Third Session: Problems with the transfer of property rights 1. The Coase Theorem
According to Nobel price winner Ronald Coase well specified exclusive, transferable property rights will go to that party who values them most – under the condition that transaction costs are zero. Example: Two persons, one smoker and one non-smoker, share an office. Value of smoking for the smoker = 100 Euro; value of clean air for the non-smoker = 80 Euro. Let us compare two different initial assignments of (transferable) property rights: Case 1: Property right to clean air The non-smoker will be willing to sell his right to clean air for a minimum price of 80 Euro. The maximum amount the smoker is willing to pay for the right is 100 Euro. Both parties can be better off when the non-smoker sells the right at an amount of more than 80 but less than 100 Euro (e. g. 90 Euro).
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Case 2: Property right to smoke (to pollute) Here is no mutually beneficial agreement between smoker and non-smoker possible. Result: Irrespective of the initial assignment of rights, the rights will end up in the hand of the person that values them most (= efficient allocation). In our example, the right will be allocated in both cases to the smoker. But the distribution is in both cases different (case 1: smoker has to pay for the right; case 2: smoker has not to pay for the right). Notice: This example represents the strong version of the Coase Theorem, i. e. the use of resources is invariant to the legal assignment of property rights (in our example: in both cases the right will end up in the hands of the smoker). In the more general case, the weak version of the Coase Theorem, the resource allocation will be efficient, not necessarily identical) irrespective of the original assignment of property rights (in our example: the willingness to pay and the willingness to accept will be dependent on the initial allocation of property rights).
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2. Embezzlement, theft, and the good faith purchaser Problem: Can a thief give good title? Can someone sell more rights than he owns?
Case 1: A leases a valuable object to B who sells it to C (= embezzlement) Case 2: B steals the valuable object from A and sells it to C (= theft) According to German law the cases are decided in the following way: If C is a good-faith purchaser He has acquired a good title in case 1 (embezzlement) He has not acquired a good title in case 2: a thief can never give a good title. Discussion from an economic point of view: The different legal treatment of embezzlement and theft makes economic sense. In case 1 (embezzlement) the owner knows B better than the good-faith purchaser does. Consequently, the owner is better suited to avoid the risk (incentive for careful selection of people when leasing valuable objects to them). In case 2 (theft) a trade-off has to be made between the original owner‟s cost of protecting against theft and the purchaser‟s cost of verifying that the seller is the owner .
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Let us discuss case 2 (theft) in more detail: Assume that it is not possible to lay hands on the thief. In this case the law allocates the risk between the original owner (= risk of having lost his property) and the goodfaith purchaser (= risk of having paid money for nothing). According to German law the good-faith purchaser faces the risk of having paid money for nothing. Two types of incentives may result: 1. Before the purchase (ex ante) the incentive for the potential purchaser increases to verify that the seller is the owner. He will spend time and money in order to decreasing the risk of loosing the good later on to the original owner without being compensated. Consequence: A reduced willingness to pay for the good and – if this is anticipated by criminals – perhaps a reduced incentive to steal. It is sometimes argued that this rule impedes trade. But the practical meaning of these incentive effects will be small, since the probability that the original owner will claim ownership is low (Shavell 2004). 2. After having bought the good (ex post) the incentive for the purchaser may increase to obscure the transaction in order to keep the good. Consequently, the incentive to make a contribution to the detection of the criminal offence decreases. If criminals anticipate this the deterrence of thievery is weakened (but: small practical meaning).
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3. Involuntary transfer of property rights: adverse possession “Adverse possession is one kind of involuntary transfer of ownership rights in real property. Under the doctrine of adverse possession, the „true owner‟ of a piece of real property cannot bring an action to eject someone who has actually possessed the property for a certain period of time” (Netter 1998). Are there economic reasons that after a period of time a transfer of ownership rights without consent and without compensation is legally recognized? Most (if not all) legal orders contain such regulations: Germany: 30 years for estate 10 years for chattel (movables)
Great Britain: 12 years for estate 6 years for chattel USA: Between 5 and 30 years (different regulations in different states).
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Economic Justifications for Adverse Possession Statutes
1. Adverse possession increases the certainty of land titles (“clears the clouds from title”) by reducing the effects of mistakes and other uncertainties: the greater the certainty about ownership, the more valuable the land. Discussion: Modern technology allows for efficient, less costly record keeping (Bouckaert/Depoorter). Sometimes a liability rule might be a better instrument to increase certainty and to facilitate transactions (Example: Restitution vs. compensation in Eastern Germany).
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2. Adverse possession prevents valuable resources from being left idle for long periods of time by specifying procedures for a productive user to take title from an unproductive user. Discussion: In most cases it will be hard to assess the most valuable use of the property. On one hand, idle land sometimes is really serving a useful purpose. On the other hand, a person wishing to use land can rent it or buy it so that the rule of adverse possession is not necessary to achieve a change in its use. Thus, idleness alone is not a good economic argument for the involuntary transfer of ownership rights. But: idleness in combination with the impossibility to determine the true owner at reasonable costs constitutes a convincing justification for adverse possession (example: Spain, where some landowners are emigrated to Latin America).
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3. Adverse possession can increase certainty by reducing the effects of mistakes and errors (adverse possession as a solution to the problems associated with boundary errors in real property). Argument (Miceli 1997): If the adverse possessor (A) invests in improving land, the true owner (B) can appropriate the quasi-rent by enforcing his property right. Because of this quasi-rent, it is desirable for the parties to determine ownership of the disputed strip of land before A invests. If boundary errors between neighboring pieces of land may exist (e. g. due to an error in a previous survey), B‟s incentive to correct A‟s error in a timely manner may be distorted: by waiting B can attract higher payments as A‟s evaluation grows. Solution: Adverse possession. (1) Creates incentives for A to avoid boundary errors prior to investing in development (first-best solution). (2) Maintains incentives for B to mitigate errors in a timely manner after A has developed (second best solution). The optimal time limit is result of the following tradeoff: “a longer limit improves the incentives for A to discover errors in first place, but a shorter period improves the incentives for B to correct errors in a timely fashion” (p. 134).
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Discussion: According to Miceli, adverse possession is superior to a liability rule in solving problems resulting from boundary errors, as (1) a liability rule eliminates A‟s incentive to discover errors before developing, (2) a liability rule creates an incentive for A to encroach intentionally on B‟s land to acquire it more cheaply than by bargaining. But: whether or not these effects arise crucially depends on the design of the liability rule.. In general, adverse possession involves an efficiency trade-off: On one hand, adverse possession can add certainty by reducing the effects of mistakes (e. g. mistakes in surveying land, in recording title; when land is passed through inheritance the title may not be completely defined at the passage of ownership). On the other hand, property owners must monitor their land, especially if they are not using it, to be sure they are not losing ownership rights to a possessor. Result: Optimal trade-off between the costs of monitoring and the reduced uncertainty is required when determining the time period.
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4. Title Systems One can reduce the cost of verifying ownership by establishing public title systems. Examples: Germany: Highly developed system of land registration. USA: Register for security rights on movables as important information for creditors. General problem (Cooter/Ulen): Property law has to develop rules that balance the impediments to commerce created by uncertain ownership against the costs of maintaining a system of verification. It is relatively more worthwhile to register a good if this good is durable, if it is non-homogeneous, if it is not-frequently transferred; if its value is high if it regularly requires shared ownership. The standard type of such good is land, but also cars, ships, airplanes etc.
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With respect to land, we can distinguish between two types of systems: 1. Registration systems Under this system the owner registers his land with the government. When a legitimate claimant arrives at a later date, the current owner retains title while the claimant must seek compensation from a public fund, financed by registration fees. Examples: Germany, “Torrens system” in some US-States. 2. Recording systems This system maintains a record of the entire sequence of consensual transfers of a piece of land, i. e. it gives evidence to the buyer, but does not establish title. In the event of a legitimate claim the claimant receives the property and the current owner receives monetary compensation, provided he has bought a private title insurance police. (Examples: UK, some US-States).
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Comparison between both systems from an economic point of view: There is one economic argument in favor of the registration system compared to the recording system (Miceli 1997). A current‟s owner subjective value of the land grows over time as he continues to occupy the land. Consequently, after some time, the subjective value will be greater than the market value. In contrast, claimant‟s subjective value typically corresponds to market value. With low transaction costs, under both systems land will end up in the hand of the party that values it most (Coase Theorem). However, with high transaction costs, a system that leaves the land in the hand of the current owner and awards monetary compensation (equal to the market value) to the claimant is Pareto superior to one that awards the land to the claimant and monetary compensation to the current possessor.