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SOUTH ASIAN ECONOMICS STUDENTS MEET, 29 NOVEMBER – 1 DECEMBER, 2010, UNIVERSITY OF COLOMBO, SRI LANKA
WELFARE AND SECURITY OF PROPERTY
An Exploration of Developing Economies
PRIYA BHATTER, UNIVERSITY OF MUMBAI, INDIA
One cannot deny the importance of welfare and development measures initiated by the state, especially in case of developing economies such as those in South Asia These development measures require the subjugation of the rights of individual property holders to the interest of “greater good.” However, security of property rights is a much needed component of economic freedom, which is essential to attract much needed private and foreign investment in these economies. This paper proposes to highlight the conflict between private ownership of property on one hand and state initiated welfare and development measures on the other, by using conditions of Pareto optimality. This paper also proposes to develop a regression model correlating security of private property to social welfare
or destroy the property. or give their property as long as their actions do not violate the identical rights of others3. sell. etc.” This may include patents.. intellectual property rights form a part of property rights in general. copyrights. American Economic Review 3 James Gwartney and Robert Lawson et al. mortgage. This will enable them to make economic decisions which are best for them. exchange. Hence. produce. The securing of private property rights therefore provides individuals with the opportunity to engage in trade and other activities which they believe will make them better off. therefore.” —Ludwig Von Mises 1 Property is traditionally defined as any physical or intangible entity that is owned by a person or jointly by a group of persons.INTODUCTION: ORIGIN AND EVOLUTION OF IDEAS “The program of liberalism. and/or to exclude others from doing these things. that is. Toward a Theory of Property Rights. 3rd revised edition(1966) Harold Demsetz. private ownership of the means of production. Although it has not been given a large amount of significance in earlier economic phenomena. individuals in an economically free society would be entitled to work.. these rights are essential in order to provide economic freedom to the people. All the other demands of liberalism result from this fundamental demand. under a rule of law. rent. Individuals have economic freedom when property they acquire without the use of force. 1 2 Ludwig von Mises. if condensed into a single word. exchange. Human Action: A Treatise on Economics. would have to read: property. an index of economic freedom should measure the extent to which rightly acquired property is protected and individuals are engaged in voluntary transactions. transfer. or theft is protected from physical invasions by others and they are free to use. consume and invest in any way they please. fraud. In other words. Depending on the nature of the property. with their freedom both protected and respected by the state. an owner of property has the right to consume. Hence. with due backing and protection provided by the state. Economic Freedom of the World: (1996 Annual Report) 2 .2 Intellectual property is “property that derives from the work of an individual's mind or intellect. Hence an economically free individual is empowered to take decisions solely on consideration of his profit.
the Noblest Triumph: Property and Prosperity through the Ages (1998).6 Economists like Marx focused on the denunciation of private property. but the idea has lost much of its significance in the current scenario.4 The classical economists like Adam Smith assumed its existence as a given condition in the economy. Whether they thought private property was a sine qua non of a free society. in his definition of property. as it allows individuals to engage in trade and production activities which they believe will make them better off. classical economists. An Inquiry into the Nature and Causes of the Wealth of Nations (1937) 6 Hans Herman Hoppe . or at any rate they care for it only to the extent to which each is individually concerned.Worldly philosophers (1999) Adam Smith. Heilbroner .The ethics and Economics of Private Property (1996) 7 Tom Bethell.The Idea of property rights is not new. accorded a central position to the role of property rights or the “relations of production” in the process of economic development. the level of protection provided to private property rights can be viewed as the extent of institutional freedom provided to individuals in order to develop to their fullest potential John Locke includes the individual’s ownership of himself and the land (resources) he mixed his labour with or traded for. 5 3 . p. Hence protection of private property rights helps to improve the productive efficiency in the economy. It also incentivizes users to economize their costs because it is they who ultimately bear the costs of their actions. Adam Smith explicitly states that the expectation of improving one’s stock of capita. as it is an important prerequisite of development. or organised theft. 95.”7 Protection of private property leads to increase in productive efficiency. is what results in efficient allocation of resources. 5 As efficiency is invariably linked with growth in the traditional ideas of development. from Adam Smith (1776) to Karl Marx (1891). Improvement of efficiency is especially important in developing countries. THE CASE EOR PROTECTION OF PRIVATE PROPERTY IN DEVELOPING NATIONS “Private property is the most important guarantee of freedom —Friedrich A. although the same might not be said about the distributive efficiency. Hayek “What is common to the greatest number gets the least amount of care. 4 Robert L. Men pay most attention to what is their own. they care less for what is common.
there will not be the same grounds for quarrels. An individual will not invest or try to increase his stock of capital by productive means.”8 This is essential in order to reduce clashes between different interest groups. The property rights index is calculated with reference to legal protection available. achieve a higher level of per capita GDP and longer life expectancies. for the years 2008 and 2009. Although government investment does have a significant impact on the level of economic growth. unless he is secure in the knowledge that he will be able to enjoy the fruits of his labour. Also “It is has also been empirically observed that countries which encroach lesser on the property rights of its citizens. Under conditions of a free market economy.(PRA) 4 . and the amount of Interest will increase.The institute is devoted exclusively to the study of property rights.”9 Consider the following studies conducted by the property rights alliance.With the failure of communism and Keynesian macroeconomic management programs in the late 20th century. 8 9 Hans Herman Hoppe The ethics and Economics of Private Property (1996) International property rights index report (2009). especially in countries with people from diverse social. economic and religious strata. It is a universally acknowledged fact that the degree of protection of property provided to individuals influences the level of foreign direct and institutional investment flowing into the economy. “Private property prevents conflict and promotes peace. a rough observation of the world tends to confirm the importance of private property and economic development. with 10 being the highest and 0 being the lowest value. The institute ranks countries in the basis of their property rights index. Protection of property rights also encourages domestic investment. Modern market economies rely on collateral to support a variety of financial market transactions and improving property rights may increase productivity by enhancing such possibilities. it must be counterbalanced by private autonomous investment in order to make the growth process self sustaining in the long run. The values of the index lie between 0 and 10. because each man will feel that he is applying himself to what is his. security of property also helps in supporting other transactions. When people have their own separate domains of interest. Property rights alliance. Also. protection of physical property and protection of intellectual property rights.
we can also look at the correlation between IPRI and Per Capita GDP as given below: Exhibit 3 Correlation between GDP and IPRI R Value 0.613981 R2 0. in descending order.309 $3. 3 4 5 quintiles Top 20 percent Second quintile Third quintile Fourth quintile Bottom 20 percent The countries are divided into quintiles Average per capita GDP (2008) $35.748 $4.924 $5.991 $23. International property rights index (IPRI) 1. The above table clearly demonstrates that the countries enjoying a higher level of protection of private property also have a higher average per capita GDP.029 $8. “When 10 I have considered 5 countries from each quintile. especially in developing countries becomes intellectually compelling.The average per capita GDP for all the countries in each quintile is computed. According to Tom Bethel in The Noblest Triumph. 10 Exhibit 2 Correlation between IPRI and R value 0.Exhibit 1 No.982 $11. .3332 An R2 value close to 0. 2. I have taken available data from the human development report and the IPRI index to obtain a correlation between the two. Also IPRI index values are obtained from the IPRI reports(2009).and the HDI and GDP per capita are obtained from the world Development report( (2009) 5 .3770 Again we can observe a moderately high correlation between HDI and IPTI (R2 nearly equal to 0. Similarly.57725 HDI R2 0. using random numbers so that the R value does not get affected by the specific values.891 $4.638 $19.341 on the basis of their property rights index.3 indicates a moderate positive relationship between the two variables. HDI and IPRI. Hence it becomes essential for developing countries to view the security of private property with respect to an increase in per capita GDP Also consider the correlation obtained between the IPRI (International Property Rights Index) and the HDI (Human Development Index) for the year 2009.817 Average per capita GDP (2009) $39.4) Hence the case for protection of private property rights.
Governments also need to invest heavily in the development of social and economic infrastructure. as the state has the responsibility of ensuring the well being of its citizens. the state can also take over common property and natural resources.A. These countries are deficient in infrastructural facilities and heavy industries. the state has the inherent power to seize a citizen's private property.” THE IMPORTANCE OF DEVELOPMENT PROJECTS AND THE USE OF EMINENT DOMAIN IN DEVELOPING NATIONS There exists a special need for large scale government spending on welfare and development schemes in developing countries. but without the owner's consent for public purpose and /or public welfare. Hence the state can appropriate private property of the individuals citing eminent domain. roadways.property is privatized. Hence the governments in developing countries may need to encroach on individual private property rights (including Intellectual Property) in order to fulfil their desired developmental objectives. schools. or seize a citizen's rights in property with due monetary compensation. Large scale government spending on welfare schemes is a norm in the modern social welfare state. power-plants etc. The government may also wish to use certain technological innovations to build such projects. however.11 While due monetary compensation is required in case of encroachment of private property. highways. dams. 11 R. bridges. Epstein. According to the theory of eminent domain. economic infrastructure typically includes railways. require large amounts of land. It is the availability of such infrastructure facilities which enables the economy to function smoothly and which induces private autonomous investment. The Economics and Ethics of private property (1985) 6 . The growth of these two sectors is extremely essential in order to induce growth and development of the economy as a whole. simply by declaring it as state property. The development of the above mentioned infrastructure projects. hospitals. and the rule of law is established in such a way that all including the rulers themselves are subject to the same law. primary healthcare centres. economies will prosper and civilization will blossom. Pioneering research and development in the field of healthcare may also be used by the government in order to provide life saving drugs and other essential medical amenities to the people. While social infrastructure typically consists of medical facilities. etc.
We construe public purpose to be the development of facilities in order to enable individuals to fully realize their potential. Section 299 of the Government of India Act. was later removed from that chapter and put into a separate part (Article 301). 1935 and the Universal Declaration of Human Rights (1948). the pursuit of “unbridled self interest” turns individuals against the “common good. A duty is implicit in this right. or in political and economic literature. STATUS OF PROPERTY RIGHTS IN INDIA The right to property is often derided as the least defensible right in the Indian constitution. in this way. 12 13 P Nichols. According to article 31. the development of the economy as a whole rather than the aggregation of private gain are to be given importance. also recognises the right to private property.”12 The theory of eminent domain emphasizes the need for collective development i. Hence. in accordance with public interest. It must be mentioned here. to hold and dispose off property. eminent domain can be used for both public and private benefit.According to Hobbes. Private property and the power of eminent domain(1999) 7 . Hence this right should be reasonably exercised. power plant or any other project which could generate significant levels of employment and other benefits to the people. The law of eminent Domain (1917) Richard Epstein. The Constitution of India derives its foundation from the Government of India Act. every citizen has the individual right to acquire. Article 17 of the Universal Declaration of Human Rights (1948).e.” which was originally in the chapter of fundamental rights.13 In recent years however. 1935 secured the right to property and contained safeguards against expropriation without compensation and against acquisition for a non-public purpose. that the exact nature of public purpose has never been clear either in uses of eminent domain by various governments across the world. The provision regarding freedom of “trade and intercourse. to which India is a signatory. and is now a legal right. For example a private company may take over land using eminent domain in order to build a bridge. namely that it should be so reasonably exercised as not to interfere with similar rights of other citizens. several governments have allowed property to be acquired for a private company which is engaged in or is taking steps for engaging itself in any industry or work for a public purpose.
In fact. not less than the right to speak or the right to travel is in truth a ‘personal’ right. The state also has the power to acquire the land of a citizen for a public purpose after paying due and adequate compensation. It is subject to the law of reasonable restrictions in the interest of the general public.The Directive principles of state policy lay down the fundamental principles of state policy and the governance of the country. The state’s power is also subject to the condition that the law made by it in so far it infringes the said fundamental right should stand the double test of reasonableness and public interest. 14 “Property Rights under the Constitution” (1969) Also. the state is directed to ensure that the ownership and control of the material resources of the community are so distributed as best to subserve the common good and that the operation of the economic system does not result in the concentration of wealth and means of production to the common detriment. the state in exercising the power to enforce this principle does in fact enforce the duty implicit in the exercise of the fundamental right. and hence welfare. a home or a savings account. That rights in property are basic civil rights has long been recognised. Hence there exists a conflict between the two paths towards economic development: The path of state planning and development schemes and the path of free-market economy with emphasis on the protection of private property rights and improvement in efficiency.14 THE CONFLICT While the advocates of Property rights believe that. nor can one deny the importance of eminent domain as an important tool in achieving that objective. a fundamental interdependence exists between the personal right to liberty and the personal right in property. Indeed. Sushant Saliant: The History of the Removal of the fundamental Right to property (article). political review 8 . “The dichotomy between personal liberties and property rights is a false one. and through the relevant principles. Neither can one negate the need for developmental schemes undertaken by the state. The conflict between the citizen’s right and the state’s power to implement the said principles are reconciled by putting limitations both on the right and the power. The said fundamental right is not absolute.. whether the ‘property’ in question be a welfare cheque. The right to enjoy property without unlawful deprivation. Property does not have rights. Neither could have meaning without the other. People have rights.”19 Moreover the right to property as shown above is an essential condition for attracting economic development and economic growth.
but after due evaluation of the cost and benefits of the proposed project. especially those in South Asia. Care must also be taken to ensure that the benefits obtained from the development measures must reach the individuals whose property has been expropriated. I propose to do so by using the Pareto optimality welfare criterion. Another fact which must be considered is that expropriation does not take place arbitrarily. the decision regarding the comparison of utilities can be analysed with the help of economic models. THE PARETO OPTIMAL CRITERION The Pareto optimality criterion was developed by the Italian economist Vilfredo Pareto.l. Ahuja . The inherent problems in the above are the problem of holdouts and the fact that there might be differences in the value of the property to the developer/state and the citizen. The increase in overall social welfare must not be at the cost of those who sacrifice their right to property. An allocation is defined as Pareto efficient or Pareto optimal when no further Pareto improvements can be made. Given a set of alternative allocations of goods or outcomes for a set of individuals. must be able to reconcile the differences between the two paths. The increase in utility/development achieved by the expropriation should not be offset by a loss in utility/development caused due to a loss of faith in the state because of its inability to secure property rights. While the decision regarding the appropriateness of the need for expropriation is one of policy.Economics 9 . Foundations of economic analysis 17 H. This can be done by providing due and adequate compensation to the holders of titles. a change from one allocation to another that makes at least one individual better off without making any other individual worse off is called a Pareto improvement or a Pareto-optimal move.15 Exhibit 4 Community A’s private property rights 15 Samuelson. whose property has been expropriated.However modern developing economies.
where community B prefers development Schemes over protection of property rights. by choosing different combinations of the level of protection of private property rights and expropriation of property through eminent domain. Also let IC2. becomes indifferent between the two. however at the given levels of compensation. but with the loss in economic growth due to loss of economic freedom. is indifferent between the two. A single community reaches equilibrium when its costs are equal to its benefits i.e. Let the indifference curves IC 1. 10 . This can be obtained by combining the cost ratios and indifference curves of each community. IC4. IC5 represent the indifference curves of community A. the cost ratio in terms of loss in development in both cases equals the marginal rate of substitution between the two choices available.Commu nity A’s expropri ation Com munit y B’s expro priati on Community B’s private property rights Consider the Edgeworth box given above. The different indifference curves indicate the different levels of development which an economy reaches. where community A prefers protection of private property rights over development schemes. IC3. represent the indifference curves of community B. IC6 .
The Marginal Rate of substitution between security of private property and expropriation will be the same for both the communities. The points on the curve AB represent the Edgeworth contract curve. where the two communities A and B prefer the same combination of security of private property rights and expropriation through eminent domain. 6 represent the costs to community A.) As at all point on the contract curve. which is the locus of all such points. 3. Moreover at any point outside the contract curve.(This is given by the points where the two indifference curves are tangent to each other. 11 . the welfare of either community can be increased. 4. while curves 2. Curves 1. without decreasing the welfare of the other. 5 represent the costs at different levels of development to community B.Equilibrium in the economy is reached when the two communities are in agreement about the level of protectionism and expropriation. we can say that a Pareto efficient condition might be obtained along the curve AB. let us consider the following diagram: Exhibit 5 Community A’S loss in development due to lack of state initiative Comm unity A's loss in develo pment due to loss in Commu nity B’s loss in develop ment due to lack of freedom Community B’s loss in development due to lack of state initiative The diagram given above represents the costs (in terms of loss in development) to both communities A and B in case of expropriation and lack of freedom. by shifting to a point on the contract curve Further.
12 . Now. Equilibrium for the economy is obtained at the points where the costs to both communities are the same.i.Equilibrium for a single community is obtained when the ratio of the costs in terms of loss in development due to lack of freedom and lack of state initiative are the same as the ratio of the availability of these 2 factors. as the benefits received . Hence curve CD represents the point at which the communities are in equilibrium. at the locus of the points of tangency of the 2 curves. The Marginal rate of technical substitution must equal the cost ratio for the factors for the community to be in equilibrium. The frontier will tend to shift outward with an increase in efficiency and improvement in economic stability. the Pareto optimal situation can be explained as follows: Consider the diagram given below Exhibit 6 E x p r o p r i a t i o n Private property rights The production possibility frontier represents the equilibrium mentioned in exhibit 5. Each point on this frontier represents the level of development that can be achieved by using expropriation and security of private property.e.
At this level of development. the assumption of long run.e. Similarly.e. The Pareto optimal situation occurs at point B. as price and cost uniformity exists only in perfect competition. Third. the cardinalist assumption i. the level of property rights. Fifth. The discussion on the level of development is based on the level of utility attained by the two communities from the development process. A and B. utility obtained from development) are measurable quantities. And finally. Fourth. security of property rights and eminent domain for the 2 communities A and B. given all other factors in the economy. the economy consists of only 2 communities. the level of expropriation and the level of development (i. the demand for the 2 cannot be mutually exclusive. Second. all other factors in the economy remain constant i.The equilibrium combination of security of property rights and expropriation can be achieved by superimposing the Edgeworth box in exhibit 4. ceteris paribus. Both the communities A and B need both protection and appropriation. the utility can be measured. for community B.e. as the equilibrium positions will only be obtained in the long run. the assumption of perfect competition in the economy holds Pareto optimality criterion cannot be explained without the assumption of perfect competition. the government will be able to ensure OQ level of freedom of property rights and will take OT level of land for expropriation. Hence we can arrive at an equilibrium combination of both the factors i. ASSUMPTIONS While trying to explain the above situation the following assumptions are to be considered. First. it becomes essential to ensure that the level of compensation given to those whose property is being expropriated is such that their 13 . where the efficient combination of the two factors for the communities A and B are equal to the rate at which the economy can substitute security of private property rights with expropriation in order to secure the objective of development. In case of development using eminent domain. Sixth. which represents the efficient combination of the two factors in question. Therefore. Community A will have RT level of expropriation and QS level of property rights.e.
K. very carefully. Davis. Hence governments. in order to realize their goals of development. The index of economic freedom and economic growth in: Holmes. and Lee Hoskins. B. O’Driscoll Jr. capitalism and freedom 2002) 14 . 1998 Index of Economic Freedom Heritage Foundation Wall Street Journal. if you want knowledge to be properly utilized. Adam Smith. I conclude my paper by stating: “The protection of private property is essential as: Nobody spends somebody else's money as carefully as he spends his own. G.welfare does not decrease ( i. Beach. Holmes. M. DC 3. (2002) Economic Freedom of the World: 2002 Annual Report.”16 However.W. So if you want efficiency and effectiveness. Gerald Driscoll. especially those in developing countries must tread the knife edge path between protection and expropriation... The effectiveness of the project in increasing the level of development must be viewed with reference to the level of disutility suffered by those whose rights have been encroached upon. R. Protection of a few should not be favoured over the objective of overall development of society. J.. The essence of the matter lies in an appropriate combination of both protection and expropriation. Washington. Vancouver..e. Canada: The Fraser Institute. Gerald P. REFERENCES 1. Cato Institute. while development which tramples on individual economic freedom will do greater harm than good. W.T. Gwartney. Property Rights a key to Economic Analysis. and O’Grady. and Lawson. Johnson. International Monetary 16 Milton Freidman. 1998. Hence stringent decision making criterion should be applied to each development project under consideration. you have to do it through the means of private property.R. an Inquiry into the Nature and Causes of the Wealth of Nations (1937) 2. Nobody uses somebody else's resources as carefully as he uses his own. Hence just compensation is essential in order to achieve a balance between expropriation and protection. they are not made worse off) while the overall welfare in question increases ( by making other people better off). the importance of the” greatest good for the greatest number” cannot be denied. Kirkpatrick. (2002) Index of Economic Freedom Washington DC: Heritage Foundation and Dow Jones & Co 4. K. Policy Analysis 5.
(2008). Sushant Saliant: The History of the Removal of the fundamental Right to property. James Gwartney and Robert Lawson et al.worldbank. Epstein. Human Action: A Treatise on Economics. the Mystery of Capital. Heilbroner.worldbank. Louis Kaplow and Steven Shavell. Hans Herman Hoppe. De Soto. Cooperation. American Economic Review 8.org/data 15 . Milton Freidman. Ludwig von Mises. the Benefits of Economic Freedom. American Law and Economics association. www. Robert L. The economic freedoms of the world index http://www. Toward a Theory of Property Rights. Property Rights under the Constitution (1969) 16 . 20. Aspects of Public Expenditure Theories 19. Private property and the power of Eminent Domain (1985) 17. 1999 12. World Bank. Hernando.A. political review 22. American Economic Review. Vol.6. The conflict between notions of fairness and the Pareto principle. Samuelson. the Independent Review. Tom Bethell.17-77 14. The Noblest Triumph: Property and Prosperity through the Ages (1998). “The relation between Economic freedom and political freedom” p. 2009. Samuelson. 83. Nicholas Berggren. Capitalism and freedom. The ethics and Economics of Private Property (1996) 7. (2007) Property rights alliance. 3rd revised edition (1966 13. 95 25. available at http://www. International property rights index report (2009).heritage.org/index/ 23.R. Economic Freedom of the World: 1996 Annual Report 11. Foundations of Economic Analysis. Conflict and power in the absence of property rights. Harold Demsetz.org/data/ 24.2003 15. p. Worldly philosophers (1999) 18. 1992 21.imf. World Development Indicators Online. Finance and Development (2001) IMF. (PRA) 10. Sturgis Skaperdas.org/external/pubs/ft/fandd/2001/03/desoto.World Bank http://www.htm 9. The world development indicators.
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