Lessig asked the law-types to look at the Calabresi and Melamed article ("Property Rules, Liability Rules, and Inalienability: One View of the Cathedral," vol. 85, no. 6, pp. 1089-1128 (1972)) and I think its appropriate to cover this in the "Future" section of our presentation.

To summarize the theory in the article, consider the following:

An entitlement is a 'right' to have a particular interest protected. Entitlements conflict because they repesent competing interests (e.g. the entitlement to make noise v. the entitlement to silence). Scarce resources require that society decide which entitlement will prevail and how that entitlment will be protected.

Property rules, liability rules and inalienability are ways of protecting entitlements. Property rules require the least amount of state intervention; in this regime, anyone who wishes to remove an entitlement from its owner must buy it from the owner in a VOLUNTARY transaction in which THE VALUE OF THE ENTITLEMENT IS AGREED UPON BY THE SELLER.

Liability rules require more state intervention because the state makes as collective determination (using some procedure -- e.g. courts) of the objective value of an entitlement and gives this objectively-determined value to the holder of an entitlement if the entitlement is destroyed or damaged. Liability rules operate if someone can destroy an entitlement as long as she pays the objective value for it. So if the holder of the entitlement is sentimental and places a higher subjective value on the entitlement; tough cookies -- she only gets the objective value.

Inalienable entitlements involve the greatest amount of state intervention because the state forbids sales of the entitlement in some circumstances (e.g. transactions made while you are drunk or incompetent (insane) are void) or all circumstances (e.g. you can't sell your kidney or sell yourself into slavery). An inalienable entitlement prevents a sale between a willing seller and a willing buyer.

Entitlements to most goods are protected by more than one rule (e.g. my house can be sold (property rule) or taken by eminent domain (liability rule) but is inalienable if I try to sell it while I'm drunk or incompetent.

So. . .when should which rule be used to protect an entitlement? Property rules work well UNLESS (1) the cost of establishing the value of the entitlement through negotiation is very high; (2) there is no adequate means of valuation for the entitlement; [1 and 2 represent high transaction costs] (3) when a result which combines economic efficiency and distributive goals is preferred and property rules would not achieve this result. In these cases, a liability rule is preferable to a property rule.

Liability rules are applied when there are high transaction costs and it is not clear who can most cheaply avoid or reduce the costs of an activity which 'is counter to' the entitlement (e.g. a polluting factory and the entitlement to clean water). Liability rules give a collective view (objective) of the value of an entitlement in order to facilitate beneficial transfers. Liability rules eliminate free-loader and holdout problems in transactions. Subjective valuations are not addressed in liability rules.

Inalienability rules are applied when a transaction creates costs to third parties (externalities) and these external costs are difficult to measure and to monetize. Inalienability also applies (1) when it is not clear how a cost-benefit analysis of transactions to transfer the entitlement would turn out (i.e. what are the costs and benefits to society?); (2) to facilitate self-paternalism (i.e. to achieve long-term v. short-term goals, citizens vote to forbid certain transactions) or true paternalism (i.e. the state is the best judge of what's best for the individual); and (3) to support certain distributive goals (i.e. since whether an entitlement can be sold or not affects who is richer or poorer; if you have an entitlement that you can't sell, you are poorer than you would be if you could sell the same entitlement).

-- Anonymous, October 26, 1998