it pristine.  And used it exclusively.  They were happy.  Until the subprime mortgage crisis hit.  And all of a sudden they owed far more on their mortgage than the house was worth.  So one night they just disappeared.  And let the bank have the house.  Once you notice their house is empty you think about that pool.  And decide what could it hurt if you went over for a swim?  You go there.  Notice they left the pumps and filters on.  And the pool is still pretty clean.  So you enjoy a swim or two.  Others find out.  And go over for a swim.  A lot of them.  The pool is crowded.  And not so clean anymore.  No one is skimming the garbage out of it.  Or maintaining the chlorine level.  Some of the kids are even peeing in the pool instead of getting out of it.  Soon the pool begins to smell bad.  Algae is growing.  The filters plug up.  With the water flow blocked the pumps strain and trip the circuit breaker.  Stopping the pumps.  And the filtering.  The crud they filtered out backs up into the pool.  Soon the water turns a greenish gray.  And looks more like a stagnant pond where dead fish float on the surface than the pristine tropical paradise it once was.

We can trace most Pollution and Environmental Damage back to the Tragedy of the Commons

Economists call this the Tragedy of the Commons.  Which is what happens when we poorly define our property rights.  In our example the pool was clean and enjoyable when someone owned the pool.  When no one owned the pool (after the previous owners abandoned it) the pool became dirty and no longer enjoyable.  Why?  Because when we own something we have an incentive to take care of it.  For our long-term enjoyment.  When no one owns it no one has an incentive to take care of it.  Some may try but others will continue to pollute.  Because they don’t own it.  And have no incentive to spend the time and money to keep it clean.  Especially when others are still polluting.  So no one tries to keep the pool clean.  They’ll enjoy it while they can.  And when the pollution gets so bad they will move on and find something else to enjoy. 

We can trace most pollution and environmental damage back to the Tragedy of the Commons.  If you love the beach so much that you buy a house on it you will keep your beach clean.  You’re not going to litter it with cigarette butts, empty bottles, food wrappers, used condoms, etc.  A public beach, on the other hand, is a different story.  Just as people will take their trash to a public field to dump it.  Because they don’t own that land and have no incentive NOT to pollute it.  And it’s cheaper than taking their trash to the private landfill that charges a fee.  Who helps to keep America beautiful by burying our trash.  And when the landfill is full someone else will buy it and make a beautiful golf course out of it.  Or something else.  As long as someone owns it something nice will happen with that land.  To maintain the value of that land to the landowner.

When you own something it has value to you.  Such as a logging company cutting down trees on land they own.  Because this land has value they will not over-log it.  And when they cut down trees they will plant new seedlings.  So the land continues to have value.  Because they will be able to cut down these seedlings after they grow into trees.  Or the future owner of that land will be able to.  Who will buy that land because it has value.  Whereas there is no incentive for a private logger working on public land NOT to over-log it.  Or to plant seedlings.  Because they don’t own that land.  Anything they don’t cut down some other logging company will.  And without any property rights to that land they won’t plant any seedlings.  Because nothing will prevent anyone else from cutting these down once they grow into trees.

Well Defined Property Rights allow Buyers and Sellers to Enter into Contracts with one Another

To do all of this buying and selling we need well defined property rights.  Clearly spelling out what the seller owns.  And what exactly the buyer is buying.  For example, a logging company buying a tree farm may want to drill an exploratory well to see if there is oil or natural gas under that land.  So he or she will want to make sure that the terms of the sale include all mineral rights.  Paying additional for these rights if necessary.  Or getting the tree farm at a lower price than other comparable tree farms because the seller wants to retain the mineral rights.

Well defined property rights allow buyers and sellers to enter into contracts with one another.  Contracts clearly state the terms of sale and any other special provisions.  Such as the seller retaining his or her right to have his or her pick of one tree anywhere on that land once a year in the month of December.  As long as buyer and seller freely enter into these agreements they expect each other to honor the terms of the contract.  And only when both parties honor the terms of the contract does the ownership of property transfer from one party to another.

Property has value.  Even the Brooklyn Bridge.  And well defined property rights protect that value.  Because the DOT owns that bridge they spend money to maintain that bridge.  A well-maintained bridge provides value for those who want to cross the East River.  Currently the various taxes they pay to the city and state make their way to the DOT.  To pay for that maintenance.  But if the city of New York found itself in serious financial trouble they could sell the Brooklyn Bridge.  To a private person.  Who wants to put up toll booths on the bridge.  The city gets a large sum of money to help with their financial trouble.  And the new private owner gets a revenue stream in the form of tolls.  And the city of New York will, of course, screw those crossing the East River.  Because they’ll now have to pay a toll to cross the Brooklyn Bridge.  But they won’t get any of their taxes back.  Because governments rarely if ever cut their taxes.  The city and the private person do well because they both have well defined property rights.  And a contract.  The people using the bridge don’t.  They had no contract with the city that clearly stated the terms for their use of that bridge.  And will continue to pay the taxes that paid their crossing fees.  As well as the new tolls.  Which is business as usual.  Because government always screws the taxpayers.  Who are always at a disadvantage when it comes to property rights and contracts when dealing with the government.  For government has the power to break contracts and take property.  Unlike private persons entering into contracts.  Who only transfer the ownership of property by mutual consent.

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