Property Rights: Negative Externalities and Social Cost

Release Date
July 27, 2017


Economics Entrepreneurship Property Rights

Property rights in a market economy can help us overcome negative externalities and create value for each other. Learn more with Dan Russell.

    1. Negative Externalities and the Coase Theorem (video): Economists often argue that government regulation is necessary to solve problems caused by negative externalities. Professor Sean Mullholland explains how property rights could solve this problem. 
    2. Justice and Private Property (video): Professor Chris Freiman discusses the morality of private property. 
    3. The Moral Foundations of Property Rights (article): Brian Summers explains why property rights are human rights and why many arguments for property rights do not go far enough.

Brian Domitrovic: How to deserve a property right. Ronald Coase is famous for his observations about who would get what, if people had to bargain with each other over their property rights. If a doctor needs to keep a quiet examination room, and the confectioner on the other side of the wall needs to run a noisy workshop, bargaining would always end with a property right, necessary to control level, going to whichever one of them could make the more profitable use of that right. In short, where efficiency is concerned, who gets what depends on who’s services are in greater demand.
An important question that Coase doesn’t talk about, is who deserves what. The doctor and the confectioner each need the right to control the level of noise in their workspace. That right is a property right, and it’s a factor of production for each of them. Which of them should get it? Which of them really deserves it? Come to that, is there any reason to think that where the market process puts things has anything to do with who deserves those things?
Consider a story. In 1980, Bill Gates, of Microsoft, was making a deal with IBM to supply a new operating system for their new invention called, a personal computer, or PC. Gates stood to make a lot of money from the deal, but there was just one problem. He needed to come up with an operating system. A fellow named Tim Patterson had already created a quick and dirty operating system. That was actually its title, or QDOS for short. He was willing to sell it to Gates. This system went on to become the Microsoft disk operating system, or MSDOS, which was released on the IBM PC in 1981. That of course, was the beginning of the billions of dollars that Gates would go on to make. What did Gates pay for the rights to QDOS, the thing that started it all? A mere 50,000 dollars.
This is a sort of David and Goliath story, except this time, it’s Goliath who wins. Patterson is the underdog, who created something really valuable. Gates was merely lucky to sweep it up and make a deal with the giant IBM. What would Coase say about a story like this? Sure, the outcome was efficient. Gates knew how to create a lot of value with the right to QDOS, and Patterson didn’t. That is, after all, why he was willing to accept, just 50,000 dollars for it. It seems that all that Coase could say, is that the story had a happy ending, after all, because the property right in question, was allocated efficiently.
Actually, I think Coase’s perspective is deeper than that. When you start looking at the world through Coase’s lens, you see stories differently. From Coase’s perspective, the main characters in this story, are not Gates and Patterson. Really, they’re just background scenery. Instead, the real main characters in this story are, a property right on the one hand. And, consumers, like you and me, on the other. The property right is the star, because that property right has explosive potential to bring value to consumers, if it can find it’s way to them.
This is a travel adventure story, that follows the odyssey of a property right. The suspense, is whether that property right will pass through the hands of the people who put the most value on it. They will be able to use it to create the most value for other people. That’s the interesting question. Will that property right find the path it needs to take, in order to get to you and me?
Did Bill Gates deserve to be the hands through which that property right passed? Well, if the question is whether there was something so special about Bill Gates as an individual, that he should have made that fortune, instead of someone else, then the answer is, probably not. And, in Coase’s original story, the right to control noise in the workspace will go to either the doctor, or the confectioner, but there’s nothing special about either of them either.
In order for these property claims to have moral weight, there doesn’t have to be anything special about Gates, or Patterson, or the doctor, or the confectioner. For a property right to have moral weight, is for the owner of that right to be entitled to it, within a system for allocating property rights that has moral weight.
A system of property rights, like the system within which Gates acquired QDOS, has moral weight in so far as that system creates value for consumers by allowing trades that put resources to their highest valued uses. Those uses can even transform people’s lives. In that sense, participants in the trading of property rights, do get what they deserve, not necessarily as a matter of reward for personal merit, but as a side effect of a process of allocation that creates enormous value for consumers.