Property Rights, Transaction Costs, and the Limits of the Market

Abstract

Although the relevance of property rights and transaction costs for trade and innovation are well-known, we still lack a formal framework to think about their origins and interplay. Within trade interactions, fully protecting the original owners' property implies that some high-valuation potential buyers inefficiently refuse to buy it because of transaction costs. When instead property rights are weak, low-valuation potential buyers inefficiently expropriate the original owners' property. The trade-off between these two misallocations entails that property rights will be weaker the larger transaction costs are regardless of whether they 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 holds true for an upstream firm's property rights on an input necessary to a downstream firm to introduce a new technology and whose cost is random and ex ante non contractible. This time, transaction costs rise with the likelihood of a more productive technology. All these implications survive when a group of traders/innovators has a larger political influence on institutional design and when the disincentive to effort effect of weak property rights is taken into account. Crucially, 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 for a panel of 135 countries spanning the 2006-2015 period. Evidence from several identification strategies suggests that these relationships are indeed causal.

Endogenous property rights and the nature of the firm

“…Opposite patterns hold true for the legal protection of the downstream firm's input (see Figures 2 and 3). These conclusions differ from those by Guerriero (2023), who focuses on hold‐up failures and thus documents that the strength of the upstream firm's property rights depends only—and in a positive way—on the downstream firm's default payoff. In addition, combined with implication (a), they contrast with the deductions of a vast literature on bargaining (Rubinstein 1982; Roth 1985), which claims that the party endowed with the largest outside option and/or moving first should receive a stronger renegotiation power.…”

“…2019; Benati et al . 2022) and, above all, to Guerriero (2023). Different from us, this contribution focuses on destructive ex post haggling and studies the downstream firm's choice of whether to produce in house rather than under joint ownership.…”

“…Different from us, this contribution focuses on destructive ex post haggling and studies the downstream firm's choice of whether to produce in house rather than under joint ownership. Accordingly, Guerriero (2023) concludes that the strength of the upstream firm's property rights should depend—and in a negative manner—only on the degree of specificity of the downstream firm's asset.…”

“…Ultimately, we run panel OLS regressions of the form $$$$ {Y}_{c,t}={\alpha}_c+{\beta}_t+{\gamma}^{\prime}\kern0.3em {\mathbf{X}}_{c,t}+{\delta}^{\prime}\kern0.3em {\mathbf{Z}}_{c,t}+{\varepsilon}_{c,t}, $$$$ where $$$ {Y}_{c,t} $$$ is Property‐Rights , IPR or Vertical‐Integration in country $$$ c $$$ at time $$$ t $$$. Here, $$$ {\alpha}_c $$$ represents country fixed effects controlling for time‐independent determinants of $$$ {Y}_{c,t} $$$ such as those discussed by the literature on endogenous property rights, that is, strength of a culture of morality and quality of legal enforcement (Dari‐Mattiacci and Guerriero 2015, 2019), degree of preference heterogeneity (Guerriero 2016a), and size of transaction costs (Guerriero 2023). Parameter $$$ {\beta}_t $$$ labels year dummies gauging macro‐shocks like financial crises and macroeconomic imbalances; $$$ {\mathbf{X}}_{c,t} $$$ gathers Process‐Specificity , Site‐Specificity and R&D‐Intensity ; finally, $$$ {\mathbf{Z}}_{c,t} $$$ might include extra controls.…”

“…Second, we consider the other determinants of property rights identified by the extant literature. These are income, inclusiveness of political institutions, non‐produced output, and both external and internal conflicts (Guerriero 2023). Including these observable factors together leaves the results almost intact, as it does considering the main determinants of either property rights or vertical integration lead one, two or three years.…”