Economics Department

Jim Klein - Theoretical work in progress

Coase examines a problem

In 1960 Ronald Coase said:

A final reason for the failure to develop a theory adequate to handle the problem of harmful effects stems from a faulty concept of a factor of production.

This is usually thought of as a physical entity which the businessman acquires and uses (an acre of land, a ton of fertilizer) instead of as a right to perform certain (physical) actions.

We may speak of a person owning land and using it as a factor of production but what the landowner in fact possesses is the right to carry out a circumscribed list of actions.

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The Law and Economics revolution in economic theory began on that day.

Rather than assuming property rights are well defined, the task for economic theory today is to derive the existence of factors of production and delineate the exogenous factors that determine the costs and benefits of enforcing the right to a factor of production.

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Umbeck's Paradox

In 1981 John Umbeck suggested a solution to the problem of defining property rights using the standard constrained maximization model.

Though his solutions were illuminating, ultimately the model generated the paradox that defining one endowment would invariably lead to an internal contradiction in the solution.

His comment that "you must endow someone with something" appears to be the problem, and that endowing individuals with anything will always generate a paradox.

How then to solve the problem?

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Samuelson's Revealed Preference and Property Rights

Though the Professor himself is skeptical, according to a recent letter, I and my colleagues are certain that the path to understanding the structure of property rights lies in the analysis of taxation and expenditure by governments.

Just as a transaction reveals the preferences of the buyer and seller, it also reveals the enforcement and trespass abilities of the parties.

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Buchanan's Theorem

In 1980 James Buchanan suggested tax revenue maximization as the basic assumption for government activity and his Chapter 7 seemed to suggest a general equilibrium solution for the structure of property rights.

In 2005 I suggested to Buchanan that a tax maximizing government would establish and maintain property rights. He confirmed my thinking and suggested it was a novel thought in the field.

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Deadweight loss: A failure of analysis

It is a commonplace of Public Finance textbooks that a per-unit tax will create a deadweight loss for consumers of the taxed good; unfortunately the conclusion is incomplete at best, and wrong under a more general analysis.

The simplest way to explain the error in the analysis is to ask "what did the taxing authorities do with the money?"

There are three possibilities:

1. They consumed it
2. They bought votes with it
3. They created a public good with it

If they choose solution 3.  and create a public good that lowers the cost of supplying the good in question, it's possible they could do all three of the above, since lowering the cost of supplying the good would further increase taxes.

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Barzel's Theorem

In discussions with Yoram Barzel concerning the Tax Maximization hypothesis, he suggested that wealth maximization by individuals and tax maximization by governments are two different things.

I casually suggested tax maximization can be derived from wealth maximization, and have named the theorem in honor of the man who suggested the problem.

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Samuelson's Public Goods and Social Costs

It seems clear that the analysis of public goods can also be used to discuss pure social costs, and then used in the Revealed Preference model above.

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Samuelson's Solution

It appears then, that Professor Samuelson has given us the tools to solve Coase's problem before he even asked it.

In a recent letter, Professor Samuelson modestly declines to take credit for this breakthrough in analysis, but, it appears he has shortchanged himself and his analytical skill.

Economists make the assumption that property rights must be "defined" for transactions to occur. This implies that the observation of a transaction must mean the property rights in the goods in question have been established and enforced. Otherwise we'd see something other than a transaction.

From this observation, it is a simple conclusion that observing transactions will reveal the structure of property rights in the system

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