2. Legal versus economic property rights

The EAPR, first and foremost, is a literature founded and sustained by the desire to understand organization behavior. In this process, it has been discovered that the concept of ‘property rights’ has no behavioral meaning absent the concept of ‘transaction costs’.Footnote ¹ Nine times out of ten in a discussion of rights, the transaction cost idea is implicit: sometimes identified as enforcement or measurement, sometimes assumed to be zero, sometimes assumed as a mere friction. When the transaction cost assumption is implicit, the concept of rights becomes a ship with a name but no rudder. Unfortunately, Hodgson’s discussion of property lacks any reference to the cost of property, and so his argument drifts around; sometimes it makes sense, sometimes it does not.

Elsewhere, I have specified this relationship as: transaction costs are the costs of establishing and maintaining (economic) property rights, where ‘economic property rights’ are the ‘ability to freely exercise a choice’. This notion is distinct from what the EAPR literature refers to as ‘legal property rights’ which are one’s rights under the law to freely exercise a choice.

Recognizing this role of transaction costs leads to the first critical point: if transaction costs are zero, then there is no behavioral distinction between legal and economic property rights.Footnote ² Here the set of choices under the law are identical to the actual set of choices. Yet in the real world this is practically never the case, and this distinction between these two concepts of rights was an early contribution of the EAPR. It forces an understanding that if transaction costs are positive, there is a difference between rights specified in the law and rights that actually matter for behavior. Therefore, since transaction costs are ubiquitous, considerations of only legal property rights will be inadequate for understanding behavior.

Thus, someone walking down a city street late at night might consider taking a short-cut down a dark alley. If, after three steps into the darkness the pedestrian sees the shadow of a shady character lurking up ahead, the fact that he has the legal property right to walk through the alley is quite irrelevant for what he does next. The explanation for why the walker turns around and spurns the alley for a longer route rests on the set of realistic choices held at that moment. The economic rights count for behavior.Footnote ³

Contrary to Hodgson’s claim that ‘It is impossible to understand capitalism . . .without an adequate conception of [legal] property’ (Reference Hodgson2015), it is quite the opposite. Without an appreciation of the distinction between legal and economic rights it is unlikely that any real understanding of behavior is possible.Footnote ⁴ In the writings of Alchian, Demsetz, Cheung, and Barzel there is a long journey to this realization. Indeed, a full understanding of Coase’s famous 1960 paper on social costs requires this distinction.Footnote ⁵ Hodgson’s call to adopt a purely legal concept of property, amounts to abandoning this important distinction.

The second critical point is that there is a functional relationship between economic and legal property rights. The ability to make choices depends – sometimes critically – on the delineation of the legal rights. One cannot, in general, speak of economic rights without having some understanding of the legal consequence. This understanding may be implicit in many analyses, but it must be there nonetheless.

Hodgson goes back and forth on the role the law plays in the EAPR. On the one hand he acknowledges that the writers in this field accept the law’s importance (e.g., ‘Barzel did not argue that the law does not matter’. (Reference Hodgson2015)), but he repeatedly claims things like ‘The mistaken removal of legal rights from the definition of property cannot be justified . . .’ (Reference Hodgson2015). No one is removing the law from property rights. Rather, the EAPR is interested in the functional relationship.Footnote ⁶

3. Just semantics?

Hodgson makes a distinction between ‘possession’ and ‘property’. He explicitly defines possession as the ‘. . .control or possible use of an asset or resource, irrespective of any assumed or decreed right to do so’ (Reference Hodgson2015); and property as the ‘. . .the right of the owner or owners, formally acknowledged by public authority, both to exploit assets . . .and to dispose of them by sale or otherwise’ (Reference Hodgson2015, citing Pipes). He goes on to state ‘The crucial difference [between possession and property] concerns the granting of formal rights by public authority. Hence property in its truest sense has another prerequisite – the political authority of the state’.

In earlier comments I suggested that there is an affine relationship between the four concepts. That is, ‘possession’ is essentially another term for ‘economic property rights’, and ‘property’ is essentially another term for ‘legal property rights’. The proof of this is found in various claims in Hodgson’s paper that are in agreement with the EAPR. Consider:

In each case, a switch of ‘possession’ with ‘economic property right’ and ‘property’ with ‘legal property right’, would lead to no change in meaning.

Likewise, there is mostly agreement in conclusions. Consider

Once again, no one using the EAPR would disagree with either statement. Much of Hodgson’s paper boils down to these distinctions without a difference. When there is a difference, it often comes down simply matters of emphasis.Footnote ⁷

Hodgson rejects the ‘merely semantics’ comment for three reasons: using the word ‘right’ to describe matters of ‘control’ is misleading; it diverts attention away from moral duties to obey authority; and the EAPR would still have an ‘inadequate treatment of (legal) property rights as collateral to obtain loans’ (Reference Hodgson2015). The first reason is as compelling as saying Fahrenheit is misleading because some freezing temperatures are positive numbers.Footnote ⁸ The second reason is a matter of opinion, and unlikely in any event (the question of moral duty is dealt with below). Finally, the third reason is a non-sequitur: if there is just an affine transformation, then Hodgson’s nomenclature must also be inadequate. However, this last point is simply false, the EAPR can and has provided explanations of collateral.Footnote ⁹

4. The heart of the matter

If the dispute Hodgson raises is simply over terms, emphasis, and subjects of research, there’s little to write home about. However, I believe what really upsets Hodgson is found in Section 3 where he discusses issues of motivation, utility, and instrumentalism. There is no question that the EAPR is instrumental and unabashedly interested in operational explanations of human behavior. Though many in the field believe that the rubber meets the road at the level of the transaction, and that observable constraints are where all the action lies, this religious element is of secondary importance. Hodgson, on the other hand, believes that a true theory of human understanding must have a set of true assumptions – mere explanation be damned. But how well does Hodgson make his case?

Not well. His first problem is that he confuses ‘motivation’ with ‘objectives’. Every economic argument assumes a motivation of maximization; indeed, this is what makes it ‘economic’. However, that says nothing about what the objective is or what is contained within the objective. For Hodgson, ‘moral sentiments’ are considered a motivation, which is simply wrong. Moral sentiments are elements of a utility function and likely part of one’s personal constraints.Footnote ¹⁰ As Hodgson accepts, however, claims about ‘utility maximization are strictly unfalsifiable’ (Reference Hodgson2015, emphasis added).Footnote ¹¹ Adding morality or anything else into the utility function is a game often tried, and always failed. In the words of Stigler and Becker:

Further to this, Hodgson also confuses moral behavior with constraints. He suggests that citizens obey laws because they recognize ‘legal authority’. But why obey authority? He claims because in democracies there is a belief that state authority is ‘legitimate’. But what makes it legitimate? Could it be that we play some type of social repeated game that reduces the transaction costs of dealing with each other? Claiming unobservable beliefs as the source of obedience might be true, but it is still subject to the Stigler and Becker critique. Hodgson goes on to say that obedience might occur because ‘it is believed to be moral’. But are violations of moral laws not enforced by God? Perhaps it is not the utility function that needs adjusting, but rather the set of relevant constraints for those who hold these moral values? Yet, if the matter is just one of a missing constraint, then where is the problem with the EAPR? Go ahead, add the constraint.