Real Estate

Real Estate

The secret pact forged in Xiaogang

Prior to 1978 in China, communal farmland was assigned to individuals to work for the government. Farmers gave anything that they produced from their land to the government, which then distributed the crops out to the people. Agricultural land was less productive in 1978 than it had been in 1949, when the communists took over. This was because the farmers did not have any incentive to produce more than the minimum; any extra work would result in the same food rations from the government.

It is said that in 1978, in a village called Xiaogang, the farmers made a secret agreement: that they would split the land up amongst themselves, produce the quota required by the government, and keep any excess they produced. As this pact violated government policy, they agreed that if any of them were jailed or killed, the others would raise his or her children.

“Back then, even one straw belonged to the group,” says Yen Jingchang, who was a farmer in Xiaogang in 1978. “No one owned anything.”

At one meeting with communist party officials, a farmer asked: “What about the teeth in my head? Do I own those?” Answer: No. Your teeth belong to the collective.

“Work hard, don’t work hard — everyone gets the same,” he says. “So people don’t want to work.”

This shift from collective property rights to private property rights provided incentive to farmers – productivity and work effort increased dramatically. These effects were multiplied by the growing competition between the farmers. They were going to the fields earlier and staying later, to produce more than their neighbors.

The agreement was eventually discovered by officials, but instead of being punished, the farmers were exemplified. New economic reforms were created which saw the Chinese economy explode. (Read more)

Of course, this story may have been exaggerated by the Chinese government (like their economic figures), which now proudly boasts of this historical revolution.

This leads to the merits of individual property rights, and inevitably to the idea of libertarianism, which is the political philosophy that emphasizes among other things, the moral view that people fully own themselves and can acquire property rights in external things. Are property rights efficient though? In the story of the Chinese farmers, they seem to be. In other cases, property rights, and problems associated with them, may not be as so.

The two problems associated with property rights are transferability and excludability. Transferability deals with the transfer of rights of the commodity from one agent to another, by selling or leasing for example, and the associated transaction costs thereof. Excludability relates to how well an agent can control who uses their resource, and for how long.

In the early 19th century, crude oil was mainly considered something that interfered with agriculture in America. Little effort was put into defining and enforcing property rights over it (“I drink your milkshake!!” – There Will be Blood). However with the development of refining techniques and the rising price of whale oil (a substitute) the definition and enforcement of these property rights increased. Since we cannot foresee technology, tastes, and therefore relative scarcity, it is impossible to specify property rights completely. Social inefficiencies will be created because of this, like losing one’s milkshake.

What’s more, the cost of establishing and protecting the boundaries of property rights can be significant. In limit, the claimants of the benefits of privatization would be willing to devote resources equal to the entire amount of the gain from private rights, which is equivalent to the loss due to not having private rights. Thus the effort to avoid the tragedy of the commons can create another tragedy, equally costly to society, namely the tragedy of private rights creation.

According to the Coase theorem, if trade in an externality is possible, bargaining will lead to an efficient outcome, regardless of the initial allocation of property rights. This was applied to the allocation of frequencies for radio stations to solve the problem of interfering signals. The theory assumes that there are no transaction costs in negotiation of rights. As transaction costs are usually not insignificant in the real world, the initial allocation of rights does matter, and will affect the attainment of an efficient outcome.

Additionally, moral hazard can creep in. Depending on who has ownership rights, a polluting factory may overstate the benefits it gains from polluting, or the victims of the pollution may misrepresent their damages. This situation of information asymmetry in negotiations, due to perverse incentives, will lead to a highly inefficient outcome.

Despite these problems, it is widely accepted that in most cases, private property rights are more efficient than collective property rights. One field in which this is not as widely accepted is the realm of intellectual property rights. Can one claim that markups of 1000’s of per cent on pharmaceutical drugs, allowed by patent restrictions, is equitable? Or that the money invested in protecting Apple’s patent of a black rectangle with rounded corners is productive? Or that the abhorrent destruction of the original Star Wars trilogy by George Lucas’ tight grip on copyright protection was justified?

On one hand, patents and copyright restrictions encourage innovation and creativity by protecting innovations and creations from freeriders. On the other, it can create an exclusive monopoly over a commodity. Some argue that that intellectual property is a public good, the use of which by one person does not diminish its use by another. Others contend that ethically, you are entitled to own anything you produce. This debate has split even the propertarian/libertarian camp.

Exclusive estate rights, on real or intellectual property, provide claimants with incentives which are entirely different to those offered by property of the commons. The question is, are these incentives socially beneficial or economically efficient?