On the Emergence of de facto Private Property under Social Ownership

 *Note: this is a repost from an earlier, defunct blog of mine. 

Part 1. The Emergence of Private Property

 

“Social ownership” is often posited as an alternative system of property to the private property-based system that exists in most of the world today. It is apparently believed that the abolition of legal private property is the necessary and sufficient condition for the creation of a non-capitalist society. However, I will argue here that de facto private ownership and markets can emerge in land, natural resources, other capital, and surpluses, absent any legal enforcement of extrapersonal property, purely as a result of legal recognition of self-ownership (that is, the absence of coercion on individuals), even under a system of social ownership. I will show that this is the case even if we assume inalienability of one's decisions. I will also argue that the emergence of a market economy in such a 'socialist' (based on 'social' ownership of the external world) setting improves the material conditions of people living in such a setting. Finally, I will argue the existence of states which enforce contracts' between individuals that 'alienate' the activity of their participants (i.e., enforces punishment for refusal to do something one promised to do in a contract, be it the rendering of labor or exchange of a good) merely expedites the development or expansion of markets rather than creating them, and that perhaps even the existence of such states can be explained (theoretically, not necessarily historically - the latter would require more research than I have done, though it's possible others have done it already) as a response to the transaction costs inherent in a stateless (purely voluntary) market.

 

To reach this conclusion, let us first start from the premise that all property is owned 'socially.' That is, everyone legally enjoys the equal right to make use of any land, natural resource, or surplus goods produced therefrom by anyone else. One may imagine that there is a state that simply does not enforce any private property rights, or that there is anarchy. As before, we will not even assume the enforcement of what we might call 'alienability.' That is, the purchase or sale of another person's action or inaction is unenforcable. In the extreme case, alienability allows for selling oneself into slavery. In more moderate cases, it might allow for the enforcable sale of one's labor (e.g. wage labor). Here, we will assume that no alienable exchange whatsoever is enforced: one may purport to sell the promise of one’s labor for the following day to another person in exchange for their labor today, then, after they’ve fulfilled their end of the bargain, renege and refuse to work for them the following day, and the state would not intervene.

 

In our hypothetical 'socially owned' world, let's suppose a farmer realizes that an innovation can be made that will increase his productivity. He may realize, for example, that by letting his plots lay fallow for one fourth of his crop rotations, even though he will reduce productivity from that plot for that rotation, by mitigating soil  depletion, this increases average productivity in the long run. Two problems, however, face this innovative farmer in a social ownership setting: 1) others will have an incentive to plant crops on the land he leaves fallow during the fallow rotation, and he cannot legally prevent them from doing so, and 2) even if no one appropriates the fallow plots, they may still appropriate the surplus he produces from them, preventing him from being able to enjoy said surplus. And yet, there may be Pareto-improvements to be made. Let’s assume the innovation is purely one of discovery, and has zero implementation cost, and it would increase average annual production by δ, and that the farmer currently is living at subsistence level, so his ‘surplus’ after implementation would be δ. Now, suppose the cost the farmer’s neighbor foregoing plotting on the farmer’s fallow plots is γ (this cost is due to the neighbor having to take the time to find other arable land and the decreased yield he will obtain on inferior land that he might plan on instead of the farmer’s fallow plots). Assuming the farmer’s neighbor is the only threat to the fallowness of the farmer’s fallow plots, as long as γ < δ, then the farmer exchanging some fraction of δ that is > γ in return for his forbearance will be Pareto-efficient. In fact, we may generalize this situation, and posit that as long as the cost of innovation, α, is less than δ – γ, it is Pareto efficient for the farmer to implement the innovation and make the necessary to retain exclusive rights to use the land (or other resource) necessary for the implementation of the innovation by making non-use contracts with other potential users of the relevant resource(s).

 

So, the farmer has found he can make a Pareto-optimal exchange with his neighbor that allows him to increase productivity and enjoy some of the surplus, while allowing his neighbors to enjoy some of the surplus as well. However, an obvious question emerges: what is to keep the parties of these contracts pledging not to make use of the (legally, still socially owned) resources from reneging on their end of the bargain? Or, alternatively, if the party promising a portion of his surplus in exchange for guarantee of non-use from others reneges on the promise to give ove some of the surplus? These contracts, I’ve established, are not enforceable under law. The answer, in essence, is credibility. The willingness of one to promise to exchange one’s non-use in return for a share of the surplus in the future from a producer depends on the trustworthiness of the producer. Conversely, the willingness of a producer who thinks he can increase production in some manner if guaranteed exclusive use to a resource to make a contract with other parties ensuring their non-use – and therefore his willingness to implement his production-enhancing endeavor – depends on the trustworthiness of the presumptive non-users. At first, there will be high transaction costs due to uncertainty, since no one will have a record of credibility in contract adherence. However, once such contracts begin to take place (at first likely on small scales with little overall risk), people will develop knowledge of who around them is credible. And, just as rating systems for potential transaction participants develop in the real world (Amazon user ratings being an example), they may develop in our hypothetical world. These rating systems could serve as the basis establishing market prices for the purchase of either future surpluses from ‘producers’ or ‘investors’ in resources, or of non-use commitments from potential users. Indeed, probability of use may itself be priced into these transactions. For example, one would likely pay one’s neighbor a greater amount to forego use than someone who lives a mile away. One may, if one is extremely risk averse, pay some amount of the prospective future surplus for forbearance even to people who live far away.

 

If sufficient technology exists, sophisticated markets could emerge in which everyone could exchange the promise of non-use for all resources in the world they have little interest in or expectation of using in exchange for a share in the ‘general surplus.’ Such exchanges could be in the form of promises of bundles of goods or services, or in some form of currency. It could be commodity currency, or promissory notes redeemed for some ubiquitously used commodity. In any case, a form of money economy would likely replace pure barter, especially in an advanced society. Another important phenomenon that would likely emerge: the willingness of people to engage in transactions with people who have poor credibility in recorded contracts or even people who refuse to participate in the market for such contracts will dwindle. This is because the more established and large the market becomes, the more opportunities will be available for participants on either side of non-use-for-surplus contracts to find credible buyers and sellers, and the less appealing it will become, comparatively speaking, to engage in transactions with those with no record.

 

But can’t people who don’t participate in the market still act as ‘free riders’ and simply take surpluses from others or use resources others have promised not to use regardless? To some extent, yes. However, the key factor limiting their ability to ‘free ride’ is information. In most cases, the ability to partake of the surplus being generated, one must know it is being produced. A producer will only inform those with whom he has non-use contracts of the surplus he is producing, and they obviously have an incentive to conceal its production from others lest they usurp their own claim to part of the surplus. This concealment of information will put such free riders at a material disadvantage, and their reduced capacity to partake of the ‘general surplus’ will serve as a disincentive to free-ride, even from a purely self-interested position.

 

To summarize my argument: If there are valid reasons – as I think there clearly are – why one would desire, either for consumption or production reasons – why many people would want to guarantee exclusive use rights to land or other resources 1) for a definite length of time, 2) for the duration of one’s lifetime (or the duration of some partnership, or other conditional duration), or 3) in hereditary perpetuity (where the contractual rights are passed on to whom one may bequest them), then the trajectory of society will be toward one in which, practically speaking, private property exists and is nearly ubiquitous. This is because almost all people have almost no use for almost all resources in the world, and therefore would probably be willing to commit to non-use for trivially small compensation for it (or perhaps even to establish credibility so as to be able to sell non-us commitment to resources potentially dearer to them at a higher price). What’s more, those who effectively identify resources from which surpluses can be produced will become progressively more adept at identifying such hidden potential for surpluses, and will this practice will likely tend toward professionalization, since activities for which productivity depends heavily on domain information and experience tend to specialize over time. Such professional surplus seekers will closely resemble the capitalists of the world we live in. Furthermore, the ability to store and share information on credibility of contract participants will serve to gradually increase the number of these transactions, lead to the equilibration of market prices of non-use, and create incentives against ‘free riding’ even for purely self-interested agents. There is, moreover, no reason why a similar system of legally unenforceable contracts aided by information markets would not function for labor contracts as well. As such, only the freedom of individuals to voluntarily agree to forego use of a resource, and the desire for exclusivity in use, are necessary for a society in which all resources are socially owned to ‘degenerate’ (or, in my opinion, evolve) into a system of de facto private property, in which capitalists use subsume risks by making investments that use resources and employ labor – in exchange for promise of material compensation - to generate goods and services, which are in turn sold to consumers for a surplus. Legally enforceable property rights are unnecessary, as private property – in essence, right of exclusive use - can effectively be constructed negatively via non-use contractual agreements with others. These property rights are, moreover, to the net benefit of society, as the exchanges through which they develop are Pareto-efficient and tend toward the allocation of resources toward those who can make the most productive use of them in satisfying consumer demand.

 

Part 2. State Enforcement of Contracts as a Means of Lowering Transaction Costs

 

One might argue that the evolution from social ownership to de facto private ownership is possible, but not inevitable, and perhaps not even likely. I would argue that the history of private property the world over strongly suggests that the emergence of private property I described above is in fact inevitable, and that the emergence of legal, state-enforced property rights is a direct consequence of this inevitability. Once contractual promises like the ones described above have begun to occur in significant number, it will become apparent that it is Kaldor-Hicks efficient to introduce alienability into the system; that is to make contracts enforceable not merely through restricting access to voluntary exchange (e.g., refusing to do business with someone has a record of violating contracts), but by imposing punishment on contract violators and/or requiring them, by force, to pay restitution.

 

It is worth noting that rise of alienable transactions in a society need not derive from coercion. People will tend to voluntarily subject themselves to ‘alienative’ transactions. This is because they reduce transaction costs. The willingness to subject oneself to punishment on the condition of breach of contract reduces, in the mind of the other party, the likelihood that one will violate the terms; this in turn means he’ll be willing to make the contract at a lower price if he’s the seller, or a higher price if he’s the buyer. Therefore, one who intends to fulfil one’s end of the bargain – unless there is significant uncertainty over whether one will be able to regardless of intent – will have an incentive to prefer such an alienative contract, as it allows one to buy at lower prices or sell at higher prices. In fact, if the only risk is the unknowability of the other transaction participants’ intentions, then the ‘community of the honest’ – all the people who intend to abide by the contracts in which they participate – will have obvious material incentives to always engage in alienative transaction, and will collectively benefit from an increase in the occurrence of mutually beneficial transactions and in the size of the sum of the surpluses generated as a result. Even if there is a risk of not being able to fulfil one’s end of a contract even if one has honest intentions (e.g., an investment may fail, leaving one unable to pay back a debt), many will likely be willing to submit to punishment for an unintentional breach of contract, reasoning that the cost of the punishment is less than the cost of losing the opportunity to engage in future transactions that would result from violating the conditional punishment clause of the contract.

 

Of course, by construction, alienative contracts are forbidden under our hypothetical social ownership-based system. But it is important to realize that the state would almost certainly have to actively suppress such contracts and take punitive action against those who engage in them. Some individuals may aid the state in suppressing their would-be punishers, but many would not because occasionally undergoing punishment (which may of course imply be forced restitution) may be worth it to be able to engage in more mutually beneficial transactions.

 

Overall, there is an unavoidable problem in the political sustainability of the prohibition on alienative contracts: those who sincerely seek to engage in mutually beneficial contracts will benefit from alienative contracts, and will tend to pressure the state (a state would, I contend, be necessary to enforce the prohibition on alienative contracts in the first place) to remove such prohibitions. Those who have no interest in engaging in alienative contracts and those who have no interest in participating in economic transactions do not benefit from the prohibition, and would have no interest in supporting it. The only group that would have an interest in the prohibition of alienative contracts is people who intend to participate in transactions and violate them. Unless this cohort is a large fraction of the population, the state will face an uphill battle in maintaining the prohibition on alienative contracts. Moreover, the state’s revenue would almost inevitable depend on either the number of transactions that occur (or some subset of them) or the total product of the economy (or some subset thereof), and since the latter depends on the former, and the former is greater when alienative contracts are permitted, the state itself will have a vested material interest in permitting alienative contracts.

 

Even if no state exists, however, most of the population will have a material incentive to indulge or permit the enforcement of fully alienative contracts. That is, if one signs a contract in which a punishment is specified as conditional on breach of contract, the general public has a vested interest in tolerating the wronged party imposing the specified punishment on the violator of the contract irrespective of whether he voluntarily submits to it. The widespread enforcement of alienative contracts would increase the costs of violating contracts and thereby reduce the uncertainty associated with them for those intent on not violating contracts. If the latter group makes up the majority of the population, then the preponderance of society will most likely benefit from this practice and tolerate if not encourage it.

 

Of course, a putatively wronged party cannot likely be trusted to enforce its own contract. Especially when the punishment to be imposed is forced restitution, one may have a material incentive to employ a ‘liberal’ definition of what constitutes breach of contract to justify expropriating the other party. The employment of neutral third parties to enforce contracts, and if necessary impose coercive punishment on violators, therefore makes sense for rational economic agents. As with arguably most industries, economies of scale likely apply, and there may be a natural tendency toward monopoly – especially within a defined geographic region – in contract enforcement. The entity I am describing may sound increasingly like a state. There is, however, a missing ingredient: the enforcement of contracts for which this neutral third party has not even been employed. Why would such an entity, say, seek to punish all robbers in its area, regardless of whether the victims have hired it to do so? The answer may resemble the answer to the question of why a pizza delivery company would pave potholes in roads: it may be worth it for an entity to render a public good when its private benefits from doing so exceed its private costs. If a third party contract enforcer is already employed by most of the residents of a town, region, or country, then it is highly likely that a thief or scammer whose victim is not one of its clients may yet victimize one of its clients in the future, incentivizing the contract enforcer to impose punishments on all thieves and scammers in its jurisdiction. Of course, then those within its jurisdiction who are not its clients will be ‘free riders,’ and those who are clients, who make up the majority, will have both the incentive and the political power to mandate everyone within its jurisdiction to become its client – and pay the concomitant fees - to solve this ‘free rider’ problem. Finally, the constant negotiation of terms with the third party contract enforcer for specific contracts between individuals or firms bears its own significant transaction costs. For many common contracts – such as simple non-use commitments – it may be less costly to assume universal standards of enforcement, punishment, and restitution for all clients/residents, and all property (or at least all property of a given category) rather than negotiating each contract individually. Thus, we arrive at what one might safely call a state. The coercive or nonconsensual aspects of laws and the enforcement thereof may be interpreted as ‘short cuts’ to enforcing the many contracts that most people would want to engage in with their neighbors anyway, but in a manner that avoids many of the transaction costs that would arise from having to negotiate each inter-personal or inter-firm contract individually. The preponderance of residents of the state’s jurisdiction may rationally tolerate the cost of such ‘corner-cutting’ on the matter of obtaining consent – such as mandating contribution to the maintenance of the state - because the cost of maintaining the state tends to be less than the cost of having to constantly negotiate and renegotiate innumerable contracts with everyone with whom one engages in economic transactions, and with the state of course, and because the reduction in uncertainty about one’s transaction partners’ intentions by the state’s coercive actions outweighs the costs, relative to, say, having to rely purely on completely voluntary transaction participant ratings systems. The state’s raison d’etre – or at least, its raison d’etre qua giver and enforcer of laws - may thus be as simple as the mitigation of transaction costs.

 

In his book, The Rise of the West, Douglas North attributes the rather sudden economic expansion in Western Europe during the 17^th century – especially the Low Countries and Britain – in large part to the cultivation of legal contract enforcement. Exchange of goods and services occurred before such contract enforcement, of course, and primitive markets existed in the form of traveling fairs, where merchants of a particular trade – wine, textiles, etc. – would sell goods together, exploiting what we would now call network effects. However, market exchanges were a fairly small fraction of economy. The gradual realization by states disproportionately dependent on exchange – states that were hubs for international trade or early textile manufacturing, such as the Netherlands, had a particularly strong incentive and the necessary economies of scale to find it worthwhile to reduce the transaction costs inherent in the uncertainty of contract adherence by assuming the role of enforcing such contracts. As a direct result of this assumption of contract enforcement, the more mutually beneficial contracts took place, raising the value of credible contract enforcement by the state as a neutral third party even more. This continuation of this ‘virtuous cycle’ was, in turn a major factor in the rapid economic development on the eve of the industrial revolution of those countries in which the state increasingly enforced alienative contracts – the Low Countries and Britain, notable – relative to those nations that lagged in the enforcement of commercial contracts and also outlawed many more forms of voluntary contract as well and languished economically – such as France and Spain. Indeed, the fact that a private property based system has arisen in every successful society in the world, and what few societies can be found where social ownership has prevailed being relegated to the margins of the global economy, may be evidence of the irresistible economic gains to be made by the vast majority of people from the fostering of private markets for – and therefore ownership of – goods, capital, and resources in general.

 

My conclusion to the second part of this essay is that the system of private property entailed by the enforcement of alienative contracts by the state was not imposed in the interests of a class, but cultivated gradually and spontaneously due to an emergent mutualistic relationship between markets and the state.  In particular, there were net gains in production and well-being to be made by enfranchising a neutral third party (a role existing states were best positioned to fill) with a ‘monopoly on violence,’ a monopoly to be used to enforce contracts and reduce the uncertainty of economic transaction. The cost of maintaining such a state was likely less than the gains from reduced transaction costs. Discerning readers may notice that what I’ve written here has a thoroughly Coasean ethos to it. Indeed, what I have illustrated is essentially a ‘negative’ application of Coase Theorem: one need not have private property for Coase Theorem to apply; even where private property does not exist, resources will be optimally allocated through the exchange of ‘negative ownership,’ or commitment not to use, and only transaction costs inhibit this optimal allocation. And it is because of these transaction costs that coercive third party enforcement of contracts – e.g., enforcement by the state – can be economically productive by reducing uncertainty-related transaction costs by more than the cost of maintaining such third party enforcement.