Solutions to the problem of common property
In principle at least, there are two conceivable solutions to the problem of common property that one might label ‘regulation’ and ‘privatization’ respectively or, according to the two mainstreams of welfare economics, refer to as the Pigouvian and the Coasean solutions to the commons problem.
By means of regulation, a bundle of given rights to a commonly used resource remains unaltered but the harmed persons try to enforce their rights more fully by narrowing access to the resource to a clearly defined group of users and by legislating rules for internal governance of the commons. As many empirical studies indicate, such organizations of joint users of natural resources have turned out to be successful which succeeded in specifying time, place, technology and/or quantity of resource units to be appropriated (see Ostrom, 1990; Anderson and Simmons, 1993; Ostrom et al., 1994). Similarly, access to highways and other roads is frequently regulated by user tolls and traffic regulations that serve as rules for internal governance which, for instance, determine in which lane and how fast to drive. By the same token, employers may choose to mitigate the commons problem in agency relations by engaging in policing the employee’s effort and output and in sanctioning violations of rules of governance. According to Alchian and Demsetz’s hypothesis (Alchian and Demsetz, 1972), firms are founded mainly in order to allow for easier monitoring in order to cope with common-property problems involved in team production. All these solutions to overuse problems are ‘Pigouvian’ in the sense that the imposition of tolls and sanctions is equivalent to Pigouvian taxes that are imposed on the harming persons. As in Pigouvian welfare theory, the externality relation is taken to be one-sided, in that it is always the harmed persons (or a benevolent government acting in their place) to whom the residual claim to the common property is assigned and who take the active part in mitigating the problem. Correspondingly, the role of the harming persons is entirely reactive.The contrary is true when privatization of the resource’s free attributes is the strategy used to reduce common-property problems. Privatization means that, in order to achieve allocative efficiency, the residual claim to common property should be assigned to that part of the externality relation that mainly affects the outcome. The strategy of privatization may be interpreted as ‘Coasean’ in that it is not only the harmed person to whom the right to the commonly used attributes may be granted. The harming person may also become the residual claimant of the unpriced attributes of a resource. Consider once again the case where legal property to a commonly used resource is absent, as, for instance, in the Hobbesian jungle or in Hardin’s herdsmen example. These anarchical or anarchy-like situations most vividly demonstrate the welfare gains that all can achieve by accepting general behavioural constraints such as a system of socially endorsed and enforced property rights that presupposes everybody’s abandonment of the ‘right’ to steal from others’ endowments or of the ‘right’ to graze cattle at the expense of others. If the anarchical ‘right to all’ is divided into generally recognized parts and individually assigned to the users, all will gain, for two reasons. First, each owner is now granted a private right to use his/her part of the resource which accrues to him independently of its actual exercise. Thus no more productive resources have to be spent on participation in an appropriation race with others. Second, since each person is enabled to alienate parts of his property, voluntary exchange becomes possible, which will give each owner an additional incentive to maintain the market value of his asset. Both of these aspects illustrate the salutary role a state can play in order to reduce the commons problem in anarchy (see, for example, Buchanan, 1975).
In firms, privatization of free attributes in agency relationships means making the agent residual claimant of the employment contract to the extent of his (or her) information advantage.
Barzel (1989, p. 61) states as an empirical hypothesis: ‘The central principle underlying an organization is that the greater is the inclination of a transactor to affect the mean outcome, the greater is the claim on the residual the transactor will assume’. Accordingly, an efficient solution to the incentive problems described above would be to conclude a fixed-rent contract where the agent pays a predetermined amount of money to the principal while himself appropriating the residual claim to his effort. In this case, the agent, even in absence of monitoring, can be expected to use the employer’s rights to his effort and to firm equipment as if he himself were the principal. Alchian and Demsetz’s monitor (Alchian and Demsetz, 1972) simply becomes superfluous. The validity of this result, however, presupposes equal inclinations to risk of both the principal and the agent. Otherwise, a conflict would arise between efficiency and Pareto-optimal risk allocation. This conflict is maximal if, as it seems reasonable to suppose, employees are more risk-averse than their employers. Optimal risk allocation, then, indicates a fixed-wage labour contract, with the agent’s disincentive to work being maximal. Hence a simultaneous solution to the motivation and the risk allocation problem - which is the main object of normative principal-agent theory - is impossible (see, for instance, Shavell, 1979, pp. 59f.).