Demsetz Research Articles

Property rights aren't primary; ideas are

AbstractThe current approach to the study of property cannot distinguish the causes of human action from the consequences of human action. It also cordons off morality thereby opening a hole in how property rights work. The scientific difficulty is that our analysis must constantly shift between the individual, their local community, and the larger polity in which both are embedded, in order to explain simultaneously different levels of consequences with different kinds of causes. The difficulty is made worse when we construct mental models without the human mind. My framework leaves the human mind in. Since Armen Alchian and Harold Demsetz, the study of property rights has had a decidedly external stance: the institution imposes itself on the individual from the outside. The problem of property rights, however, also calls for inquiry from the inside out of human agency, because in the study of property, ideas are primary.

The Knowledge Encapsulation Phenomenon and Its Role in The Construction of a Knowledge Trasnfer Cost Theory

The paper offers a general foundation for the currently fragmented economic studies on knowledge. We argue that such a foundation can be found in the frequently ignored phenomenon of knowledge encapsulation, coined by Harold Demsetz. Knowledge encapsulation refers to a situation under which economic agents are incentivized to compress the costly full knowledge it into incomplete knowledge algorithms. To prove the potential of placing such a phenomenon at the core of a general theory of knowledge, we identify the full knowledge elements and analyze the cost minimizing effects that encapsulation has on them. We then study a wide spectrum of knowledge encapsulation mechanisms, from instructions and superstitions to institutions and outsourcing. We demonstrate that each of these mechanisms can substantially decrease the full knowledge costs without causing a corresponding increase in costs of using incomplete knowledge. These results confirm the universality and the broad scope of knowledge encapsulation phenomenon and allow us to tentatively recommend its application in the general economic theory of knowledge. We further note that the Demsetzian approach may re-orientate the focus of knowledge studies in economics from the process of knowledge creation to its transfer.

Toward a Demsetzian Knowledge Theory

The paper attempts to outline a general theory of knowledge in economics based on the work of Harold Demsetz. We identify that “knowledge encapsulation” is a key Demsetzian idea that could unite the otherwise fragmented or narrow research on knowledge in economics. The knowledge encapsulation concept holds that mobilizing cognitive resources and acting under full knowledge is costly. This creates an incentive to compress knowledge into an algorithmic form, which can then be transferred in a cost-efficient manner between a multitude of agents. From this idea of Demsetz, we create a simple theoretical model. To prove its generalizability, we extrapolate it onto a wide range of cases, from traditions and superstitions to institutions and division of knowledge. We conclude that knowledge encapsulation applies to an extensive array of phenomena. However, such encapsulation must also be supplemented by adequate enforcement and mechanisms of coping with ex-post consequences of its use. If our analysis is correct, then the Demsetzian theory could be a strong contender for becoming a fruitful alternative research paradigm on knowledge in economics.

Collectivist Cultures and the Emergence of Family Firms

Using a sample of 1,103 Chinese private-sector firms that went public during 2004–16, we find that founders of firms from regions with stronger collectivist cultures engage more family members as managers, retain more ownership in the family, and share the controlling ownership with more family members. These findings are robust to a battery of diagnostic tests to account for alternative institutional factors that may induce the relationships. The results are consistent with the hypothesis that because the collectivist culture reduces information asymmetry, shirking problems, and associated monitoring costs among family members, more family ownership and management are expected in firms when founders are from collectivist regions. The overall evidence supports the theory of the firm pioneered by Harold Demsetz and his coauthors.

Productivity, Prices, and Concentration in Manufacturing: A Demsetzian Perspective

Concentration and price-cost margins have increased since the 1980s in many industries. These developments have raised concern about weakened competition and resulting harm to consumers and the need for tougher antitrust enforcement. In 1973 Harold Demsetz cautioned against inferring weakened competition from high or rising margins and concentration. He argued that this correlation between margins and concentration could arise from productivity differences across competitive firms. This paper studies the interplay between concentration, prices, and productivity across US manufacturing industries over two 15-year periods from 1982 to 2012. The consistent pattern is that high and rising concentration has been associated with better productivity growth. I show that widening margins, whether related to concentration or not, are mainly driven by productivity gains rather than prices, as in the competitive process outlined by Demsetz. Skepticism about tougher antitrust policy may be warranted: this would risk harm to productivity without benefiting consumers.

Personal Data as Property

Today, a growing chorus of experts, journalists, and policymakers calls for the creation of property rights in personal data. In theory, property rights emerge when the gains from propertization outweigh the costs of securing those rights. This formula, originally identified by Harold Demsetz, explains the development of property rights in land, intellectual property, and many other assets. Applying Demsetz’s theory, this Article asks whether the time has come to extend property rights in personal data. The answer is yes. The first half of Demsetz’s formula estimates the gains from extending property rights. Under the contract-law-based status quo, the market for personal data suffers from high information and enforcement costs along with inadequate incentives to supply and safeguard data. Propertization promises to mitigate — though not completely resolve — those challenges. The second half of Demsetz’s formula trains on the cost of securing property rights. For property rights to be secure in practice — not just desirable in theory — institutional investments are necessary. The conventional wisdom holds that only state-run institutions, such as courts and regulators, can protect property. But rather than rely on regulators and courts, policymakers should deputize private adjuncts to define and enforce property rights. This approach enlists the most efficient managers of information — data processing firms — in securing property. Compared with a propertization regime that relies on state-run institutions, mobilizing private adjuncts promises to substantially lower the cost of securing property rights. Because the gains from propertization are larger, and the costs smaller, than previously thought, both prongs of Demsetz’s formula favor the creation of property rights in personal data.

Productivity, Prices and Productivity in Manufacturing: a Demsetzian Perspective

Concentration has increased since the 1980s in a variety of industries. Price-cost margins have also increased over this period. These developments have raised concern about weakened competition and resulting harm to consumers. Calls for tougher antitrust enforcement have become louder. Many years ago Harold Demsetz (1973) cautioned against inferring weakened competition from a confluence of rising margins and concentration. He argued that productivity differences across firms were a potential “omitted variable.” This paper provides evidence on the interplay between concentration, prices and productivity across several hundred US manufacturing industries over two 15 year periods from 1982-2012. The consistent pattern is that high and rising concentration has been on average associated with better productivity growth. Rising concentration has also been associated with widening margins of price-cost margins. I show that widening margins generally, whether related to concentration or not, are mainly driven by productivity gains, not prices. as in the competitive process outlined in Demsetz (1973). Some skepticism about tougher antitrust policy may be warranted, since this would risk harm to productivity without benefiting consumers.

The Deterioration of Appropriate Remedies in Patent Disputes

The Deterioration of Appropriate Remedies in Patent Disputes

Fracking as a Test of the Demsetz Property Rights Thesis

Since its introduction in 1967, the account of property rights formation by Harold Demsetz has pervaded the legal and economic literature. Demsetz theorized that as a once-abundant, commonly-shared resource becomes more valuable and sought-after, users will move to more clearly define property rights in the resource. Despite the high transaction costs of this approach, the costs of organizing and enforcing a rights regime become worthwhile in the face of scarcity. And privatization, in turn, leads to more efficient use of the resource by the individuals holding the property rights, with less externalization of the harmful effects of resource use. Modified accounts provide a more nuanced story, in which “governance” — broadly speaking — emerges to address scarcity concerns. This governance can include traditional regulation that draws clearer property rights in the resource and forces cost internalization as well as innovative, less formal regimes such as monitoring and reporting of resource use, voluntary agreements to internalize certain harms, and other commons management tools. But a conundrum remains: in some cases, scarcity does not generate regulation or innovative governance, and the legal scholarship has called for more empirical testing of the reasons for this anti-Demsetzian response. Hydraulic fracturing, or fracking, presents a perfect case study for this sort of test. This oil and gas extraction technique, which has recently boomed in the United States, has identifiable, substantial negative externalities, including, for example, air pollution and overwithdrawals of freshwater during droughts. Yet states and industry actors have not consistently responded with regulations or innovative governance strategies to internalize these externalities. In this Article we explore the responses in three states experiencing a fracking boom and theorize the reasons for the diverse responses of these states to greater fracking externalities, including responses that do not track Demsetz. We conclude that traditional political explanations, often pejoratively referred to as “capture” or “rent seeking,” political culture, and legal institutions — particularly courts — account for the divergence between what we observe empirically and Demestz’s theory.

Patent Pool and Deprivatization of Patents

Abstract Most economic theories on patent pools focus exclusively on patent owners’ licensing practices in explaining why patent owners voluntarily form a patent pool. Such an approach ignores the “property” root of patents. Judge Posner emphasized the importance of using economic theories on physical properties to analyze intellectual properties. Led by this spirit, I applied the evolutionary theory of property rights, formulated by Chicago School economist Harold Demsetz, to analyze the formation of patent pools. Demsetz’s theory posits that a transition in property rights structures results from interacting parties’ efforts to maximize utilities in face of changes in external factors that bear on the parties’ benefit-cost calculation. Later studies by various property rights economists have found that the existence of externalities, the cost of enforcing the right to exclude, and the economy of scale can respectively change the benefit-cost calculation of property owners/users, and drive property rights structures towards either privatization or deprivatization. I argued that the formation of patent pools can be understood as deprivatization of patents – a transition from a private property system to a commons system – in response to three phenomena in the patent system: complementary patents, high costs of enforcing patent rights, and excessive patent fragmentation. When transaction costs of patent pooling are outweighed by its benefits, we can expect to see more patent pools being established.

Savagery, Civilization, and Property: Theories of Societal Evolution and Commons Theory

Abstract This article argues that modern commons theory has been substantially shaped by early modern ways of thinking about the evolution of civilizations. In particular, it has hewed closely to models that gelled in the Enlightenment-era works known as “stadial theory,” by authors such as Lord Kames and Adam Smith, and passed down to the twentieth century, to theorists including Garrett Hardin, Harold Demsetz, and Elinor Ostrom. It argues that stadial thinking reached modern commons theorists largely through the disciplines of anthropology and human ecology, paying particular attention to the debate among anthropologists over aboriginal property rights, colonial and international development discourse, and neo-Malthusian conservationism. The effects of stadial theories’ influence include a belief among many that private property represents a more advanced stage of civilization than does the commons; and among others a Romantic yearning to return to an Eden of primitive and community-based commons. Thus do deep cultural attitudes, rooted in the speculative thinking of an earlier age, color today’s theories — positive and normative — of the commons.

Patent Pool and Deprivatization of Patents

Harold Demsetz proposed an evolutionary theory of property rights that a transition of property rights structure results from interacting parties’ efforts to maximize utilities in face of change of external elements that bear on their benefit cost calculation. Although Demsetz’s theory was developed by analyzing tangible properties, it can adequately explain why patent owners voluntarily form patent pools. Under Demsetz’s theory, the existence of externalities, the cost of enforcing the right to exclude, and the economy of scale can all respectively change the benefit-cost calculation of property owners/users. The formation of patent pools can be understood as a transition from a private property system to a commons system in response to three phenomena in the patent system: complementary patents, high cost of enforcing patent rights, and excessive patent fragmentation. When the transaction cost of reaching agreements in patent pools is outweighed by its benefits, we can expect to see more patent pools being established.

The Coase Theorem and Core Theory

Abstract The writings of Ronald Coase, along with those of Armen Alchian and Harold Demsetz, on the theory of property rights, transaction cost economics, and the economics of institutions have yielded powerful insights and transformed many areas of economics. The seminal paper of Ronald Coase (Coase 1960, “The Problem of Social Cost,” Journal of Law and Economics, 3(1),1–44) not only clarified the notion of externality but also laid the foundations for a powerful theory of property rights and transaction cost economics. The insights of that paper have helped to shape the field of Law and Economics and also proved important in such fields as Environmental Economics, among others. It is worth mentioning that Coase’s work also led to our late colleague John Dales’ important book (Dales 1968, Pollution, Property, and Prices: An Essay in Policy-Making, University of Toronto Press) that formulated the idea of markets in pollution rights (cap-and-trade). In this note we will briefly review our work spanning many years linking the Coase Theorem to Cooperative Game Theory and Core Theory, emphasizing inter alia the importance of our approach for rationalizing property rights and contractual arrangements.

A Brief 'Prehistory' of the Theory of the Firm

The mainstream theory of the firm did not exist, in any serious manner, until around 1970. It was only starting then that the current theory of the firm literature began to emerge, based largely upon the work of Ronald Coase and to a lesser degree Frank Knight. It was work by Armen Alchian, Robert Crawford, Harold Demsetz, Michael Jensen, Benjamin Klein, William Meckling and Oliver Williamson, among others, that drove the upswing in interest in the firm among mainstream economists. Before then there was no great interest shown in the firm as a significant economic institution by any school of economic thought. What literature there was constituted, essentially, the `prehistory' of the theory of the firm. For more than two thousand years tools were available that could have given rise to a theory of the firm but none appeared. During this period the most sophisticated analysis that occurred was that which concentrated on micro-level production, and that only after 1930, while before then the deliberations that did transpire, limited though they were, were more focused on macro-level or aggregate production. Up until the 1970s the development of the theory of the firm was a story of neglect and disinterest.

Contemporary China’s Rural Landownership with Reference to Antony M. Honoré’s Concept of Ownership

:This article analyses the property rights that Chinese peasants have under the present Household Responsibility System (HRS) using Antony M. Honoré’s work on ownership, especially his analysis of eleven standard incidents of the full liberal concept of ownership. It confirms Honoré’s insight that these standard incidents can be divided among two or more persons, and thus there are different types of property rights which are variants and alternatives to the liberal type of property rights. This article also confirms that the Chinese land system is a real alternative to the full liberal concept of ownership. The current Chinese land system is alleged to be “unclear and insecure” because it is not the kind of private ownership that neoliberals champion. In the tradition of the “bundle of rights” theory, it is helpful to use Honoré’s concept of ownership, rather than Harold Demsetz’s type of property rights, to understand the current Chinese system.

Public Capitalism: The Political Authority of Corporate Executives

<i>Public Capitalism: The Political Authority of Corporate Executives</i>

Harold Demsetz. From Economic Man to Economic System: Essays on Human Behaviour and Institutions of Capitalism. New York, USA. 2011. 198 pages. U.S. $ 39.99

Harold Demsetz,Emeritus Professor of Business Economics at the University of California, Los Angeles, has done an excellentjob of putting together research in the area of human behaviour and the influence of institutions thereon. Demsetz is one of the leading figures of the New Institutional Economics School. In this book, his focus is on the institution of capitalism, which is by far the most influential systemprevalent now. It presents and reviews historical developments in the area and cites influential works, which makes the book a very interesting read. The book is nottechnical and is meant for a broad readership.

The Paradoxical Roles of Property Rights in Growth and Development

AbstractThis essay challenges the ubiquitous and rarely questioned assertion that legal property rights are necessary for economic growth and argues that this view of development is incomplete, misleading, and dangerous. The faith in legal property rights emerged from neo-institutional economics, particularly from the work of Ronald Coase, Harold Demsetz, and Douglass North, who recognized that economic assets depended on informal social norms as well as formal legal ones. To date, however, development assistance policies have been narrowly focused on formal legal institutions and have resulted in limited success and often destabilized existing property regimes, leaving societies worse off than before. Through a comparative and historical analysis, this essay preliminarily addresses these theoretical and policy failures and aims to deepen and complicate our understanding of the role of formal legal property rights in changing societies. Examples from the 16

Resurrecting the ghostly entrepreneur

The longstanding debate on the exact theoretical role and nature of the entrepreneur has traditionally featured the works of three great economists, Joseph Schumpeter, Frank Knight and Israel Kirzner. Each had a somewhat different take on this question, but each of them shared the common assumption that the entrepreneurial function exists as an independent and objective input into the productive order. However, this assumption was vigorously called into question in a little noticed but very important piece by Harold Demsetz in 1983. Demsetz may be said to have “unbundled” the other writers entrepreneurial packages and could find substantially nothing therein that was not already accounted for in the standard neoclassical market model, with investors being rewarded for taking risk under conditions of uncertainty. He comes very close to denying that there even exists a separate entrepreneurial function in the production process. This paper then proceeds to argue that Demsetz has overstated his case and that there is a distinctive aspect to entrepreneurship that has not heretofore been noted in the literature. That is the idea of “the idea”, the original cognitive formulation of a plan, a new business, an invention, a reorganization or any other new concept. The problem in understanding the role of the entrepreneur is one of intellectual property, since, at the moment of idea formulation, there is no practical way to give property right protection to an abstract idea. A comparison to the patent and the copyright system elucidates this point. The only practicable method of protecting the inherent value of a new non patentable or non-copyrightable idea is by joining it with another input which can receive property right protection, such as any of the traditional production inputs. This explains the common confounding between entrepreneurship and starting a new firm. Because of the team production nature of the venture, it is impossible to measure the marginal contribution of each of the constituent elements, thus explaining why a lot of entrepreneurial ventures are “one-man” firms. The matter of compensating for entrepreneurial services in publicly held corporations is also considered.

The Chicago Intellectual Property Rights Tradition and the Reconciliation of Coase and Hayek

In this paper I trace a fairly continuous line of argument about the institutional mechanisms by which intellectual property is produced and maintained in an advanced, commercial economy.1 The better part of the economic thinking on this subject owes directly to an approach to policy advocated by Ronald Coase.2 Coase's ideas influenced a number of talented economists especially after his arrival at the Law School in 1964. I speak of a intellectual property rights tradition not only because of the splendid bouquet of ideas at the law school proper, but also because of the cross-fertilization that took place between the lawyers and several economists on the Chicago econom ics faculty.3 The enigma of intellectual property can be summarized quite simply this way: Since commercially valuable information can be kept proprietary only for limited periods of time, how is it that so many individuals and businesses are at work producing this information each day? Somehow they must benefit from producing valuable information, either by the lead time advantage they gain over competitors before this information becomes generally available to other firms or else by somehow keeping this information from being utilized by other competing firms. Surely, other firms must be discouraged from copying or at least copying without permission from the original information owner. How do information-producers establish their proprietary interests in the first place? How do they protect their intellectual harvests from would-be poachers who wish to free-ride on the first information producer's often costly investments?4 To appreciate the contribution of the tradition, toward the unraveling of this puzzle, I have organized my discussion in three main parts. In Part I, I emphasize Aaron Director's role both in inaugurating a field of research in law and economics at Chicago and in pioneering a particular methodology for accomplishing that task. Director and his students literally paved the way for Coase and the celebrated property-rights approach to policy analysis.5 As I demonstrate in Part II, Coase's students, especially Harold Demsetz and Steven Cheung, applied Coase's thesis to the problem of the production and profitable distribution of business information.6 The Coase group broke new ground. They systematically applied a method which they called comparative institution analysis to the problem of intellectual property.7 I also survey Edmund Kitch's work, which utilizes the basic logic of the Chicago human capital approach in order to reach a surprising result about the effectiveness of the division of knowledge and the organization of work within large business organizations.8 Finally, in Part III I show that the property rights approach applied to intellectual property helps us reconcile Friedrich A. Hayek's celebrated appreciation of the pricing system as a mechanism for quickly and effectively utilizing commercially valuable economic information with another of Coase's pioneer ing essays, namely, the one about the nature of the firm.9 To some extent the firm exists to retard the diffusion of commercially valuable information while, at the same time, effectively and selfishly utilizing that information for business gain. Whereas Hayek argued that, once property rights are