The Economics of Property Rights: Towards a Theory of Comparative Systems (International Studies in Economics and Econometrics)

result, the scale of hunting activity rose sharply. Both consequences must have increased considerably the benefits associated with free hunting. The property rights system began to change, and it required to take account of the economic effects made important by the fur trade. The geographical or distributional evidence...indicates an unmistakable correlation between early centers of fur trade and the oldest and most complete development of the private hunting territory. (H. Demsetz, "Toward a Theory of Property Rights," American Economic Journal. 57, 1967, p. 352) If the prevailing institutional structures are poorly attuned to circumstances and fail to embrace such contracts, utility-seeking individuals will generate spontaneous pressure to modify the rules of the game in order to embrace the novelty. These gradual, evolutionary changes in the prevailing institutional arrangements are adjustments in the rules of the game made in order to adapt the system to changes in the set of social choices. For example, the resumption of population growth in fourteenth-century Europe brought about an increase in the value of land relative to labor. The benefits from the right of ownership in land rose relative to its cost. Slowly, pressures mounted for the right of ownership in land to replace the feudal property-rights structures. In modem times, the expansion of markets and technological developments made mass production of goods relatively cheap and profitable. However, individual entrepreneurs and business firms had to raise large amounts of capital in order to exploit new opportunities and the owner's unlimited liability for debts created a serious problem. Unlimited liability threatened the exploitation of new opportunities because it made contractual agreements for bringing in privately owned resources too costly. A new concept eventually emerged: limited liability. Under this rule each owner's liability would be limited to the value of his investment in the enterprise. Moreover, it shifted the risk to financial institutions, which have a comparative advantage in judging and evaluating investment opportunities. This modification in the rules of the game enhanced the rise of the modem corporation. EXOGENOUS CHANGES Institutional changes are also influenced by ideologies, various pressure groups, and bureaucratic judgments about what is best for the public. Instead of adapting the rules of the game to the changing requirements of the game, exogenous changes adapt the game to the rules preferred by a specific interest group. For example, codetermination is a major social experiment in Westem Europe (more will be said about codetermination later in this book). Under this system labor representatives participate in the management of business firms. Labor leaders, bureaucrats, and some intellectuals in Western Europe argue that codetermination bestows benefits on labor without any detrimental effects on shareholders. But, if codetermination is beneficial to both shareholders and labor, why must shareholders be forced by law to accept it? Why do they not voluntarily negotiate this institutional restructuring? There is no law in Europe that prohibits the imposition of codetermination. The fact that shareholders must be forced of individuals holding property rights. The king was at the top of this long chain of "contractual" relationships, and the actual tillers of the land (serfs) were at the bottom.As the Middle Ages progressed the Catholic Church became an increasingly powerful institution. It acquired a substantial monopoly in the field of education. Libraries were located in monasteries and cathedrals, and the vast majority of literate people were monks. The Church thus became the repository of accumulated knowledge. Consequently, it acquired the power to interpret knowledge, to determine its uses, and to influence the direction of its growth. The Catholic Church also was monopolistic in religion, since it had no opposition in matters of faith.Predictably, the Church played a major role in the development of institutions in the Middle Ages. The church provided the philosophical rationale, the moral justification, and, most importantly, the religious sanction for the socioeconomic system based on a hierarchical method of holding property rights in land. The moral basis for political authority and socioeconomic privileges of medieval nobility was divine right. Kings and lords believed that they governed by the grace of God rather than with the consent of their subjects. This meant that secular rulers in the Middle Ages needed to have the Church-a worldly institution acting as "God's intermediary"-on their side.The power of the Church explains two important features of community life in the Middle Ages: (i) a strong marriage between theology and philosophy, and (ii) an equally strong marriage between ethics and economics. The laws, customs, and social institutions of the Middle Ages were determined largely by the teaching of theologians. All aspects of social life were prejudged, controlled, and monitored by the Catholic Church. Religious life and everyday social life were indistinguishable in the Middle Ages.By the end of the ninth century, this synthesis of religion and secular life took the form of a feudal society with a distinct and sharply defined class structure. The mobility between social classes was very low, almost nonexistent. A child bom to a peasant was to remain a peasant for the rest of his life. A child bom to a nobleman became a member of the nobility. Every man was considered equal in his class and entitled to the means of subsistence suited to his station in life.Philosophy and science were guided by the call to explain or justify theological tradition. The role of philosophy was to explain and support theological conclusions. Any conflict between the two was considered to be caused by some philosophical error. Thus, philosophy in the Middle Ages was largely a handmaiden to theology. Similarly, economic activities in the Middle Ages were regulated by ethical criteria. The legitimacy of eggiDomic activities was tested by reference to the moral teachings of the Church, not^to utility. The medieval Church was thus the final authority in morality, social life, and economic activities.The attitude of early church fathers toward trade and investment reflected the moral teachings of the Church. The Church recognized the necessity of trade but warned that such economic activity stimulated the acquisitive spirit, which was perilous to the soul. It is then not surprising that trade was dominated by Jews, who lived outside the Christian orbit.Those philosophical developments in Western Europe were the result of a desire to improve understanding of the world by emphasizing logical thinking, science and experimentation. In doing so, the thinkers of the time and their theories initiated a radical departure from centuries of medieval tradition. THE RELIGIOUS REFORMATION The religious reformation had a profound effect on the relationship between ethics and economics in the Middle Ages. It sanctioned the spirit of acquisition and justified the accumulation of wealth. Moreover, it undermined the Catholic Church monopoly in matters of faith. Martin Luther (1483-1546) advocated a frugal, hard-working life and provided the spiritual foundation for the work ethic. John Calvin (1509-1564) taught that to prove himself among the chosen, man has to work hard, be frugal, and seek success in his "calling." He gave religious sanction to the accumulation of wealth. The Puritan spirit gave a tremendous impetus to the development of the frugal, hard-working, and accumulating individual. It is interesting to note that capitalism first developed in two countries with Puritan populations: England and Holland.Philosophical factors and the Reformation emphasized reason, science, knowledge, experimentation, hard work, savings, and the accumulation of wealth. Slowly, the idea that the universe is fixed and ordained by God began to be overtaken by new ideas of human progress and free will. By the second half of the eighteenth century, the world was ready for Adam Smith to turn the age of reason toward a better understanding of economic processes. NEW FRONTIERS \*\*New" philosophy gave birth to new ideas. However, tradition in Europe was strong. The old order, with its customs, class privileges, and medieval values, was powerful and resistant to new ideas. Traditional Christianity was too deeply rooted to be so quickly altered. Moreover, Europe was also quite poor and overcrowded to have "room" for the new ideas to be given an empirical test. In short, the new ideas lacked space to be tried out. The exploration and settlement of new frontiers, primarily the Americas, provided an excellent "laboratory."The most important contribution of new frontiers to the rise of capitalism was in providing a tradition-free space in which to test new ideas. Freedom from religious constraints, from humble origins, and from traditional ethics allowed thousands of people to pursue their individual preferences, to be responsible for their own actions, and to create their own place in a new society. Once those ideas were applied to everyday life and proven successful, they traveled back to Europe and contributed to the transformation of medieval man into modem man.In addition to providing a tradition-free space for the application of new ideas, the new frontiers made an additional contribution to the rise of capitalism. Of every $100 worth of gold and silver produced in Western Europe and newly-opened territories after Front Matter....Pages i-xiv Front Matter....Pages 1-1 Scarcity, Institutions and Economic Behavior....Pages 3-6 The Rise of Capitalism....Pages 7-13 The Rise of Socialism....Pages 15-23 Front Matter....Pages 25-25 Basic Institutions of Capitalism....Pages 27-34 Exchange in a Private Property Capitalist Economy....Pages 35-43 Production in a Private Property Capitalist Economy....Pages 45-52 The Right of Ownership and the Firm....Pages 53-64 The Attenuated Right of Ownership and the Firm....Pages 65-71 The Role of Financial Markets in a Private-Property, Free-Market Economy....Pages 73-83 Front Matter....Pages 85-85 The History and Development of the Soviet Union Through the 1980S....Pages 87-95 Basic Institutions of the Soviet-Type Economy: State Ownership....Pages 97-103 Basic Institutions of the Soviet-Type Economy: Economic Planning....Pages 105-114 Basic Institutions of the Soviet-Type Economy: The Political and Economic Monopoly of the Politburo....Pages 115-120 The Behavior of the Soviet-Type Firm....Pages 121-127 Performance of the Soviet-Type Economy....Pages 129-139 Toward the End of the Soviet-Type Economy....Pages 141-172 Front Matter....Pages 173-173 Basic Institutions of the Labor-Managed Economy....Pages 175-180 The Behavior of the Labor-Managed Firm....Pages 181-189 Failure of the Labor-Managed Type Economy....Pages 191-200 Back Matter....Pages 201-204 To understand recent developments in Eastern Europe requires a method of analysis that is capable of internalizing into a theoretical framework (i) the logical premises deduced from the costs of transactions and incentive structures generated by various institutions and (ii) the evidence for refutable implications of those premises. The economics of property rights is such a theory. It expands the scope of the ability of economic analysis to explain a wide range of institutional structures and provides empirical corroboration of its logical implications. The economics of property rights is, then, an effective scholarly instrument that offers more significant understanding of the three current issues in the area of comparative economic studies: (i) evaluating the performance of alternative institutional arrangements, (ii) explaining the failure of socialist institutions in Eastern Europe, and (iii) identifying the costs (political as well as economic) of institutional reforms in that part of the world. In that sense, the book is both timely and relevant. In the late 1980s East Europeans crossed the threshold of fear and forced their leaders to abandon Marxism. With that theory of history dead and buried, the cost of current sacrifices in the pursuit of socialism has risen relative to the present value of its expected future benefits. -- Provided by publisher