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Property Rights: The Key to Economic Development, Cato Policy Analysis No. 482

Property Rights: The Key to Economic Development, Cato Policy Analysis No. 482

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Published by Cato Institute
Executive Summary

Prosperity and property rights are inextricably

linked. The importance of having well-defined

and strongly protected property rights is

now widely recognized among economists and

policymakers. A private property system gives

individuals the exclusive right to use their

resources as they see fit. That dominion over

what is theirs leads property users to take full

account of all the benefits and costs of employing

those resources in a particular manner. The

process of weighing costs and benefits produces

what economists call efficient outcomes. That

translates into higher standards of living for all.



It is only in the last few decades, however, that

economists have accepted the importance of

property rights. Throughout much of the history

of modern economics, the subject was given

short shrift. Even stalwart supporters of the market

economy glossed over the subject. Not surprisingly,

much bad development policy resulted

from that neglect. Even if policymakers in developed

countries and international institutions

now recognize the critical role played by a system

of private property in economic development,

they are limited in what they can do to help

developing countries evolve such a system.

Policymakers can, however, avoid recommending

policies that undermine private property.
Executive Summary

Prosperity and property rights are inextricably

linked. The importance of having well-defined

and strongly protected property rights is

now widely recognized among economists and

policymakers. A private property system gives

individuals the exclusive right to use their

resources as they see fit. That dominion over

what is theirs leads property users to take full

account of all the benefits and costs of employing

those resources in a particular manner. The

process of weighing costs and benefits produces

what economists call efficient outcomes. That

translates into higher standards of living for all.



It is only in the last few decades, however, that

economists have accepted the importance of

property rights. Throughout much of the history

of modern economics, the subject was given

short shrift. Even stalwart supporters of the market

economy glossed over the subject. Not surprisingly,

much bad development policy resulted

from that neglect. Even if policymakers in developed

countries and international institutions

now recognize the critical role played by a system

of private property in economic development,

they are limited in what they can do to help

developing countries evolve such a system.

Policymakers can, however, avoid recommending

policies that undermine private property.

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Published by: Cato Institute on Mar 26, 2009
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Prosperity and property rights are inextrica-bly linked. The importance of having well-defined and strongly protected property rights isnow widely recognized among economists andpolicymakers. A private property system givesindividuals the exclusive right to use theirresources as they see fit. That dominion overwhat is theirs leads property users to take fullaccount of all the benefits and costs of employ-ing those resources in a particular manner. Theprocess of weighing costs and benefits produceswhat economists call efficient outcomes. Thattranslates into higher standards of living for all.It is only in the last few decades, however, thateconomists have accepted the importance of property rights. Throughout much of the histo-ry of modern economics, the subject was givenshort shrift. Even stalwart supporters of the mar-ket economy glossed over the subject. Not sur-prisingly, much bad development policy resultedfrom that neglect. Even if policymakers in devel-oped countries and international institutionsnow recognize the critical role played by a systemof private property in economic development,they are limited in what they can do to helpdeveloping countries evolve such a system.Policymakers can, however, avoid recommend-ing policies that undermine private property.
 Property Rights
The Key to Economic Development
by Gerald P. O’Driscoll Jr. and Lee Hoskins
_____________________________________________________________________________________________________
Gerald P. O’Driscoll Jr. is senior fellow at the Cato Institute and Lee Hoskins is senior fellow at the Pacific Research Institute.
Executive Summary
No. 482August 7, 2003
 
Why Property Rights?
The excuses for development failure arelegion: lack of natural resources; insufficientfunding of education, culture, religion, andhistory; and, recently, geographical location.As Friedrich Hayek, Nobel laureate in eco-nomics, taught us in another context, wecannot explain success by examining failure:“Before we can explain why people commitmistakes, we must first explain why theyshould ever be right.”
1
The question that we need to ask is whyshould nations prosper? We argue that thedifference between prosperity and poverty isproperty. Nations prosper when private prop-erty rights are well defined and enforced.
The Wealth of Nations
UCLA researchers Richard Roll and JohnTalbott provocatively titled a paper, “WhyMany Developing Countries Just Aren’t.”
2
Economic development has been exceptionalrather than typical. As Peruvian economistHernando de Soto points out, capitalism hasbeen successful mainly in the West.
3
Theresult is incredible disparities in living stan-dards around the world.Depending on the measure, real incomevaries across countries by a factor of morethan 100. In 2000, real per-capita GDP was$50,061 in Luxembourg and $490 in SierraLeone. Those figures are measured in pur-chasing power parity (PPP). Using 1995 con-stant dollars produces even more extremevariations across countries.
4
Differencesbetween neighboring countries can be huge.Depending on the income measure used, realper-capita GDP in the United States is aboutfour to eight times that of Mexico. Thesocioeconomic consequences of that differ-ence are huge and well-known. Conserva-tively measured, South Koreans have 17times the income of North Koreans. That dif-ference surely has something to do with thecurrent tensions on the Korean Peninsula.In the 1930s, the Finns and Estoniansenjoyed a similar standard of living. The twocountries are virtually neighbors. Their lan-guages share a common linguistic root, andthey are culturally similar and share manyvalues. (Despite being a Baltic country geo-graphically, Estonians consider themselves tobe a Nordic people.) Depending on the mea-sure employed, in 2000 the average Finnearned two and a half times to more thanseven times what the average Estonianearned. Fifty years of Communist rule surelyhad something to do with the gap in incomesthat opened between the two countries.In the past, substantial differences existedbetween the standard of living in East andWest Germany—two countries with essential-ly the same resources, education, culture, lan-guage, religion, history, and geography.
5
Whythe tremendous income differences?Hong Kong and Singapore are city states,almost completely lacking in naturalresources. They border much larger andpoorer neighbors. Hong Kong in particularexperienced long periods of immigrationfrom its poorer neighbor, mainland China.Yet both island nations sustained periods of annual growth of real per-capita GDP at 5percent for a long period. Singapore’s realper-capita GDP doubled from 1962 to 1971.
6
The real per-capita GDP of Hong Kong, a for-mer colony of Great Britain, now exceedsthat of the mother country ($25,153 vs.$23,509 at PPP in 2000). The paradoxesabound. Despite its own recent economicmiracle, China’s real per-capita GDP in 2000was still just under $4,000. Taiwan’s is over$17,000, more than four times China’s. (Bothmeasured in PPP.) Prof. Allan Meltzer hasrecently commented on these near-laborato-ry experiments in development:In each of these comparisons, cul-ture, language, and traditions are thesame. Outcomes are markedly differ-ent. The countries with capitalistinstitutions and the market systemgrew richer; the others faltered orwent backwards. A South Korean
2
Nations prosperwhen privateproperty rightsare well definedand enforced.
 
now lives on an average incomeabout equal to average incomes inthe United States in 1945. His NorthKorean cousin, if he manages to sur-vive, exists by eating roots and grass.My colleague Nick Eberstadt pointsout how much diet and living stan-dards matter: seven-year-old SouthKorean boys are 8 inches taller thanNorth Korean boys.
7
Actual, historical economic developmentof countries cannot be explained by the pres-ence or absence of natural resources. Re-sources are neither necessary nor sufficient fordevelopment. Development has occurred ininhospitable circumstances, and
lack of 
devel-opment has occurred in countries rich in nat-ural resources. Oil’s “curse” is well known.
8
Real per-capita income in Saudi Arabia is afraction of what it once was. Nigeria, an oilproducer, is categorized as a highly indebtedpoor country. And, Argentina, rich in naturalresources including oil, has recently experi-enced a long recession due to its bad policiesand defective institutions.
9
In their empirical studies, economists cor-relate output with investment capital,human capital, and productivity.
10
Empiricalrelevance aside, there is a fatal conceptualflaw in this approach. Both sides of the equa-tion are measuring the same thing:The left side measures a flow fromwealth, while the physical andhuman capital variables on the rightside measure the stock of wealth.Obviously, if one regresses wealth onwealth plus some “true” determinantof wealth, the latter doesn’t havemuch opportunity to be detected assignificant.
11
It is no wonder then that institutionaldeterminants of growth have been neglected.Even when included in empirical studies,they compete against wealth in explainingeconomic growth. The modeling of thegrowth process has obscured it.Our paper is not intended to be a review of the empirical development literature. Rolland Talbott do a nice job of that.
12
Our focusis on what does matter for growth: privateproperty. We do take note of the empiricalresults in Roll and Talbott, however.Roll and Talbott find that nine institu-tional variables explain over 80 percent of theinternational variation in per-capita grossnational income, with property rights (+) andblack market activity (-) having the highestlevels of significance. The other variables areregulation (-), inflation (-), civil liberties (+),political rights (+), press freedom (+), govern-ment expenditures (+), and trade barriers (-).We commend their paper to the reader whowants more details on the empirical findings.Before turning to the conceptual case forproperty rights as the primary determinant of economic growth and development, we ask why property rights had come to be neglectedin the economic literature. We cannot simplyblame economists’ models, but must examinetheir theoretical underpinning.
The Economists’ Oversight
In his book on the history of property rights,Tom Bethell examines the neglect of propertyrights in the economic literature. He concludesthat the existence of private property was a pre-sumption that underlay the work of the classicaleconomists. Its absence was unthinkable, so itsimportance went undefended. As he put it, “inthe Great Britain of Adam Smiths day, criticismof private property hardly ever found its wayinto print.”
13
Richard Pipes agrees: “If the glori-fication of private property reached its apogee inEngland, where it enjoyed the support of a largebody of private owners, it first came underfrontal assault in
ancient regime
France.”
14
Adam Smith did not neglect propertyrights in his legal work. The first lecture in hisfirst series of lectures on jurisprudence began:The first and chief design of everysystem of government is to maintain justice: to prevent the members of 
3
By the middle othe 19th century,private propertywas underintellectualattack.

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