Toward a Constitutional Theory of Property Rights
Prior to and since the death of Harold Demsetz, there have been a series of wonderful posts here on Econlib that have highlighted the importance of his work, in particular his article, “Toward a Theory of Property Rights” (1967). What makes it such a great article is not only that it was a seminal contribution to the economics of property rights, but that reading its central point, namely that the role of property rights is to guide the internalization of externalities, contains various applications and implicit assumptions that provide fruit for future research. For example, as David Henderson has pointed out in a previous post, Demsetz highlighted the military draft as an additional example of a negative externality, one that could be internalized and priced through the implementation of a volunteer army, one that establishes the exchange of private property over labor services.
Demsetz also hints at serfdom as an example of a negative externality, and the transition from serf labor to free labor also represents an internalization of a negative externality guided by the evolution of private property in labor. As Demsetz has explained elsewhere in a Liberty Fund interview with Mark Grady, the powerful insight of this article is representative of an “old trick” that defines his research, namely, to explain and explicate given (or implicit) assumptions in the research of other scholars. My purpose here is to explicate what I regard as another implicit assumption in Demsetz’s article, which further exemplifies the fruitfulness of his work, namely the institutional preconditions for the emergence of property rights.
Before turning to my main point, I will briefly summarize Demsetz’s argument and then explain how his article can also be extended to develop a constitutional theory of property rights. The core of Demsetz’s argument is that the logic of choice can extended to explain the emergence of property rights. That is, individuals will devise private property rights arrangements in response to changes in the transaction costs of internalizing an externality. As Demsetz puts it (1967, p. 350), “property rights develop to internalize externalities when the gains of internalization become larger than the cost of internalization.” His example of the emergence of property rights due to the rise of the fur trade throughout the 18th century among the Montagnes who inhabited regions around Quebec illustrates this previous point. Prior to the rise of the fur trade, hunting only took place primarily for the purposes of food, the significance of which, in terms of externalities, was small enough that it did not pay for anyone to take account of them. With the rise of the fur trade, the lack of private property over beavers led to overhunting in the sense that no individual finds it in their self-interest to take full account of the costs imposed on subsequent hunters, resulting in a negative externality. The advent of the fur trade led to an increase in the relative price of furs as well as hunting activity, both of which incentivized the emergence of property rights to internalize the externality of hunting. This resulted from the expected gains of internalization exceeding the expected transaction costs of devising and enforcing property rights arrangements over beaver pelts.
The theoretical argument and historical illustration provides a straightforward and powerful lesson of how property rights replace potential competition for resources in the form of violent conflict for peaceful competition for resources in the form of productive specialization and voluntary exchange. I say the word “potential” for a very specific reason, since the example in this paper provides yet another puzzle, one that I’m paraphrasing from Professor Richard Wagner’s fantastic book, Mind, Society, and Human Action (2010): why are not the Native Americans in this historical example not incentivized to fight when furs become more valuable? Or, to put it another way, what are the institutional arrangements precluding the Native Americans from fighting between each other, or for that matter, between the Native Americans and Europeans who would later colonize the area for such resources?
My point is meant in no way to undermine the theoretical validity of Demsetz’s argument. After all, there is only so much an author can do in one paper. Rather, my point is to render explicit an implicit assumption in his own argument. What I’m suggesting here is that the outcome illustrated in Demsetz’s example is predicated on an implicit assumption, namely there exists a set of institutional preconditions that internalize another negative externality, namely the costs of violent conflict itself (such costs being the foregone opportunity to engage in productive specialization and exchange). Understood this way, the emergence of property rights in Demsetz’s example is contingent on a set of rules that internalize the cost of using violence, or put another way, minimize the returns to using violence, as a means to define and allocate property rights. What all this implies is that Demsetz’s story can be incorporated into framework of constitutional political economy, developed by James Buchanan and Gordon Tullock (1962) (as well as F.A. Hayek (1960)), one that redirects attention to a rule-level of analysis, which govern the emergence of property rights as by-product of interaction within a set of rules. As Hayek best states this point in The Constitution of Liberty (1960, p. 151): “from the delimitation of a private sphere by rules, a right like that of property will emerge.”
My co-author, Vincent Geloso, and I address this point in a paper published in the most recent issue of Public Choice, entitled “Trade or raid: Acadian settlers and native Americans before 1755.” Our case study parallels that of Demsetz by observing the interaction between French colonists outside Quebec (the Acadians) and a Native American tribe (the Mi’kmaq) between the seventeenth and eighteenth centuries in the areas around the Bay of Fundy in the modern provinces of Nova Scotia and New Brunswick. One way to understand the contribution of this paper is that it extends Demsetz’s central insight by observing the rules governing collective decision-making between the Acadians and Mi’kmaq. Living under a relative state of anarchy (compared to Quebec itself), the Acadians and Mi’kmaq, respectively, developed institutions (the council of sagamores for the former, and the parish assembly for the latter) for coordinating collective action. These institutions relied heavily on high levels of consensus in their decision-making and they possessed no coercive abilities. As a result, the emergence of concentrated interest groups proved more difficult. For such interest groups to form in each society in order to capture the gains from violence, the ability to shift the costs of fighting onto the rest of the population would have been required. Thus, both the Acadians and the Mi’kmaq were able to minimize the relative returns to using violence by adopting rules of collective decision-making that favored consensus-building, the by-product of which was to incentivize the emergence of property rights, facilitating productive specialization and exchange between these respective groups.
To summarize, the threat of violence can be a productive activity if it is restricted as a means to define and enforce property rights, or it can unproductive if violence is used as a means to engage in wealth transfers in the form of public predation or private predation. From this perspective, the fundamental basis for securing and defining property rights, and hence economic development, is the minimization of the returns to violence in the first place. The question then becomes one of how the relative payoffs become established regarding the utilization of trade or violence to allocate resources. All of this points to, as I’ve suggested, a constitutional level of analysis governing the formation of property rights.
Rosolino Candela is a Senior Fellow in the F.A. Hayek Program for Advanced Study in Philosophy, Politics, and Economics, and a Program Director of Academic and Student Programs at the Mercatus Center at George Mason University
Buchanan, James M. and Gordon Tullock. 1962. The Calculus of Consent: Logical Foundations of Constitutional Democracy. Ann Arbor: University of Michigan Press. Reprinted in The Collected Works of James M. Buchanan, Vol. 3, The Calculus of Consent: Logical Foundations of Constitutional Democracy. Indianapolis: Liberty Fund, 1999.
Candela, Rosolino A., and Vincent J. Geloso. 2021. “Trade or Raid: Acadian settlers and Native Americans before 1755.” Public Choice 188 (3-4): 549–575.
Demsetz, Harold. 1967. “Toward a Theory of Property Rights.” The American Economic Review 57(2): 347-359.