The relationship between planning and the market from the perspective of property rights theory: A transaction cost analysis

Abstract

Current social and economic theory has yet to explain why, despite the many advantages of the market mechanism, planning is employed at all levels of market economy. Like other studies, this research proposes an explanation based on the form of property rights; however, it uses specific definitions of market, private planning and collective planning that establish unambiguous links between them and the structure of ownership. Thus, the article supports the position that the employment of planning or market mechanisms in economic and social activities depends solely on the structure of property rights. The contribution of this article is the formulation of two criteria for the allocation of property rights derived from Coase’s seminal works, termed in this text as Coase’s criterion of institutional optimisation and Coase’s market cost criterion. An important aspect of this proposal is the suggestion that Coase’s theory can be a powerful tool with which to study shared/common entitlements. It illuminates the nature and the mechanisms of private and collective planning and their relationship to the market. The article concludes that private planning may exist only if it is good enough to improve the efficiency of the market. Collective planning is indispensable when markets employ shared/collectively owned resources.

Keywords

collective planning market-planning relationship nomocracy private planning property rights

Introduction

After a century of fierce opposition in ideology and politics, the tension between planning and the market is still prevalent in social and economic theory. And still, many economists, mainly neoliberal and libertarian, consider planning as secondary to the market, useful only to remedy market failures, if at all (e.g. Block, 2014; Hoppe, 1989). However, other theorists acknowledge that a market economy is made up of agents who plan (Alexander, 2001; Kaza and Knaap, 2011; Lai, 2014). Some of them emphasise the need for planning relevant to the market mechanism and even do so by building on concepts generally employed by neoliberal and neo-institutional theories – for example, Moroni (2007, 2010) drawing on Hayek and Lai (2005, 2014) drawing on Coase. This research proposes another viewpoint from a similar perspective.

In this research, planning and the market are viewed as mechanisms that coordinate social activities. Planning is a purposeful activity – it is about defining goals and determining the methods to employ in order to achieve those goals (Hopkins, 2001; Kaza and Knaap, 2011). Thus, planning and management are so closely connected that the terms are often used interchangeably, although they are not one and the same. Management (which is synonymous with governance and organising) can be regarded as a continuous process of developing and implementing plans (Knaap et al., 1998; Slaev, 2016a); thus, planning is a phase or a cycle of management.

This article proposes an explanation of the relationship between planning and the market based on the structure of property rights. The market has traditionally been associated with private property rights and central planning with public and collective ownership. However, these connections have not been definitively clarified: collective and public property may also take part in market transactions, and all private companies do plan the use of their private resources. But because property rights determine the control over human activities (Alchian and Demsetz, 1972), they are essential not only for the functioning of the market but also for planning. There is little sense in planning if the planner does not own entitlements over the employed resources (Slaev, 2016a). Municipal/state planners are able to plan local development only insofar as the government is in control of public properties and has the right to manage private properties by imposing regulations, that is, to plan by edict (Lai et al., 2015). Hence, on behalf of the state, planners actually exercise certain (though limited) management rights, which are a specific form of property rights over private lands.

This article uses specific definitions of the forms/mechanisms of social coordination that establish unambiguous links between them and the structure of ownership. It makes a clear distinction between private and collective planning (Foldvary, 2005, 2014; Lai et al., 2015; Moroni, 2014b) and finds that the relationships of these two types of planning to the market differ essentially. Thus, the form of coordination (private planning, collective planning, the market or a mixture of the three) is strictly predetermined by the particular structure (bundle) of property rights in any given situation. Finally, this article asserts that the structure of property rights is ultimately determined by two criteria, both derived from Coase’s seminal works.

The article employs the property rights approach to show that it is instrumental not only to define the differences between planning and the market but also to identify what they have in common. Neither of these two basic forms of social interaction is primary or subsidiary – they are equally important parts of the unitary process of exercising property rights. In fact, planning and the market are so complementary that markets cannot function without planning. Thus, the ‘market-planning’ dichotomy is incorrect in many respects (Lai, 2014).

The contribution of this article is that it proposes two criteria for the allocation of property rights, criteria that are derived from the works of Coase (1937, 1960). A key aspect of this contribution is the suggestion that Coase’s theory is relevant to the analysis of shared/collective/common property rights. To date, Coase’s theory has not been sufficiently employed for this purpose. Buchanan and Tullock (1962), in their seminal work The Calculus of Consent, refer to Coase only twice. Elinor Ostrom (1990), in Governing the Commons, does not even mention ‘The Problem of Social Cost’. But as this article observes, when the shared/collective entitlements option is explicitly outlined using what I term Coase’s criterion of institutional optimisation, the Coasian approach proves to be a powerful tool with which to study collective entitlements and actions.

Analytical framework

The article proceeds as follows. The first section defines types of planning and the market in light of property rights theory. This in turn requires a relevant classification of property rights. Drawing on the concept of incomplete property rights (Barzel, 1997), in this analysis, I employ three categories of entitlements: (1) exclusive (private), (2) partial (shared/collective) or (3) missing. When we distinguish between private and collective planning (which are, in fact, essentially different), it follows that to manage individual/private resources, markets and private planning are employed; to manage common (shared, collective) resources, collective planning is employed before the markets operate. Thus, the structure of established property rights is the sole determinant of whether markets or planning will be employed to manage a social activity.

In light of this conclusion, the second section of the article analyses in some detail the mechanism of allocating property rights in social interactions and finds that it is based on two criteria, both derived from Coase’s theory. First, Coase’s criterion of institutional optimisation defines whether exclusive/private property rights, shared/collective property rights or no entitlements will be established over a resource. Second, Coase’s market cost criterion defines whether all entitlements will be acquired by one entity (e.g. a firm) and private planning will operate or whether private entitlements will remain scattered among many private owners and the market will operate.

The article then examines whether and under what conditions planning can be beneficial to the market and explores the nature of the benefits and whether they are critically needed for the functioning of markets. To assess the effects of planning, I analyse the changes in quantities of sales. More sales indicate better functioning of the market; hence, when planning contributes to an increase in sales, it is beneficial to the market. Other market measurements could serve the same purpose, such as market expansion, growth or enlargement. Planning can also benefit the market in other important ways, for example, product diversification, quality improvement and innovation (Lai and Lorne, 2014, 2015). However, this study focuses on the quantity of sales because their increase, ceteris paribus, is easily measurable and provides sufficient evidence.

Defining the market and planning as ways of coordinating social activities with respect to property rights

Types of property rights

If we are to define planning and the market based on the forms of ownership, first we must classify these forms. The distinction between private and public ownership is most frequently employed; however, as Buchanan (1965) points out (pp. 1–2), there is a ‘whole spectrum of ownership-consumption possibilities, ranging from purely private … to purely public’ property rights, and ‘[w]hile it is evident that some goods and services may be reasonably classified as purely private … it is clear that few, if any, goods satisfy the condition of extreme collectiveness’. In other words, most goods contain different ‘degree[s] of “publicness”’ (p. 7). Therefore, distinguishing between individual/private and common entitlements (with different degrees of publicness) could be the better approach to property rights analysis.

To get a better understanding of Buchanan’s view, it is useful to consider the increasingly accepted notion that property rights are never complete (e.g. Allen, 2000; Lueck and Miceli, 2007). Barzel (1997) states that ‘property rights are not absolute’ (p. 4) and ‘are never perfectly delineated’ (p. 90) because perfect delineation is prohibitively costly (Coase, 1960). Drawing on Barzel’s statement, I employ the term ‘exclusive’. Exclusive rights entitle their owner to individual disposition of a good or resource or (some of) its attributes. More precisely, in many cases, the owner is still obliged to comply with others (e.g. by respecting nuisance law), but in most situations, she is able to manage her property solely through her individual decisions (e.g. by selling the property). The key feature of private property is that it is exclusive, which means that the owner of a good or a resource and her entitlements are strictly defined. However, when property rights are incomplete, there are different levels of entitlements. Hence, common entitlements can be explained by the assumption that below a certain level or a threshold, the individual can no longer manage the property on her own; rather, a number of owners manage it together and each owner holds partial property rights. In such a case, the property of an entity (e.g. a stock company), when seen ‘from above’ or ‘from outside’, is privately owned by this entity – but considered ‘from below’ or ‘inside’, it is common to the co-owners. This is obviously true for properties of clubs, collective and stock companies, associations and communities. Buchanan (1965: 13) explains that delineating club property means exclusion (of those ‘outside’ the club) as well as inclusion (of those ‘inside’). Similarly, even the term public property may have a double meaning. The road network of a country is designed to serve the country’s citizens and businesses. These citizens and businesses pay taxes to finance the development of the road network, and by voting they can influence this development. So they are co-owners of this network. Foreigner visitors do not pay taxes to this country; they can neither contribute to nor influence the development of the road network. They use the road network only as guests, not as owners. In this sense, just as the property of a collective company is private to the firm and common to its co-owners, public property (e.g. the road network and national defence) is private to the state (i.e. exclusive to foreigners) and common to the state’s citizens.

This is not to say that the term public property is meaningless; rather, this article emphasises the complexity and relativeness of property rights in real-world situations. Economics textbooks (e.g. Ahlersten, 2008; Reynolds, 2011) define public goods as non-excludable, that is, one may not exclude other people from the use or consumption of the public good; they are also non-rivalrous, that is, consumption of the public good by one individual does not decrease the consumption of others. Textbooks usually cite as examples education, infrastructure, fresh air and biodiversity. But for many public goods, the ‘non-rivalry’ feature can be challenged (Foldvary, 2014; Moroni, 2014b). Road networks can be congested, and educational institutions can become overcrowded. Fresh air and biodiversity may be threatened by depletion. Non-excludability is a much stronger and more definite feature of public goods, as discussed in the next paragraph. Clearly, common property is non-excludable to all co-owners – partners, shareholders, family members, members of communities/societies. The excludability/non-excludability feature is directly linked to the optimisation of the entitlements requirement in Coase’s theory.

Actually, in every real-world situation, there is a clear criterion to distinguish between the types of property: the relationship between a person or an entity and the object of property rights. There are three possible relationships. First, if the individual/entity has exclusive property rights, then the object is the individual or private property of this person/entity. Second, when a number of individuals and/or entities own a good or a resource together, then each one of them has partial property rights. Finally, a person/entity may have no entitlement; if no person or entity has any entitlement over a good or a resource, then it is nobody’s.

Public property is often confused with missing entitlements even by outstanding authors, such as Demsetz (1967: 354). The difference is easy to illustrate. For example, consider mineral resources, on one hand, and forest fruits or ocean fish, on the other hand. All these are usually considered public property, but over the former strict property rights of the state are established, whereas over the latter virtually no property rights are defined. Von Ciriacy-Wantrup and Bishop (1975) were probably the first to make this distinction.

Therefore, this article uses the terms individual property and common property. It also uses private as synonymous with individual, when the individual property of an entity (a firm, a club or a community) is considered, and joint/collective/shared as synonymous with common. This taxonomy is not essentially different from that of Demsetz (1967) and Alchian and Demsetz (1973), who all distinguish between private, communal and state/public ownership, or from the classification of Buchanan (1965) outlined above. The merit of the classification proposed in this article is that it draws a direct connection to Coase’s theory and one of its key concepts – the assumption of institutional optimisation, defined in this article as Coase’s institutional optimisation criterion.

Definitions of planning and the market based on the concept of property rights

Since the classics of economics theory, private property has been seen as the basis for market relations. Indeed, to take part in a market transaction (to sell a good), a person (or a club) should have exclusive property rights over the good exchanged.

In contrast, public property has been seen as the province of planning. Marx (1990 [1867]) developed his theory that public ownership is the basis of the classless society where all social activities are organised by planning. But in fact, private or partial property rights are the basis of planning, too. As I have already stressed, there is no sense in planning the use of resources if the planning authority has no entitlement over these resources. Any individual or entity plans an activity only insofar as he or it owns property rights over the resources employed in the activity. That is why the state in Marx’s theory has to expropriate all industrial properties – in order to be able to manage and plan industrial development as the sole (private) owner of all industries.

In fact, there are two essentially different types of planning, depending on whether the planner is the exclusive owner of the resources necessary for the planned activity and can independently manage them or whether she as a co-owner has only partial property rights and can manage the resources only within her partial entitlements. The first type is individual/private planning, and the second type is collective (joint/group/social) planning, in which resources are managed collectively (in co-ownership) by two or more individuals/entities. Clearly, for two or more individuals/entities to plan, they must first allocate management and other property rights among themselves (Slaev, 2016b). That is why such planning is based on rules and regulations (Moroni, 2015).

The theory of nomocracy (Hayek, 1973, 1976; Moroni, 2007, 2010) provides the best explanation of the differences between individual and collective planning. The approach of individual/private planning is what Hayek called teleocratic: it is strictly rational and based on direct provisions. If a person or an entity owns all resources for an activity, she or it can plan in detail. Principally, the more detailed, the better the teleocratic plan is. In contrast, the approach that should be employed by collective planning is nomocratic. Such planning uses no direct provisions because a number of individuals would hardly pursue identical goals, but no one has exclusive property rights, so no one can take decisions on their own. Hence, nomocratic planning does not define specific ends, but only principles and rules that allocate rights of management and rights of use. Regulation in this case is a more appropriate term than planning (Slaev, 2016a). Still, concerning resources that are under the exclusive control of the central body of the community, nomocratic planning employs the stricter rational approach (e.g. strictly planning the road and utility networks). As Lai and Lorne (2015) put it, ‘[s]tate planning is broadly defined as the state making and enforcing the rules for transactions [i.e., nomocratic management] and investment in the resource market’ (p. 45), that is, teleocratic planning and management of the development of infrastructure (see also Holcombe, 2013; Moroni, 2014a).

Hence, individual/private property is the basis of the market and individual planning, whereas common property is the basis of collective planning. For the purpose of this research, I employ the definitions proposed in a recent article (Slaev, 2016b), in slightly modified form:

Individual (private) planning is the coordination of human/social activities when one person or entity owns exclusive property rights over all resources involved in those activities. As the sole owner of the resources, this person/entity can plan in maximum detail; thus, teleocratic (strictly rational) planning is the essence of this method.

The market is the coordination of social activities when individuals or individual entities own exclusive property rights over some resources needed for the activities but no one owns all resources. In this case, the execution of the activities requires exchange of resources.

Collective (group, social) planning is the coordination of social activities when two or more persons/entities co-own the resources needed for these activities. This type of planning employs the nomocratic method. The first and main purpose of nomocracy is to allocate property rights between the co-owners (Slaev, 2012, 2016b), so it is based on regulation – it employs rules, rather than direct provisions (Moroni, 2010). In addition to regulation, however, collective (nomocratic) planning also employs the rational (teleocratic) planning method (Moroni, 2010) to manage the resources placed under the exclusive control of the central body (i.e. common/public resources).

Allocation of social activities among the three forms of coordination

According to the definitions in the previous section, the established property rights over the resources are the key factor in allocating social activities among the market and the two types of planning. To put it definitively, whether the activities will be arranged through the market or through any type of planning depends solely on this factor – the established structure of property rights. This is indeed so; however, it doesn’t mean that the question ‘planning or market?’ is meaningless. There is a feedback connection, and entitlements are often established in a particular configuration because that configuration is the most efficient mechanism of social interaction in the given situation. However, within an already established structure of property rights, there is no room for variation, and that structure strictly defines the employment of relevant forms of market or planning or their combination. Hence, the fundamental question is what property rights will be established over the resources. The answer to this question depends on two criteria, both derived from Coase’s works.

Private or collective property rights – Coase’s criterion of institutional optimisation

The first of the two criteria is the one defined in ‘The Problem of Social Cost’ (Coase, 1960: 15–16). It states that ‘a rearrangement of [property] rights will only be undertaken when the increase in the value of production consequent upon the rearrangement is greater than the costs which would be involved in bringing it about’. This means that an institutional change (establishment or rearrangement of property rights) will only happen when the value of the outcome of the change (net of associated costs) exceeds the value of the input. In fact, this criterion is an implication of the ‘corollary of the Coase Theorem’ (Lai and Lorne, 2015), in conjunction with the hypothesis of rationality as explained by Cheung (1998).

However, in his article, Coase did not need to analyse the role of shared/common entitlements because his goal was to prove that market solutions to externalities, based on well-defined property rights, are principally superior to Pigovian solutions (i.e. solutions based on central management and state interventions). The fact that market solutions generally require private property rights seems to mislead many researchers, who consider private entitlements as the only possible option and miss the collective entitlements option. For example, in ‘Toward a theory of property rights’ (1967), Demsetz overlooked the difference between collective and missing property rights (but later studied collective entitlements with Alchian, 1972). In fact, as this article will show, the establishment of partial/collective entitlements is very often the most efficient option. Therefore, both private and shared entitlements should be explicitly identified in this criterion, which should be formulated as follows:

At any phase of development, one of the three types of property rights will be established over any resource depending on the balance between the final benefits and the associated costs: (1) individual/private, (2) shared/common or (3) no entitlements (i.e. no one has property rights). Hereafter, I term this Coase’s criterion of institutional optimisation (or Coase’s institutional optimisation criterion).

To be used efficiently, different resources require different forms of ownership – individual/private or shared/common. At least two factors determine the efficacy of the established entitlements, namely:

The efficiency of managing property rights;

The total costs of production, transaction and organising incurred under the specific form of property.

Concerning the first factor, private property rights are managed (either by the market or by individual planning) much more efficiently than common entitlements. Numerous studies have explained the market’s productive, allocative, technical and other types of efficiency (e.g. Caves and Associates, 1992; Leibenstein, 1966; Markovits, 2008). Besides, market efficiency is realised automatically. As the following paragraphs explain, private planning is not less efficient; rather, it is more efficient than the market – otherwise it will not be employed. Private entities employing inefficient planning will simply go bankrupt.

In contrast, the efficient management of common property rights through collective planning is not automatically achieved but is actually a major challenge. It often fails because it requires agreement between co-owners of entitlements, which is, as a rule, difficult to achieve. The larger the number of co-owners is, the greater the problems of collective management (Buchanan and Tullock, 1962). Problems emerge even when only two or three individuals share property rights because the principle of individual responsibility is lost and each co-owner may incur losses or benefit undeservedly from the actions of the other – the shirking behaviour (i.e. the behaviour of a person who shirks in a collective action and free-rides on the efforts of his partners) observed by Alchian and Demsetz (1972). Even bigger issues arise when a group is large enough to need central management. Then, as Demsetz (1967) points out, ‘a small management group becomes de facto owners’ (p. 355). Delegation of entitlements occurs from the ‘regular’ members of the large group to the small management group, and thus, entitlements are more or less perverted.

An impressive body of literature – starting with studies like those of D. Black and K. J. Arrow – deals with the problems of collective governance and public choice. In their seminal work, Buchanan and Tullock (1962) examine decision-making in collective structures with different voting systems and find that the unanimity rule incurs particularly high decision-making costs, so it is largely unworkable in practice, whereas the majority rule is associated with lower decision-making costs but larger external costs. Buchanan and Tullock thus explain major drawbacks of collective governance, for example, why it is often inefficient and why representative individuals tend to maximise their own utility instead of pursuing the public interest. Other studies on decision-making and management issues in collective structures, such as joint ventures and public companies, fall in the area of agency theory (Jensen and Meckling, 1976; Mitnick, 1975; Ross, 1973). Inherent issues of collective governance also refer to corruption and misuse of coercive powers, as well as to overuse/depletion of natural resources (Demsetz, 1967; Hardin, 1968). Hence, the first outlined factor – the efficiency of management – is much more favourable for individual property rights than for common ones. That is why privatising commonly owned resources is usually the best approach to overcome the failures of collective management and planning, that is, by internalising externalities whenever collective entitlements can be transformed or replaced by individual ownership (MacCallum, 1970). Nevertheless, numerous resources employed in any social activity are in common ownership. Why?

In light of Coase’s institutional optimisation criterion, the answer is obvious. It relates to the magnitude of the second of the outlined factors – the total production, transaction and organising costs incurred under the specific form of property. Property rights will be established only insofar as they are beneficial net of associated costs; however, this criterion must be considered concerning partial as well as exclusive entitlements. The point is that by using partial entitlements (i.e. common property rights), individuals and entities economise on the costs of production, transaction and organising. There are countless examples of such economies. Consider collective and stock companies, manufacturing and agricultural cooperatives – they all economise on costs of supplies, consumables, organising or services. A major reason is to decrease investment costs by sharing equipment, land, buildings and other premises. Public forms of transport are another obvious example. Condominium homeowners economise on the cost of land and floor space. The same goes for police services, educational institutions and healthcare systems. Individual users can rarely afford expensive private police for personal protection; even very well-off families can rarely afford individual teachers for their children. There are also other reasons that seem to have little relevance to savings, for example, when individual consumption is considered impossible. Examples include air in a neighbourhood, family ownership, heritage or goods that by nature cannot be used individually. But again, Coase’s criterion of institutional optimisation is the key factor. If establishing individual entitlements were perceived as beneficial in a family, spouses would pay for legal services for a matrimonial contract; if it were perceived as worthwhile to breathe individual air, enormously high glass walls and roofs could be built to separate the air over one’s plot from that of the neighbours. Common/shared property rights save costs and are thus pervasive in economy and social life.

At this point, the political aspect of Coase’s institutional optimisation criterion must be emphasised. While this criterion is primarily about efficiency, Coase’s theory is the basis of institutional/neo-institutional economics; thus, efficiency is embodied in institutions (Webster and Lai, 2003). Institutions determine the value of transaction costs and the costs of organising and decision-making. In a society, political institutions occupy the highest tier of the social order; therefore, their relevance or irrelevance to the stage of development is a major and crucial factor boosting or hampering economic efficiency.

To summarise, collective planning (as the form of social coordination relevant to collective/common property rights) can be either beneficial or detrimental to the market. Too often it is detrimental because central management tends to pervert the objectives defined by those who have delegated their property rights to the managing body. This happens for reasons associated with public choice, agency management, ignorance or corruption. Alternatively, collective planning can be beneficial to the market because it helps people economise by using common resources. Thus, Coase’s criterion of institutional optimisation refers to the balance between the benefits and losses. Finally, either individual/private, or common, or no property rights will be established over a resource depending on the increase in value net of associated costs.

One or many owners of private property rights – Coase’s market cost criterion

Management is much more efficient and streamlined when resources are owned privately by individuals and entities (Holcombe, 2013). To realise social activities when different owners possess different resources privately, they have to exchange them, and thus, the market is the normal form of economic and social activities. But as Coase (1937) finds in The Nature of the Firm, for the production of various goods, the internal organisation of a firm (the visible hand of the firm’s management) can be more efficient than the invisible hand of the market. Coase states that to surpass the price mechanism, ‘the entrepreneur has to carry out his function at less cost’ of organising than the cost of ‘the operation of the market’ (p. 392). Clearly, if this requirement is not met, the firm will cease to exist. Therefore, implicit in this requirement is the criterion of whether the costs of organising incurred by a firm are lower than the market transaction costs. In this article, I term this Coase’s market cost criterion. In fact, this criterion is the well-known core of Coase’s (1937) theory of the firm. In the field of planning, the implications of this theory have been explored by Lai (1997) and Webster and Lai (2003). However, by defining it as a criterion, I stress the specific pattern of property rights behind Coase’s theory of the firm: to produce a good individually/privately without employing the market mechanism, the firm must be the sole owner of all resources engaged in the production process. As Coase (1937) puts it, a

factor of production (or the owner thereof) [emphasis added] does not have to make a series of contracts with the factors with whom he is co-operating within the firm, as would be necessary, of course, if this co-operation were as a direct result of the working of the price mechanism. (p. 391)

Furthermore, it is reasonable to consider this criterion a specific form or case of the institutional optimisation criterion. However, this second criterion should be distinguished and emphasised because it is this criterion that defines whether planning or the market mechanism will coordinate the production of a good – the criterion of institutional optimisation alone does not necessarily predetermine which of the two mechanisms will operate. When private property rights are established, it is Coase’s market cost criterion that ultimately defines whether private entitlements will be possessed by a number of owners and a good (or service) will be provided by the market mechanism or whether one of the owners (the most efficient in organising the production) will buy off all resources and produce the good (or provide the service) privately through private planning.

To evaluate the impact of this type of planning on the market, I underline the fact that, because all resources are owned privately, all changes in the entitlements are realised through voluntary market transactions. Hence, private planning may work only by cooperating with the market and may not be detrimental to the latter.

To summarise, in the first section of this article, I have shown that property rights are the basis for defining the three ways of coordinating social activities: the market, private planning and collective planning. In the second section, I have shown that which one of the three mechanisms will be used for a given social activity depends solely on the established property rights over the resources. But then the question arises of what property rights should or will be established over resources. To answer this question, I suggest that the establishment of property rights is based on two criteria, both derived from Coase. First, the institutional optimisation criterion determines whether exclusive/private, partial/common or no property rights will be established over a resource. Second, the market cost criterion determines whether the individual/private entitlements over all resources employed in a social activity will be concentrated in one individual or entity or, alternatively, whether private entitlements will remain scattered among a number of owners.

How planning benefits the market

When planning and markets are viewed through the lens of property rights analysis based on Coase’s two criteria, markets and planning are complementary mechanisms that need each other. This article focuses on the question of whether proper planning is beneficial to the market; it does not investigate the relationship in the opposite direction. Whether the market is beneficial to planning should be analysed in other research.

To investigate the relationship between planning and the market, I examine the impact of planning on the quantities of sales. If sales quantities increase as a result of employing planning, then, ceteris paribus, such planning is beneficial to the market. Moreover, in some cases, planning creates a new market or protects an existing market from extinction. As explained in the next paragraph, the ceteris paribus assumption includes the conditions that the production costs and the quality of the goods/services do not change. Thus, the eventual changes are due only to the employment of planning and may not cause loss to the seller(s); rather, they are beneficial both to seller(s) and buyer(s).

The analysis developed in the following paragraphs is in some respects similar to the one undertaken by Lai and Lorne (2015). The difference is that their analysis focuses on the positive impact of state rules that expand markets through the reduction of transaction costs or shifts in supply (pp. 49–54). The state legitimately acts ‘as an umpire of various forms of competition in a polity’, for example, by using interventions like price fixing ‘whenever two or more dimensions of competition are in conflict’ or by ‘enabling Schumpeterian innovation through granting intellectual property rights’. (Schumpeterian innovation is considered the core of technological change that drives economic progress.) In contrast, the analysis in this section focuses on the distinctive impacts of private and collective planning on the market.

The benefits of private planning are generally easier to observe. Figure 1 is a simple illustration of Coase’s market cost criterion, as explained in The Nature of the Firm. According to Coase (1937), producing a good by the price mechanism incurs production and market transaction costs, whereas the production of the same good by a firm incurs the same production costs as well as the costs of organising. Therefore, ceteris paribus, the only difference is whether market transaction costs or organising costs should be added to the costs of production. The former are presented by the market supply curve S_m (as the sum of production and transaction costs) and the latter by S_f (production costs plus costs of organising). However, only firms whose costs of organising (i.e. private management) are lower than the market transaction costs will survive, so this is the case depicted by Figure 1. But then the sales quantities (q_f) are bigger than they would be if the good were produced by the price mechanism (q_m). Hence, the increased sales quantities indicate that such planning is beneficial to the market.

Figure 1.

Changes in sales quantities due to private planning.

The diagram in Figure 1 illustrates countless real-world situations. Many goods are produced and many services are provided by the always-efficient price mechanism, but successful companies, by virtue of their private management/planning, are able to reduce costs further and thus enlarge existing markets. Furthermore, by creating popular new products, these companies create new markets.

Unlike individual/private planning, collective planning is definitely less efficient than the market. Nevertheless, collective planning is beneficial to the market because of its critical role in providing commonly owned resources. Common resources cannot be employed by markets or may not be employed efficiently unless they are managed by collective planning. For common resources to enter a market transaction, all legitimate co-owners must consent; this is achieved only through central management and, necessarily, through collective/central planning (Slaev, 2016b). Alternatively, negative externalities arise and market failures occur.

To analyse the benefits of collective ownership (which are related to Coase’s institutional optimisation criterion), consider a condominium with a number of owners. Despite pervasive preferences for single-family housing, many people choose to live in central areas because they benefit from better access to various jobs and services. In London as in any big city, the price of land in many central areas is many times higher than in suburban areas (e.g. www.primelocation.com, www.uklanddirectory.org.uk). To economise on the cost of land, some residents share it and live in condominiums, but that requires collective management and planning. Choosing a condominium means that the savings on expensive land are greater than the value of the drawbacks of collective management. To examine these economies, compare the costs of an apartment to those of a detached house. Generally, the costs of a housing unit comprise (1) the cost of land, (2) the construction costs and (3) other costs such as development fees, organising costs, profit and other entrepreneurial resources. Assume that to build a detached house in a suburb of London, a person would need to buy a lot of at least 400 m². The price for such a small suburban lot could well be £240,000 (£600 per m²), while for an urban lot £1,600,000 (£4000 per m²) would be a reasonable value. If we assume a construction cost of £1060 per m² and 25% other costs, a 200 m² suburban house with the lot will cost £565,000, whereas in an urban location it would cost £2,265,000. Clearly, the market for such detached houses in urban locations would be very limited if there were any such market at all. In the city, therefore, many individuals will share the price of land and buy apartments in a condominium. In this example, an apartment in an eight-unit building would cost £515,000 (one-eighth the price of the lot plus £212,000 for construction and 25% other costs), which is an acceptable price. Thus, a market is created.

In a condominium, in addition to the land, several other common resources generate economies – for example, the staircase. But this requires common management that generates nuisance, and rules are needed to mitigate it. If an individual is not willing to tolerate nuisance and abide by rules, she will have to construct her own staircase. For an apartment at the fourth floor, the total floor space of the staircase would be, say, 100 m² (25 m² per floor). Therefore, this owner will have to pay £132,500 extra for the construction of an individual staircase (25% other costs included). The situation is thus similar to the problem with the land discussed above. The relationship is analysed in Figure 2, where MC represents the construction cost and S_ind is the supply curve for apartments with individual staircases. Because the demand curve D in this case does not intersect the supply curve S_ind, no market exists. Thus, not establishing common property rights is detrimental to the market. Only when the cost for the construction of the staircase (or, similarly, the cost of land) is shared among all owners, as depicted by S_comm, are sales realised (q₀) and a market is created.

Figure 2.

Changes in sales quantities due to collective planning.

Another example involves a producer of vegetables. The producer buys from the market any resources he needs, including land (purchased or hired). However, since von Thünen, we have known that the price of land varies not only due to its productivity but also due to its distance from the central market. But actually, this distance is determined by the road network. In fact, not all resources are acquired privately by this producer – he also uses public resources such as the road network, sunlight and air. The road network plays a major role in determining the transport costs and price of land. This network is a public good – that is, no local resident or business can be excluded from its usage, and the government is in charge of its development and use. Thus, the development and the use of infrastructure are determined by central governance, planning and regulation. These relations, too, refer to the diagram in Figure 2 because the role of the roads in relation to the adjacent properties is very similar to the role of the staircase in relation to the apartments it serves. In this example, MC presents the sum of the costs of production and transport of the goods, and S_ind presents the cost of constructing a private road. The value of the road is too high and S_ind does not intersect the demand curve, which means that there will be no private road and the producer can neither buy the resources needed nor sell the production. A market can exist only if public roads are provided, but they, like any other collective good, can be provided only by collective planning. Infrastructure is probably the most obvious example that, for a market to exist, public goods are needed and central planning ‘cannot be eradicated’ (Lai, 2014).

In a situation similar to that of the producer of vegetables, problems of entitlements over sunlight present a further example of the relationship between collective planning and the market. Such a problem is discussed by Holcombe (2013), who analyses the positive connection between the two when planning builds on the spontaneous order created by the market and the negative relationship when planning tries to ‘override’ the market. Holcombe argues that zoning regulations exemplify the negative relationship because they restrict the rights of private owners and thus override the market. Holcombe refers to the case of New York City, which in 1916 introduced zoning in response to the erection of ‘the high-rise Equitable Building that towered over its neighbors, blocking their sunlight’ (p. 200). Basing his argument on Coase (1960), Holcombe proposes that the problems with sunlight should be solved by achieving optimal allocation of entitlements through market transactions. One might object, however, that sunlight may not be traded directly because it is common property (Slaev, 2016b). Each co-owner of sunlight (each neighbour in the neighbourhood) would value it differently, so without coordination among co-owners of sunlight, its price is unknown. What’s more, the sale of sunlight by one neighbour would inflict a negative externality on the other neighbours, which also qualifies as a market failure. To realise a proper market transaction (i.e. to establish a relevant price, sell sunlight and share the revenue), co-owners may found a collective firm. However, founding collective firms for every such reason would be too costly. Instead, imposing zoning regulations would incur acceptable costs for establishing property rights to make the sunlight resource tradable. In this case, according to Coase’s criterion of institutional optimisation, establishing common entitlements is the most efficient option, and zoning is ‘a superior solution to bargaining’ (Lai et al., 2015; on zoning, see also Lai, 2014). It solves the externality issues and avoids market failure; hence, it is beneficial to the market.

Still, in certain respects, Holcombe and the libertarian theorists are correct. Like all other tools and forms of collective planning, zoning may have not only positive but also (and all too often) negative impacts on the market. The key factor is whether regulations are used to protect the property rights of the neighbours (i.e. by implementing nuisance law) or only to limit the rights of the concerned owners by satisfying ‘professional’ views or serving the sometimes perverted interests of central management. Indeed, any regulation limits the property rights of certain private owners. Applying Coase’s institutional optimisation criterion yields the following conclusion concerning the usefulness and performance of zoning or any form of regulation: if the increase in the value of entitlements of the third parties concerned (e.g. the neighbours), net of associated costs, is bigger than the loss in the value of the entitlements of those whose property rights are limited, then such regulations are beneficial to both society and the market.

Probably, the most widespread justification of planning in economics theory concerns externalities. Resource depletion is a classic example of an externality. When a resource is depleted, the market shrinks and ultimately goes extinct. Here, the point is to examine the role of property rights in the depletion of natural resources, as well as the role of planning and the market. ‘The Problem of Social Cost’ demonstrates the inextricable connection between externalities and property rights. Coase’s point is that the definition of entitlements allows the market to operate, which provides for the efficient allocation of property rights (p. 40); thus, problems of externalities will be solved.

Today, largely as a result of Coase’s theory, there seems to be a general consensus in the scientific literature that property rights are directly related to issues of externalities and, in particular, to problems of depletion of natural resources. This concept has become the basis for many national and international policies aimed at establishing entitlements over resources, such as the cap-and-trade initiatives of the US Environmental Protection Agency, the Emission Trading Schemes of the European Union (EU) and others. However, there is no consensus concerning the precise role of private and public property rights. Many authors, for example, Demsetz (1967) and Block (2014), believe that public property rights create the problem. In contrast, many other researchers argue that private property rights are not the only or the best means of addressing the overharvesting of natural resources (Ostrom, 1990; Runge, 1981). Still, there is general agreement that the absence of any entitlements or regulations is a key factor in the high rates of depletion of open resources (Bullock and Collier, 2011; Hauge et al., 2009; Lai et al., 2015).

If the only two options are established property rights or no property rights, then the absence of entitlements is the negative solution and private property rights are the positive one. But if we consider partial/shared property rights as a third alternative, we find that they are very often the most viable option. As this article has shown, partial/shared entitlements are established by imposing rules/regulations. Therefore, like the direct establishment of entitlements, imposing rules/regulations also helps to avoid the absence of property rights. This explains why many researchers consider regulation a relevant tool with which to address externalities and protect resources from depletion. But rules and regulations are the proper tools of collective governance and nomocratic planning (Moroni, 2010, 2015). Therefore, in such situations, collective governance and nomocratic planning are beneficial to the market because, by establishing property rights, they protect resources from depletion and the market from extinction.

Still another important factor suggests the importance of central management when natural resources are concerned. Natural resources differ from one’s labour, for instance, in that one’s labour is under one’s own ownership by origin, whereas natural resources are no one’s property by origin. That is why communities tend to retain control over particularly scarce or valuable resources – for instance, insufficient food in primitive societies or mineral resources in modern societies. The same is true of natural resources threatened by depletion (Collier and Scott, 2009; Ostrom, 1990). To manage such resources, governments employ central planning and regulation and thus determine the scope and mechanisms of the market. As evident in the examples of cap-and-trade schemes mentioned above, natural resource markets are defined and regulated by national governments and international agencies – for example, the European Environmental Agency, the US Environmental Protection Agency and the Clean Development Mechanism Executive Board of the United Nations (UN) Framework Convention on Climate Change. The main instrument used by central planning to create and manage markets of natural resources is the allocation of property rights through the establishment of rules and regulations (Lai, 1993; Lai et al., 2015).

Based on the above discussion, Figure 3 analyses the impact of planning in situations where the market process employs natural resources that are subject to accelerated depletion. Because accelerated depletion necessarily involves resources with no entitlements, applying Coase to this classical example of an externality means establishing property rights over those resources. A relevant example is a company fishing herring in the North Sea – a resource that is severely overharvested (Hauge et al., 2009). This is happening due to inadequate international and national regulations, which, as this article has emphasised, means poorly established property rights. The fishing company therefore employs two kinds of resources: those with well-established entitlements, for example, boats and labour, and those with poorly established entitlements, for example, the herring stock.

Figure 3.

Market extinction due to missing property rights.

Figure 3 is similar to the popular diagram illustrating the loss of social welfare in cases of negative externalities (Ahlersten, 2008; Reynolds, 2011), that is, when the social costs are higher than the private costs. However, two differences should be emphasised. First, in Figure 3, MC_p is the curve of the cost of the resources used by the fishing company with established property rights, and MC_n is the curve of the cost of all resources - both with established and with no entitlements. To clarify the difference, usually the former indicates the private costs and the latter indicates the social costs. The actual level of production is determined by the intersection of the demand curve and the curve of the cost of resources with established property rights. The value of resources with no entitlements is not accounted for because producers capture such resources (e.g. herring stock) for free. Thus, the loss of social welfare is depicted by the hatched area (1) between the demand curve, the curve of the costs of resources with no entitlements and the vertical line at the level of production – q_p.

A second difference between Figure 3 and the popular diagram is the shape of MC_n. Assume that q_d is the threshold rate of consumption, which equals the rate of regeneration of the resources – in this example, the herring stock. Up to this threshold, the rate of consumption of the resources with no entitlements is lower than the rate of their regeneration, but above this level consumption causes depletion of the herring resources. Then, the form of MC_n is changed. For quantities above q_d, the herring stock becomes scarcer and the actual worth of the marginal quantities grows steeply – curve MC^*_n. However, this growing value of the open-source resource does not influence the market equilibrium. Thus, the social welfare loss is increased by the surface of area (2). If the quantities consumed continue to grow, the loss grows even faster until consumption reaches the rate when the resources are fully depleted – q_e. Hence, the lack of property rights will ultimately result in market extinction. Markets on their own are not able to define and establish property rights over natural resources, so this should be the role of government realised through central governance, planning and regulation (see Milton Friedman (1962) on the role of government in solving externality issues).

To summarise, significant issues with property rights emerge when markets employ natural resources. The key problem is that because these resources are ‘produced’ by nature, initial entitlements over them are absent. For such resources, especially if they are of great value, stable entitlements can be established only by social consent – that is, consent among all individual members and groups of the community who claim interests in the matter. Markets can be most efficient in reallocating entitlements (Coase, 1960), but they can operate only after the initial establishment of property rights, as markets are based on exchange and exchange requires already established entitlements. It is the role of central management to arrange the initial allocation of property rights based on social consent. For this purpose, central management employs collective planning. Hence, to use natural resources, markets need central management and planning. When planning is unsuccessful, its failures cause depletion of natural resources and market extinction.

Conclusion

This article has explored the relationship between planning and the market by employing property rights analysis. Drawing extensively on Coase, it has suggested that Coase’s theory can be a powerful vehicle for analysing incomplete entitlements and shared/common property rights. The structure of entitlements over the resources employed in an activity determines which form of social coordination will be used in this activity – the market, individual planning, collective planning or some mixture of the three. Hence, the primary problem is not ‘planning versus the market’ but rather the concrete structure (the bundle) of property rights. In turn, the structure of property rights is determined by two criteria, both developed in Coase’s (1937, 1960) theory. The criterion of institutional optimisation determines whether exclusive (private), partial (common) or no property rights will be established over a resource. Which of these three forms of ownership will be instituted depends on the increase in the value of entitlements net of associated (production, transaction, organising) costs. The market cost criterion determines whether private property rights over all resources needed for an activity will be possessed by a single owner and the activity will be realised through private planning, or resources will be possessed by a number of owners and the activity will be coordinated by the market.

Using these two criteria, I have shown that both individual and collective planning can be beneficial to the market and can improve its performance. Individual planning replaces the price mechanism only through market transactions (when one market player buys off all resources needed to produce a good), so this type of planning cannot be detrimental to the market. However, the relation is more complex when collective planning is concerned. Collective planning may be associated with major shortcomings of management, but, on the other hand, it is indispensable when markets employ common/jointly owned resources. Because shared/collective property rights are pervasive in social and economic life, markets may not exist without central planning.

The significance of the issues discussed here is clear. In theories of economics, social science and environmental studies, the ‘market versus planning’ issue has been a source of division since the early 20th century. The goal of this article is to show that planning and the market are not rivals but equally powerful and important parts of a unitary process – the exercising of property rights. Planning and the market are two alternative ways to exercise entitlements; as such, they are in many respects opposites, but they are also complementary. They become rivals only when decision-makers, politicians or managers – for ideological or political reasons – try to impose one of these two mechanisms over the other without respecting the existing structure of property rights. The creation and existence of such structures (bundles) of entitlements are determined entirely by the two criteria of Coase analysed in this article.

Footnotes

Acknowledgements

The author is grateful to the three anonymous referees and the Editor, Professor Angelique Chettiparamb, for their particularly helpful comments and advices.

Funding

The author(s) disclosed receipt of the following financial support for the research, authorship, and/or publication of this article: The author acknowledges the financial support by the European Union FP7-ENV.2011.2.1.5-1 (TURAS Project) Grant Agreement no. 282834.

Author biography

Aleksandar D Slaev teaches Planning at Varna Free University and the University of Architecture, Civil Engineering and Geodesy in Sofia. He has published books in the area of urban development - “Market Theory of Urbanism, Part 1: Economics of Urban Development”, “Economic Modelling in Urban Planning” and “Housing Forms”, co-authored “Territorial Planning and Administrative Structure” and “Financing Urban development”. He is currently working on “Market Theory of Urbanism, Part 2” and “A Theory of Relative Property Rights”.

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