Property Rights, Transaction Costs, and the Limits of the Market
Abstract: Although property rights and transaction costs are key, their determinants and interaction are still poorly understood. Within trade interactions, a rise in transaction costs has the marginal effect of inefficiently pushing some high-valuation potential buyers to expropriate the original owners' property and the infra-marginal one of decreasing the social gain from the transfers that are still consensual. Then, it must also reduce the protection of property rights, which gages the probability of unsuccessful expropriation. This pattern holds true regardless of whether transaction costs are driven by frictions outside the control of traders or determined by the mix of the dispersion in their valuation and either the original owners' market power or their privileged information. A similar conclusion applies to an upstream firm's property rights on an ex ante non contractible input necessary to a downstream firm to introduce a new technology. This time, transaction costs rise with the likelihood of a more productive technology. These implications survive if a group of traders/innovators has a larger political influence on institutional design and if the disincentive effect of weak property rights is considered. The model predictions are consistent with the negative effects of proxies for market frictions and failures on measures of the protection of personal, intellectual, and financial property that I document for a panel of 135 countries spanning the 2006-2015 period. This evidence suggests that the negative correlation between weak property rights and economic outcomes might be partly spurious.