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Wednesday, March 30, 2011

The relationship between property rights and economic growth

Ashok Ayyar, MPA 

"[Government] cannot take from any Man any part of his Property without his own consent. For the preservation of Property being the end of Government, and that for which Men enter into Society, it necessarily supposes and requires, that the People should have Property, without which they must be suppos’d to lose that by entering into Society, which was the end for which they entered into it, too gross an absurdity for any Man to own."  -John Locke, "On the Extent of Legislative Power," Second Treatise on Government (1689)

Locke argued above that personal property is antecedent to government, and its protection should be the principal function of government.[1] In his eyes, a state without fidelity for private property is no state at all, for it has violated the very social contract for which it was created.

Lockean thinking occupied the minds of political philosophers for nearly three centuries before recently migrating to economics. As if struck by lightning, development economists became enraptured by the idea of linking strong property regimes to GDP growth. Using conventional tools of the trade like cross-country regressions[2],  instrumental variables[3], and more nuanced institutional economics methods[4], several well-cited studies have asserted the importance of private property (qua property rights, or as part of the bundle of values sloppily lumped into the “rule of law”) for growth.

Taking this one step further, economist Hernando de Soto put forth the boldest and most articulate version of the property rights claim: not only are stable, secure, and well-defined property rights incidental to growth, but they are necessary for it. Ever the gumshoe, De Soto supported his argument by gathering ground-level observations of how property rights actually operate in poor countries. His capstone result, The Mystery of Capital (2000), tells a plausible story: though capital is indisputably the engine of economic growth, it is not simply cash or machines. Capital is the “legal expression of an economically meaningful consensus about assets.”[5] Law converts the passive potential energy of raw assets into capital, transmuting dull lead into effulgent gold. It turns a parcel of land or an enterprise into a reservoir of surplus value that can again be harvested for profit. Where developing countries have stumbled, de Soto contended, has been in their failure to establish an ordered “system of rules” that facilitates this process. And what else is such a system but law?

A well-ordered property law allows ordinary people to: 1) fix the economic potential of assets, 2) integrate dispersed information about assets in one place, 3) make people accountable for their debts, 4) make assets marketable, and 5) connect assets beyond the informal networks of their owners.[6] While Western nations gradually acquired a property law with these characteristics, developing countries remain mired in a disjointed property system that, at best, converts assets into capital at a glacial pace. People in those countries spend months or years tangled in the web of red tape.

The property rights chorus now reverberates in the halls of the World Bank and other development agencies.[7] Though there are still some dissenting voices, their cautions are muttered sotto voce, far from any actual policy-making.

Yet, as policy students, we should question the wisdom of this (and other) accepted truths. Have de Soto et. al. really conquered their foes, and convincingly made the case for formal property rights? Or is this idea, like so many others in the kitchen-sink development literature, another paean sung to a false god?

I think de Soto’s camp has won the debate for now, both on its merits and by virtue of policy-world take-up. I am inclined to believe that secure property rights are, if not the silver bullet, instrumental to economic growth. Furthermore, growth theory today has zeroed in on “institutions” as the best explanatory variable for growth. Notably, property rights appear at or near the top of most clearly-defined lists of institutions.[8] Thus, whether standing bare, or dressed in the clothing of institutions, property rights as the road to growth commands great support – and deservedly so. Only time will tell if the resulting policy of property law reform pans out.

[1] Do not forget the founding fathers enshrined his thinking as the cornerstone of the new republic. See Richard Hofstadter, The American Political Tradition (1948), pp. 10-12.
[2] Robert J. Barro, “Determinants of Economic Growth: A Cross-Country Empirical Study,” National Bureau of Economic Research, Working Paper No. 5698 (1996).
[3] Ibid. See also Daron Acemoglu, Simon Johnson, & James A. Robinson, “The Colonial Origins of Comparative Development,” American Economic Review, Vol. 91 (2001).
[4] Oliver C. Williamson, “The New Institutional Economics: Taking Stock, Looking Ahead,” Journal of Economic Literature, Vol. 38 (2000).
[5] Hernando de Soto, The Mystery of Capital (2000).
[6] Ibid.
[7] At the Bank, the high priest of property rights is Phillip Keefer, and he seems to have won over his colleagues. See Stephen Knack & Phillip Keefer, “Institutions and Economic Performance: Cross-Country Tests Using Alternative Institutional Measures,” Economics and Politics, Vol. 7 (1995).
[8] Take it from no less an authority than Douglass North. See Douglass C.  North, Institutions, Institutional Change and Economic Performance (1990), noting the most important source of underdevelopment is because of the absence of stable property and contractual rights.

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