6. The Limits of Property Rights and the Problems of External Costs and External Economies
Property rights, as they are circumscribed by laws and protected by courts and the police,
are the outgrowth of an age-long evolution. The history of these ages is the record of
struggles aiming at the abolition of private property. Again and again despots and popular
Their movements have tried to restrict the rights of private property or to abolish it altogether.
These endeavors, it is true, failed.
But they have left traces in the ideas determining the legal form and definition of property.
The legal concepts of property do not fully take account of the social function of private
property.
There are certain inadequacies and incongruities which are reflected in the determination of
of the Market Phenomena.
Carried through consistently, the right of property would entitle the proprietor to claim
all the advantages which the goods employment may generate on the one hand, and would burden
him with all the disadvantages resulting from its employment on the other hand.
Then the proprietor alone would be fully responsible for the outcome.
In dealing with his property he would take into account all the expected results of his
action, those considered favorable as well as those considered unfavorable.
But if some of the consequences of his action are outside the sphere of the benefits he
is entitled to reap and of the drawbacks that are put to his debit, he will not bother in
his planning about all the effects of his action.
He will disregard those benefits which do not increase his own satisfaction and those costs
which do not burden him.
His conduct will deviate from the line which it would have followed if the laws were better
adjusted to the economic objectives of private ownership.
He will embark upon certain projects only because the laws release him from responsibility
for some of the costs incurred.
He will abstain from other projects merely because the laws prevent him from harvesting
all the advantages derivable.
The laws concerning liability and indemnification for damages caused were and still are in some
respects deficient.
By and large the principle is accepted that everybody is liable to damages which his actions
have inflicted upon other people.
But there were loopholes left, which the legislators were slow to fill.
In some cases this tardiness was intentional, because the imperfections agreed with the
plans of the authorities.
When in the past, in many countries, the owners of factories and railroads were not held liable
for the damages which the conduct of their enterprises inflicted on the property and
and Health of Neighbors, Patrons, Employees and Other People Through Smoke, Soot, Noise,
Water Pollution and Accidents Caused by Defective or Inappropriate Equipment.
The idea was that one should not undermine the progress of industrialization and the
development of transportation facilities.
The same doctrines which prompted and still are prompting many governments to encourage
Large investment in factories and railroads through subsidies, tax exemption, tariffs
and cheap credit were at work in the emergence of a legal state of affairs in which the liability
of such enterprises was either formally or practically abated.
Later again, the opposite tendency began to prevail in many countries and the liability
of Manufacturers and Railroads was increased as against that of other citizens and firms.
Here again, definite political objectives were operative.
Legislators wished to protect the poor, the wage earners and the peasants against the
wealthy entrepreneurs and capitalists.
Whether the proprietor's relief from responsibility for some of the disadvantages resulting from
From his conductive affairs is the outcome of a deliberate policy on the part of governments
and legislators, or whether it is an unintentional effect of the traditional wording of laws,
it is at any rate a datum which the actors must take into account.
They are faced with the problem of external costs.
Then, some people choose certain modes of want satisfaction merely on account of the
and the fact that a part of the costs incurred are debited not to them but to other people.
The extreme instance is provided by the case of no man's property referred to above.
If land is not owned by anybody, although legal formalism may call it public property,
it is utilized without any regard to the disadvantages resulting.
Those who are in a position to appropriate to themselves the returns, lumber and game
of the forests, fish of the water areas and mineral deposits of the subsoil, do not bother
about the later effects of their mode of exploitation.
For them, the erosion of the soil, the depletion of the exhaustible resources and other impairments
of the future utilization are external costs, not entering into their calculation of input
and Output.
They cut down the trees without any regard for fresh shoots or reforestation.
In hunting and fishing they do not shrink from methods preventing the repopulation of
the hunting and fishing grounds.
In the early days of human civilization, when soil of a quality not inferior to that of
the utilized pieces was still abundant, people did not find any fault with such predatory
methods.
When their effects appeared in a decrease in the net returns, the plowmen abandoned
his farm and moved to another place.
It was only when a country was more densely settled and unoccupied first-class land was
no longer available for appropriation that people began to consider such predatory methods
wasteful.
At that time, they consolidated the institution of private property in land.
They started with arable land, and then, step by step, included pastures, forests, and fisheries.
The newly settled colonial countries overseas, especially the vast spaces of the United States,
whose marvelous agricultural potentialities were almost untouched when the first colonists
from Europe arrived, passed through the same stages. Until the last decades of the 19th
In the century, there was always a geographic zone open to newcomers, the frontier.
Neither the existence of the frontier nor its passing was peculiar to America.
What characterizes American conditions is the fact that at the time the frontier disappeared,
ideological and institutional factors impeded the adjustment of the methods of land utilization to the change in the data.
In the central and western areas of continental Europe, where the institution of private property had been rigidly established for many centuries, things were different.
There was no question of soil erosion of formerly cultivated land.
There was no problem of forest devastation, in spite of the fact that the domestic forests had been, for ages, the only source of lumber for construction and mining,
and of fuel for heating and for the foundries and furnaces, the potteries and the glass factories.
The owners of the forests were impelled to conservation by their own selfish interests.
In the most densely inhabited and industrialized areas up to a few years ago,
between a fifth and a third of the surface was still covered by first-class forests,
managed according to the methods of scientific forestry.
Late in the 18th century, European governments began to enact laws aiming at forest conservation.
However, it would be a serious blunder to ascribe to these laws any role in the conservation of the forests.
Before the middle of the 19th century, there was no administrative apparatus available for their enforcement.
Besides, the governments of Austria and Prussia, to say nothing of those of the smaller German states,
virtually lacked the power to enforce such laws against the aristocratic lords.
No civil servant before 1914 would have been bold enough to rouse the anger of a Bohemian or Silesian magnet,
or a German-mediatized Standeshair.
These princes and counts were spontaneously committed to forest conservation
Because they felt perfectly safe in the possession of their property and were eager to preserve unabated the source of their revenues and the market price of their estates.
It is not the task of catalactic theory to elaborate an account of the complex factors that produced modern American land ownership conditions.
Whatever these factors were, they brought about a state of affairs under which a great
many farmers and the majority of the lumbering enterprises had reason to consider the disadvantages
resulting from the neglect of soil and forest conservation as external costs.
It is true that where a considerable part of the costs incurred are external costs from
From the point of view of the acting individuals or firms, the economic calculation established
by them is manifestly defective and their results deceptive.
But this is not the outcome of alleged deficiencies inherent in the system of private ownership
of the means of production.
It is, on the contrary, a consequence of loopholes left in this system.
could be removed by a reform of the laws concerning liability for damages inflicted, and by rescinding
the institutional barriers preventing the full operation of private ownership.
The case of external economies is not simply the inversion of the case of external costs.
It has its own domain and character.
If the results of an actor's action benefit not only himself but also other people, two
alternatives are possible.
1.
The planning actor considers the advantages which he expects for himself so important
that he is prepared to defray all the costs required.
The fact that his project also benefits other people will not prevent him from accomplishing
what promotes his own well-being.
When a railroad company erects dikes to protect its tracks against snow slides and avalanches,
it also protects the houses on adjacent grounds.
But the benefits which its neighbors will derive will not hinder the company from embarking
upon an expenditure that it deems expedient.
2.
The costs incurred by a project are so great that none of those whom it will benefit is
ready to expend them in full.
The project can be realized only if a sufficient number of those interested in it share in
the costs.
It would hardly be necessary to say more about external economies if it were not for the
fact that this phenomenon is entirely misinterpreted in current pseudo-economic literature.
A project P is unprofitable when and because consumers prefer the satisfaction expected
from the realization of some other projects to the satisfaction expected from the realization
of P. The realization of P would withdraw capital and labor from the realization of
some other projects for which the demand of the consumers is more urgent.
The layman and the pseudo-economist fail to recognize this fact.
They stubbornly refuse to notice the scarcity of the factors of production.
As they see it, P could be realized without any cost at all, that is, without forgoing
any other satisfaction.
It is merely the wantonness of the profit system that prevents the nation from enjoying
gratuitously the pleasures expected from P.
Now, these short-sighted critics go on to say, the absurdity of the profit system becomes
are especially outrageous if the unprofitability of P is merely due to the fact that the entrepreneur's
calculations neglect those advantages of P which for them are external economies.
From the point of view of the whole of society, such advantages are not external.
They benefit at least some members of society and would increase total welfare.
The non-realization of P is therefore a loss for society.
As profit-seeking business, entirely committed to selfishness, declines to embark upon such
unprofitable projects, it is the duty of government to fill the gap.
Government should either run them as public enterprises, or it should subsidize them in
order to make them attractive for the private entrepreneur and investor.
The subsidies may be granted either directly by money grants from public funds or indirectly
by means of tariffs, the incidence of which falls upon the buyers of the products.
However, the means which a government needs in order to run a plant at a loss or to subsidize
an unprofitable project must be withdrawn either from the taxpayers' spending and investing
power or from the loan market.
The government has no more ability than individuals to create something out of nothing.
What the government spends more, the public spends less.
Public works are not accomplished by the miraculous power of a magic wand.
They are paid for by funds taken away from the citizens.
If the government had not interfered, the citizens would have employed them for the
The Realization of Profit Promising Projects, the realization of which they must omit because
their means have been curtailed by the government.
For every unprofitable project that is realized by the aid of the government, there is a corresponding
project, the realization of which is neglected, merely on account of the government's intervention.
But this non-realized project would have been profitable, that is, it would have employed
the scarce means of production in accordance with the most urgent needs of the consumers.
From the point of view of the consumers, the employment of these means of production for
the realization of an unprofitable project is wasteful.
It deprives them of satisfactions which they prefer to those which the government-sponsored
Project can furnish them.
The gullible masses who cannot see beyond the immediate range of their physical eyes
are enraptured by the marvelous accomplishments of their rulers.
They fail to see that they themselves foot the bill, and must consequently renounce many
satisfactions which they would have enjoyed if the government had spent less for unprofitable
projects.
They have not the imagination to think of the possibilities that the government has
not allowed to come into existence.
These enthusiasts are still more bewildered if the government's interference enables
sub-marginal producers to continue producing and to stand the competition of more efficient
plants, shops or farms.
Here, they say, it is obvious that total production is increased and something is added to the
The Wealth that would not have been produced without the assistance of the authorities.
What happens, in fact, is just the opposite.
The magnitude of total production and of total wealth is curtailed.
Outfits producing at higher costs are brought into existence or preserved, while other outfits
producing at lower costs are forced to curtail or to discontinue their production.
The consumers are not getting more, but less.
There is, for instance, the very popular idea that it is a good thing for the government
to promote the agricultural development of those parts of the country which nature has
poorly endowed.
Costs of production are higher in these districts than in other areas.
It is precisely this fact that qualifies a large part of their soil as sub-marginal.
When unaided by public funds, the farmers tilling these sub-marginal lands could not
stand the competition of the more fertile farms.
Agriculture would shrink or fail to develop, and the whole area would become a backward
part of the country.
In full cognizance of this state of affairs, profit-seeking business avoids investing in
the construction of railroads connecting such inauspicious areas with the centers of consumption.
The plight of the farmers is not caused by the fact that they lack transportation facilities.
The causation is the other way round.
Because business realizes that the prospects for these farmers are not propitious, it abstains
from investing in railroads which are likely to become unprofitable for lack of a sufficient
amount of goods to be shipped.
If the government, yielding to the demands of the interested pressure groups, builds
It certainly benefits the owners of farmland in those poor districts of the country.
As a part of the costs that the shipping of their products requires is borne by the Treasury,
they find it easier to compete with those tilling more fertile land to whom such aid
is denied.
But the boon of these privileged farmers is paid for by the taxpayers, who must provide
the funds required to defray the deficit.
It affects neither the market price nor the total available supply of agricultural products.
It merely makes profitable the operation of farms which hitherto were sub-marginal, and
makes other farms, the operation of which was hitherto profitable, sub-marginal.
It shifts production from land requiring lower costs to land requiring higher costs.
It does not increase total supply and wealth, it curtails them, as the additional amounts
of capital and labor required for the cultivation of high-cost fields instead of low-cost fields
are withheld from employments in which they would have made possible the production of
some other consumer's goods.
The government attains its end of benefiting some parts of the country with what they would
have missed, but it produces somewhere else costs which exceed these gains of a privileged
group.
The External Economies of Intellectual Creation
The extreme case of external economies is shown in the production of the intellectual
are all groundwork of every kind of processing and constructing.
The characteristic mark of recipes, that is, the mental devices directing the technological
procedures, is the inexhaustibility of the services they render.
These services are consequently not scarce, and there is no need to economize their employment.
Those considerations that resulted in the establishment of the institution of private
Ownership of Economic Goods did not refer to them. They remained outside the sphere
of private property not because they are immaterial, intangible and impalpable, but because their
serviceableness cannot be exhausted. People began to realize only later that this state
of affairs has its drawbacks too. It places the producers of such recipes, especially
the inventors of technological procedures and authors and composers in a peculiar position.
They are burdened with the costs of production while the services of the product they have
created can be gratuitously enjoyed by everybody.
What they produce is for them either entirely or almost entirely external economies.
If there are neither copyrights nor patents, the inventors and authors are in the position
of an Entrepreneur.
They have a temporary advantage as against other people.
As they start sooner in utilizing their invention or their manuscript themselves, or in making
it available for use to other people, manufacturers or publishers, they have the chance to earn
profits in the time interval until everybody can likewise utilize it.
As soon as the invention or the content of the book are publicly known, they become free
Three Goods, and the inventor or author has only his glory.
The problem involved has nothing to do with the activities of the creative genius.
These pioneers and originators of things unheard of do not produce and work in the sense in
which these terms are employed in dealing with the affairs of other people.
They do not let themselves be influenced by the response their work meets on the part
of their contemporaries.
I do not wait for encouragement.
It is different with the broad class of professional intellectuals whose services society cannot
do without.
We may disregard the problem of second-rate authors of poems, fiction and plays, and second-rate
composers, and need not inquire whether it would be a serious disadvantage for mankind
to lack the products of their efforts.
But it is obvious that handing down knowledge to the rising generation and familiarizing
the acting individuals with the amount of knowledge they need for the realization of
their plans requires textbooks, manuals, handbooks and other non-fiction works.
It is unlikely that people would undertake the laborious task of writing such publications
if everyone were free to reproduce them.
This is still more manifest in the field of technological invention and discovery.
The extensive experimentation necessary for such achievements is often very expensive.
It is very probable that technological progress would be seriously retarded if, for the inventor
and for those who defray the expenses incurred by his experimentation, the results obtained
were nothing but external economies.
Rights and copyrights are results of the legal evolution of the last centuries.
Their place in the traditional body of property rights is still controversial.
People look askance at them and deem them irregular.
They are considered privileges, a vestige of the rudimentary period of their evolution
when legal protection was accorded to authors and inventors only by virtue of an exceptional
privilege granted by the authorities.
They are suspect, as they are lucrative only if they make it possible to sell at monopoly
prices.
Moreover, the fairness of patent laws is contested on the ground that they reward only those
who put the finishing touch leading to practical utilization of achievements of many predecessors.
These precursors go empty-handed, although their contribution to the final result was
is often much more weighty than that of the patentee.
It is beyond the scope of catallactics to enter into an examination of the arguments
brought forward for and against the institution of copyrights and patents.
It has merely to stress the point that this is a problem of the delimitation of property
rights and that with the abolition of patents and copyrights, authors and inventors would,
Privileges and Quasi-Privileges
The restrictions which laws and institutions impose upon the discretion to choose and to
act are not always so insurmountable that they could not be overcome under certain conditions.
To some favorites, exemption from the obligation binding the rest of the people may be granted
are considered as an explicit privilege, either by the laws themselves or by an administrative act of the authorities entrusted with the law's enforcement.
Some may be ruthless enough to defy the laws in spite of the vigilance of the authorities.
Their daring insolence secures them a quasi-privilege.
A law that nobody observes is ineffectual.
A law that is not valid for all or which not all obey may grant to those who are exempt,
whether by virtue of the law itself or by virtue of their own audacity, the opportunity
to reap either differential rent or monopoly gains.
With regard to the determination of the market phenomena, it does not matter whether the
exemption is legally valid as a privilege or illegal as a quasi-privilege.
Neither does it matter whether the costs, if any, incurred by the favored individual
or firm for the acquisition of the privilege or quasi-privilege are legal, for example,
a tax levied on licenses, or illegal, for example, bribes paid to corrupt officers.
If an importation embargo is mitigated by the importation of a certain quantity, the
The prices are affected by the quantity imported and the specific costs incurred by the acquisition
and the utilization of the privilege or quasi-privilege.
But whether the importation was legal, for example, a license granted under the system
of quantitative trade control to some privileged people, or illegal contraband, does not affect
the price structure.