Is the stabilisation of property rights a necessary or sufficient goal for accelerating economic development in developing countries?

1. Introduction

 The highly contentious subject of property rights has been extremely popular for the basis of studies on economic growth in recent years. The orthodox approach is to push for the development of property rights as this holds the key to investment and will promote growth. However, the heterodox approach shows that property rights are important, but are not sufficient in the development of an economy. This essay will highlight the key arguments on both sides of this subject and will then conclude with some points for discussion.

 2. Property Rights are the Key to Success

 The more conventional and orthodox approach to the subject of property rights is the stance that property rights are the key to economic development and growth. Many authors have written papers with such a conclusion and the argument has a lot of weight. This section of the essay will highlight the conclusions these authors have drawn and discuss their implications for developing countries.

The research relating institutions to growth has grown in popularity and stature in recent times as the “focus of development has recently changed from ‘getting the prices right’ to ‘getting institutions right’”[1]. The variable that seems to unite scholars who support the role that institutions have on growth is that of ‘property rights’. At the beginning of this school of thought, Coase argued

“that any system of property rights is capable of leading to Pareto-efficiency provided it is a complete system, a complete system meaning one where all rights to all the benefits from all scarce resources are imputed to someone and are tradeable”[2].

If an economy has strong property rights, it would imply that there is a strong legal framework for businesses to operate which boosts confidence and trust within the economy to increase investment (both internal and external). The argument, therefore, is that this confidence will boost growth and prosperity for the economy. Another link “is that institutions reduce the costs of production and distribution, allowing private agents more scope to benefit from specialization, investment, and trade”[3].

An article by North starts by summarising Coase’s work by highlighting how the neoclassical model only holds in reality under “the severely restrictive assumption of zero transaction costs”[4]. Under this restriction, there would be no need for institutions as economic growth would only depend on population and their saving. However, there are undoubtedly transaction costs and thus institutions do matter. Institutions are needed to allow transparent property rights which will decrease transaction costs and thus increase the number of transactions. With increasing specialization and division of labour comes a larger uncertainty (via principal-agent issues such as shirking) and more complex relationships. If the institutional framework cannot adapt, then this development will stop and the evolution will reverse. In order for an economy to grow,

“[i]mpersonal exchange with third party enforcement is…essential…[a] society that would achieve the productive benefits of great specialization can only do so with an elaborate structure of law and its enforcement. There are no cases of complex high income societies that do not have an elaborate structure of government.”[5]

North uses the examples of the Netherlands and England in the sixteenth to eighteenth century where “the development of market-induced pressures to alter the political system in such a way as to embed rules and their enforcement in an impartial body of law as far removed as possible from arbitrary changes”[6]. He also goes on to highlight how unstable or unenforced property rights will not lead to the development of “the institutions of finance, credit, banking, marketing, insurance, etc., which would make possible transacting at a profitable production cost”[7].

Demsetz takes a similar approach and states that property rights can help form expectations which one can use when dealing with others – “[a]n owner of property rights possesses the consent of fellowmen to allow him to act in particular ways”[8]. Demsetz shows how property rights can internalise the externalities created but also highlights how there can be organisational costs in collective agreements;

“The soot from smoke affects many homeowners, none of whom is willing to pay enough to the factory to get its owner to reduce smoke output. All homeowners together might be willing to pay enough, but the cost of their getting together may be enough to discourage effective market bargaining”[9].

In sum, according to North and Demsetz, property rights have to be present to create an advanced financial system and can facilitate the internalisation of externalities. With this, an economy can grow and develop by creating an environment where both investors and consumers feel confident to transact. However, they do not necessarily explain where these institutions have come from.

A paper which sort to highlight both why certain institutions were created, as well as how institutions can facilitate economic growth, was written by Acemoglu et al[10]. This article is based on looking at where and why the Europeans settled and then discuss the subsequent institutional ramifications. The main thrust of their argument is claiming that in the countries where there was a high prevalence of disease (such as malaria) would consequently have high mortality rates. As a result, the Europeans would not settle permanently and thus were less likely to create long-term development institutions. The institutions created here would be more likely to be extractive i.e. simply plunder the land. They cite the example of the Belgian colonisation of Congo where they did not set up private property rights nor any checks and balances to protect against government expropriation. The states which did not have high mortality rates (e.g. New Zealand, Australia) would have the European settlers creating institutions which had a long-term vision – private property rights were established.

The assumptions which this paper makes can be summarised in their flow diagram:

(Potential) settler mortality → settlements → early institutions → current institutions   → current performance

It assumes: 1. the settlements are determined by the mortality rates; 2. that the type of institutions created depend on the settlement; 3. that the institutional type continued to operate even after independence and; 4. the economic performance depends purely on the institutional framework it operates. If a state did have a large amount of disease, would this (in itself) not be the explanation for poor economic performance? The authors claim that the European settlers mainly died from malaria and yellow fever and that the indigenous adults had some form of immunity. As a result, disease is unlikely to be the reason why many countries in Africa and Asia are poor today.

In their regression analysis they show;

“that once the effect of institutions on economic performance is controlled for, neither distance from the equator nor the dummy for Africa is significant. These results suggest that Africa is poorer than the rest of the world not because of pure geographic or cultural factors, but because of worse institutions”[11].

These findings on how institutions are the main determinant for economic performance is also consistent with work undertaken by Bassanini et al – they argue a strong case for the positive role that institutions have on the economy using regression analysis whereby changes in policy and institutional framework have promoted growth “over and above the changes in factor inputs”[12].

 In the debate between public versus private enterprises, a transfer of property rights can explain how this process occurs. Boycko et al. cite many examples of articles relating poor performing public enterprises[13]. With this basis in mind, privatisation has been encouraged as it “widens the separation between the manager and the politician, and in this way stimulates restructuring”[14]. They also go on to state that

“By transferring control from politicians to the managers privatisation makes politicians accountable for the profits used on excess labour spending, since they need to subsidise the firm to convince managers to incur this spending.”[15]

The transfer of control relates to the transfer of property rights as claim to the firm/land etc has changed. This accountability of politicians should bring greater caution in granting subsidies to fulfil macroeconomic objectives, and thus should increase efficiency of spending.

Papageorgiou and Turnbull take a more specific and detailed analysis of statute length on property. They first show a partial equilibrium model of the value maximising statute of limitations for individual land areas. They find that longer statutes of land tend to benefit the owners of non-urban land.

“And within the urban sector, even shorter statutes tend to benefit inner-city property, whereas somewhat longer statutes benefit land nearer the outer limits of urban development”[16].

As urban land has a larger present value of land rent,

“the potential loss to the landowner from a prior claim in the form of forgone rents is greater than for rural land. This greater potential cost of exposure to such claims lowers the optimal statute duration for urban land when compared with rural land”[17].

This indicates that the issue of property rights and institutions is far more complex than simply encouraging the evolution of the financial system and internalising the externalities; one has to create the correct, specific (in this example) property right for the specific use (in this example this is land). It also goes on to suggest a political system for a country;

“this result implies that, because the statute of limitations must apply uniformly to all land within a jurisdiction, a federal system of multiple jurisdictions (states, departments, or provinces), each responsible for setting its own statute length, will be more efficient than a single national uniform law”[18].

An article written by Besley looks at the interaction between property rights and investment in two regions in Ghana. Ghana is a country which is “in a transition between a traditional system of land rights (which emphasizes claims of the community) and a modern one (which emphasizes the claims of the individual)”[19]. The two regions they look at are Wassa (where most of the land is owned) and Anloga (where most of the land is rented). In Wassa, the majority of the investment comes from planting more trees to grow cocoa. Here, as most of the land is owned, land rights are significantly linked with the level of investment – “An extra right with approval from the lineage raises the probability of investing by 2.5 percent”[20]. In Anloga, property rights have far less of impact on investment but they take this result with caution – “the findings suggest that the measured rights variables that appear…to affect investment may actually evolve symbiotically with investment”[21]. However, they do concede that the link between individualistic property rights and investment is not complete – if the individuals cared for the wellbeing and equality of all members of a community, then communal rights will be just as successful in promoting investment.

In sum, many authors have contributed to the conclusion that institutions (and more specifically, property rights) are fundamental to the outcome of economic growth and are more important than other variables such as factor inputs.

 3. There is More to Development than Property Rights

 Whilst Sindzingre saw there was a case for institutions promoting growth, she also saw major limitations. She argues that poor economic performance has more factors than simply institutions, reforms and policies. For example, certain reforms such as privatisation and liberalisation can be “more or less effective depending on these other determinants, which are often of a structural nature, and effectiveness depends on the expected time frame, short- or longterm”[22]. She also compares the rate of change of institutions to that of growth and concludes that institutions cannot possibly be the only cause for growth as growth rates are often volatile while institutional change is much slower[23]. Engerman and Sokoloff state that one should be cautious of the ‘link’ between institutions and growth;

“Economists do not have a very good understanding of where institutions come from, or why some societies have institutions that seem conducive to growth, while others are burdened by institutions less favorable for economic performance”[24].

They also argue that because we know very little about the development of institutions, it is hard and troublesome to show its effect on growth.

Even though Acemoglu et al[25] find a positive correlation between average protection against risk of expropriation 1985-95 and log GDP per capita 1995, both they and Aron highlight the issue of causality; do property rights encourage investment which promotes growth or is it that only the richer countries can afford to enforce these rights? Also other factors, such as initial factor endowments, could explain the differences in wealth, human capital etc. Contrary to the argument for the role of institutions, Glaeser et al., Bassanini and Engerman and Sokoloff[26] all argue the case for human and social capital. According to Glaeser et al. institutions are “second order performers” and claim that the first order is human and social capital which in turn shape and mould the institutions[27].

Thus far, the literature has focused on how institutions (and thus property rights) can affect the economy under the more orthodox parameters of liberalization, privatization and stabilization. However, while these factors are important, it has been noted by Khan that improvements to an economy can be broken into two sections: 1. market enhancing governance and; 2. growth enhancing governance. Market enhancing governance tries to ensure that the markets work efficiently, through e.g. property rights/rule of law etc, and thus private investors will drive economic development. As a result, this limits the state to providing public goods and to minimise rent seeking and government failure. Growth enhancing governance “focuses on the role of governance in enabling catching up by developing countries in a context of high transaction cost developing country markets”[28]. As a result, a more heterodox approach to governance would be to argue that markets are

“inherently inefficient in developing countries and even with the best political will, structural characteristics of the economy ensure that market efficiency will remain low till a substantial degree of development is achieved”[29].

Therefore the ability of the state to accelerate accumulation in both the private and public sectors, as well as ensuring productivity growth, will lead to economic growth.

The main thrust of the market enhancing governance approach is that stable property rights are needed because the contested or unclear property rights will raise the transaction costs of buyers and sellers and thus will stop some transactions. However, Khan highlights two problems with this approach: 1. the historical evidence shows that it is extremely difficult achieve these governance conditions in poor countries (mainly because the expenditure capability of the state is limited). As a result semi-market or non-market asset redistribution is needed (such as TVEs in China which will be discussed below). 2. Growth in developing countries requires catching up through the acquisition of new technologies and learning to use these new technologies rapidly[30]. This is consistent with Glaeser whereby his work found that institutions are “second order performers” and claim that the first order is human and social capital which in turn shape and mould the institutions[31]. In acquiring this new technology and capability, Khan recommends that the state needs to incentivise investment (i.e. create rents via subsidies etc) but also needs to be disciplined to ensure non-performers do not get to keep the implicit rents. The successes he states are: tariff protection worked for virtually all countries, direct subsidies worked for South Korea and a subsidized and prioritized infrastructure worked for China and Malaysia[32].

In the same paper, Khan also shows that while there is a slight trend between the property rights variables (as given by the World Bank etc.) and economic growth, this is present only when all income level countries are pooled together. Even if we took these results to be robust, the data and indices used are from robust. Determining a scale of the ‘level of corruption’ can be skewed by many factors – has a person scoring Nigeria also been to Uganda etc?, is the prevalence of ‘corruption’ higher in a certain country than another?, does ‘corruption’ matter to people in a flourishing economy? As a result, the pooling of many countries can highlight the issue of causality.

A final, interesting point raised in this paper is the comparison of China and India. Khan highlights that China does not necessarily perform better than India in the market enhancing governance such as stability of property rights or its corruption ‘score’. Instead, China out-performs India by indentifying the growing and successful sectors and facilitating its resource allocation. As a result, rents are created (which incentivizes the investment) combined with a credible threat of losing failing firms shows that the market enhancing governance, which is the orthodox rhetoric, is not necessarily the only key to growth.

Bowles and Dong confirm this conclusion by looking at TVEs (Township and Village Enterprises) in China. TVEs are a community based enterprise which, in 1993, accounted for around 29% of China’s industrial output and 40% of its exports[33]. Even though privatisation is pushed by more orthodox quarters, there is no statistically significant evidence to suggest a difference in productivity. Moreover, with the TVEs promoting high employment and equality, these enterprises fulfil socio- and macro-economic needs. While Alchian and Demsetz looked at ways of solving the principal-agent problem of shirking via changing who the residual claimant is[34], TVEs solve this problem via the stigma attached to it within the community. The solidarity approach of TVEs has far more social and ‘development based’ strategies that may be considered better than private enterprises for emerging states.

On a more general level, Qian[35] highlights how the interaction of institutions within the political sphere of a country is more important than trying to impose ‘first-best’ ideals. He cites China’s economic growth as his example, showing that imperfect institutions, if compatible with the political framework, can foster growth in an economy. While it is true that eventually creating institutions which enforces a good rule of law and decreases corruption etc will lead to sustained economic growth as the economy changes, his argument is not to apply a one-size-fits-all approach. Zhang[36] adds to this by pointing out that it is decentralisation and globalisation which has led to fierce regional competition which leads to the government protecting enterprises (i.e. rent creation). “This protection has served as a substitute for the weak formal property rights and legal systems that still prevail in China, and has helped fuel rapid economic growth”[37]. However, the strong competition means that the government cannot easily tax private investment such as FDI and so, must look for other methods of raising revenue – this comes from ‘procuring’ land, at a fraction of its market value, from farmers via the weak land laws. This is a dangerous game to play as it will run the risk of a social uprising of unemployed farmers. However, as Zhang points out, if the government starts to improve rural property rights for farmers, the unrest would ease.

 4. Conclusion

 This essay has shown that under the orthodox rhetoric, decreasing transaction costs via the improvement of institutions (and thus property rights) will allow more transactions to take place, economic growth and development and incentivise investment. However, it has also shown that there needs to be a distinction market enhancing and growth enhancing governance. Poor (i.e. not first-best) institutions can allow economic growth to flourish given the correct political sphere to work in. Privatisation is not necessarily the only path for developing countries to choose – TVEs in China has shown that given the correct environment, productivity and effort can be the same (if not better) than in private enterprises, but with the benefit of fulfilling socio- and macro-economic targets. There must be other factors which affect economic growth such as human (and social) capital and initial factor endowments.

I do not necessarily think this is the end for the orthodox rhetoric – its argument has a lot of weight and, at worst, highlights the goal that developing countries should strive for. However, the path to this goal could take a myriad of routes and the initial change to ‘first-best’ institutions may be too expensive and inefficient for such economies. However, taking a similar path as China with regards to land ‘grabbing’ could lead to social unrest which might have major ramifications for the economy in the long-run. I feel that work by Engerman and Sokoloff and Acemoglu summarise my indecision with the best route for developing countries: Engerman and Sokoloff state that “overall, we argue that the role of factor endowments has been underestimated, and the independence of institutional developments from the factor endowments exaggerated”[38] while Acemoglu calls the effect of institutions on economic growth something of a “black box”[39]. On balance, one could argue that property rights and the evolution of institutions are necessary but not sufficient for economic development.

[1] A. Sindzingre – Reforms, Structure or Institutions? Assessing the determinants of growth in low-income countries – Third World Quarterly, Vol. 26, No. 2 2005 page 285

[2] Coase (1960) in R.C.O. Matthews – The Economics of Institutions and the Sources of Growth The Economic Journal, Vol. 96, No. 384. (Dec., 1986) page 904

[3] S.L. Engerman and K.L. Sokoloff – Institutional and Non-institutional Explanations of Economic – Working Paper 9989 2003 page 7

[4] Coase in North, D. – ‘Institutions, Transaction Costs and Economic Growth’ – Economic Inquiry Vol XXV 1987. p419

[5] ibid p425 [my italics]

[6] ibid p426

[7] ibid p427

[8] Demsetz, H. – ‘Toward a Theory of Property Rights’ – The American Economic Review, Vol. 57, No. 2 1967  p347

[9] Ibid p357

[10] Acemoglu, D., Johnson, S. and Robinson, J. – ‘The Colonial Origins of Comparative Development: An Empirical Investigation’ The American Economic Review, Vol. 91, No. 5 (Dec., 2001), pp. 1369-1401

[11] ibid p1372

[12] A. Bassanini, S. Scarpetta and P. Hemmings – Economic Growth: The Role of Policies and Institutions 2001 page 35

[13] Donahue (I989), Lopez de Silanes (I993), Mueller (I989) etc

[14] Boycko, M., Shleifer, A. and Vishny, R. – ‘A Theory of Privatisation’ – The Economic Journal, Vol. 106, No. 435 (Mar., 1996), pp. 309-319 p316

[15] ibid p316-7

[16] Papageorgiou, C. and Turnbull, G.K. – ‘Economic Development and Property Rights: Time Limits on Land Ownership’ Economic Development Quarterly 2005 p278

[17] ibid p276

[18] ibid p278

[19] Besley, T. – ‘Property Rights and Investment Incentives: Theory and Evidence from Ghana’ – The Journal of Political Economy, Vol. 103, No. 5 (Oct., 1995), pp. 903-937 p904

[20] ibid p920

[21] ibid p931

[22] A. Sindzingre – Reforms, Structure or Institutions? Assessing the determinants of growth in low-income countries – Third World Quarterly, Vol. 26, No. 2 2005 page 300

[23] ibid page 285

[24] S.L. Engerman and K.L. Sokoloff – Institutional and Non-institutional Explanations of Economic – Working Paper 9989 2003 page 28

[25] D. Acemoglu, S. Johnson and J. Robinson – Institutions as the Fundamental Cause of Long-run Growth – Working Paper 10481 2004 Figure 1

[26] E. Glaeser, F. La Porta, F. Lopez-De-Silanes and A. Shleifer –  Do Institutions Cause Growth? – Journal of Economic Growth 9, 271-303, 2004, Bassanini, A., S. Scarpetta and P. Hemmings – Economic Growth: The Role of Policies and Institutions. Panel Data. Evidence from OECD Countries – OECD Economics Department Working Papers, No. 283, OECD Publishing (2001) and Engerman, S. L. and Sokoloff, K. L. – ‘Factor Endowments, Institutions, and Differential Paths of Growth Among New World Economies: A View from Economic Historians of the United States’ –– NBER Historical Paper No. 66 (1994)

[27] E. Glaeser, F. La Porta, F. Lopez-De-Silanes and A. Shleifer –  Do Institutions Cause Growth? – Journal of Economic Growth 9, 271-303, 2004 page 298

[28] Khan, M. – ‘Governance, Economic Growth and Development since the 1960s’ Background paper for World Economic and Social Survey 2006 Box 1

[29] ibid p2

[30] ibid p4-5

[31] E. Glaeser, F. La Porta, F. Lopez-De-Silanes and A. Shleifer –  Do Institutions Cause Growth? – Journal of Economic Growth 9, 271-303, 2004 page 298

[32] Khan, M. – ‘Governance, Economic Growth and Development since the 1960s’ Background paper for World Economic and Social Survey 2006 p6

[33] Bowles, P. and Dong, X-Y. – ‘Enterprise Ownership, Enterprise Organisation, and Worker Attitudes in Chinese Rural Industry: Some New Evidence’ – Cambridge Journal of Economics 1999 p1

[34] Alchian, A. and Demsetz, H. – ‘Production, Information Costs, and Economic Organization’ – The American Economic Review, Vol. 62, No. 5 (Dec., 1972)

[35] Qian, Y. – ‘How Reform Worked in China’ – In Dani Rodrik, editor, In Search of Prosperity: Analytic Narratives on Economic Growth, Princeton University Press, 2003, pp. 297-333

[36] Zhang, X. – ‘Asymmetric Property Rights in China’s Economic Growth’ – Paper presented at the session on “Land Rights and Social Security in China” of the Annual

American Economics Association Meetings, Boston, January 6-8, 2006. 

[37] Ibid p17

[38] S.L. Engerman and K.L. Sokoloff – Factor Endowments, Institutions, and Differential Paths of Growth Among New World Economies: A View from Economic Historians of the United States –– Historical Paper No. 66 NBER 1994 page i

[39] D. Acemoglu and S. Johnson – Unbundling Institutions – July 2003 page 35


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