Academic journal article
By Epstein, Richard A.
The Yale Law Journal , Vol. 106, No. 7
I. Introduction: Two Kinds of Rules, Two Kinds of Risks
In their 1972 article, Guido Calabresi and A. Douglas Melamed introduced the now standard distinction between property rules and liability rules.(1) A property right gives an individual the right to keep an entitlement unless and until he chooses to part with it voluntarily.(2) Property rights are, in this sense, made absolute because the ownership of some asset confers sole and exclusive power on a given individual to determine whether to retain or part with an asset on whatever terms he sees fit. In contrast, a liability rule denies the holder of the asset the power to exclude others or, indeed, to keep the asset for himself. Rather, under the standard definition he is helpless to resist the efforts by some other individual to take that thing upon payment of its fair value, as objectively determined by some neutral party.(3)
Calabresi and Melamed would have made a major contribution if they had simply pointed out how these remedial choices recur in widely divergent substantive settings. Yet their article became enormously influential by pinpointing the key economic consequence that flows from these alternative specifications of remedial protection for any entitlement. Because property rules give one person the sole and absolute power over the use and disposition of a given thing, it follows that its owner may hold out for as much as he pleases before selling the thing in question. In contrast, by limiting the owner's protection to a liability rule, that holdout power is lost, and in its stead the owner of the thing receives some right to compensation for the thing that has been taken away from him against his will.
It is one thing to articulate a distinction, it is another to determine how it should be used. Although their work was pathbreaking in many ways, Calabresi and Melamed nonetheless failed to address systematically the challenge of deciding whether legal protection via a property or a liability rule should be conferred to holders of particular sorts of assets, or why. It is to that question that I shall address myself here. I shall lay out my cards clearly at the beginning. In a world in which transaction costs were zero, where all disputes could be costlessly resolved, the choice between liability rules and property rules would be of little or no importance -- just another application of the ubiquitous Coase Theorem.(4) On the one hand, the holdout danger from a property rule would be of no consequence because the two parties could exchange an infinite number of offers within an infinitesimal period of time; in essence, that is what a world of zero transaction costs would entail. On the other hand, a liability rule would have no serious downside either. Armed with our zero transaction costs assumption, any dispute on valuation could be resolved both accurately and instantly. In both cases, each asset would end up in the hands of the party who valued it most with no institutional drag, so that the choice of institutional arrangements would be of little or no consequence to the overall situation.
It is an open question, however, whether one can even understand what a world of zero transaction costs means, given the violence it does to our ordinary understanding of the importance of time. Be that as it may, our world is not one in which transaction costs are zero. Rather, they are positive and large, so that the choice between the two rules is certain to have major consequences for the overall operation of any legal system. Given this fact, it becomes clear that each legal system will have to choose some legal rule that minimizes the transactional imperfections that occur in securing the transfer of assets from one person to another. The standard practice in virtually all legal systems assumes the dominance of property rules over liability rules, except under those circumstances where some serious holdout problem is created because circumstances limit each side to a single trading partner. …