LESSON 5 The Institution of Private Property

In this lesson you will learn:

• The reason society requires institutions to deal with scarcity.
• The three main institutional settings in which this book will apply economic analysis.
• The essential features of a capitalist system, also known as a market economy.

Society Requires Rules

So far in this book, we’ve explained that economics studies exchanges, and that basic economics simply spins out the logical implications of purposeful actions. In Lesson 4, we defined some of the basic concepts of economics, and applied them to a hypothetical man stranded on a tropical island. The laws or principles that we developed for our Robinson Crusoe are valid for everyone else, and are just as applicable in a bustling metropolis as on Crusoe’s island. But in these more complicated settings, economics will show us patterns that we could not have noticed in the simple Crusoe scenario.

However, once we move from an isolated person into a world of two or more people, there’s a new wrinkle in our analysis: What happens when two people want to use the same unit of a good in incompatible ways? In the case of Crusoe, we could say that in a sense, he was “exchanging with” Nature herself. For example, Crusoe would give up five hours of his leisure every day, and in return Nature would give him a daily stream of 20 coconuts. Given the physical realities of the island, those were the “terms of employment” offered to Crusoe.

At an abstract level, the situation is the same when Crusoe gets rescued and returns to civilization. He looks around his environment, discovers the various exchanges that are available to him, and proceeds to make those choices that give him the highest benefits relative to their costs. Yet at the same time, economics says that everybody else is doing the same thing. All alone on his island, Crusoe had the only intelligent mind, so only Crusoe was evaluating the value of various units of coconuts, rocks, vines, and so forth.

In a large city, all of the physical items that can satisfy human goals are being appraised by millions of different minds. If a man sees a coconut, it’s not simply a question of whether it’s worth his effort to go grab it. For if that coconut is already part of someone else’s stockpile of savings, the two people’s goals can’t both be achieved.

In society, the economic problem of scarcity leads to conflict. There aren’t enough units of goods to go around and satisfy everyone’s goals or preferences. In addition to the tradeoffs and constraints imposed by Nature, in society there are the additional constraints imposed by everyone on each other.

In this book we will focus on three different institutions that humans have historically used to deal with the social conflict caused by economic scarcity. In this Part II of the book, we will apply the insights of economics in the realm of capitalism, or what is called a market economy. In Part III, we will briefly explore the attempt to handle scarcity through socialism, a system in which the government owns all goods or at least all the producer goods. And finally in Part IV, we will use economics to analyze what happens in a so-called mixed economy, where the government actively interferes with a background market economy, in order to improve its alleged shortcomings.

Capitalism: This Is Private Property

The term capitalism was originally a smear used by Karl Marx, who wanted to convey the idea that it was a system serving the narrow interests of the capitalists. However, as we’ll see in later lessons, the capitalist system showers wealth on all of its members, whereas the socialist system concentrates incredible power in the hands of the privileged elites.

A capitalist system is based on private property. In this institutional arrangement, goods and services are owned by individual private citizens, or by groups of such citizens. In a pure capitalist system, not only every house and car, but every tractor, acre of farmland, and assembly line are all respectively owned by private citizens, sometimes organized in groups. A good’s owner is the person with the legal authority to decide how that good shall be used. So in a capitalist system, when a man spots a coconut, he isn’t (legally) allowed to consume it, unless he is the owner, or unless he gets permission from the owner.¹

Property Is Fundamental

Property does not exist because there are laws, but laws exist because there is property.

—Frédéric Bastiat, “Property and Law” (1848), http://bastiat.org/en/property_law.html

Don’t Take Our Word For It

“Thou shalt not steal.”

—The Lord God, quoted in Exodus 20:15

In practice, there are no real-world examples of a pure capitalist system. In addition to its private sector, every major economy today has a public (government) sector. At the same time, since the fall of the Soviet Union, there are no major economies today that even claim to operate under pure socialism. Instead there is a spectrum of the relative scope of the government versus the private sector.

Political theorists and economists have argued extensively about the ideal position on this spectrum—including its two end points of pure capitalism versus pure socialism. Because this book is an introduction to basic economics, rather than political philosophy, we will simply present sketches of three points on the spectrum: the two ends and the midpoint.

In this section of the book (Part II), we will sketch the operation of a pure capitalist system, one in which all goods and services are privately owned and exchanged in the marketplace. We will simply assume that the participants in the market respect these property boundaries. Other books can provide economic analysis to help you form an opinion as to the proper role for government to play in the provision of judicial, police, and military services that might be necessary to sustain widespread respect for private property.

The Market Economy and Free Enterprise

Economists often refer to “the market” as if it were a being with an independent mind. For example, economists who are suspicious of political interference might say, “The bureaucrats should mind their own business and leave these decisions to the market!”

However, the market or the market economy simply refers to the whole web of exchanges that individuals make with their private property. When economists say things like, “The market channeled more teachers into the town as its school-age population grew,” this is just shorthand for saying that the incentives in a society based on private property led individual teachers to choose to relocate to the particular town. In subsequent lessons you will learn how these incentives operate in a market economy, but for now we should just be clear that “the market” is not a person or even a place, but refers to interactions between owners of private property.

People often describe a capitalist system as having free enterprise. This means that individuals (or groups of individuals) are free to enter any line of work they so choose. In medieval times, entry into the various professions was strictly regulated by guilds. For example, someone couldn’t simply announce that he was a better tailor or carpenter than the other workers in town, and try to outcompete them. But in a market economy, anyone who wants to enter a certain profession can do so. Of course, he needs to respect the private property rights of others: If he wants to operate out of a store, he needs to rent the space or buy it himself. And if he is to be a successful tailor, he will need to convince potential customers to voluntarily trade away their money in exchange for his products and services. The crucial element of free enterprise is that there is no additional hurdle that the would-be tailor needs to jump over; all he needs to do is convince other private owners that they can all mutually benefit from dealing with him in his capacity as a tailor.

Finally, we note that the most significant piece of property is your own body. Whether we are dealing with Crusoe on his island, or brain surgeons in a major city, the services performed by human beings are some of the most valuable items in the economy. In a capitalist system, these items too must be assigned private owners. Slavery occurs when some individuals have the legal right to the bodies (and the services they perform) of other individuals. Both for moral and practical reasons, slavery forms no part of a pure capitalist system. In a market economy, workers are free to choose their employers—or to go into business for themselves—as a natural consequence of their ownership of their bodies.

Lesson Recap...

• Society requires institutions to establish rules and procedures so that people can interact with each other peacefully, and avoid conflict over scarce resources.
• This book will study the three institutional settings of capitalism, socialism, and a mixed economy.
• A capitalist system, also known as a market economy, features private ownership in resources. People are free to choose their own occupations and start whatever business they want, but any resources the business uses must be purchased or rented from the owners.

NEW TERMS

Institutions: Social relationships and practices that allow people to interact with each other. Institutions provide a framework of predictability in society.

Capitalism: A economic system relying on private property and free enterprise. No single person or group controls the system as a whole.

Socialism: An economic system in which government officials decide how society’s resources shall be used to produce particular goods and services.

Mixed economy: A system that allows private citizens to legally own resources, but in which government officials lay down rules that limit the choices the legal owners can make with their property.

Capitalists: The people in a capitalist society who control (large amounts of) financial wealth. The very wealthy capitalists exercise a large degree of control over businesses.

Private property: A system in which resources are owned by people outside of the government.

Owner: The person who has legal authority to decide how a particular unit of a resource or good shall be used. The owner can usually transfer ownership to another person.

Private sector: The portion of an economy that is controlled by people outside of the government. (For example, a grocery store is in the private sector.)

Public sector: The portion of an economy that is controlled by the government. (For example, the local police station is in the public sector.)

Market / Market economy: Can be a synonym for capitalism. It also refers to the collection of voluntary exchanges that occur in a capitalist system.

Free enterprise: A system in which individuals can choose their own occupations and are free to start whatever business they wish. They don’t need special permission from anyone to enter an industry.

Guilds: The organization of occupations in the medieval period, before the capitalist era. A person who wanted to become a blacksmith or a carpenter would first need to be accepted by other members of the guild.

Slavery: A system in which some human beings are considered the legal property of others.

STUDY QUESTIONS

1. Did Crusoe need an institution of private property?
2. Why does economic scarcity lead to potential conflict in society?
3. What are the three main institutional settings we will study in this course?
4. Is the sketch of a pure market economy a realistic depiction of the United States?
5. What does it mean when an economist says, “We should let the market decide”?