Property Rights Institutions in Development

Property Rights Institutions in
Development
Chapter FIVE
1
Outline
This chapter covers
1. Property rights basic concepts
2. Property rights theory
3. The economic role of property rights
2
Property rights: Basic concepts
Property
 Many people regard property as a tangible ‘physical object’
Institutional economists use a different conceptual
language
 Property is considered as a “benefit (or income) stream” in

that the owner controls this benefit stream (Bromley1991)
 Something is “property” if it has value to someone after

costs are considered
3
Right…
……A right may be a ‘set of actions and behaviours that
possessor of a property may not be prevented from
undertaking, or a duty on all others to refrain from preventing
those actions or behaviours’
4
Property Rights?
 Property Rights, are the social institutions that define or

delimit the range of privileges granted to individuals to
specific resources, such as parcels of land or water.
 “Rights individuals appropriate over own labour and goods

and services they possess
 Right to exclude non-owners from access;
 Right to appropriate the stream of economic rents; and
 Includes rights to trade property
 Property rights - legal rights to use an economic property

(resource) and to derive income and benefits from it
5
 Property rights to a resource are social and institutional
arrangements by which individuals are aware of what parts of
the resource are their and others’ property, what
duties are imposed on them and upheld by the state
(Bromley 1991)
 Property rights define: “who has access to which resources

or benefit streams and under what conditions”
(Vatn 2005).
6
Property regimes:
 Private: private, individual
 Common: as a private of a group of co-owners
 State (public): held and managed by the government
 Open access: no property
7
Property Regimes
PRIVATE COMMON
OPEN ACCESS STATE
8
Private Property rights
Basic
 Assigns ownership to individuals-Individual or “legal
individual” holds rights
 Guarantees those owners control of access and the right to
bundle of socially acceptable uses
 Requires owners to avoid specified uses deemed socially
unacceptable
 Private ownership may lead to most efficient resource use
and management
 Private ownership must be consistent with the social norms
and traditions of the society and then they could work
9 appropriately
Private property rights
Advantage
 Private PRs can decrease transaction costs

 Private PRs have low administration costs & minimize
government price intervention
 Private PRs adjust automatically to market changes
10
Common property rights
 A “commons” a community-
managed resources whose use
is shared by members
 Common property vs.
 open access resources
 communal land tenure
 Two key factors in analysis of common property:
 Tenure (the group right)
 Management (institutions)
11
Common property rights…
 They could be defined as private rights to a group of co-
owners(Bromley1991)
 Membership in group is limited by legally recognized and
practically enforceable rights
 Common property rules and resource use can break down if
defined group grows too large or there is significant technical
change
12
Property Rights Theory
Property rights theory includes:
 Libecap (1989): Contracting for Property Rights
 North (1990): Institutions, Institutional Change and

Economic Performance
 Eggertsson (1990): Economic Behavior and Organization
 Hart (1995): Firms, Contracts and Financial Structure
13
Libecap (1989): Contracting for Property
Rights
 Libecap (1989) maintains that property rights are formed and
enforced by political entities, and that property rights reflect
the conflicting economic interests and bargaining
strengths of those affected.
 Property Rights, are the social institutions that define or

delimit the range of privileges granted to individuals to
specific resources, such as parcels of land or water.
 Right to exclude non-owners from access;
 Right to appropriate the stream of economic rents; and
14 Right to sell or otherwise transfer the resource to others.
Rights
 Property rights institutions range from formal arrangements,
including constitutional provisions, statutes, and judicial
rulings, to informal conventions and customs regarding the
allocations and uses of property.
 Such property rights institutions critically affect decision

making regarding resource use and, hence, affect economic
behavior and economic performance.
15
Rights
 Property rights institutions are determined through the
political process, involving either negotiations among
immediate group members or lobbying activities
that take place at higher levels of government.
 The political process of defining and enforcing property

rights can be divisive because of the distributional
implications of different property rights allocations.
16
Rights
 Pressures to change existing property rights can emerge from
the following factors:
 Shifts in relative prices;
 Changes in production and enforcement technology;

and
 Shifts in preferences and other political parameters.
17
Rights
 All else being equal, the greater the size of the

anticipated economic benefits of institutional change,
the more likely new property rights will be sought and
adopted
…because it is more likely that a politically acceptable share
arrangement can be devised by politicians to make enough
influential parties better off so that institutional change can
proceed.
18
Rights
 The larger the number of competing interest groups,

the more likely distributional conflicts will block or
delay institutional change
…because the greater the number of competing interest
groups with a stake in the new definition of property rights,
the more that claims must be addressed by politicians in
building a consensus for institutional change.
19
Rights
 The greater the heterogeneity of competing interest
groups, the more likely distributional conflicts will block or
delay institutional change.
 Important differences across the parties in information

regarding the resource, as well as in production costs,
size, wealth, and political experience, will make the
formation of winning political coalitions, and a
consensus on the proposed assignment or adjustment
of property rights more difficult.
20
Rights
 Distributional conflicts will be intensified if there are known
serious information asymmetries among the competing
parties regarding the evaluation of individual claims.
 These distributional conflicts will occur quite aside from

any strategic bargaining efforts if private estimates of
the economic value of current property rights and of
potential economic losses from the new system cannot
be conveyed easily or credibly to politicians and the
other bargaining parties.
21
Rights
 The greater the concentration of wealth under the proposed

property rights allocation, the greater the likelihood of
political opposition and the less likely institutional change will
be adopted without modification by politicians.
 In these circumstances, enough influential parties may

see their economic welfare made worse, or at the least
not improved, by the change that political support for
such change does not materialize.
22
Rights
 The failure of gold mining in many parts of Ethiopia, despite
well-recognized and significant aggregate economic gains from
unitizing gold mining, is an exemplar of how asymmetric
information and distributional conflicts over rental shares can
limit the adoption of property rights to reduce common pool
losses.
 To assert that property rights will evolve to achieve efficiency
seems to gloss over much of the impediments that can block
institutional change in under-developed countries, for example.
23
North (1990): Institutions, Institutional Change
and Economic Performance
 North (1990) abandons the efficiency view of institutions,

which he himself promoted in the 1970s, and maintains that
rulers devise property rights in their own economic
interests and that positive transaction costs result in the
persistence of inefficient property rights.
 As a result, it is possible to provide an account for the

widespread existence of property rights throughout history
(and in the present) that did not produce economic
growth.
24
 The inability of societies to develop effective, low-cost

enforcement of contracts is the most important source of
both historical stagnation and contemporary
underdevelopment in the third world.
 Enforcement in the third world economies is uncertain not

only because of ambiguity of legal doctrine (a measurement
cost) but also because of uncertainty with respect to the
behavior of the judicial system.
25
 Contrasting the institutional framework in countries such as

the United States, England, France, Germany and Japan with
Third World countries makes clear that the institutional
framework is the critical success factor of economies both
cross-sectionally and through time.
 The institutional framework shapes the direction of the

direction of the acquisition of knowledge and capabilities,
and that direction will be the decisive factor for the long-
run development of that society.
26
 Property rights and economic incentives are the underlying

determinants of economic performance.
 One gets efficient institutions by a polity that has built-in

economic incentives to create and enforce efficient property
rights.
 Path dependence is the key to an analytical understanding of

long-run change in property rights.
27
Eggertsson (1990):
Economic Behavior and Institutions
 Property rights to a resource are often partitioned.
 For example, in the case of land, person A and person C

may possess the right to dump ashes on the land, person
A and person B may possess the right to grow wheat on
the land. Person D may possess the right to fly an airplane
over the land.
 And each of these rights may be transferable. In sum,

private property rights to various partitioned uses of
land are “owned” by different persons.
28
Eggertsson (1990):
 Harold Demsetz’ “Toward a Theory of Property

Rights” in the American Economic Review offers an
optimistic theory of property rights: “Property rights
develop to internalize externalities when the gains of
internalization become greater than the cost of
internalization” (1967).
29
Eggertsson (1990):
 Characteristic of this optimistic view, the formulation of
decision making with regard to property rights is solely
in terms of private benefits and private costs. The theory
does not deal with the free-riding problems that plague
group decision, nor is there any attempt to model the
political process.
30
Eggertsson (1990):
 Maintains that one of the first steps to modify the optimistic
model of property rights involves linking this model to the
“interest-group theory of property rights,” legislation and
government.
 Property rights, which serve the narrow self-interest of

special interest groups but cause substantial output losses to
the community as a whole, are explained in terms of
transaction costs, free-riding, and asymmetric information.
31
Eggertsson (1990):
Concludes (along with North, 1990) that there is

overwhelming historical evidence to support the proposition
that states appropriate structures of property rights are
needed to reduce transaction.
32
Hart (1995):
Firms, Contracts, and Financial Structure
 Because contracts are incomplete, the ex post allocation
of power (or control) matters.
 Contractual incompleteness and power can be used to

understand a number of economic institutions.
 Power (the ex-post allocation of control) is irrelevant in

agency theory because an optimal comprehensive contract
is made and will not be renegotiated.
33
Hart (1995):
 Modern property rights theory is closer to the
incomplete contracting approach of transaction costs
theory.
 Once we recognize that contracts are incomplete and

transaction costs are positive, then the boundaries of the
firm matter for economic efficiency.
 Specifically, modern property rights theory maintains that

firm boundaries are chosen to allocate power optimally
among the various parties to a transaction.
34
Hart (1995):
 A merger between firms with highly complementary
assets enhances economic value because it reduces
haggling and economic hold-up problems. (Hart
provides formal modeling of transaction-cost logic.)
 The possession of power (residual control rights) is

taken to be the definition of ownership in the
modern property rights approach.
35
Hart (1995):
 Further, the power that employers possess by owning
non-human assets gives the employer leverage.
 In reply to Alchian and Demsetz’ (1972) agency

theory assertion, authority and power do exist. Put
compactly, control over economically relevant non-
human assets leads to control over humans.
 The law of forbearance reinforces the authority that employers

possess.
36
Hart (1995):
 Application:
 The Vertical Merger of Fisher-Body and General Motors is
persuasively explained in property rights/transaction costs terms:
Much of the asset specificity can from investment in relationship-
specific know-how by the Fisher Body workers, which would have
made it difficult for General Motors to find another supplier if Fisher
Body had tried to engage in hold-up. Vertical financial ownership
replaced long-term contracting, which allowed the parties to adjust in
an adaptive, sequential manner. Ownership provided necessary ex
post residual control rights.
37
The economic role of property rights
Question
 How can well-defined property rights stimulate economic

growth?
 The more certain property rights are, the more capital
accumulation there will be
 The more certain are property rights, the more entrepreneurship

there will be
 The “West” experience growth because countries developed

secure private property rights (North and Thomas 1973)
38
 Thinkers in the last two decades have focused on the role of
institutions in long-term economic growth, and among
them, property rights (see Acemoglu et al 2001, 2002, 2004,
2005; Mauro 1995; Knack and Keefer 1995; Barro 1996; Aron
2000; Easterly and Levine 2003; Dawson 2003; Rodrik 2004).
 A particular focus on the role of property rights emerged

with papers from Daron Acemoglu et al singling out the
security of property rights as a predominant determinant of
income level differences…. E.g. North and South Korea.
39
Empirical evidence
Daron Acemoglu and Simon Johnson, 2005. “Unbundling

Institutions.” Journal of Political Economy, 113(5): 949-995.
 ‘‘Unbundling is a process by which a company with several

different lines of business retains core businesses while selling
off assets, product lines, divisions or subsidiaries…
…Unbundling may also refer to offering products or services
separately that had previously been packaged together’’.
40
Unbundling Institutions
 North(1998) argues that good institutions will
simultaneously support private contracts and provide checks
against expropriation by the government or other politically
powerful groups.
 And there are growing consensus among economists that
“institutions” is a primary determinants of economic
performance.
 However, the contemporary literature has not attempted
to determine the relative roles of institutions supporting
private contracts(“contracting institutions” ) and institutions
constraining government and elite expropriation (“property
right institutions”).
41
 There are well-established theoretical argument emphasizing
the importance of contracting institutions which links the
efficiency of an organization and type of contract( Coas
1937,1960; Williamson 1975,1985) and Property rights
against government expropriation (Jones 1981; De Long and
Shleifer 1993; Olson 2000).
 The paper by D Acemoglu attempt to unbundle the broad
cluster of institutions and learn more about the relative
importance of contracting versus property rights institutions
at the macro level.
42
Property Rights and Contracting Institutions
 Property rights institutions: rules and regulations protecting

citizens against the power of the government and elites.
 These institutions are related to political and state society
relations. And there are major difference in property right
institutions
across countries.
 While government expropriation of business income or
assets is deemed virtually impossible in many countries by
the international agency Political Risk Services, it is
judged as very likely in many sub-Saharan African and
Central American countries.
43
Empirical Strategy and Data
 Description of variables : The outcome variables is :

 GDP per capita(Measure of long run growth)
 Ratio of investment to GDP( measure of whether the
society is able to channel money into investment)
 Amount of private credit as a percentage of GDP(measure
of finance provided through the banking sector and credit)
 Stock market capitalization as percentage of GDP
(measure of equity finance)
44
 Contracting Institution (Fc): three measures were used as

a proxy:-
1. Index of legal formalism developed in Djankov(2003);
Number of legal procedures to resolve a simple case of
collecting on unpaid check
2. An index of the overall procedural complexity of
resolving a court case involving non-payment of
commercial debt :
3. Number of distinct procedures to resolve a court case
involved in the same process (WB, 2004).
45
Property right institutions, Ic; three measures were used

1. The base measure is “constraint on executive” from the
Polity IV data set, capturing the degree of constraints on
politicians and politically powerful elites (Gurr 1997). This
measure ranges from one to seven. higher score indicates
greater constraints
2. The second measure is “protection against expropriation”
by government, averaged over 1985-95, from Political Risk
Services. Its value ranges from 0 to 10 for each country
and year where zero low protection.
3. Third measure is the Heritage Foundation’s private
property index
46
Conclusion
There is considerable evidence that “institutions” are

important determinants of economic and financial outcomes.
Despite the importance of these questions for the study of
long run economic performance, there has been relatively
little work investigating which types of institutions matter
more and for which economic outcomes.
This paper offers robust evidence that property rights
institutions have a major influence on long-run economic
growth, investment, and financial development.
While contracting institutions appear to affect the form of
financial intermediation but have a more limited impact
on growth, investment, and the total amount of credit in
47the economy.
The END!
Contact me @: misgie2008@yahoo.com
Misgina A. (Ph.D.), Asst. Prof. of Agricultural Economics and Management at
ECSU l Migration and Development
48

Property Rights Institutions in Development

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Property Rights Institutions in

1. Property rights basic concepts

2. Property rights theory

3. The economic role of property rights

 Property is considered as a “benefit (or income) stream” in

 Something is “property” if it has value to someone after

 Property Rights, are the social institutions that define or

 “Rights individuals appropriate over own labour and goods

 Property rights - legal rights to use an economic property

 Property rights define: “who has access to which resources

 Private: private, individual

 Common: as a private of a group of co-owners

 State (public): held and managed by the government

 Open access: no property

OPEN ACCESS STATE

 Private PRs can decrease transaction costs

 Libecap (1989): Contracting for Property Rights

 North (1990): Institutions, Institutional Change and

 Hart (1995): Firms, Contracts and Financial Structure

 Property Rights, are the social institutions that define or

 Such property rights institutions critically affect decision

 The political process of defining and enforcing property

 Shifts in relative prices;

 Changes in production and enforcement technology;

 Shifts in preferences and other political parameters.

 All else being equal, the greater the size of the

 The larger the number of competing interest groups,

 Important differences across the parties in information

 These distributional conflicts will occur quite aside from

 The greater the concentration of wealth under the proposed

 In these circumstances, enough influential parties may

 North (1990) abandons the efficiency view of institutions,

 As a result, it is possible to provide an account for the

 The inability of societies to develop effective, low-cost

 Enforcement in the third world economies is uncertain not

 Contrasting the institutional framework in countries such as

 The institutional framework shapes the direction of the

 Property rights and economic incentives are the underlying

 One gets efficient institutions by a polity that has built-in

 Path dependence is the key to an analytical understanding of

 For example, in the case of land, person A and person C

 And each of these rights may be transferable. In sum,

 Harold Demsetz’ “Toward a Theory of Property

 Property rights, which serve the narrow self-interest of

Concludes (along with North, 1990) that there is

 Contractual incompleteness and power can be used to

 Power (the ex-post allocation of control) is irrelevant in

 Once we recognize that contracts are incomplete and

 Specifically, modern property rights theory maintains that

 The possession of power (residual control rights) is

 In reply to Alchian and Demsetz’ (1972) agency

 The law of forbearance reinforces the authority that employers

 How can well-defined property rights stimulate economic

 The more certain are property rights, the more entrepreneurship

 The “West” experience growth because countries developed

 A particular focus on the role of property rights emerged

Daron Acemoglu and Simon Johnson, 2005. “Unbundling

 ‘‘Unbundling is a process by which a company with several

 Property rights institutions: rules and regulations protecting

 Description of variables : The outcome variables is :

 Contracting Institution (Fc): three measures were used as

Property right institutions, Ic; three measures were used

There is considerable evidence that “institutions” are