The Limits of Liberty: Between Anarchy and Leviathan

Under regimes where individual rights to do things are well defined and recognized, the free market offers maximal scope for private, personal eccentricity, for individual freedom in its most elementary meaning. The failure of the romantic advocates of anarchy to recognize this feature of free markets is difficult to understand; this is one of the sources for the paradox observed in the 1970s and noted above in Chapter 1. Socialist organization, defined broadly as extended collective or state control over voluntary exchange processes, must be and can only be antithetic to anarchy, despite the surprising linkage of these two contradictory organizational norms in much of the romantic literature.
*16

Economics, the science of markets or of exchange institutions, commences with a well-defined structure or set of individual rights and offers explanatory, predictive propositions concerning the characteristics of outcomes along with conditional predictions about the effects of imposed structural changes on such outcomes.
*17 Economic theory is sufficiently powerful to explain many varieties of exchange relationships. The central tradition of this theory involves analysis of two-party exchanges imbedded in and constrained by a network of interrelated potential and actual trading pairs. It is not my purpose to summarize this theory here. As Chapter 3 will suggest, however, straightforward extension of some of the models to the many-party, complex exchanges that collective action may represent yields substantial explanatory results. In all cases, and this is my emphasis, the analysis proceeds from some initial imputation of rights among participating persons in the interchange, an imputation that is assumed to be conceptually observable and also to be recognized and respected by all parties.

Commonality and Noneconomic Interaction

The dependence of efficient trade upon a delineation and identification of individual rights is revealed most clearly in the case of fully partitionable “private” goods. It should be evident that the requirements for mutually accepted definitions of structure need not be so restricted. Consider facilities that may, due to either technological necessity or social decision, be accessible to all members of the relevant group. Mutual agreement on the behavioral limits with respect to the use of such property is, at base, no different from mutual agreement on the boundary lines for strictly private holdings. My recognition that the fruit salesman owns the watermelons is not, in concept, different from my recognition that both he and I have rights to walk along the village street, rights that both of us honor and respect, and which neither of us calls into dispute. We both utilize the common-access facility, and we do so without overt conflict only because of our mutual recognition and acceptance of these rights. If a particular road or street should be “Private”; if one of us should hold legal title to the facility which embodies rights to exclude, the other would normally respect a “No Trespassing” sign if one appears. This despite the possibility that, descriptively, the road or street facility might be identical in the two settings. Conflict emerges, or may emerge, not from any specific assignment of individual rights, but from disagreement over and uncertainty about just what the legally enforceable assignment is.

The same principle applies to many aspects of human behavior that are not normally classified as “economic” and that are not explicitly treated as exchange relationships. The reconciliation of individuals’ desires to “do their own things” with the fact that they live together in society is accomplished largely by mutual agreement on spheres of allowable or tolerated activity. “Equal freedom,” as a norm or rule for social intercourse, has little or no meaning until and unless individuals are first identified in terms of acknowledged limits to behavior. The acceptance of such limits is so familiar to us all, pervading wide reaches of routine behavior as well as our attitudes toward the behavior of others, that we rarely think of the structure of individual “rights” that is underneath. Our attention is turned to definition of rights only when the tolerated limits are exceeded, when previously accepted boundaries are crossed. Only at this stage do we begin to consider drawing the limits more carefully, possibly calling on enforcement agents, or thinking about recourse to personal means of redress or defense.

The set of manners, the customary modes for personal behavior, which reflects the mutual acceptance of limits, will of course vary somewhat from culture to culture, but it is relatively easy to think of examples in any setting. I do not start my power mower early on Sunday morning, and my neighbor does not play stereo music loudly after eleven at night. Both of us recognize the possibly harmful effects on the other, and we refrain from imposing costs in this manner, even at some personal sacrifice. If one of us violates this set of “live and let live” rules, the other is prompted to take specific action in redress. If my neighbor operates his stereo loudly in the wee hours, and does this repeatedly, I should be prompted to try deliberately to annoy him with my lawn mower, to get the police to enforce the antinoise or antinuisance ordinance, or, if one does not exist, to try to get the town council to enact such an ordinance. If all else fails, I might then resort to direct physical action against the neighbor’s property or person.

It is in this context that some of the behavioral changes of the 1960s raise fundamental and disturbing issues for social stability. As noted, individuals have lived, one with another, under implicit behavioral rules that were respected by all, or nearly all, persons in community. But one of the instruments employed by the participants in the counterculture involved the explicit flaunting of traditional codes of conduct, the direct and open disregard for what had previously been considered to be acceptable standards for elementary “good manners.” This placed stresses on the ordered anarchy that still describes much of ordinary social life in our society, stresses which were evidenced by calls for “law and order,” for formalization and enforcement of rules that were previously nonexistent.

Social stability requires agreement on and enforcement of a structure of individual rights, whether these rights be over the disposition of privately partitionable goods, over the usage of common facilities, or over ordinary patterns of interpersonal behavior, and whether the enforcement be externally imposed or internally monitored. A possible source of ambiguity should be mentioned here. Mutual agreement, backed up if necessary by effective enforcement, is a necessary condition for social interchange. But this agreement may embody any one of an almost infinite variety of actual distributions and/or imputations of rights among persons, constrained by any one of an equally large number of possible sets of rules for personal behavior. Neither the specific distribution of rights among separate persons nor the general characteristic of the rights structure itself is relevant directly to the issue of mutual agreement, certainty in definition, and enforcement.
*18 Physical facilities may be variously partitioned among individuals, as units of “private property.” Or, alternatively, such facilities may be organized under rules that dictate common usage by large groups of persons, including the whole membership of the community. If the limits to individual behavior are well defined, voluntary social interaction can proceed in an orderly fashion under any structure. Interpersonal dealings can take place under
any agreed-on assignment. Only at a second, and quite different, level of discourse do problems arise about the relative desirability of specific distributions of rights and/or about the relative efficiencies of different structures. The tendency or proclivity to inject either equity or efficiency norms, or both, too early has plagued the discussion of property rights throughout the ages.

It is, of course, possible to evaluate alternative distributions on personally chosen criteria of “justice” or “equity.” More positively, it may be possible to array alternative structures of rights by criteria of economic efficiency. The owners of cattle and sheep on a grazing range may either (1) hold rights to the common pasture or (2) hold individually fenced-off parcels of land. The second arrangement may, on examination and analysis, prove to be more efficient than the first in some standard efficiency sense, but the relative inefficiency generated under the common-ownership arrangement is not at all comparable and indeed is different in kind from that which might emerge when mutuality of agreement on rights disappears, when there is uncertainty as to just what structure of rights will be legally enforced. The range wars in the American West in the late 1880s arose because of such uncertainties as these, and not because the structure in existence was grossly inefficient in the orthodox sense or was demonstrably “unjust” by other criteria.
*19

Rights and Contract

The argument to this point is straightforward and could scarcely be disputed. A necessary starting position for a society of free individuals, related one to another in a network of interdependence, is some agreement on a structure of rights which, in effect, defines the entities who enter negotiations. It is difficult even to imagine a relationship when such mutual agreement is wholly absent. How could two men, meeting for the first time, carry out the simplest form of interchange without implicit acceptance of some behavioral limits?

As I have noted, these bases for individual behavior in society are simply taken for granted by most of us, so much so that we rarely pause to examine the issues that are posed. As Blackstone suggested: “These inquiries, it must be owned, would be useless and even troublesome in common life. It is well if the mass of mankind will obey the laws when made.”
*20 Once individual rights are acknowledged, contractual negotiations become possible, and, as economists, we launch off into the interesting problems posed by the contracting or exchange process itself. We sometimes fail to recognize, or otherwise forget, that the whole institution of contract, whether this takes the simplest form of isolated two-party trade or the more complex
n-person agreement, rests on the possibly shaky foundations of mutual agreement on individual rights, including agreement by an enforcing agent, a state, which must also limit its own behavior. It is perhaps time that economists begin to devote more attention to the origins of contract.

The modern contributions to the “economics of property” can only be welcomed. I refer to the contributions of Alchian, Cheung, Demsetz, Furubotn, Kessel, McKean, North, Pejovich, Thomas, and others.
*21 Nonetheless, the emphasis in this now burgeoning subdiscipline is on the way in which alternative property-right structures can modify individual and group behavior, with the orthodox criterion of economic efficiency implicitly at the base of the analysis. To this point, these contributions have not concentrated on explaining the emergence of property rights.
*22

This may be illustrated with reference to Harold Demsetz’s discussion of private-property rights among the Canadian Indians.
*23 In his interpretation of the history, the Indians of the Labrador peninsula accepted common usage of hunting grounds prior to the dramatic increase in beaver-skin prices caused by French traders. This price increase stimulated increased hunting effort; beaver skins became relatively scarce, and individual hunting tended to produce an uneconomic utilization of the common resource. As a means of internalizing the external diseconomies that this rights arrangement fostered, the Indian tribes shifted from a common-usage to a private-property structure. The historical accuracy or inaccuracy of this account need not concern us here. But note that Demsetz essentially “explains” a change in rights structure by resort to a new contractual arrangement made desirable by exogenous changes in economic data. He is employing the historical example to demonstrate the proposition or principle that there will always be a tendency for characteristics of the rights structure to be shifted toward that set which is most efficient under the conditions faced by the community. There can be no quarrel with this, and Demsetz’s contribution can be acknowledged. We should not, however, make the mistake of saying that this approach explains the origin or emergence of rights among individuals or families (tribes) independent of contractual agreement, whether this be explicit or implicit. In his conceptual model, the rights of the several participants must have been mutually recognized by all participants
before further contractual negotiations could be undertaken to change the structural characteristics.

With regard to the emergence of initial rights, we must acknowledge that any attempted economic explanation will be insufficient. How might the rights of individuals (families, tribes), rights to do things, including rights over domain, rights that are mutually respected, arise? What is the logical basis of property? To such a question, there cannot be an exclusively contractarian answer. The concept of externality may, however, prove helpful in pointing toward meaningful analysis. Demsetz argued that property rights change for the objective of “internalizing externalities.” His particular discussion was directed, as noted, toward explaining how structures are shifted toward satisfying overall efficiency norms. He did not, at least explicitly, try to extend his thesis backward, so to speak, to examine the noncontractual elements.

This step can be taken if we introduce a sufficiently broad definition of externality. In a world without interpersonal conflict, potential or actual, there would, of course, be no need to delineate, to define, to enforce, any set of individual (family) rights, either in the ownership and use patterns of physical things or in terms of behavior with respect to other persons. I use “conflict” rather than “scarcity” here, because even if all “goods” that might be “economic” should be available in superabundance, conflict among persons might still arise. Social strife might arise in paradise. Total absence of conflict would seem to be possible only in a setting where individuals are wholly isolated one from another, or in a social setting where no goods are scarce and where all persons agree on the precise set of behavioral norms to be adopted and followed by everyone. In any world that we can imagine, potential interpersonal conflict will be present, and, hence, the need to define and enforce individual rights will exist.

The “Natural Distribution”

Consider a simple two-person world. All “goods” save one, which we shall call
x, are available to each person (A and B) in superabundance. But good
x is “scarce.” No production is required for its enjoyment, however, and quantities of this good simply “fall down” in fixed proportions onto each of the two persons at the onset of each period of consumption. There are no property rights, no law, in this economy. Hence, we may say that the consumption or use of a unit of
x by individual A imposes an “external diseconomy” on B, and similarly, that the consumption of a unit by B imposes a diseconomy on A. In an orthodox externality setting, and notably in small-number groups where transactions costs are not prohibitively high, we might predict that “trade” between the two persons would take place, accomplishing an internalization of the reciprocal externality relationship. In our example, however, regardless of the initial distribution of
x, there is no surplus to be secured through a direct trading process. Nonetheless, each of the two persons will have an incentive to “internalize the externality” that the other imposes on him.

Both A and B might seek to consume all of the good
x that is available. As Thomas Hobbes perceptively noted, in this state of nature each person has a “right” to everything. Each would find it advantageous to invest effort, a “bad,” in order to secure the good
x. Physical strength, cajolery, stealth—all these and other personal qualities might determine the relative abilities of the individuals to secure and protect for themselves quantities of
x, which may be quite different from the relative quantities that were arbitrarily assigned by the initial disposition. These attributes may, but need not, include some inherent “live and let live” attitude among members of the common species. In any case, as a result of the actual or potential conflict over the relative proportions of
x to be finally consumed, some “natural distribution” will come to be established.
*24 This cannot properly be classified as a structure of
rights, since no formal agreement is made, although there might well exist mutual recognition of the appropriate bounds on individual action. Nonetheless, the natural distribution may represent a conceptual equilibrium, in which each person extends his own behavior in securing (defending) shares in
x to the limit where marginal benefits from further effort are equal to the marginal costs that such effort requires. In the “natural distribution,” the two persons, A and B in our example, continue to impose external diseconomies on each other in the sense noted above. But now, because this distribution does offer a base from which some predictions may be made, indirect “trades” become possible that will internalize the external diseconomies.

The “natural distribution,” secured upon investment of effort in attack and/or defense of consumption shares in
x, serves to establish an identification, a definition, of the individual persons
from which contractual agreements become possible. Absent such a starting point, there is simply no way of initiating meaningful contracts, actually or conceptually. But, in the natural distribution, both A and B will recognize, on rational observation, that much of the effort expended in securing and defending stocks of
x is wasteful. Whatever might be the characteristics of this distribution, whether rough symmetry prevails or whether one participant becomes a consumption giant and the other a pygmy, and even if all of
x is secured by one party,
both parties will be made better off if agreement can be reached. Trades can be arranged in the sense of agreement on a set of behavioral limits. Mutual gains are possible in this way over a wide range of assignments of final consumption, with the particular assignment finally negotiated dependent on bargaining skills and other factors.

The Emergence of Property

It is appropriate to call this a genuine basis for the emergence of property rights.
*25 Both parties agree to and accept the assignment, which carries with it the complementary agreement that they will not behave so as to violate the terms. Both parties can, therefore, reduce their private investment in attack and defense; in the limit, the full value of
x can be realized without cost.
*26 The agreement on rights of the two parties represents a contractual internalization of an externality relationship that existed in the precontract state of nature. Note, however, that the reversion to some sort of “natural distribution” is required in order that potential trading participants can themselves be identified. This may be illustrated by tracing an alternative conjectural history of the emergence of private property among the various Indian tribes of the Labrador peninsula. The increase in the demand for beaver converted what had previously been an abundant resource into one that was scarce. No property rights previously existed, and the new scarcity produced conflict among the separate tribes. As a result of actual or potential intertribal wars, some “natural distribution” emerged that came to be recognized by all tribes. A reassignment of territorial hunting grounds could then have taken place by mutual agreement, with each tribe finding it advantageous because of the allowable reductions in military effort.
*27

The specific distribution of rights that comes in the initial leap from anarchy is directly linked to the relative commands over goods and the relative freedom of behavior enjoyed by the separate persons in the previously existing natural state. This is a necessary consequence of contractual agreement. In Hobbes’s model, there are, by inference, considerable differences among separate persons in a precontract setting. To the extent that such differences exist, postcontract inequality in property and in human rights must be predicted. For my purposes, there is no need to discuss in detail the degree of possible inequality among separate persons in the conceptual state of nature that has been used to derive the logical origin of property rights. Those who have referred to the strong enslaving the weak may well have exaggerated the differences. The romantic moderns, on the other hand, who adopt their own variants on Rousseau’s noble savage may be equally off the mark in the opposing direction. To make meaningful statements here, it would be necessary to sift and to examine the available anthropological, ethological, and historical evidence, a task that lies beyond both my competence and my interest.

Nor need the analysis depend critically on the acceptance or rejection of any particular model or hypothesis about human behavior. We need not follow Hobbes and assume that men behave from narrowly defined self-interest. We could assume, equally well, that even in some state of nature men behave in accordance with self-interest tempered by regard for their fellows. Or, in the other limit, we might also assume that individuals adopt precepts for behavior that reflect the interest of the human species. The inequalities among persons that may be conceptually observed in the “natural distribution” will result both from the inherent differences in personal capacities and in the types of behavior actually adopted. If, for example, personal capacities should be widely different, but, at the same time, all persons behave nonindividualistically, the observed natural distribution might reflect considerably less inequality than that which would be observed under hedonistic behavior patterns. Since all we can observe, even conceptually, is the natural distribution itself, the precise combination of inherent personal qualities and behavioral norms is not relevant. It is, however, relevant to note that there is no basis for assuming equality in the conceptually observed distribution among persons in the natural state, and, consequent on this, no basis for predicting equality in the agreed-on allocation or distribution of rights in the initial postcontract setting. There is nothing to suggest that men must enter the initial negotiating process as equals. Men enter as they are in some natural state, and this may embody significant differences.

Violations of Contract

The gains-from-trade that are potentially achievable by an agreement on rights are realized by all parties through the disinvestment in socially wasteful effort devoted to both predatory and defense activity. An agreed-on assignment will not normally be stable in one particular sense. Once reached, one or all parties may find it advantageous to renege on or to violate the terms of contract. This applies to
any assignment that might be made; the tendency toward individual violation is not characteristic of only some subset of possible agreements. Within the setting of an agreed-on assignment of rights, the participants in social interaction find themselves in a genuine dilemma, familiarized under the “prisoners’ dilemma” rubric in modern game theory. All persons will find their utility increased if all abide by the “law,” as established. But for each person, there will be an advantage in breaking the law, in failing to respect the behavioral limits laid down in the contract.

This may be illustrated for our two-person model through a simple matrix, as shown in figure 2.1. In the natural distribution, in which neither party acknowledges or respects any rights to the single scarce good, the utility levels achieved are shown in Cell IV. The left-hand numbers in each cell represent utility indicators or net payoff values for A, the right-hand numbers those for B. As indicated, the utility payoffs need not be equivalent in this anarchistic “equilibrium.” (We need not introduce complexities about interpersonal utility comparability at this point since it is the absence of equality that is important, not the demonstration of inequality.) Upon agreement, the utility payoffs are those shown in Cell I, where both persons are in positions that are superior to those achieved in Cell IV. Also, joint or combined payoffs are maximized in Cell I. (Here, again, qualifications concerning interpersonal comparability and, hence, additivity would be required for completeness.) As depicted, however, both A and B have private incentives to renege on or to violate the contractual agreement on rights provided that they can do so unilaterally. The position for individual A is improved if he can secure a shift to Cell III, while that for individual B is improved if he can somehow get to Cell II.

In the strict two-person setting, either one or both of the persons may refrain from violating the contract because he may rationally anticipate that the other’s reaction would force a quick return to the precontract state of nature. In the simple game setting of figure 2.1, Cell I is in the “core,” to introduce a term specific to modern game theory. No player can guarantee for himself a better outcome than that which he secures under universal adherence to the agreed-on rights assignment. No person can assure himself that breaking the law will not result in a worsening of his own position. This characteristic suggests that there are important elements of stability in a Cell I position. Such stability tends to disappear, however, as the number of participants in the interaction increases, even if the formal properties remain unmodified. Furthermore, variations in the characteristics and relationships within the payoff structures, which will be introduced in later chapters, may eliminate the stability that here is apparent.

Two-Stage Contract

To this point, the conceptual emergence of some initial assignment or imputation of individual rights has been discussed in an extremely abstract and simplified model. I have assumed that only one scarce good exists other than time itself. The model is also limited to a two-person interaction; and it is timeless, which amounts to saying that none of the elements change over time. It will be necessary to relax each of these restrictions. The treatment must be generalized to allow for scarcity in many goods, to explain the interaction of many persons; and the effects of time in modifying the contractual relationship must be incorporated directly into the analysis. In the remainder of Chapter 2, I shall make the first two extensions. The introduction of time is sufficiently complex to require additional space.

We may continue to use the two-person model but allow for more than a single scarce good. Conflict between A and B in the state of nature will now arise over the disposition of all of those goods that are not superabundant. For present purposes, we shall continue to assume that these goods are not produced, but instead that quantities of these goods simply “fall down” in some distribution between the two persons.

As in the one-good model, a natural distribution will emerge from actual or potential conflict. This distribution, which will now be many-dimensional, will be influenced by the initial disposition of the goods, and by the relative personal characteristics and behavior patterns of each person. The outcome may be described by a vector whose components represent net amounts of each of the scarce goods finally enjoyed in consumption by each person,

(X
_A, X
_B; Y
_A, Y
_B; … ).

In attaining his share in this natural distribution, each person finds it necessary to invest effort (time and energy) in predatory and/or defense activity. There is no difference in this respect between this and the one-good model. And, as before, the natural distribution provides the base from which contractual agreements become possible. Agreement will, as before, take the form of some mutual acknowledgment of rights. Gains are secured from the reductions in predation-defense effort. This contract, which becomes the initial leap from Hobbesian anarchy, is the first stage of a two-stage contractual process. For purposes of convenience, I shall, here and later, refer to this as “constitutional contract.”
*28

Figure 2.2

It is the existence of two stages or levels of agreement that distinguishes the many-good from the one-good model. In the latter, the initial agreement on shares in the single scarce good represents the limit to trade. No further contracts between the two persons will offer mutual gains. The two-person group attains the Pareto-frontier through its initial agreement on rights of disposition. The many-goods model differs sharply at precisely this point. If individual tastes differ, there may be potential gains-from-trade over and beyond the initial “trade” of agreements on individual rights. The trading process at this second, or
postconstitutional, stage is, of course, the domain of traditional economic theory. Individual participants are assumed to enter the potential trading arena with identifiable endowments and/or capacities, and their rights to these initially held endowments are assumed to be mutually accepted by all members of the community and to be enforced by the state. The two-stage contractual sequence may be depicted simply with a diagram like that of figure 2.2. The utility attained by individual A is shown on the ordinate, that attained by individual B on the abscissa. The natural distribution, that outcome which emerges as a quasi-equilibrium in the genuine state of nature, is shown at D. The initial constitutional contract, which involves nothing more than mutual agreement on some structure of rights, shifts the outcome in a general northeasterly direction, bounded as indicated by the dotted lines drawn from D. Suppose that the actual agreement shifts the utility positions to C. In the one-good model, no further trades are possible, and the utility-possibility frontier is attained for the two-man community. In the many-goods model, however, further trades in specific goods may be mutually advantageous. This will always be possible if tastes differ and if the agreed-on assignments do not correspond precisely to the preferred final-goods packages.

There seems little reason to predict such precise correspondence, although some tendency toward correspondence might be present. In the natural state, individuals will devote more effort to securing and protecting those final goods that stand relatively high in their own preference rankings. Furthermore, in the conceptual bargaining over the rights to be accepted, individuals will tend to sacrifice goods that they value relatively lower than goods which they secure in “exchange.” Relative abilities to secure and defend goods, and to secure goods in conceptual bargaining, need not correspond closely with relative values placed on goods by the separate participants. Under any combination of these elements that generates an absence of precise correspondence between originally agreed endowments and optimally preferred bundles, trades can be made, and these trades will move the utility positions further in the northeasterly direction, with the bounds for postconstitutional trades indicated by the dotted lines extending from C. In some final trading equilibrium, say, E, the utility-possibility frontier is attained. The constitutional contract involves the initial shift from D to C; postconstitutional contract involves the shift from C to E. Economists have concerned themselves almost exclusively with the latter to the neglect of the former.
*29

Further classification that is more familiar to economists can be made within postconstitutional contracts or exchanges. The shift from C to E can take place through two types of process. In the first, individuals exchange goods that are rival in usage and fully partitionable or divisible among persons, both at the stage of initial rights assignments and at the stage of final consumption. If X and Y are two such goods, and individual A is initially given rights to relatively more X, he will then give up units to B in exchange for units of Y. This trade, which we may call
private-goods trade, using conventional terminology, may be institutionalized through markets when large numbers of potential traders are interlinked.

Mutual gains may continue to exist, however, over and beyond these achievable by trades in purely partitionable goods. Joint rather than separate consumption of some goods may be relatively efficient. To illustrate, let us suppose that both goods X and Y are rival in consumption of A and B, but that good Z is potentially able to meet the demands of both persons simultaneously; there is no rivalry in consumption with respect to Z. We continue to assume that we are examining a no-production economy, with initial supplies of goods arbitrarily distributed. In this setting, some question might be raised as to why Z, defined as a purely public good, again to use conventional terminology, should be included in the “scarce” category with individual rights to its disposition assigned in an initial contract at the constitutional stage. If treated independent of all other goods, there would be no need for any such assignment; indeed one means of describing a purely collective or public good is to say that no distributional problem exists.
*30 But when distributional conflict characterizes other private or partitionable goods, X and Y in this example, individuals may seek to establish rights over the distribution of Z as an indirect means of securing more X and Y in the postconstitutional trading process. This will become more relevant as we move to more complex and more realistic models later in the book. In any case, we assume here that the agreed-on assignment of rights provides net quantities of both private and potentially public goods to A and B. For illustration, suppose that this structure assigns all units of X to A, and all units of both Y and Z to B. Trade in private goods, X and Y, proceeds in the orthodox manner. For the good that is nonrival in final use, Z, individual B will agree to make some (all) of it available jointly to A upon the payment, by A, of some appropriately negotiated quantity of X, which is rival in final usage.
*31 This sort of “trade” with respect to Z is different in kind from trade among persons in ordinary goods and services that are rival in consumption. The shift of a community from the position depicted by the movement from C to E in figure 2.2 is accomplished by some combination of
private-goods trade and
public-goods trade, both of which take place within the limits defined by constitutional contract.

From Small to Large Numbers

Before proceeding from the two-person to the
n-person model, it is perhaps useful to summarize the conceptual schemata that has been developed. From a

1. natural distribution, a

2. constitutional contract is negotiated, from which, in turn,

3. postconstitutional contract becomes possible, through

a.  private-goods trade (goods rival in consumption) and/or

b.  public-goods trade (goods nonrival in consumption).

When we introduce a large number of participants, negotiations may take place among subgroups or coalitions contained within the larger and more inclusive community membership. A “natural distribution” may, therefore, be conceived at any one of several levels of aggregation. At one extreme, which we might call the pure natural distribution, no coalitions exist, and each person acts strictly on his own in the genuine Hobbesian “warre” of each against all. From this base, however, “constitutional contracts” may be made among members of groups of any two or more persons, with internal assignments of rights, while as among the separate groups conflict continues. At such levels, the separate subgroups or coalitions (some of which may include only one member) are in a natural distribution fully analogous to that described for the two-person model. The process of contractual internalization may proceed as the subgroups become larger until some final negotiating process which incorporates all persons in the community within a single constitutional structure.

The final or ultimate constitutional contract will define the rights assigned to each person in the inclusive community. And each person will find his own position improved over that which he might have enjoyed in any one of the natural distributions noted above, because he will not have to exert or contribute effort to defense and predation, either as an individual on his own account or as a contributing member of a subset of the total community.
*32 The second, or postconstitutional, stage of negotiation can commence. At this point, the shift from the two-person to the
n-person model introduces other important differences in results. With respect to private-goods trade, exchanges can proceed in the orthodox manner that has been exhaustively treated by economists. Market institutions will be formed; bargaining ranges will be restricted by the presence of multiple alternatives for each buyer and each seller of goods; outcomes will tend to be more determinate than in the small-number setting. The important point to be stressed, for my purposes, is that these exchanges in private goods still take place between separate pairs of traders, between individual buyers and individual sellers. Each exchange remains a two-party transaction, as in the simplified model, despite the addition of numbers. There is no necessity to bring all members of the community into each contract. There is nothing that might be classified as “social contract” here.

Over and beyond all such exchanges in private goods, there may exist further potentially realizable surpluses from “trades” in public or collective-consumption goods and services, those that can simultaneously meet the demands of
all persons in the group. In reference to our simple example, suppose, as before, that Z is such a public good, which may be consumed jointly and simultaneously by all members of, say, a three-man community, A, B, and C. Assume, as before, that all of the available supply of Z is under the disposition of individual B under terms of the basic constitutional contract. “Trades” can be made which involve a transfer of privately partitionable goods from A and C to B in exchange for the latter’s willingness to make available Z for joint consumption. The point to be emphasized here is that, in such trade,
all members of the final consuming group must be brought directly into the contractual negotiations with respect to provision of the public good. It is not possible to factor down a network of economic exchange into separate two-party transactions. This feature categorically distinguishes public-goods trade from private-goods trade when large numbers are involved. With the former, with public-goods trade, something akin to “social contract” again comes into being, comparable in numbers of participants to the constitutional contract that delineates individual rights.

Before we can develop further the implications of this similarity, and the confusion that the similarity fosters, certain ambiguities must be clarified. For expository purposes, I have assumed that all scarce goods fall into either one or the other polar extreme—the purely private good or the purely public good.
*33 Furthermore, I have implicitly assumed that the “range of publicness” for all goods in the public-goods classification extends precisely to the limits of the inclusive community membership. This assumption is perhaps even more restrictive than the polar classification. There may exist many goods that qualify as “public” or “collective” over differing numbers of consumers but which, at the same time, become fully rival in consumption as the number of users is increased. The size of the consuming “club” that meets efficiency criteria may be much less than the total membership of the community.
*34 If such “clubs” are small, relative to the size of the total community, market institutions can emerge that will internalize the required contractual arrangements, even though the strict pairwise exchange-characteristics of pure markets are violated. For our purposes, having recognized that much of the noncollective sector may embody such small-number jointness, we can treat all “trades” that do not involve substantial fractions of the total community membership as taking place in “private goods.” In somewhat more practical terms, this amounts to a neglect of local government decision-making, as such.

The analysis suggests that “social contracting,” defined as those negotiations which involve
all members of the community, may take place conceptually at two levels or tiers: at some initial stage of constitutional contract, in which agreement is reached on an assignment of individual rights, and at some postconstitutional stage in which individuals agree on quantities and cost shares of jointly consumed goods and services. Essentially the same problems emerge at each tier, problems that are created largely by the necessity to bring large numbers of persons into the same contractual arrangements. The sheer cost of getting agreement on any outcome rises sharply as numbers increase. In two-party trading, only the single buyer and the single seller need agree. This difference in numbers alone makes for major differences in costs. But the absence of alternatives exacerbates the attainment of agreement in many-party negotiations. It may not prove overwhelmingly costly for very large numbers of persons to reach agreement if each participant has available to him other avenues for securing comparable objectives. To the extent that an individual has other opportunities, he can withdraw from participation in the large-number group if a proposed settlement does not fall within his broadly defined preferences. For the single inclusive community, however, the necessary participation of all members eliminates the prospects of effective alternatives. National states, from which out-migration can take place normally only at significant costs to an individual, rather than local governments, become the real-world organizational units to which the analysis is most directly applicable.

A final qualification must be introduced at this point in order not to give the appearance of inconsistency with the discussion in subsequent chapters. This involves the delineation or assignment of individual rights emerging from constitutional contract. It is essential that the potential variability in the specification of individuals’ rights be recognized. The conceptual agreement may range from an assignment that invokes relatively little “law” in the formalized sense to an assignment that rigidly constrains individual behavior over many dimensions of adjustment. An assignment of rights is not an all-or-nothing choice. Ceteris paribus, the liberty inherent in anarchistic order without law is the most desirable state of affairs. The extent to which an individual, or the community of individuals, may be willing to trade off the liberty that remains present even in the Hobbesian jungle for the stability promised in regimes with varying degrees of formal restrictiveness will depend on the nastiness of the jungle, the value placed on order, the costs of enforcement, and on many other factors, some of which will be subsequently discussed.

16.

For a relatively recent book that falls within the romantic tradition, and which summarizes other works, see Daniel Guerin,
Anarchism, intro. Noam Chomsky, trans. Mary Klopper (New York: Monthly Review Press, 1970).

There exists a variant of anarchism which is, instead, based squarely on the recognition of the free market’s role in facilitating individual relationships in the absence of government. This has been called “private property anarchism” by Laurence Moss, who traces out the contributions of Americans to this variant. See Laurence S. Moss, “Private Property Anarchism: An American Variant” (Paper presented at the Southern Economic Association meeting in Washington, D.C., November 1972). Murray Rothbard is a modern expositor of this variant. See his
For a New Liberty.

17.

This is my own definition of economics. It is elaborated in some detail in my 1963 presidential address to the Southern Economic Association. See “What Should Economists Do?”
Southern Economic Journal 30 (January 1964): 213-22. This view is at variance with those who define economics in terms of the central maximizing principle. Differences in definition here need not, however, affect the main argument of the text.

18.

This is emphasized clearly by David Hume; see
A Treatise of Human Nature, ed. L.= A. Selby-Bigge (Oxford: Clarendon Press, 1960), pp. 502-3. Hume’s whole discussion concerning the origins of property rights and the advantages of such rights for social stability is similar in many respects to that which is developed in this book.

Hegel’s basic conception of property is also similar to that developed here. See Shlomo Avineri,
Hegel’s Theory of the Modern State (Cambridge: Cambridge University Press, 1972), pp. 88f.

19.

The “theory of property” that is implicit in my discussion here and elsewhere in the book can perhaps best be classified as some mixture of the “personality” and “utilitarian,” especially as the latter is represented by the discussion of David Hume. These and other useful classifications of theories of property, along with a good general discussion, are found in Frank I. Michelman, “Property, Utility, and Fairness: Comments on the Ethical Foundations of ‘Just Compensation’ Law,”
Harvard Law Review 80 (April 1967), especially pp. 1202-13.

20.

The citation is from Blackstone’s
Commentaries on the Laws of England, 12th ed. (London: T. Cadell, 1794), 2:2-3.

21.

A partial listing of the contributions is as follows: A. A. Alchian and R. Kessel, “Competition, Monopoly, and the Pursuit of Money,” in
Aspects of Labor Economics (New York: National Bureau of Economic Research, 1962), pp. 157-75; S. Cheung, “Private Property Rights and Sharecropping,”
Journal of Political Economy 76 (December 1968): 1107-22; Harold Demsetz, “The Exchange and Enforcement of Property Rights,”
Journal of Law and Economics 7 (October 1964): 11-26; R. McKean, “Divergences between Individual and Total Cost within Government,”
American Economic Review 54 (May 1964): 243-49; Douglass C. North and Robert Paul Thomas,
The Rise of the Western World: A New Economic History (Cambridge: Cambridge University Press, 1973). These and other contributions are discussed by Furubotn and Pejovich in a lengthy review article, which also includes a full set of references. See Eirik Furubotn and Svetozar Pejovich, “Property Rights and Economic Theory: A Survey of Recent Literature,”
Journal of Economic Literature 10 (December 1972): 1137-62.

22.

Among the modern “property rights economists,” S. Pejovich is the only one who has attempted a generalized discussion of origins. He states explicitly that his aim is to show that “the creation … of property rights is endogenously determined” (p. 310). A careful reading of Pejovich’s paper suggests, however, that the endogeneity does not refer to the exchange process. Instead, individuals are motivated by private utility-maximizing norms to invest resources in defense and predation of resource stocks, behavior which is, of course, descriptive of Hobbesian anarchy. I prefer that we limit “economic explanations” of institutional change to the contractual process. In this context, as my analysis suggests, property rights may emerge from an economic calculus that prompts the negotiation of a “constitutional contract.” But this is quite different from the results emergent from the independent, utility-maximizing behavior of the parties. See S. Pejovich, “Towards an Economic Theory of the Creation and Specification of Property Rights,”
Review of Social Economy 30 (September 1972): 309-25.

23.

Harold Demsetz, “Toward a Theory of Property Rights,”
American Economic Review 57 (May 1964): 347-59.

24.

The formal characteristics of this “natural distribution” have been worked out by Winston Bush. See his “Individual Welfare in Anarchy,” in
Explorations in the Theory of Anarchy, ed. Gordon Tullock (Blacksburg, Virginia: Center for Study of Public Choice, 1972), pp. 5-18.

The notion of such a distribution is, of course, to be found in the work of several of the philosophers who have thought about the origin of property, notably in Aegidius, Hugo Grotius, and Thomas Hobbes.

25.

This conceptual explanation is variously presented by many of the social philosophers, notably those in the general contractarian tradition. Particular versions are to be found in the works of Aegidius, Bodin, Grotius, Hobbes, and Hume. For a good summary treatment, see Richard Schlatter,
Private Property.

26.

The more general theme that all investment that takes the form of protecting rights must be, in the net, socially wasteful is developed at some length by Gordon Tullock in his forthcoming book,
The Social Dilemma.

27.

For a paper that specifically introduces the Demsetz example, but which interprets the emergence of property rights in a manner fully consistent with that which is developed here, see Charles R. Plott and Robert A. Meyer, “The Technology of Public Goods, Externalities, and the Exclusion Principle,” Social Science Working Paper No. 15 (revised) (California Institute of Technology, February 1973).

28.

The position taken here is that
both constitutional and postconstitutional rights conceptually emerge from
contract, but that it is essential that the two stages be kept distinct. This may be compared with the position advanced by F. A. Hayek in his work
Law, Legislation, and Liberty, vol. 1,
Rules and Order (Chicago: University of Chicago Press, 1973). If I interpret his argument correctly, Hayek suggests that “law,” which is equivalent to what I have called constitutional contract, is not contractual in origin but emerges from an unpredictable evolutionary process. He advances this argument in opposition to the “constructivists,” who are alleged to think of law as willed by someone. In histori-cal fact, evolutionary elements may explain much of the emergence and development of “law.” Acceptance of this does not, however, negate the application of contractual-constructivist criteria in an evaluation of that “law” which exists, and which might be willfully modified.

29.

Note that the distinction made here need not require that any historical relevance be attributed to constitutional contract. No matter how a structure of property rights may emerge, it is useful to separate the definition of structure from the exchange of rights within this structure.

30.

For an elaboration of this point, see my
Demand and Supply of Public Goods (Chicago: Rand McNally, 1968), especially chap. 9.

31.

In the elementary discussion here, I am assuming that B is able to exclude A from the use of Z without excessive cost. If nonexclusion is inherent in Z, then no property right will be initially assigned in this good in the no-production setting. If Z must be produced, however, the discussion becomes applicable, even if, once produced, Z is nonexcludable. Exclusion will, in this case, take the form of not producing.

32.

Complexities arise in the large-number setting which make any assignment of rights less stable than in the small-number setting. There are two reasons for this difference. In the first place, almost any imputation or assignment that is agreed on will dominate that which the individual would anticipate were he to opt out and to try to exist on his own in pure anarchy. With large-number communities, however, the set of rights assignments that will dominate, for each person, the position that he might expect to secure if
any coalition opts out, is much more restricted, and, indeed, this set might be empty in many interactions. These aspects of interactions have been discussed in detail, formally, in modern game theory. To use the appropriate terminology, for large-number groups there may be no imputation or assignment that is in the core, and, if a core does exist, the number of imputations contained may be small. For an introductory discussion of these concepts, see Duncan Luce and Howard Raiffa,
Games and Decisions (New York: John Wiley and Sons, 1957).

Second, even if the assignment finally arrived at should qualify for inclusion in the core in the game-theoretic sense, individuals would still find it advantageous to violate the terms if they predict an absence of response on the part of remaining members of the group. This tendency toward instability is present in both the small- and large-number groupings, but the sheer impersonality or anonymity of individuals in large groups makes strategic behavioral calculations much less likely to occur.

33.

This is the same assumption that was made by Samuelson in his classic formulation of the welfare norms for public-goods provision. See Paul A. Samuelson, “The Pure Theory of Public Expenditure,”
Review of Economics and Statistics 36 (November 1954): 387-89.

34.

For a more extended treatment, see my “An Economic Theory of Clubs,”
Economica 32 (February 1965): 1-14.