Lecture 3: Laissez-FaireReadings: 1. Ibbott, Chapter 32. Leach, Chapter 8 pp.123-128 3. H Scott Gordon “ The Economic Theory of a Common Property Resource: The Fishery in the JPE, 1954 which can be downloaded at http://www.jstor.org/stable/18255714. Garrett Hardin “The Tragedy of the Commons” Science Magazine, 1968 which can be downloaded at http://www.sciencemag.org/content/162/3859/1243.full

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• We have had examined views of the state– Hobbes: The visible hand of the State’s sovereign power creates the peace

necessary for prosperity.– Smith: The invisible hand of the marketplace is superior to the State in allocating

scarce resources.• The Political Left is panicked by the apparent movement towards a laissez-

faire world in which global markets reign supreme. The state seems to be in retreat. – Neo-liberal Think Tanks, Tea Party, Libertarianism– Existing Agreements: NAFTA, MERCOSUR, EC, etc.– Proposed Agreements: APEC, FTAA, etc.– UN Treaty Organizations: GATT, WTO, etc.

• Will a spontaneous and benevolent social order will emerge if the state is severely limited so that the invisible hand of a global market can do its magic?

• Is the coercive Power of the State only useful in creating peace?

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• A political movement known as Anarchism suggested that the elimination of the state would usher in a golden age of peace and prosperity. There are two branches of anarchism.

• Anarchists see no role for the state, and in particular wish to eliminate the state’s role in defining and defending private property. With no state a benevolent social order will spontaneously emerge.

• Libertarians see the state having only one role – the creation and defense of private property. With private property in place, the marketplace will create a benevolent social order.

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Q: What is property?A: In Common Law systems, property is usually understood to be comprised of real property (land and land improvements from buildings to machinery sited on land) and personal property (tangible assets such as goods and money and intangible assets ranging from financial securities to patents, copyrights, and trademarks and other registered forms of intellectual property). In Civil Law systems, property is usually classified in a similar way as either immoveable or moveable.

Q: What is private property?A: Private property is usually understood as a bundle of individual rights over property. It is a bundle of rights over real property and personal property that includes:

1. the right to use and enjoy all permitted uses and benefits from your property,2. the right to exclude others from using your property,3. the right to transfer or sell these rights.

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• Without these individual rights, property would be worthless and markets, which serve the purpose of transferring property rights, would cease to function.

• Would private property rights spontaneously emerge without a state?

• Is private property really necessary for a good social order to emerge?– Plato vs. Aristotle– Aquinas vs. Thomas More (Utopia)– Locke vs. Proudhon

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• What does economics have to say about private property?• Until recently, private property was simply assumed and was not

examined. This changed when Scott Gordon (Canadian Economist) introduced his model of the fishery which was generalized by Garrett Hardin (American Ecologist) as the “Tragedy of the Commons”.

• This model opens up private property to examination as one of many possible social arrangement for rationing community access to a common pool or common resource.

• This has been deeply explored by Elinore Ostrom (American Political Scientist) who won the 2009 Nobel Laureate in Economics for her work examining the different ways that human society has dealt with the tragedy of the commons.

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• Model: Assume that there is a community with a lake that has a valuable fishery, and that the lake is common property for the community. – Members of the community have to make the choice of whether to go

fishing for the day or to work for a daily wage of ‘w’ (the opportunity cost of going fishing is w).

– The total value of the fish caught rises as more and more people go fishing, but there are diminishing returns.

– At some point, a maximum catch value is reached, and the addition of any fishers beyond this point will cause the catch to fall from over-fishing.

• The total social benefits (TSB) and total social costs (TSC) to the community from fishing are illustrated in figure 3.1. Notice that the slope of the TSC curve is w.

Laissez-FaireFigure 3.1

$

TSC

Number of Fishers

0 10 5

TSB

Z

w

12

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• Assume that the lake is currently being used by 12 fishers and ask whether this is a social equilibrium given that there is free community access to the common lake property.

• We can determine that each individual fisher’s opportunity cost is w, the wage that she could earn in the next best alternate activity.

• Her expected revenue from fishing is likely to be about the average catch, or Z/12. – If the private marginal benefit from fishing (Z/12) exceeds the private

marginal cost (w), then more people will be attracted out of the alternative employment.

– If, the private marginal cost (w) exceeds the private marginal benefit (Z/12) then people will tend to stop fishing and take up the alternative employment.

– Only if the private marginal benefit equals the private marginal cost (Z/12 = w) will the number of fishers be at an equilibrium.

Laissez-FaireFigure 3.2

12

$

TSC

Number of Fishers

0 10 5

TSB

Z

1 15

Laissez-FaireFigure 3.3

12

$

TSC

Number of Fishers

0 10 5

TSB

Z

1 15 16 17

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• The social equilibrium will occur when the use of the free access lake attracts no additional fishers. – For 15 or fewer fishers, the PMB>PMC and more people will take up

fishing. – For 17 or more fishers, the PMB<PMC and people will give up fishing. – When there are 16 fishers, the PMB=PMC and there is no incentive for

anyone to take up fishing or leave fishing as fishers and non-fishers earn the same income.

• The unique equilibrium for this community with open access to the common property is therefore 16 fishers earning their income from the lake while the remaining members of the community earn their income in the alternative employment activity.

• Notice that the common property equilibrium leads to over-fishing. Fewer fishers would mean higher income from the community resource.

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Q: What the best social outcome might be. A: Limit the number of fishers to maximize the rent from the community resource (MSB = MSC) and put all others to work in agriculture.

Implications: 1. The maximum sustainable catch is too high.2. Rationing access to common property resources is essential for

prosperity. 3. Anarchism will fail to provide a benevolent social order. 4. Civilizations will fall if the tragedy of the commons destroys the

basis of their prosperity.

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Figure 3.5

12

$

TSC

Number of Fishers

0 10 5

TSB

Z

1 16

Z*

*

5w

12w

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• How can society optimally ration access to property so that MSC = MSB?

• Several possible approaches:– Community Values– Public Property (State owned and managed) – Private Property

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• A profit maximizing owner would seek to charge fishers a price for the right to access to the lake.

• The problem for the owner then is what price to charge for access. For a fisher who is considering paying, the new private opportunity cost of fishing becomes the sum of lost wages and the new access price (w+p).

• A new line can be drawn to indicate the total private cost of fishing which is equal to the private opportunity cost times the number of fishers. This is done in figure 3.6.

Laissez-FaireFigure 3.6

12

$

TSC

Number of Fishers

0 10 5

TSB

Z

1 16

Z*

*

5w

12w

TPC TPC*

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• When the fee for access is p=0, then the TSC curve is also the TPC curve, and the equilibrium is 16 fishers.

• As the price for access rises, the TPC curve becomes steeper, with the slope of the TPC curve being simply w+p.

• As the price for access rises, the number of fishers in equilibrium begins to fall and the profits rise.

• Total profit (B) for the landlord is the number of fishers (F) times the price for access (p) so that B = F*p.

• This reaches a maximum when the number of fishers falls to 5 at the price p* in the above diagram.

• If the price were to rise any higher, profits would fall for the owner.

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There are two important implications of this analysis. 1. The first is that a private owner will automatically manage the

resource in a way which efficiently maximizes the total social income.

2. The second implication is that the whole of the surplus value is collected by the new owner of the resource. While individual members of the community are no worse off then they were under over-fishing (each person earns w), all the benefits from more efficiently utilizing the community’s resource goes to the new owner.

In other words, private property promotes efficiency but at the expense of creating inequality.