Economics - Headway

Standard 8.  market failures occur when markets fail to allocate efficiently or meet other goals, and this often leads to government attempts to correct the problem.

Benchmark - Identify and analyze market failures caused by poorly-defined or poorly-enforced property rights, externalities, and public goods; evaluate the rationale and effectiveness of government attempts to remedy these problems.

India is one of the nations responsible for the significant decline in absolute poverty that began in the last decades of the 20^th century. However, even the World Bank, the source of the data on declining world poverty, notes that India still has a long way to go, and that anti-poverty programs there have not continued to demonstrate the stunning successes they had in the 1980s and early ‘90s.

The sad fact is that over one-quarter of the Indian population is still severely impoverished. Improvements in standard of living in many of India’s urban centers stand in stark contrast to persistent deprivation in some of the largest and most rural states. This uneven pattern of success in reducing poverty provides the opportunity to examine the larger context in which capitalist institutions operate, and helps us resist the temptation to oversimplify or to suggest that solutions are obvious or easy to implement.

India, for example, has long been a democracy with a firmly entrenched rule of law and boasts an extended history of formal recognition of property rights. However, it also has a 1500 year-old cultural institution – the caste system – that frequently undermines property rights institutions by subverting the rule of law that would enforce them.

160 million Indians, 15% of the population, are Untouchables, the lowly and intensely reviled outsiders of the Hindu caste system. There are middle class and educated Untouchables and from 1997-2002 an Untouchable, K.R. Narayanan, was India’s president, but these are noted exceptions. They call themselves “Dalits,” the oppressed, and they make up 90% of India’s impoverished and 95% of her illiterate population.

Formal property rights institutions exist in India – even for the Dalits. The Indian constitution (1950) officially banned untouchability and the 1989 Prevention of Atrocities Act made it illegal to “. . . parade people naked through the streets, force them to eat feces, take away their land, foul their water, interfere with their right to vote, and burn down their homes.” (Source:Hillary Mayell. “India’s ‘Untouchables’ Face Violence, Discrimination.” National Geographic News, June 2, 2003http://news.nationalgeographic.com/news/2003/06/0602_030602_untouchables.html).

Informally, however, the Dalits – particularly those in rural areas – know that the lack of enforcement renders their property rights tenuous at best and frustratingly meaningless at worst. The all-too-common stories of people like Girdharilal Maurya are a poignant reminder that property rights are human rights.

“. . . [H]e is a leatherworker, and Hindu law says that working with animal skins makes him unclean. . . . And his unseemly prosperity is a sin. Who does this Untouchable think he is, buying a small plot of land outside the village . . . [and] demanding to use the new village well[?] … He got what Untouchables deserve.

“One night while Maurya was away in a nearby city, eight men from the higher Rajput caste . . . broke his fences, stole his tractor, beat his wife and daughter, and burned down his house. . . .

“Girdharilal Maurya took his family and fled . . . . It took two years for him to feel safe enough to return – and then only because human rights lawyers took up his case, affording him a thin shield of protection.

‘I see them almost every day,’ Maurya now says of his attackers. ‘They roam around freel

• Defending and enforcing property rights is crucial.  If the rule of law is effective, property ownership acts as an incentive for investment and a catalyst for the creation of capital and wealth. 
• Property rights can be established and secured in three ways:
  • i)        Rule of physical force (also called anarchy)
    • Anarchy, the condition of competitive violence, has, to a greater or lesser extent, been the norm through most of human history, rendering it virtually impossible for the poor to own property.
      • In anarchy, the source of property rights is coercion by physical force.  Access to property is restricted to those with the physical ability to take and defend it, or with the wealth to pay others to do so.
      • In conditions of anarchy, property rights are enforced only by vigilance or personal policing.  There is no effective enforcement by the state.
      • Peaceful transfer of property rights is difficult and uncommon.  It is limited by disorder, by lack of a consistent enforcement, and by the absence of formal and recognized proof of ownership.
  • ii)      Rule of men
    • Under the rule of men, formal law may exist, but the hierarchy of power determines if, when, and how it is applied.
      • The National Content Standards in Civics and Government identifies the rule of men – “the ability of government officials and others to govern by their personal whim or desire” – to be in direct opposition to the rule of law (156).
        • Those who rule may gain positions of power through a variety of means – inheritance, usurpation, conquest, or even election – but they maintain power through political connections and military might. 
    • Property rights are tenuous, subject to the good will of those who govern.
      • Settlement of disputes over property is frequently arbitrary and is often tinged with political favoritism.
      • Enforcement is arbitrary and lacks consistency.
      • Transfer of assets and/or property rights is restricted by the need to obtain permission from those “in charge.”
    • The wealthy may be able to bear the costs of influencing the hierarchy of power, but the poor are not.
  • iii)    Rule of Law
    • The National Standards for Civics and Government define the rule of law as an essential component of limited government, whereby a society “. . . is governed according to widely known and accepted rules followed not only by the governed but also by those in authority” (47).
      • The standards identify the benefits of the rule of law:
        • It “establishes limits on both those who govern and the governed”
        • It “makes possible a system of ordered liberty that protects the basic rights of citizens”; an
        • It “promotes the common good” (116).
    • The rule of law means that even the poor have secure property rights and can therefore use their property to improve their well-being.

 4.  Secure property rights in market economies create incentives that promote growth and the accompanying improvements in material well-being.  (Review Lesson 1 outline for the importance of economic growth as they key to reducing absolute poverty.)

• Property rights-holders face strong incentives to preserve the value of their assets.
  • Simply stated, people take better care of things they own because they bear the opportunity cost if they do not
  • Owners consider the future value of their assets as well as the present value because they know that the future value is theirs.  Ownership encourages them to protect the asset so they can secure the continuing return.
    • This phenomenon can be seen by comparing the care and maintenance of similar houses by an owner-occupant and by a renter.  Even if the renter is not deliberately abusive, he is much less likely to be as conscientious as the owner
    • In a similar vein, while automobile owners check the oil and rotate the tires on their cars, it hard to imagine rental customers doing so
• Owners with full property rights also face strong incentives to improve their assets through investment. 
  • Secure property rights create incentives for owners to invest in capital and capital improvements, and this process results in the creation of more wealth.
    • Secure property rights encourage investment because owners are confident that any future value created will be theirs.  Unclear ownership rights – such as commonly exist under anarchy or the rule of men – reduce the benefits of making investments and improvements
    • A renter has little incentive to bear the expense of adding a deck to the house he lives in.  He would enjoy having the deck, but knows that when his lease expires, he has no claim on the value he created.  A homeowner, on the other hand, considers the increased future resale value of the house as well as the present enjoyment of the deck, and therefore faces a greater incentive to bear the current costs of building it.

5.  Secure property rights can also increase the likelihood of investment by providing collateral for debt.

• Debt need not be, as is often assumed, a drag on the economy and a trap for the poor.  Instead, it can be an instrument of economic growth. 
  • Debt allows people to use both their past income (savings) and their future income to acquire human and physical capital.  When people take on debt to make current expenditures, they contract to repay the debt with future income.  Debt allows them to acquire more capital than they could purchase using only their past income.
    • As people acquire more capital, their productivity and their income increase.
  • Collateral, commonly in the form of assets (property) to which the borrower has secure property rights, is offered as a surety that reduces the risk taken by banks and other lenders. Because collateral is necessary for the assumption of debt, securing rights to property can boost economic growth.  
    • By depriving people of collateral, insecure property rights reduce investment in capital, businesses, or other wealth-creating assets. 
    • The poor are, arguably, the least able to bear the costs of securing their property rights in order to gain access to capital. Unable to invest, their standard of living is therefore constrained by their current income and their ability to save
  • People with low incomes are often the biggest beneficiaries of collateral-secured debt.  The rich are much more able than the poor to pay cash for assets, while the poor depend on the ability to borrow.
    • Consider how home mortgages extend the opportunity for home ownership to those with low incomes.  Mortgages are debts allowing a current expenditure to be repaid with future income.  Because property rights are secured by rule of law, a lender is willing to accept the home itself as collateral. Without this arrangement, home ownership would be much reduced, restricted to the wealthy
    • Consider how small business loans extend opportunities for mom-and-pop businesses.  Without borrowing, those with low incomes are unlikely to accumulate the savings necessary to lease or purchase start-up capital goods and supplies.

 Case 2:  What If You Couldn’t Go into Debt ?

Wander into Mtandire, a shanty town near Lilongwe, the capital of Malawi. The roads are unpaved, bumpy and wet. Maize sprouts in every backyard. Cars are so rare that children wave excitedly as you drive by, and chickens fearlessly block your path. A slum in one of the poorest countries in the world’s poorest continent: you would expect the people who live there to be very poor indeed. You certainly would not expect to find a large store of potential [emphasis added] wealth in Mtandire. Look harder.   Grace and John Tarera slaughter goats for a living. Demand is brisk: Malawians adore goat stew. The Tareras want to expand their business to meet this demand, but they lack capital. Mrs. Tarera thinks they need about 20,000 kwacha ($250). This may not sound much, but in Malawi, where the average annual income is only about $200, it can take years to raise such a sum.

But wait: the house where the Tareras live is worth at least 25,000 kwacha. They bought the land five years ago and threw up a brick bungalow, fussily furnished and painted a satisfying shade of light blue. Surely they could borrow using the house as security? No, because they cannot prove they own it.

The Tareras’ house, like all the others in Mtandire, is built on ‘customary’ land. That is, the plot’s previous owners had no formal title to it. The land was simply part of a field that their family had cultivated for generations.”

“Now, Think Small.” The Economist. 13 Sept. 2001. 

6.  Secure property rights contribute to economic growth by releasing resources from protective activities to productive activities.

• If government does not define and protect private property, property owners must do so themselves. 
  • Using time and resources for protection imposes a heavy opportunity cost, a cost more easily borne by the wealthy than by the poor.
    • Comparisons of murder, theft, and burglary rates per capita in poor neighborhoods and wealthier ones, even in developed countries, provides empirical evidence that property rights are much less secure and less well-enforced for the poor. 
    • In developing countries the disproportionate burden of protection means that the poor give up time and energy they would otherwise dedicate to providing basic necessities. 
• Where governments define and secure formal property rights, the poor can spend less of their time enforcing their claims.  The result is that they spend more time in activities that contribute to rising standards of living.

7.  The recent economic history of India offers an example of the importance of institutional changes in property rights and the rule of law in encouraging economic growth.  The following description of the Indian economy serves as a background to Case Study 3, a description of how the Bhoomi project has successfully targeted archaic, corrupt, and costly titling practices. 

• India’s growth is most clearly evident in its burgeoning information technology sector – labeled one of the world’s “most dynamic” by the World Bank.  IT generated revenues of approximately $8 billion in 2000, providing thousands of jobs to India’s urban population.

Case 3:  Land Title Reforms Part of India’s Successful Attack on Poverty

Fostering the conditions for growth in the rural economy . . . must be considered central to an effective strategy for poverty reduction in India.”World Bank, India Poverty Data Paper, 2004 

Project:  Bhoomi:  Online Delivery of Land Titles in Karnataka, India

India’s impressive progress in reducing absolute poverty has been sporadic with respect to location.  Increasingly, poverty is concentrated in rural areas in some of India’s largest states.  

In many of these states, a corrupt and inefficient infrastructure undermines the security of property rights.  This, in turn, reduces incentives for investment and slows wealth-producing voluntary exchange in markets.

The Bhoomi project in the state of Karnataka was designed to computerize 20 million records of land ownership by 6.7 million farmers.

Problem:  To get a bank loan, a farmer had to obtain a copy of his RTC (Record of Rights, Tenancy, and Crops).  Before the Bhoomi project, RTCs were available only from the Village Accountant:

“In the manual system, land records were maintained by 9,000 Village Accountants, each serving a cluster of 3-4 villages. . . . Requests to alter land records (upon sale or inheritance of a land parcel) had to be filed with the Village Accountant. However, for various reasons the Village Accountant could afford to ignore these “mutation” requests. Upon receiving a request, the Village Accountant is required to issue notices to the interested parties and also paste the notice at the village office. Often neither of these actions was carried out, and no record of the notices was maintained. Notices were rarely sent through post.

An update to the land records was to be carried out by a Revenue Inspector, if no objections were received within a 30-day period. In practice, however, it could take 1-2 years for the records to be updated.

Land owners find it difficult to access the Village Accountant, as his duties entail traveling. The time taken by Village Accountants to provide RTCs has ranged from 3 to 30 days depending upon the importance of the record for the farmer and the size of the bribe. A typical bribe for a certificate could range from Rs.100 to Rs.2000.* If some details were to be written in an ambiguous fashion, out of selfish motives, the bribe could go up to Rs.10,000. Land records in the custody of Village Accountant were not open for public scrutiny.”   (Source: http://www1.worldbank.org/publicsector/egov/bhoomi_cs.htm  accessed 2-05)

• *100 Rs (Rupees) = about $2.20 and 2000 Rs = about $45.00.  While this amount seems small, it is important to remember that $45 is about 1/10 of India’s 2001 per capita GDP of $460, meaning that for most poor farmers, it is a significant expense.

Project:  Set up computerized “Bhoomi Centers” to reduce costs by increasing the efficiency of titling and title transfer and by eliminating opportunities for corruption.  Using a computerized kiosk, farmers can update information and get printed copies of their RTCs for about Rs.15.

“Today [2001], a computerized land record kiosk (Bhoomi centre) is operational in 140 of the 177 taluks in Karnataka. . . . A second computer screen faces the clients to enable them to see the transaction being performed. Copies can be obtained for any land parcel in the taluk by providing the name of the owner or the plot number. A Village Accountant is available full-time at these kiosks.”    (Source: http://www1.worldbank.org/publicsector/egov/bhoomi_cs.htm accessed 2-05)

Outcomes:

• One way that markets increase output is by facilitating the transfer of resources, like land, to their most productive uses. 
  • The computerized land record system generates reports on land ownership according to a variety of variables including size, type of soil, and crop record.  Such reports are valuable not only for government and policy personnel, but also in the land markets that are a key component in reducing rural poverty.
• One of the major costs of securing loans (getting copies of RTCs) has been reduced, and plans to provide banks and other financial lending institutions electronic access to the land record database should provide additional incentive for farmers to invest in increased production.
  • Besides a drastic reduction in bribery, the Bhoomi centers experienced an immediate 50% increase in the number of requests for change of title.  In the past, only the most persistent, or those able to pay the bribes completed the documentation of sales, trades, or inheritance of land.  The opening of the Bhoomi centers precipitated a flood of requests as the population updated changes that they had previously not documented.  Newly titled owners were thus able to transfer land and/or use the land for collateral.
• A similar project to computerize land registration offices in the state of Andhra Pradesh also has reduced the cost to farmers of securing title and honest valuations of their property.

“Land registration offices throughout Andhra Pradesh now operate computerized counters to help citizens to complete registration requirements within an hour instead of several days, as was necessary under the earlier system. The lack of transparency in property valuation under the old system resulted in a flourishing business of brokers and middlemen, leading to corruption.” (http://www1.worldbank.org/publicsector/egov/cardcs.htm  accessed 2-05)

(2012 update:  See website for Bhoomi project:  http://www.bhoomi.karnataka.gov.in/)

8.  Summary: 

• Successful anti-poverty efforts in developing countries like Peru and India validate predictions based on observing the history of western development since the Industrial Revolution:  human rights to property foster economic growth.
  • To be effective stimulants of economic growth, property rights must exist within a rule of law that offers reasonable expectations of stability and enforcement
  • Secure property rights to self and possessions release resources from protective to productive endeavors
  • Rights to private property promote economic growth by providing incentives to invest in future production, and facilitate such investment by acting as collateral for the assumption of debt.
  • The poor are burdened more heavily than the rich by the costs associated with ill-defined or insecure property rights, and stand to gain greatly from property rights reforms.

Conclusion     

Property rights and the rule of law are the essential foundation for economic progress and reductions in poverty.  From the natural right of individuals to the fruits of their own labor to the mundane expectation that the security of people’s homes, businesses, and possessions will be enforced, the capitalist institution of private property creates conditions conducive to economic growth and generates incentives that make growth likely to occur.

Throughout developing countries, lack of secure property rights founded on the rule of law denies the poor access to wealth-generating capital, robbing them of initiative and hope.  The life-giving importance of this institution is summed up in Hernando de Soto’s description of Cairo, a description that researchers are finding applies to much of the impoverished world:

When you step out the door of the Nile Hilton, what you are leaving behind . . . is the world of legally enforceable transactions on property rights.  Mortgages and accountable addresses to generate additional wealth are unavailable even to those people in Cairo who would probably strike you as quite rich.  Outside Cairo, some of the poorest of the poor live in a district of old tombs called “the city of the dead.”  But almost all of Cairo is a city of the dead – of dead capital, of assets that cannot be used to their fullest.  The institutions that give life to capital . . . do not exist here. (De Soto 16)

(See .doc download linked at top of screen for full lesson outline, including figures, source list, Appendix 1:  “Investigating the Relationship Between Property Rights and Economic Growth – Economists Study the the Amazonian Frontier of Brazil,” and Appendix 2:  “Selected Readings on Property Rights and Poverty”.)

Write a response to this statement: It is useless for governments to try to alleviate poverty and property rights should be lax, or carefree so that everyone has the opportunity to get property.