The debate on how legal systems should protect entitlements holds great importance. It has a broad impact on overall social welfare, influencing bargaining outcomes, legal disputes, judicial decisions, and their associated distributional effects. According to a well-known classification in Law & Economics, entitlements can be safeguarded via (i) a “property rule” that prohibits takings and violations of the entitlement without the explicit consent of the owner or via (ii) a “liability rule” that requires transgressors to monetarily compensate the owner for any infringement of the entitlement.
Property rules mandate that parties negotiate an exchange, whereas liability rules do not have this requirement and would permit individuals to take things from others or violate their entitlements as long as they fully compensate victims. Property rule protection is understood to be preferred when transaction costs are low, and parties can bargain to achieve an efficient outcome. In contrast, liability rule protection is preferred when transaction costs are high and impede the efficient reallocation of entitlements. Liability rules allow those who value something the most to take it without the need to bargain and to secure the consent of the owner. They thereby lead to the realisation of gains that would otherwise be unattainable due to the difficulty or impossibility to negotiate with the owner, who, by being fully compensated, does not lose anything. In effect, the Law & Economics literature embraced the criterion of transaction costs to determine how the law should protect entitlements.
Law & Economics scholars often favour liability rules because they would prevent owners from impeding the efficient reallocation of entitlements to those who value them the most, particularly in cases of efficient takings, i.e. when the entitlement is more valuable to the taker than to the owner. However, this theoretical preference sharply contrasts with the reality of how legal systems protect entitlements, particularly when it comes to the safeguarding of possessory interests in things. In practice, legal systems all around the world predominantly rely on property rule protection, explicitly seeking to prevent efficient takings from occurring, with the sole exception of eminent domain cases.
In this project, I present an advantage for property rules over liability rules which has been overlooked in the literature and that is based on economic analysis and does not depart from its impact on social welfare. This advantage concerns the aptitude of each rule to resolve the conflict that emerges after one person takes something from the other and to reduce the human tendency to retaliate in socially costly manners against those who take something from us without our consent. By effectively reducing conflict and this type of retaliatory responses, the law can mitigate the deadweight losses associated with socially costly forms of conflict and retaliation. Consequently, legal redress exerts, ex post, and after someone takes something from another, a positive impact on overall social welfare.
Imagine a scenario where someone highly values your car and decides to take it from you. In such a situation, you would understandably feel aggrieved and, without legal protection, might be tempted to retaliate in costly ways against this person, potentially escalating the situation. You might engage in heated discussions, arguments, or quarrels, resorting to verbal or even physical aggression. Alternatively, you might attempt to harm the taker's reputation, ostracise him or her, or sever your relations with him or her, among other means of inflicting harm, even though these actions may come at a personal cost. However, the law can effectively curb this retaliatory tendency – this inclination to "reciprocate negatively" based on the norm of reciprocity – by assuring you of compensation for your loss under liability rule protection or by ensuring the return of your car under property rule protection. The question at hand in this project is which of these schemes is better apt to resolve the conflict and minimise the losses incurred from socially costly forms of retaliation by victims of takings.
Under the liability rule, you receive compensation, but you do not receive any share of the gains from the forced exchange since the taker captures them all. There are two primary reasons why you might feel aggrieved in this situation. Firstly, if you experience disutility from unequal outcomes, you have a motive to retaliate against the taker to address the inequality. Secondly, if you derive disutility from someone violating your autonomy and taking something you possess without your consent, you have another reason to retaliate against that person. In other words, taking both reasons into account, the taker benefits from his or her own wrongdoing, leaving victims of takings feeling aggrieved even after receiving full compensation, and thus still tempted to punish the transgressor.
Under the property rule, the courts would demand the taker to return the car to you. In this scenario, nobody gains any profit, and no one's situation is worsened or improved compared to before the act, disregarding potential legal costs associated with the proceedings (in fact, under the English rule, you would also be compensated for such costs). Despite this, you may still have a motive to retaliate against the taker since he or she violated your autonomy and took your possession without your consent. While compensation or an injunction cannot reverse this action, the unequal outcome where the taker benefits from their wrongdoing does not occur, thereby diminishing one reason for you to feel aggrieved. Consequently, property rule protection is expected to be more effective in reducing conflict and discouraging retaliatory actions compared to liability rule protection.
I provide empirical evidence supporting this hypothesis in a laboratory experiment. In this study, half of the participants had to work on a task involving counting zeros in a large matrix to earn a fictitious good with monetary value, while the other half had the opportunity to take that good from the owner, if he or she successfully completed the previous task. In the control group, owners could solely respond to takers through retaliatory actions, incurring costs to punish takers. Under the liability rule and property rule conditions, owners could retaliate against the taker, as in the control group, and, simultaneously, seek monetary compensation for their losses or demand the return of the good, respectively. Both rules resulted in reduced retaliation, but the property rule exhibited a greater reduction. This effect was observed only in situations where the taker benefited from the act of taking, obtaining all the gains from the forced transaction. Notably, the reduction in retaliation was not observed when taking followed by compensating the owner yielded no profit for the taker.
This result provides one further argument for the prevalence of property rule protection all around the world for the protection of possessory interests in things. No legal system, with exceptions only for the cases of eminent domain, allows people to take things from others unless they fully compensate the victim. This contrasts with the preference of many scholars in Law & Economics for liability rule protection, which does have many advantages, leading to more exchanges since liability rules do not allow owners to impede efficient reallocations of entitlements as property rules do. However, when takings occur without consent of the owner, retaliation and conflict will be the result, even if the victim is compensated. This provides a reason for the law’s preference for property rule protection in such cases.
