Property Rules, Liability Rules and Externalities

Abstract

In this paper we argue that traditional explanations of the dichotomisation of property rules and liability rules are somehow misleading, since they tend to neglect the evolutionary complementarity between die two rules in a world of incomplete property rights characterised by sizeable ex-ante transaction costs in rights’ definition. When rights are a complete bundle of well-defined uses, the application of a property rule reaffirms and reinforces the correlation between rights and duties. In a world of incomplete rights, externalities over undefined uses call for a court intervention aimed at defining a new property right through either a property rule or a liability rule. Independently of whether new rights are created by property or liability rules, die nature and die extent of future externalities over conflicting undefined uses could generate new processes of rights’ definition. The emergence of an externality always implies an evolutionary complementarity between property rules and liability rules whose boundaries actually depend, in alternative legal systems, on die degree of incompleteness of original rights.