Regional President Speech

Property Rights and the Rule of Law: An Economist's Perspective by W. Lee Hoskins President, Federal Reserve Bank of CleveHand at Case Western Reserve University School of Law ApriI 3, 1990 The opinions expressed in this paper are entirely those of the author, except where noted, and do not necessarily reflect the views of the Federal Reserve Bank of Cleveland or of the Board of Governors of the Federal Reserve System. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis Property Rights and the Rule of Law: An Economist's Perspective Contents I . Importance of property rights in a free-market economy II. How economists today think about property rights III. Various definitions and the origins of property rights A. Anglo-Saxon B. Central European C. United States Constitution IV. Importance of the establishment of property rights for the Soviet Union and recent developments Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis -2- I. Importance of property rights in a free-market economy Lawyers generally learn, by the end of their first or second year of law school, that the law of property and the conservation of property rights constitute a large part of the subject matter of the American legal system. Over the last two centuries, it is fair to state that, albeit imperfectly, property rights of all types have received a greater and more persistent degree of protection than under any other competing legal or economic system, probably more than under any other legal or economic system that ever existed. Economists often fail to appreciate the importance that property rights have achieved under American law. All too often, looking at the American legal system, economists have concluded that, from Teddy Roosevelt's battles against Mark Hanna and the trusts at the turn of the century until Jimmy Carter's "special credit restraint" program in the spring of 1980, the twentieth century has brought forth a virtually unrelieved assault on classical property rights, with relief finally appearing on the horizon in the form of Reagan Administration taxation, labor law, and antitrust policies. As we shall see, that is a bit of an exaggerated notion. It is fair to state that new forms of or emphases on certain property rights have risen in influence during this century, while others arguably have declined, but that an aggregate bundle of property rights remains more or less where we found it nearly a century ago, in much better condition than 150 or 200 years ago, and ready for the challenges of the twenty-first century — if we but know how to preserve or improve that bundle of rights. Similarly, twentieth-century American lawyers often have tended to give short shrift to economists' concern for the protection and promotion of Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis -3- property rights, especially since great inroads were made into the previously existing body of American property law by the reforms of the New Deal era and by the World War II- era controls that were long in expiring. The reality, and the synthesis between these two competing (but complementary) points of view, is that each cannot do without the other. Adam Smith, whose writings were familiar to Jefferson, Madison, Hamilton, and others among our founding fathers, expressed this notion best, as follows: Commerce and manufactures can seldom flourish long in any state which does not enjoy a regular administration of justice, in which the people do not feel themselves secure in the possession of their property, in which the faith of contracts is not supported by law, and in which the authority of the state is not supposed to be regularly employed in enforcing the payment of debts from all those who are able to pay. Commerce and manufactures, in short, can seldom flourish in any state in which there is not a certain degree of confidence in the justice of government. (Adam Smith, The Wealth of Nations. Book V, chapter 3, "Of Public Debts," 441, 445, Edwin Cannan, ed. (Chicago: University of Chicago Press, 1976)). Let it not be forgotten that Smith, held to be the father of the modern economics profession, also held a university chair in "moral philosophy," gave lectures on jurisprudence, and wrote, most of the time, about issues that ought to be of concern to any business lawyer. Anyway, both lawyers and economists have to be concerned about property rights: property rights normally are not and cannot be guaranteed without an effective administration of justice, what I have called here the "rule of law," and judges ruling on legal actions affecting property rights have to be concerned with the economic effects of Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis -4- those decisions. Laws that reflect no respect for property rights are as vain as some misguided theoretical attempts, such as those that occur in fascistic states, to align the most powerful elements of society together with a suprematist assertion of property rights (to be enjoyed only by those powerful elements, to be sure), in virtually complete derogation of the common understanding of the rule of law. We are still relearning some of the classic economic lessons about property rights that have been illustrated most vividly recently by events in Eastern Europe and China: transferable property rights are essential to the creation and maintenance of anything even vaguely resembling a free-market economy. Smith held that the three essential elements of human material and spiritual progress were land, labor, and capital. Economists following Smith came to understand that property rights in those three things had to be transferable to be of much use in constructing what we often call today a capitalistic society, but what would have been called a classically liberal society until the 1930s — one characterized by free markets (unrestricted right of entry), the use of price competition to alleviate the pernicious effects of monopoly or oligopoly, and open trade (avoidance of artificial international or internal trade barriers, like quotas or tariffs). My personal preference is for such a view of the world, but for me to be able to maintain it, the law must cooperate, not so much by intervening in market processes but, rather, by refraining from intervention. Most intervention involves the shifting of either property rights or costs from one sector of the economy to another, and it still remains to be proven that interventionist outcomes, over time, are either fairer or more efficient than purely market-determined outcomes. Also, in the absence of transferability of Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis -5- property rights, social systems and economies tend to stagnate. Thus, where a noble class owns all landed property, rarely or never transfers the land to third parties, and binds all labor to the land, society tends toward a feudal form of organization in which modern capitalism has great difficulty existing. The presence of a transferable labor supply, combined with a modest amount of accumulated capital, still can give rise to a rudimentary form of capitalism, much like that described by the writings of Adam Smith, Voltaire, and others among their contemporaries in eighteenth-century Britain and France. Similar levels of social development exist in modern Latin America, the Soviet Union, and other parts of the developing world, even while land tends to be nontransferable and still is held in more or less feudal form, or is owned entirely by the state. But modern, efficient forms of capitalism seem capable of evolving fully only where property rights in land also become transferable, as generally is the case in North America and Western Europe. Before continuing this discussion, in order to clarify our terms a bit, I mean to clarify our definitions by stating that the term "property rights" means such concepts as ownership, possession, or legal title to an object or thing, including certain classes of intangible things, like the right to receive payments of money. Two elements of pr ivate property rights are essential: (1) the exclusive rights of an individual to use his resources as he sees fit (as long as he does not violate someone else's rights); and (2) the ability of individuals to transfer or exchange these rights on a voluntary basis. The weakness of modern economic analysis, and I hope that I am strong enough to overcome this weakness, is to overlook or ignore the essentiality of voluntarv exchange as the basis of effective property rights: often, economists merely assume that, an exchange of a bundle of property rights Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis -6- renders a person better off materially, then that exchange is a valid one, even if it was involuntary. Such lines of thinking tend to point in the direction of central planning, Benthanite utilitarianism, and the like, and make it quite difficult for typical academic, business, or governmental economists to remember that exchanges of property rights are legitimate only if they are voluntary. Purchases and sales of property, goods and services are merely exchanges of bundles of rights in that property or those goods and services. If a bundle of rights, or its transferability, is restricted or weakened, transaction costs increase, and all exchanges of that bundle of rights become less efficient than they otherwise would be. By the term "rule of law," I mean that "regular administration of justice" to which Adam Smith referred (supra). and by "regularity of administration," I mean the concept of predictability of outcomes that Justice Oliver Wendell Holmes held to be the hallmark virtue of the common law, properly adjudicated. By the term "justice," I mean the administration of law in the same sense in which Aristotle meant the term (The Nichomachaen Ethics, chapter 5, "Justice," 171-202, trans. __________ (London: Penguin, 1953, reissued 1986)); that is, a just outcome is one that is both lawful (approved by the plain meaning of the law) and fair (appropriating to oneself no more and no less than is one's just due). In deciding what is a just appropriation to oneself of the world's goods, one has to struggle, of course, to overcome the kind of Sherman McCoy, "masters of the universe" type of thinking that Tom Wolfe portrayed in Bonfire of the Vanities. Even if I think I deserve more, everyone else thinks he deserves more, too, after all. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis -7- A good summing up of the interrelation between property rights and the rule of law once was transmitted to one of my colleagues by the Islamic legal scholar and moral philosopher, Khalid Ishaque, as follows: "You must make it possible for an honest man to earn his living honestly — without this, the rule of law cannot exist." (Ishaque, the leading civil rights lawyer in Karachi, Pakistan, is described in V.S. Naipaul, Among the Believers: An Islamic Journey 110-117 (London: Penguin, 1982)). 11 • How economists today think about property rights. The prevalent view among most economists, also reflected among legal scholars influenced by the Law and Economics movement, is that the efficient use of scarce societal resources can be maximized only if "mutually exclusive rights to the use of particular resources [are parcelled out] among the members of society. If every piece of land is owned by someone — if there is always someone who can exclude all others from access to any given area — then individuals will endeavor by cultivation or other improvements to maximize the value of land. ... [This] principle applies to all valuable resources," thus illustrating that "legal protection of property rights creates [economic] incentives to use resources efficiently." (Richard A. Posner, Economic Analysis of Law 30, 3d ed. (Boston: Little, Brown, 1986)). Comparable analyses of the importance of assigning transferable property rights to voluntary inidividual economic actors appear in twentieth-century economic literature in, among other places, Friedrich A. Hayek's The Road to Serfdom (1944); Ludwig von Mises, Human Action (1960?); Frank Knight, [1924 Journal of Political Economy — confirm!: Armen Alcian and ___ Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis -8- University Economics. 2d ed. (___________ ); andJ RonaldJ Coase, , " Social I Costs," __________[confirm]. I have learned that a generation off youngerr economists has been influenced profoundly in the same general direction by Milton and Rose Friedman, Free to Choose (1986?). Any one of these books or articles can stimulate your thoughts more profitably, I think than the opinions of any Supreme Court Justice in the last 20 years. A few illustrations of the thinking of economists about various types of property rights might serve to illustrate the points I want to make. [Raid the NABE speech.) [Buffaloes, whales, steam engines plowing through cornfields, uninusred vs. federally insured financial institutions, "homeless" multinational corporations; the dirty underbelly of propoerty rights: slavery, prisoners of war (Alcian et al. in recent Law & Economics Journal), conscription, and totalitarianism (Arendt & Orwell).] III. Various definitions and the origins of property rights A. Anglo-Saxon [Cite Jefferson's 1824 letter to Major Cartwright on the Whig theory of history and Anglo-Saxon law, whence our law is derived. Cite Buterfield and Burke, contra. on the Whig theory of history.] B. Central European [Napoleonic, Roman, and Canon Law concepts of propoerty rights ignored any right of the common man in common law, minimized property rights (except for the few, the church, or the state), and minimized Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis -9- both voluntary exchange and transfers of land titles. Central planning, state subsidies of giant corporations (indeed, corporations), and the like grew up under this legal concept. Unfortunately, many economists from this tradition (but not the Austrians!) ignore individual liberties and voluntary exchange. Yet, this is the tradition, including universal banking, that we are about to embrace in reforming U.S. financial structure. Do we fully understand the legal and economic rationales for what we are about to do?] C. United States Constitution as noted above, the main economic thinkers among our founding fathers, plus albert Gallertin, understood Adam Smith, Voltaire, and Enlightenment economics generally. They created the Constitution largely for economic motives and assumed that a certain amount of tension, checks-and-balances, was necessary to make both our legal and economic systems work. Early on, decisions were made to modify Adam Smith's laisser-faire model in favor of federal bailouts of state debts, federal chartering of corporations (national banks), and protective tariffs; later the commerce clause of the Constitution was interpreted creatively and expansively to expand the sphere of influence of certain classes of property rights. But were these things voluntary exchanges? Should the complaints of parties adversely affected be heard? And what about transactions involving human beings as property (slavery, conscription, totalitarianism, etc.)? Should law or economics govern? Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis -10- IV. Property rights in USSR and recent developments A. Describe Polish, (Mexican, & Brazilian reforms) B. Describe Lenin's NEP C. Describe current USSR and Chinese reforms D. What should USSR be trying to do re property rights? V. Conclusion Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

W. Lee Hoskins (1990, April 2). Regional President Speech. Speeches, Federal Reserve. https://whenthefedspeaks.com/doc/regional_speeche_19900403_w_lee_hoskins

@misc{wtfs_regional_speeche_19900403_w_lee_hoskins,
  author = {W. Lee Hoskins},
  title = {Regional President Speech},
  year = {1990},
  month = {Apr},
  howpublished = {Speeches, Federal Reserve},
  url = {https://whenthefedspeaks.com/doc/regional_speeche_19900403_w_lee_hoskins},
  note = {Retrieved via When the Fed Speaks corpus}
}