Coasify

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This article is sponsored by Coasify, a new app that helps you with all of your needs: define and enforce property rights, enable gains from trade, internalize externalities, and align incentives.

Just kidding, but someone please make this app!

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Defined and enforced property rights are the main ingredient for economic prosperity, many say. Hardly can I disagree! What it means, in each case, to define and enforce property rights is a much harder puzzle. I recently wrote down a list of what I think are the eleven-and-half pillars of economics (things that economists know), and one of them was:

6. Prices are exchange ratios; they are generated by exchanging property rights that can be exchanged.

a. Control rights and residual clamancy rights without alienation rights are necessary but not sufficient for generating prices.

b. Alienation rights consist of (i) the personal ability to alienate and (ii) a potential trading partner.

This, I would argue, is one of the most difficult rather obvious ideas to wrap your head around in economics.¹ 1960 may have been a while ago, but Ronald Coase’s “The Problem of Social Cost” was not that long ago in paradigmatic idea time—the paper is old, but the idea is young.

Alienation rights—sometimes called transferability—matter a lot because exchange is at the heart of economics. You can’t exchange what you can’t alienate. Here I want to highlight some microcosms of economic forces at work: when something valuable is turned into something transferable, the price mechanism is unleashed to do its work of achieving allocative and productive efficiency.

Reread that formula: Something Valuable -> Something Transferable -> Price Mechanism -> Gains From Trade -> Allocative and Productive Efficiency. The key arrow is the first one, and “the rest being brought about by the natural course of things” (out of context Adam Smith quote).

1. Street Votes

Sam Bowman on the Something Valuable:

If you’re in a semi-detached house somewhere in London, let’s say it costs £600,000, £700,000, depending on where you live. If you get permission to build up to say six storeys, the value of the house that you live in and the land that it’s on could rise up to, say, £2 million, because you can build so much more value on that land.

People want to live in London, but there’s not enough housing. We’d like there to be more, but we cannot get the OK to build. Zoning is a problem. Many people who live there don’t want to build up: the new buildings are big and ugly and come with hustle and bustle. Negative externalities are a problem.

Enter Street Votes. Step one: allow people on the street to vote to change their zoning to build up.² They can decide no change, some change, lot’s of change, etc.

Let’s say, for the sake of argument, that there were one person on the block that is holding up the vote—they don’t want to change the zoning; they are a classic NIMBY. With a vote, he can demonstrate that preference, but he cannot demonstrate the intensity of the preference.

Step two: allow the transferability of his veto right. By allowing him to alienate his right, he can exchange it, and in exchange we will see a market price emerge. How much does he care about the big ugly apartment? How much does the developer care about building? Whoever values the rights more will pay for the veto right, and the bearer of externality will be compensated. Win-win. Or perhaps the incumbent really values his neighborhood status quo a lot and holds onto his veto right. It is in his right to do so, but now at a, say, £1 mil opportunity cost.

Whatever the outcome, by defining and enforcing the property rights (especially the rights of alienation), economic forces work such that we can now do interpersonal value comparisons and allocate resources to whomever values them most. Coasification, if you will.

Bowman: Some of the nicest parts of London were built by single owners who capture all of the externalities and so build in a single, consistent manner. Regent Street is an example. Lots of Bloomsbury. Lots of the very lovely, dense old parts of London were built by a single person because they internalise the externalities, and so they have an incentive both to build beautifully and to not build things that obviously make the internal value of what they have worse.

An addendum would be a gradient of (still transferable) votes based on proximity—should the next-door neighbor have a stronger veto than the guy a couple streets over?

2. Airline Auctions

At this point, most people know about airline auctions—when an airline overbooks a flight, they reach out and ask for bids. How much will they have to pay you to not take this flight?

The Something Valuable here is the right to not getting kicked off. Before implementing auctions, no such right existed, much less was tradable.

From the birds-eye view, we would want to send the people on the flight who value it the highest or would suffer the worst if they got kicked off. But imagine asking each person “hey do you think you value this flight in the top 90% of passengers?” What would they say? Yes.

When an airline can credibly commit to paying them off in an auction, then people will be willing to reveal exactly how much they value not getting kicked off. The airline will only have to buy that right—it is both existent and tradeable now—from a few people.

The tradability of the right means that it generates a price, the price guides action such to allocate the right to the person who needs it most.

Aside: Yes, a whole swath of Coasify examples involve auctions, the electromagnetic spectrum and search engine advertisements as prototypical. There is a good reason why.

To show why, remember that the sealed-bid second-price auction, sometimes called the Vickrey Auction (after William Vickrey), is a special case of the Vickrey-Clarke-Groves auction. Theodore Groves’s contribution is interesting in its own right, but for us (today), Edward Clarke’s is more so.

Edward Clarke contributed his part in public finance, the setting of pricing (or voting for) public goods. Public goods pricing is a problem because individuals have an incentive to free ride. If you ask me how much I value the public good, I have a chronic incentive to under-report. Why pay my small part if it won’t affect whether the public good will be provided or not? And if everyone acts this way, no one contributes, and everyone is worse off.

But what if we had a way to incentivize the participants to reveal exactly how much they valued the public good? Well, the Clarke Tax can do the trick. One way to think of the Clarke Tax is the net magnitude of externalities of showing up to vote. If I show up to vote for Option A over Option B, the other voters who hold A > B are better off—my presence to them is a positive externality. But the voters who hold B > A are worse off—my presence to them is a negative externality. Clarke showed that if everyone is charged the difference between positive and negative externalities (but taxed only if they are able to flip the outcome), then everyone will be willing to share their true values for the public good.

All that to say, if there is a way to take Something Valuable (like an outcome-changing vote) and make it transferable, putting a price on it, people will internalize their externalities.

In this case the voter has to buy the right to change the outcome, as with the street vote and the airline auction, the subject got to sell their something valuable. But the money flows from the one benefiting from the exchange to the one incurring the negative externality based on the status quo property rights—recall that the Coase Theorem doesn’t care who has the rights to begin with, and making something alienable is an essential part of reducing transactions costs.

3. Uber

Are we tired of using Uber as an example in economics? Yes. Will we still use it? Yes. The example is simple and can be extrapolated but is especially illuminating because it was privately implemented.

Riders have an end: they want to achieve transportation. There is a latent stock of transportation sitting around that cannot be traded because the transaction costs are too high—the latent stock being your back seat. Mike Munger’s three T’s of transactions costs Triangulation, Transfer, and Trust are a useful tool here (triangulation is finding a potential trading partner, an individualized knowledge problem; the other two are self-explanatory).

Say before the crime wave of the ’90s, there was enough trust to let a stranger in your car (or vice versa). We called it hitchhiking. Enough people did it that you could set out with a positive expectation of getting a ride—triangulation was solved. But what exactly was in it for the driver? Making it a reciprocal transaction was rare, so when social trust broke down, so did the practice.

Uber solves all three transactions costs problems at once, by solving the transfer problem first. That valuable latent stock of transportation—your back seat—now has a calculable opportunity cost when it stays empty. You could instead trade it for money and engage in a mutually beneficial exchange, which makes it in both the driver and riders interest to become trustworthy and triangulate.

What Uber did was define and enforce property rights. When someone says their new app is the Uber of X, if they are serious, really they mean it is the Coasify of X.

4. Matching Programs

Sometimes you know you want to trade and you have alienation rights, but the Something Valuable is finding the perfect trading partner. Mechanism designers often make cool sophisticated algorithms to do this (usually with limited applications). More Al Roth’s please! Usually the algorithms are computationally expensive too, and of course you have to solve the fundamental knowledge problem first. Donating a kidney is like picking up a hitchhiker plus getting a major surgery: no interpersonal measurement of benefits and lots of personal costs. What if we could make better matches?

Another cool Roth idea is the signaling mechanism on JOE (Job Openings for Economists). The Something Valuable is a credible signal that an applicant likes a certain job best, out of hundreds. If you asked them, they could just say “yes this is my top pick” for every single one. The solution? An artificially scarce signaling button that can only be used twice.

But might I say, more Milton Friedman’s first? Consider school vouchers: simply giving some agency to exit the status quo induces competition for improvement. Why not go one step further: school-earmarked consumer subsidy. Then actual transferable property rights can generate actual prices and allow us to compare actual magnitudes.

The moral for designing market mechanisms is that the more agency you can give to the players, the less computationally expensive, clever, or sophisticated the mechanism has to be. Let us sell our kidneys!

I could go on (I am tempted to bring up patent buyouts, but I’ll save that for another time). Yes property rights are important. Yes they are a key ingredient to economic prosperity. But sometime it takes a clever insight to define and enforce property rights or reduce transactions costs to allow exchange, which means the same thing.

1. There are many difficult nonobvious ideas in economics: Where does political legitimacy come from? How do ideas or ideologies affect economic institutions? How to achieve external validity in any experiment?

2. The voting mechanism is exogenous here; the link said 60% have to agree to the plan.