(This essay was published in Hong Kong Economic Journal on 1 June 2016.)

 

In a liberal democracy, a property owner has the right or freedom to make use of her own assets in any way she chooses subject only to the requirement that she does not interfere with the right or freedom of other individuals to make use of their assets as they choose. According to John Locke, the central purpose of the state in a liberal democracy is to protect and defend the private property rights of its citizens.

 

The term asset refers to things that have value. Some assets, for example, an ice cream factory or a Rembrandt painting can be bought and sold in the market for a monetary value.

 

Some assets, however, cannot be bought and sold, for example, the mind and body of a person because while it may have monetary value, the law prohibits slavery. The freedom of speech, freedom of worship, habeas corpus, and other essential freedoms could all be conceptualized as the right or freedom of a person over the use of his mind and body.

 

All assets can have multiple uses and can be used in different ways. An asset that is used to generate income is called capital–– a term invented by Karl Marx, who thought that the central feature of capitalist society is the ability to generate income through the accumulation of asset value.

 

Distinguishing between asset and capital is important. Assets are valuable things that are owned and can be used to meet human satisfaction, may be bought and sold, and potentially generate income. If they are used in a way to generate income, then they become capital.

 

Some assets do not produce income and are used simply for personal enjoyment, so they are just assets and not capital. A person’s mind and body cannot be bought and sold, but it can be used to generate income, and economists have called this human capital.All forms of capital are assets, but not all assets are capital.

 

A Rembrandt painting used only for personal enjoyment or private entertainment is an asset, but not capital. If, however, the owner charges a fee for every viewing of her Rembrandt, then the painting becomes capital. Any asset always has the potential to become capital unless it is prevented from becoming so.

 

All properties are owned either privately or publicly. If they are owned publicly, then every citizen is an owner and the government will determine how these are to be used and whether a fee will be charged. The decision process is normally defined by law and exercised through some political process, for example, by a government bureau, a court, a public committee, or legislature.

 

Some moral philosophers, for example, Michael Sandel, believe that it is morally unacceptable to charge a fee for the use of some assets, but not others. For example, it is acceptable to charge a fee for a taxi ride, but not for viewing a Rembrandt. So according to Sandel, the morally acceptable solution would entail disallowing people to charge viewing fees for Rembrandt paintings.

 

If we follow Sandel’s suggestion, then two possible outcomes may result. First, the owner of the Rembrandt will only let her friends view it and the public will not be able to view it. Second, the government will confiscate the Rembrandt (with or without compensation to the owner) and allow public viewing free of charge. Unless the owner is willing to accept the compensation for surrendering her painting to public viewing, this would constitute a violation of her private property rights – of her freedom. The owner would have been unjustly treated in the name of a moral principle or social justice.

 

A central question of justice is whether the public has the right to view the Rembrandt for free, and who has the authority to make this decision. Is a democratically elected government justified in confiscating the private property of a citizen in the name of social justice or the people’s will? If it is justified in the case of a Rembrandt, then is it also justified in the case of an ice cream factory, and what about the mind and body of a person?

 

Locke’s liberal democracy would not let this happen because it violates the fundamental principle of the role of the state to protect and defend private property rights. However, Rousseau’s populist democracy would allow it because he considered the choice of the people to be supreme and precious, hence, it must be obeyed. In a populist democracy, the freedom of the individual and the sanctity of private property rights are no longer absolute.

 

In the 20th century, two famous debates concerning the superiority of liberal versus populist democracies took place. The first debate was on whether liberal capitalism would deliver superior economic performance over populist socialism. In the 1950s the answer was not clear. Most intellectuals in the West believed that populist socialism would win the race. But by the 1980s, the answer was clear and they had been shown to be wrong.

 

The second debate was on whether liberal capitalism would deliver a more just society than populist socialism. Again most intellectuals in the West believed that populist socialism would win the race. By the 1980s, the answer also became clear – populist socialism left a much worse human rights record and produced a more unjust society than liberal capitalism.

 

How did this happen? When private property is appropriated by society, most assets become less efficiently utilized and more injustice is committed.

 

A private owner, as the beneficiary claimant to the income generated from an asset, has a strong incentive to deploy it in its most productive activity, take good care of the asset, ensure its proper maintenance, apply it prodigiously, and if an agent is hired to manage the asset, then the agent too will also be rewarded appropriately and monitored carefully.

 

An agent of the government charged with managing the asset will not have a strong incentive to utilize and manage it as well. A bureaucrat will seek to minimize risk and effort, a politician will seek to maximize publicity and votes, and a public committee will suffer from the idiosyncratic interests of its members.

 

The outcome is not only economically inefficient, but can also be unfair. With fees set at zero, there will be excess demand. The rules for rationing will be determined by the government’s agent. A bureaucrat or politician cannot easily capture the full value of the public asset in question because there are political constraints that disallow such behavior. If she tries to do so, it would be treated as corruption and criminal conduct. But who gets the rest of the value?

 

A politician may openly arrange for the asset, say a Rembrandt painting, to be viewed first by her constituents with VIP arrangements for her most important supporters. An education bureaucrat will arrange viewing with priority given to teachers and students, while an environment bureaucrat favors green groups, a finance bureaucrat favors bankers, a technology bureaucrat favors IT firms, and so on.

 

Values are therefore distributed according to the political interests of the agent-in-charge. The benefits, instead of being allocated by ability to pay fees, are now set by political criteria. This is constituency building and career development through political peddling. Why should the opportunity to view a Rembrandt be determined by political access? Is this justice?

 

The practice of confiscation will be even more pernicious if it is selectively targeted so that certain assets are more likely to be confiscated. This would encourage large-scale lobbying efforts to determine which assets should be confiscated and which exempted. It would create plenty of opportunities for corruption and bribery.

 

Besides confiscation, the most attacks on private property rights are made through taxation and regulation. These are in effect another form of taking away private property rights.

 

On the surface, taxation does not alter ownership rights of an asset, but only removes a portion of the income generated by the asset and lowers the rate of capital accumulation. If the tax rate is uniform across all asset classes and economic activities, then a distortion of resource allocation is minimized. Taxation creates incentives to perform non-market underground activities that cannot be effectively taxed. Some forms of self-employment work can be easily camouflaged. But the distortion is not serious if tax rates are low.

 

But if tax rates are high, there will be an incentive to move some economic activities underground or overseas to low-tax jurisdictions to avoid taxation. There will also be an incentive to lobby for tax relief for certain kinds of economic activities, which, if successful, would mean the tax system discriminated against some activities in favor of others. This would provoke counter-lobbying efforts. In some countries, like the US, the tax code is very complex.

 

Once a tax regime becomes very complicated and has high tax rates, the decision of how to utilize one’s assets becomes increasingly driven by tax considerations rather than the value of the activity per se. For this reason, I have never supported a widening of the tax base in Hong Kong, which over time would complicate our tax regime and raise tax rates.

 

If a value-added or consumption tax were introduced, one could be certain that powerful lobbies would appear to exempt some expenditures from taxation, food for example, and before long the tax system would become very complicated (in Europe, the definition of what constitutes butter and margarine for tax purposes in international trade would fill a volume as thick as a telephone book). An increasing amount of resources would be deployed in all kinds of unproductive activities that are wasteful and are a form of injustice.

 

The effects of regulation on private property rights are varied and far more pernicious. Regulations come in many forms: price regulation, quantity regulation, entry barriers, health and safety regulations, and so on.

Price controls restrict the income terms of private contracts, for example, rent control. The right to contract implies that the asset involved is exclusively owned. When the right to receive income is partly taken away from a contracting party, the diverted income will tend to dissipate unless the right to it is exclusively assigned to another individual.

 

Under rent control, a landlord is not allowed to raise rents beyond the controlled price. This difference between the market rent and the controlled rent is the diverted income that landlords are unable to collect. But such diverted income is not exclusively assigned to another individual and it will be dissipated over time. The dissipation process could take many forms; the following is one likely form.

 

Landlords in the short run would cut back on maintenance, charge expensive key money or furniture fees, seek to evict the tenant when the tenancy expires, choose tenants based on discrimination, and so on.  If tenants can sub-lease the rent-controlled apartment then the tenant is able to capture the diverted income. In the very long run, landlords might abandon the building as the value of the asset deteriorated and it was no longer viable to pay property taxes, maintenance costs and assume the risk of accidents, and recover these costs from collected controlled rents. They would also have no hope of evicting the tenant and the neighborhood around the building would continue to deteriorate.

 

When the building is abandoned, the government would have to take ownership of the asset. The government too has no incentive to own the building and rent it out to tenants. As a result, the government would propose to transfer ownership of the building to the incumbent tenant if she is willing to pay property taxes. The long-term effect of rent control would in practice transfer ownership from the original landlord to the incumbent tenant. Price control in effect erodes private property rights. And in this case erodes it totally. This is not a hypothetical process but actually took place in New York City in the last century in rent-controlled neighborhoods. The greatest loss is the lost opportunity to redevelop the neighborhood.

 

An asset is “private property” if, and only if, three distinct sets of rights are associated with its ownership. First, is the exclusive right to use, or to decide how to use, the asset, including the right to exclude other individuals from its use. Second, is the exclusive right to receive income generated from the use of the asset. Finally, the right to transfer its ownership to any individual the owner sees fit, and including the right both to enter into contracts with other individuals and to choose the form of such contracts. These rights are interrelated. A restriction imposed on the right to receive income, as in the case of taxation or rent control, will yield predictable changes in behavior in the exercise of the other two sets of rights.

 

The rising political demand to erode private property rights in a liberal democracy through taxation, regulation and confiscation, if acceded to, will eventually erode the very foundations of liberal capitalism and transform it into populist socialism. The process is gradual and is conducted in the name of moral principles or social justice. But its true effect is to transform private property rights, upon which the foundations of a liberal democracy should be built, into public property, leading to the erosion of individual rights and freedoms.

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