In the first essay in an eight-part series on The Right To Property, we look at how the human pursuit of happiness is made possible by the Holy Trinity of private property, voluntary exchange and the price system.
A property right is the exclusive authority to determine how a resource is used. An individual, or the government, or a corporation, or a group of individuals can own this resource. The question that property rights resolve is “who makes the decision for the appropriate use of a resource?” Property rights are more about decision-making than about a specific property or asset. In this sense, they are the foremost human right.
The classic (or Lockean) notion of private property rights includes the individual’s ownership of herself, and the resources she mixed her labor with, or used for trade. Self-ownership, private property in resources, and the ability to do anything that does not infringe on someone else’s right of ownership and property, are components of a Lockean system of private property rights.
Based on this simple Lockean framework, in a modern society, property rights entail the exclusive right to choose the use of particular resources, the exclusive rights to the stream of benefits (and costs) arising from a resource, and the right of voluntary exchange of the resource. If an individual owns a piece of land, she can determine if the land must be used as an apple orchard, or to build a house. She will then receive the benefits of either use, i.e. the apples from the orchards are hers to sell, or the house is hers to live in, leave vacant, or rent to another. The benefits arising from each of these choices are borne by her alone.
A system of property rights – at its core – forces the individual to bear the cost of her actions. This is the most important economic function of a system of private property. Given that we live in a world of scarcity, and each resource has many alternative uses, the main economic question in society is regarding the decision-making authority regarding scarce resources.
Where a resource is privately owned, the owner may use the property for her own benefit, but she also directly incurs the cost of using it. Common property, or poorly enforced state/public property leads to over use, and depletion of resources, since there is no incentive for any single individual user to preserve the property and enjoy the benefits from preservation. For example, in India, one often sees “cleanliness is godliness” in action in individual homes, yards, temples, etc. – which are kept perfectly clean. But the moment one steps on public land, the same individuals treat it as common property, creating enormous waste management and disposal problems. Without private ownership, individuals using the common resource impose a cost on everyone else in society. Private property provides an incentive to conserve resources and maintain capital for future gains.
Thus, property rights create the appropriate incentive structure to economize resources. However, to truly realize the economic benefits of this incentive structure, a system of private property rights must be accompanied by a system of voluntary exchange. Where two individuals voluntarily consent to a particular trade, this implies that the trade makes both individuals better off (based on the assumption that one will not consent to an exchange to her detriment). A voluntary exchange increases the well being of individuals involved in the trade, and the entire system of voluntary exchange therefore increases the well being of society. This was the basis for Adam Smith’s foundational argument that a society based on exchange creates the incentives for specialization, thereby increasing the wealth of nations.
The most important consequence of a system of property rights combined with a system of voluntary exchange is it leads to the emergence of a price system. When an individual faces the full costs and benefits of her actions (system of private property), and engages in voluntary exchange, the exchange ratios (prices) reflect the relative scarcity of the resource. As many exchanges take place, the price system serves as a signal of the relative scarcity of the resource; individuals can observe this price and determine if they value the resource more than the money required to acquire it, or not. Without a system of property and voluntary exchange, prices do not signal the scarcity value – and the information most required to coordinate the actions of society is not generated.
Prices, as determined by demand and supply, also signal which resources are more urgently demanded relative to other resources. Owners of resources, and entrepreneurs combining many resources, act as residual claimants of profits, and therefore have a strong incentive to satisfy the most urgent wants in society. This also has significance for identifying which inputs can be used most economically to satisfy the urgent wants. . It is therefore a signal wrapped in an incentive.
While debating the merits of socialist planning i.e. the use of a government-led system of owning and allocating resources, Ludwig von Mises pointed out an important implication of eliminating a system of private property and exchange, and the resulting price system. If the government wants to build a new line, should they use steel or titanium for the rails? This seems like a ridiculous question in a world with a functioning price system. But in a world without it, this question is not so easy to answer. Both steel and titanium are technologically feasible for building railroads. In fact, titanium might be more durable, and even technologically superior on some margins. Yet, across the world, titanium is not used for railroads. Only a working price system (emerging from private property and voluntary exchange) conveys that, at the margin, titanium is much more expensive than steel, and therefore one must economize the use of titanium leaving it for more urgently desired uses (like medical and industrial equipment) instead of using it for railroads. The price system conveys this information to railroad manufacturer entrepreneurs, and also incentivizes them to do the right thing, i.e. due to the high cost of acquiring titanium as an input, these entrepreneurs will economize, and do what is best for society, i.e. leave titanium for other more valuable uses, and instead use steel for railroads.
While Mises posed this question in the 1920s as a challenge to socialist planners, there is nothing hypothetical about this example. Modern day Venezuela is an example of the hell unleashed on individuals when a system of private property, exchange, and prices is eliminated. Today, infants cannot get food or medicines and there is a chronic shortage for virtually every essential good and service in Venezuela. This is the consequence of eliminating the price system. Venezuela has quickly descended to rioting over basics like oil and toilet paper, replacing competition through a price system with competition by force and violence.
While we barely notice a well-functioning price system, taking it for granted in a modern economy, this coordinating function of the price system is starkly clear in bad times. Let us take the example of a hurricane causing a disruption in one of the coastal towns in India. Usually when there is a hurricane, the usual distribution channels get disrupted, and there is an immediate shortage of essentials – like water, grain, oil, kerosene, medicines etc. And within a few hours/days long lines emerge to access these goods.
If the price system is allowed to operate, the prices for these goods will immediately rise. The price increase serves two purposes. It signals to entrepreneurs in the neighboring towns that there is an opportunity to make a profit by making these essential goods available. This information is extremely useful. In a town ravaged by a hurricane, any system that quickly generates information of the most urgent wants economizes on individual, community, and state effort. In addition to the signal, it also creates the appropriate incentives for the individual and society. Without such a price rise, and the consequent increase in profit, there is no incentive for the entrepreneur to make a long trip to a hurricane-affected area to sell his goods. These people are often derogatorily referred to as “profiteers” or “price gougers”, but they are in some sense providing a social service, by acting swiftly to address the most urgent wants of individuals in a dire situation. Consequently, the affected area attracts many entrepreneurs, and within a short time, the prices fall because many entrepreneurs motivated by profit have addressed the shortage. Natural disaster affected areas often experience riots and violence over the use of scarce resources. The price system can eliminates these problems as it coordinates the actions of entrepreneurs and consumers, and incentivizes all parties to economize.
An important consequence of a system of property rights in society is that it eliminates violent and destructive competition for controlling resources in society. Instead, property rights and voluntary exchange, guided by a price system, replaces resource allocation by violence with resource allocation through price competition and peace. Strong and stable property rights regimes are one of the most important components of economic development.
A capitalist economy can only stand on a system of property rights, exchange, and decentralized price system. Without these foundations, resources are not efficiently allocated to their highest valued use, and other means of allocations are used. Most commonly, in the absence of a price system, a system of political allocation quickly emerges, where those with the greatest access to the use of force, or the greatest access to political power, receive the scarce resources. Those who are powerless are left behind. This is familiar to most Indians, where resources are often nationalized, and enormous restrictions are places on voluntary exchange. Nationalizing banks creates poor incentives for bank managers (bureaucrats) to allocate credit through political channels. State owned banks in India have far higher bad loans and NPAs compared to private banks.
Often the case is made that property rights are about the economy, and there is a trade-off between property rights and personal or human rights. There is in fact no such trade-off, and loss of decision-making power over resources infringes on all other rights and liberties enjoyed by individuals. In one sense, the decision-making authority over the use of resources is the most important human right. One can determine if a warehouse must be used as a printing press, or as a butcher shop, or a monastery, or a storage unit. If the state regulates the use and allocation of newsprint, or compromises the allocation of resources to a printing press, then the medium or resources to effect the right to free speech as lost. Similarly, if all land is state owned, and individuals wish to protest against the state, then there is no safe space for free association and assembly of protesters. And the inability to allocate a place to assemble and worship, there is a severe infringement on freedom of religious expression.
Without the ability to control the use of scarce resources, no individual can pursue liberty and happiness. As property rights give individuals the power to determine use of resources, they are the ultimate human right, and the enabler and guardian of all other human rights.
Read the next part of the series here.
Also listen to: Imagine No Possessions, Episode 26 of The Seen and the Unseen, in which Shruti Rajagopalan talks to host Amit Varma about The Right to Property.