Property economics versus new institutional economics: alternative foundations of how to trigger economic development.

Author:Steiger, Otto

The ex-communist [and developing] countries are advised to move to a market economy, and their leaders wish to do so, but without the appropriate institutions no market economy of any significance is possible. If we knew more about our own economy, we would be in a better position to advise them.

--Ronald Coase, "The Institutional Structure of Production"

What are the core economic principles to be implemented for protected transactions in developing and transitional countries to trigger economic development? In recent decades, two approaches have been developed which claim to answer this question: (i) the theory of property rights, or new institutional economics, originating from Armen Alchian (1977) and Harold Demsetz (1967; see also Alchian and Demsetz 1973) and developed by Nobel laureate Douglass C. North (1973, with Robert P. Thomas; see also North 1981 and 1990) (1) and (ii) the property-based theory of the economy, or property economics, developed by Gunnar Heinsohn and Otto Steiger (2004, 2003, 2006a, b, and d; see also Stadermann and Steiger 2001 and Steiger 2006a), with similar contributions by Hernando de Soto (1989 and 2000), Tom Bethell (1998), and Richard Pipes (1999). (2) The analysis of the institution of property forms the core of both schools. They maintain that property is the most important source of economic activity.

Although economic development is only one of the topics of their theoretical framework, both schools claim to answer Richard Easterlin's (1981) seminal question, "Why Isn't the Whole World Developed?" New institutional economics focuses on the traditional dichotomy of economics between private, or individual, and common, or state, property, both defined as the right to the physical use of resources, including the returns thereon, and the right to their exchange or alienation and that to their change. Challenging this dichotomy as being of secondary importance only, property economics differentiates between property, defined as the rights of burdening and encumbrance (or collateralization) and that of exchange (or alienation), rights that do not touch resources, and possession, defined as the only right to physically use resources and the returns thereon, including the right to change their form and substance. As a right, possession is bound to property. (3)

The term possession is unknown to economic scholars of past and present (see, however, Epstein 1998 discussed in the subsection on "The Fundamental Flaw in New Institutional Economics: The Missing Distinction between Possession and Property"), and burdening and encumbrance have never been discussed in their analyses of property--not even in the new institutional economics' theory of property rights.

The paper is organized as follows: the first section presents the fundamentals of property economics, and the second presents those of new institutional economics as alternative explanations of economic activity in the underdeveloped world, whereby institutional economics is analyzed from the viewpoint of the core of property economics--the distinction between property and possession. On the basis of the different approaches to economic development made by the two schools, the third section evaluates reform and development programs of multilateral institutions with a view to their suitability to trigger economic activity.

The Property Theory of the Economy, or Property Economics

Unlike new institutional economics, the school of property economics does not neglect the distinction between property and possession. It rather makes this distinction the basis of its theory, which intends to answer what Heinsohn and Steiger regard as economic theory's core question and, thereby, is fundamental in explaining business or economic activity: which is the loss that has to be compensated by interest? The property theory of the economy accepts neither a temporary loss of goods, as in neoclassical, nor a temporary loss of money, as in Keynesian economics, as being the cause of interest. When money is created in a credit contract, property economics holds, the loss causing interest is the loss of an immaterial yield which is called property premium. In the money-creating and the money-lending credit contract, property has to be burdened and encumbered. By burdening and encumbrance, the freedom of property is temporarily blocked, that is, the property premium is given up.

The Distinction between Possession and Property

A property premium automatically arises whenever property titles are added to possession titles to resources and goods. This is usually done by discontinuous, not incremental, change. It is a legal act, which makes the difference between mere possessional systems of production and a genuine economy in which agents' activities are always property driven. Correspondingly, the economy, not production as such, disappears when property is abolished. It goes without saying that this theoretical analysis is of utmost importance for the appropriate establishment of property reform programs in the third world and transitional countries.

According to Heinsohn and Steiger, mankind knows three idealized distinctive systems of material reproduction--that is, production, distribution, consumption, and accumulation--only one of which involves economic activities. It is important to note that the three systems are distinguished by their different socio-institutional structures: (i) the customary, or tribal, community regulated collectively by reciprocity and implying redistribution; (ii) the command, or feudal seigniority, regulated by coercive redistribution; and (iii) the property-based society regulated by interest and money in the form of collateral-based contracts and with no redistribution. (4) While the first two systems know of possession only, with common and individual rules of its not-free members--rules that cannot be enforced by independent law--the third system knows of property in addition to possession, with common and private rights of its free citizens that can be enforced by independent law. And while the possession-based systems--(i) and (ii)--only allow for the physical use of goods and resources, including the appropriation of the returns thereon and the change of their substance and form--goods and resources which cannot be alienated by sale and lease, the property-based system turns goods and resources into commodities and assets. Unlike mere goods and resources, commodities and assets cannot only be used physically, with the returns thereon appropriated and their substance and form changed, but they can also be sold and leased, burdened and encumbered (see overview in table 1).

With regard to economic development, the difference between the possession-based systems of material reproduction and the property-based system is a fundamental, not a gradual, one. While possession-based communities and seigniorities, like most of today's third world and transitional countries, may run undisturbed for very long periods of time, their lack of genuine property rights condemns them to a mere control of resources. In these territories, accumulation and, hence, economic development require previous savings, while the property-based society enables accumulation without such reduction in consumption by simply burdening and encumbering assets. Property economics verifies its analysis of the lack of property rights in possession-based systems by anthropological studies of tribal communities and economic-historical studies of command seigniorities in antiquity, the Middle Ages, and modern times, especially that of state socialism. Heinsohn and Steiger's approach also reveals why today no worthwhile economic activities take place in the underdeveloped parts of the world.

The Property Theory of Interest and Money, or the Core of Property Economics

Property economics aims to demonstrate the inability of traditional economic research to understand the institution of property and the problem of how to trigger economic activity. Although the eminent mercantilist James Steuart ([1767] 1993) had already developed fundamental insights into the importance of the property title of collateral for a genuine monetary economy, it took more than 200 years, until a few Keynesian economists, with Nobel laureates John Hicks (1981, 153) and Joseph E. Stiglitz (1981, with Andrew Weiss) as the most prominent ones, showed a renewed interest in collateral. However, until now and not unlike new institutional economists, they have failed to understand the essence of this title as a property title. (5)

With the distinction between possession and property in mind, Heinsohn and Steiger have formulated their property theory of the economy as the property theory of interest and money (see also overview in table 1). As each and every agent in this economy needs money, the authors started their approach with the system's bank of issue, today the central bank. As the prime creditor in the economy, this institution, sometimes even the state, has to set the standard necessary in all contracts, the money of account (6) to which the money proper--its banknotes--is related. In the money-creating credit contract, (7) with a commercial bank as its counterparty, the bank of issue has to obey two rules: (i) to secure its loans and, thereby, safeguard its reserves or "own capital" (8) by claiming collateral--a property title--from the commercial bank and (ii) to burden its own capital, again a property title, to withdraw notes in case of any debtor's default and, thereby, guarantee the circulation of the notes forwarded to its sound debtors (see more detailed Heinsohn and Steiger 2006c).

The second of the above rules implies that the bank of issue incurs a loss of property premium by burdening its capital, which is compensated by the rate of interest charged to the commercial bank. The first rule implies that the latter bank incurs a loss of property premium by...

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