The ideal of private property
The more completely and privately the property rights to an asset are defined, the more will its holder be inclined to maximize the full value of the resource. This insight, which can be taken as the central starting point of property rights economics, is not novel (it is foreshadowed, for example, in the biblical ‘parable of the good shepherd’; see John 10: 11-13).
What is new in the theory of property rights is the systematic analysis of the behavioural consequences that are to be expected when the salutary role of private rights is violated. This question has been neglected and left unanswered within orthodox economics, for the only type of property that neoclassical theory takes into account is fully defined private property. Each owner of a commodity is the unrestricted residual claimant of the asset who bears all benefits and costs (the usus fructus) of resource use. In such a highly specific property rights regime, any person benefiting another will be fully rewarded by the beneficiary and any person harming another has to fully compensate the victim. To put it into common economic terminology, Pareto-relevant externalities, positive or negative, are implicitly assumed to be nil.As the celebrated Coase theorem (Coase, 1960) states, the existence of such a first-best world requires all transactions costs to be zero - including all monetary and time costs that accrue as a result of the specification, exchange, supervision and enforcement of property rights. If, and to the extent that, people can costlessly bargain for rights, the particular assignment of legal liabilities has no effect on the achievement of allocative efficiency. The Coasean approach contradicts the orthodox Pigouvian perspective of an externality relation according to which the person who harms another has either to fully compensate the harmed person or to give up his/her activity. In sharp contrast to this, Coase takes into account that externalities always consist in two-sided relationships. Consequently, the Coase theorem holds that, in a world of costless bargaining, also the externally affected party may compensate the acting party in order to achieve efficiency. Regardless of who initially owned the (de facto) right to affect another person’s welfare, the emerging property rights allocation is efficient since that person ultimately turns out to be the owner of the right who values it most highly. Of course, there will be different distributional implications of both solutions.