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The legal system provides the foundation for the protection of property rights and enforcement
of contracts. As we discussed in Element 4 of Part 1, trade moves goods toward people who
value them more and makes larger outputs possible as the result of gains from specialization
and large-scale production methods. To reduce the uncertainties
accompanying trade, a legal
system must provide evenhanded enforcement of agreements and contracts. This increases the
volume of exchange and the gains from trade, and thereby promotes economic progress.
Well-defined and enforced property rights are crucial for the realization of gains from
trade. Property is a broad term that includes ownership of labor services, as well as physical
assets such as buildings and land. Private ownership of property involves three things: (1) the
right to exclusive use; (2) legal protection against invaders—those who would seek to use or
abuse the property without the owner’s permission; and (3) the right to transfer (sell or give) to
others.
Video:
Eusebio’s Dream Property Rights
Private owners can decide how
they will use their property, but they are held
accountable for their actions. People who use their property in a manner that invades or
infringes on the property rights of another will be subject to the same legal forces that protect
their own property. For example,
private property rights
(?)
prohibit me from throwing my
hammer through the windshield of your automobile because if I did, I would be violating your
property right to your car. Your property right to your automobile restricts me and everyone
else from its use (or abuse) without your permission. Similarly, my ownership of my hammer
and other possessions restricts you and everyone else from using them without my permission.
The important thing about private ownership is the incentives that flow from it. There
are four major reasons why the incentives accompanying clearly defined and enforced private
ownership rights propel economic growth and progress.
First, private ownership provides people with a strong incentive to maintain and care
for items that they own. If private owners fail to maintain their property or if they allow it to be
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abused or damaged, they will bear the consequences in the form of a decline in their property’s
value. For example, if you own an automobile, you have a strong incentive to change the oil,
have the car serviced regularly, and see that the interior of the car is well-maintained. Why is
this so? If you
are careless in these areas, the car’s value to both you and potential future
owners will decline. If the car is kept in good running order, it will be of greater value to you
and to others who might want to buy it from you. For the owner, the market price will reflect
that stewardship. Good stewardship is rewarded, but bad stewardship is penalized by a
reduction in the value of the asset.
In
contrast, when property is owned by others (such as the government, or a large group
of people owning in common—in socialist economies this was said to be “ownership by the
people”), the incentive for each user to take good care of it is weakened. For example, when
the government owns housing, no individual or small group of owners has a strong financial
incentive to maintain the property, because no individual or small group will pay the costs of a
decline in the value of the property or benefit from its improvement. That is why government-
owned housing, compared to privately owned housing, is more
often run down and poorly
maintained. This is true in both capitalist nations where markets provide price signals, and in
socialist countries where they do not. Laxity in care, maintenance, and repair reflects the weak
incentives that accompany government ownership of property, even in the midst of working
markets for other privately owned assets. A common saying in Soviet times captured this
problem: “When
everybody is the owner, nobody is the owner.”
It is not just the lack of private ownership itself that causes problems so much as the
differing interests between the users of property and the group or individual who bears the cost
of misuse. Much the same problem occurs in the rental market where the private owner differs
from the user. This is why rental contracts often contain long lists of how the property can and
cannot be used. In Eastern Europe before the transition, it was not uncommon to climb filthy
stairs past broken elevators and burnt-out light bulbs, only to enter gloriously maintained
apartments because people cared about where they lived privately but not for common spaces.
Early in the transition, how to assign ownership rights to the
housing stock became a major
issue. It was clear that the units should become private property, but whose property? For
houses and apartments built in the recent past, the answer was easy—give them (or sell them
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for a low price) to the occupants. But what about older buildings that had been seized from
their owners when the communists came to power? Should ownership be given to those who
lived in the unit or to those (or the descendants of those) whom had their property “stolen?”
The answer adopted by the Czechs was to give back (restitute) the property to its former
owners but leave the sitting tenants in place covered by rent controls. This approach ran into
obvious
problems, as owners did not have sufficient income to maintain the property and
resented not being able to sell it for its market worth.
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