Friday, November 2, 2012

Lee Anne Fennell on "Resource Access Costs"

A regular reader asked for my thoughts on Lee Anne Fennell’s new paper on “Resource Access Costs” (available here), which is forthcoming in the Harvard Law Review. Since I was planning to read the paper (as I do all of Lee's work) anyway, I'm happy to comply. The flight to Phoenix last night, with the rare luxury of a row to myself, afforded me ample time and space to finish reading the paper, and to draft this blog post about it. This is not a formal review of Lee’s article; it’s just a blog post raising issues that struck me on a first reading. So, any criticisms should be treated as tentative at best and discounted accordingly.

I should begin by pointing out for those who don’t already know it that Lee is perhaps the most gifted, creative, and incisive of the current generation of property scholars, which is saying a great deal because property, and property theory in particular, has become a very lively field in the past couple of decades. It is always a special thrill to read Lee’s new papers because I’m bound to learn things I didn’t know, or see ideas I thought I understood well viewed in a novel way, through a different and always illuminating lens.

Lee’s new paper on “Resource Access Costs” does not disappoint. In it, she takes on one of the biggest concepts in all of modern property theory (and in all of economic theory), “transaction costs,” and subjects it to a sustained critique, which she intends to lead to an abandonment of the concept in favor of a more useful and better defined conception of “resource access costs.” Put very simply, she finds the concept of “transaction costs” (a phrase, she notes, Coase never actually uses) to be ill-defined sometimes over-inclusively, sometimes under-inclusively. Do transaction costs include or exclude the costs of monitoring and enforcing performance? Is strategic behavior a transaction cost? Different scholars provide different answers to these questions, creating ambiguity about the scope of “transaction costs.”

Lee also (quite rightly) takes issue with a predominant normative theme in the literature that reducing transaction costs is always desirable because it results in more trade (with the unwarranted and usually unstated assumption of ever-increasing gains from trade). Her point (which Demsetz has also made), is that transaction costs cannot be equated with inefficiency in this way because the costs of reducing transaction costs may sometimes be greater than the benefits gained from further trade. For example, one very easy way to increase the amount of transacting in society would be to get rid of rules against trespass and theft. But such a move would hardly enhance social-welfare. Indeed, among its other functions, property itself serves as an impediment to inefficient resource reallocations, as Lee notes.

So far, so good. But Lee’s analysis raises issues with Coase that (a) were not part of the problem Coase was confronting or (b) he actually dealt with effectively. First, Coase (since 1937) was interested in impediments to market transacting that might require alternative “social arrangements,” such as firms or governments. For him, as for the Old Institutionalist, John R. Commons, the transaction was the basic unit of economic activity and the focal point of analysis. He was not writing a general theory of property, but only treated property as it facilitated (or impeded) transacting. Second, Coase never argued that transaction costs were an especially important category of costs – more important than, say, production costs, transportation costs, or the costs of exclusion. Rather, Coase just observed that transaction costs were an important category of costs that neoclassical economists were simply assuming away. 

As Lee suggests, Coase’s framework did assume the existence of property rights, but Coase (a) explicitly acknowledged that property rights are costly to define and maintain, and (b) ultimately agreed with Steven Cheung that the assumption of property rights is unnecessary in (and even inconsistent with) the mythical world of the Coase Theorem. As Cheung pointed out (before Pierre Schlag, whom Lee credits for the observation), in the world of the Coase Theorem there is no reason to prefer market allocations over those of socialist central planners. And, according to Cheung (in his 1998 presidential address to the Western Economic Association), Coase also approved of his choice to relabel “transaction costs” as “institution costs,” which might be an alternative solution to at least some of the conceptual and terminological problems Lee identifies in her paper.

Coase never argued (unlike Posner, for example) for transaction-cost minimization as a normative goal. Rather, his own critique of Pigou’s approach to externalities suggests that Demsetz’s purported critique of Coase, on which Lee relies quite extensively, is misguided. Just as some externalities are not worth internalizing because the costs would outweigh the benefits, so transaction costs should only be reduced to the point where the marginal benefits of the next unit of reduction would equal the marginal costs (MC=MB). Coase was adamant about the need to compare the respective costs and benefits of all alternative “social arrangements.” As he said in his justly famous 1960 article “The Problem of Social Cost,” our topmost concern in choosing among alternative social arrangements should be with the “total effect.”

In short, Coase agrees with Lee (as do I) about the problems associated with the various, inconsistent, and sometimes pernicious ways in which the phrase “transaction costs” is thrown about by the self-described, but faux “Coaseans,” who specify a normative goal of approximating the world of the “Coase theorem” via “Coasean bargaining” that would occur if only society could reduce unnecessary impediments to transacting.

The most important insight in Lee’s paper is her recognition that transaction-prevention costs also must be treated as important in a world where many people try to appropriate the property of others without permission. Owners undertake various kinds and extents of investments to prevent unwanted transfers, including building fences, installing security devices, and occasionally filing costly lawsuits. Lee is quite right that these costs are just as important to overall social welfare (or, as Coase refers to it, the “social product”) as the costs associated with consummating welfare-enhancing transactions. As she quite rightly observes at the top of page 25, property as an institution is at least as much about resisting unwanted transfers as it is about transactions.

That said, I remain unconvinced that her preferred phrase “resource access costs” marks a substantial improvement; in any case, it’s not enough of an improvement. Replacing the overly broad category of transaction costs with an even broader category of resources access costs would create as many problems as it would solve. Lee herself notes several possible objections to her formulation towards the end of her paper, including the fact it focuses too much on access, ignoring or subsuming other potentially important cost categories. I think she’s absolutely right about that, but I don’t buy her attempt to rationalize her focus on access, rather than, say, use, based on the assertion (p. 50) that the law cannot directly compel uses. At least sometimes, the law does compel uses, as in the use-it-or-lose-it system of western water law’s prior appropriation doctrine or adverse possession. Indeed, property law generally has an entrenched “bias” against “non-use” (as John Sprankling, among others, has shown). The law also, sometimes, prevents uses, including nuisance-causing and illegal activities. Those are costs imposed on property owners by the legal system.

As an alternative solution to the real problems Lee exposes, we might be better off specifying in finer detail  the wider variety of cost categories associated with creating, protection, and transferring property rights. Those categories might usefully include “exclusion costs” (a term that could cover the problem of preventing unwanted transactions over property), “access costs,” and “use costs.” In fact, each of the sticks in the conventional bundle of property rights (with all due respect to those scholars who would reject the bundle-of-rights approach to property) could define a separate cost category to go along with other well understood cost categories, such as production costs, information costs, strategic behavior, monitoring costs, enforcement costs, etc.

Every reason exists to insist that legal scholars as well as economists be more specific about the sources or types of costs they are contemplating. And of course, they need to compare them all within a total cost framework. (In this respect, the myopic focus of some scholars on transaction costs in property allocation is similar to the myopic focus of some environmental scholars on compliance costs in preferring cap-and-trade or tax-based approaches to traditional forms of regulation, regardless of comparative monitoring and enforcement costs.)

It’s also worth noting that one person’s “exclusion costs” might be another person’s “transaction cost.” Assume, for instance, that X owns Blackacre, which he does not want to sell, and Y wants to acquire Blackacre from him (by hook or by crook). It might be argued that X’s cost of preventing a transfer to Y might be identical to Y’s costs of acquiring Blackacre by such a transfer. Are these costs better described as belonging to the one rather than the other, and categorized the one way as opposed to the other? Coase might say that they are in fact joint-costs of X and Y stemming from a conflict over ownership, access, and/or use of Blackacre.

Finally, I would be surprised to learn that Lee truly believes it is possible at this late date to rid the literature of “transaction costs,” whatever its pathologies in use. We can certainly hope, however, that scholars will bear in mind that they are not the only costs that matter within either the legal system or the wider economy. At the very least, scholars should not use ambiguous phrases like “transaction costs” (or “resource access costs” for that matter) without delineating precisely what they mean by them, so as to avoid possible confusion. 

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