One of the abstractions from reality that economists like to make is that property rights are perfectly well defined and can be easily enforced. That means that it is clear who owns what, and what we can do with it. In reality, property rights aren’t well defined. It is not always clear if the tree you planted is on your side of the property line, or your neighbours. And, even if it isn’t on your land, is your neighbour allowed to cut it down (especially if its 30 ft tall now)? In fact, the simple truth is that most (if not all) property rights can’t be perfectly enforced under all states of nature; and in many instances, there is no mechanism, no insurance contract, nor norm or law to govern what to do when that unanticipated state of nature occurs.
You don’t need to be a rocket scientist to know that when property rights are ill defined or hard to enforce, it leads to trouble. Bickering and fighting with the neighbours; trees that get needlessly lopped; divorces get unnecessarily messy. TH heard of someone in the US being shot in a line-up for petrol (gas) during a period of petrol rationing over a dispute about who was first in line. The resources that get lost can sometimes greatly exceed the value of the disputed property right (think of the guy that got life in prison not to mention the guy that lost his life in the line for gas). That is why we have the law. The law just doesn’t enforce property rights, it tells us what to do when something within the system goes wrong and there is a dispute over property rights. Sometime the law is written (e.g. which creditors get what when you can’t pay your mortgage). Sometimes the law is unwritten – like women and children first on the Titanic when it wasn’t clear who had a right to a berth in a life boat. And sometimes the law still needs to be written because the case in hand was once “unthinkable.”
Three or four years ago it was (almost) unthinkable that a Greek person’s right to be paid in euro could not be guaranteed. One reason why Torrens Hume is a big advocate of coming up with a mechanism for a smooth exit from the euro area (see here and here for example) is simply because the problems associated with not knowing whether Greek’s (and holders of Greek debts) can be expected get paid in euro and the implications of that is causing financial markets to become severely distorted. There is also a closely related problem associated with the uncertainty surrounding what happens when the Government of Greece defaults on its debts (see James Haley at the New Age of Uncertainty on the need for a sovereign debt restructuring mechanism).
In TH’s most humble opinion, the biggest failure of European policy making during the last three years is that it has been unable to write down the rules of the game that govern the euro area members when the unthinkable happens. In this context the “game” consists of euro exit, sovereign default, bank capitalisation and federalisation. (Did anyone watch the Munk debates – Is the European Experiment a Failure?)
The trouble is that when there is uncertainty, people procrastinate over large, irreversible decisions, because tomorrow will always reveal more information that might help in making that decision. Thus the economic uncertainty induces policy makers to wait before writing down the rules because the economic situation might get better tomorrow and economic agents fail to invest their resources in productive activities, because they don’t know how policy makers will act on the issues of euro exit, sovereign default, bank capitalisation and federalisation.
In blunt terms, we are stuck in a terrible Nash equilibrium: policy makers are waiting for economy to get better while the economy is waiting for policy makers to act. In the meantime, unemployment in Greece and Spain is over 20% and rising, the European economy is starting to slip into what could be an extremely serious recession – think of the major banks in Spain and Italy failing — and the rest of the world is struggling to escape the vortex (Asian economies are already slowing as exports to Europe are slowing or contracting). This is nothing short of tragic.