Harold Demsetz. 1967. Toward a Theory of Property Rights

Harold Demsetz. 1967. "Toward a Theory of Property Rights," American Economic Review 57, 2 (May): 347-59.

I. The Concept and Role of Property Rights

1. A primary function of property rights is that of guiding incentives to achieve a greater internalization of externalities. 
2. All that is needed to internalize externalities is ownership, which includes the right of sale.

II. The Emergence of Property Rights

1. Property rights develop to internalize externalities when the gains of internalization become larger than the cost of internalization.
2. New property rights emerge to cope with new externality problems that come with changes in technology, the opening of new markets, changes in social mores, changes in common law precedents, etc.

III. The Coalescence and Ownership of Property Rights

1. Communal ownership means that the community denies to the state or to individual citizens the right to interfere with any person's exercise of communally-owned rights.
• Disadvantage:
•  Results in great externalities and rules out a "pay-to-use-the-property" system; high negotiation and policing costs make ineffective a "pay-him-not-to-use-the-property" system.
2. Private ownership implies that the community recognizes the right of the owner to exclude others from exercising the owner's private rights.
• Advantages: 
• The concentration of benefits and costs on owners creates incentives to utilize resources more efficiently.
• The cost of negotiating over externalities will be greatly reduced because any negotiations take place between two private owners; under communal ownership, negotiations would have to be between all users of the property.
• Negotiation options in the market to deal with externalities:
• Contractual agreement among owners that directly deals with externalities at hand. 
• The buyout of some owners by others. If there are several externalities, so that several contracts will need to be negotiated, or if the contractual agreements should be difficult to police, then outright purchase will be the preferred course of action.
3. State ownership implies that the state may exclude anyone from the use of a right as long as the state follows accepted political procedures for determining who may not use state-owned property.
4. Exception to the assertion that ownership tends to be an individual affair: publicly-held corporatism.
• Advantage:
• There might be significant economies of scale in the operation of large corporation if not all owners need to participate in the decisions the company must make.
• Disadvantage: 
• Depending on the structure of ownership, there may be some externality difficulties under the law of partnership; externalities depend on the liability of the owners.