Property Rights Institutions in

Development
Chapter FIVE

1
Outline
This chapter covers
 Property rights basic concepts
 The economic role of property rights
 Property rights theory

2
Property Rights Institutions

„„More generally, the stronger the set of property

rights, the stronger the incentive to work, save, and
invest, and the more effective the operation of the
economy. The more effectively an economy operates, the
more growth it will produce for any set of resources‟‟.

3
 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 includes:
 Scarce physical resources such as houses, cars, books….
 Non-human creatures like dogs, cats, horses or birds
 Intellectual property such as inventions, ideas, or words
4

 Property rights: Basic concepts
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‟.

5
Property rights: Basic concepts
Property Rights?

 Property rights define the theoretical and legal

ownership of resources and how they can be used to
derive income and benefits from it.

 The main legal property rights are the right of possession,

the right of control, the right of exclusion, the right to
derive income, and the right of disposition.

 Moreover the rights:

 to exclude non-owners from access;
 to appropriate the stream of economic rents; and
 to trade property.
6
Property rights: Basic concepts
 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).

7
Property rights: Basic concepts
Property regimes:

 Private: individual

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

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

 Open access: no property

8
Property Regimes

PRIVATE COMMON

OPEN ACCESS STATE

9
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
10appropriately
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

11
 Common property rights

 Resources are jointly owned – held in common – by a

limited group of individuals. That group is entitled to
exclude other individuals from using the property, and use
of the property is decided and supervised by the group.
 Common property
 communal land tenure
 Two key factors in analysis of common property:
 Tenure (the group right)
 Management (institutions)

12
Common property rights…
 Common Property is property that is owned by a group of
individuals. Access, use, and exclusion are controlled by the
joint owners.
 True commons can break down, but, unlike open-access
property, common property owners have greater ability to
manage conflicts through shared benefits and enforcement.
 Membership in group is limited by legally recognized and
practically enforceable rights.

13
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)

14
The economic role of property rights
 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.

15
 The economic role of property rights:
Empirical evidence

Daron Acemoglu and Simon Johnson, 2005. “Unbundling

Institutions.” Journal of Political Economy, 113(5): 949-995.

16
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” are a primary determinants of economic
performance.
 Unbundling is a split of the broad cluster of institutions and
learn more about the relative importance of contracting versus
property rights institutions at the macro level.

17
Unbundling Institutions
 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”).
 Acemoglu and Johnson (2005) distinguish between two
different types of institutions: contracting institutions (CI) –
those that enable private contracts between
citizens – and property rights institutions (PRI) – those that
protect citizens against expropriation by the government and
powerful elites.

18
Unbundling Institutions
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.

19
Unbundling Institutions
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 (is where investors connect to buy and
sell investments) capitalization as percentage of GDP
(measure of equity finance)… Equity financing is
the process of raising capital through the sale of shares

20
Unbundling Institutions
Empirical Strategy and Data

 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).

21
Unbundling Institutions
Empirical Strategy and Data

Property right institutions, Ic; three measures were used

1. The base measure is “constraint on executive” from the
State 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 (Index scores the relative freedom of
22 world economies based on 10 factors).
Unbundling Institutions
Empirical Strategy and Data

Heritage Foundation Index: A joint effort of the Heritage

Foundation and the Wall Street Journal, the index scores
the relative freedom of world economies based on 10
factors: property rights, freedom from corruption,
government spending, fiscal freedom, business freedom, labor
freedom, monetary freedom, trade freedom, investment
freedom….

23
Unbundling Institutions
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
24the economy.
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

25
 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
26 Right to sell or otherwise transfer the resource to others.
 Libecap (1989): Contracting for Property
Rights
 Property rights institutions range from formal arrangements,
including constitutional provisions 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.

27
 Libecap (1989): Contracting for Property
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.

28
 Libecap (1989): Contracting for Property
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.

29
 Libecap (1989): Contracting for Property
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.
30
 Libecap (1989): Contracting for Property
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.

31
 Libecap (1989): Contracting for Property
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.
32
 Libecap (1989): Contracting for Property
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.
33
 Libecap (1989): Contracting for Property
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.

34
 Libecap (1989): Contracting for Property
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.
35
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.
36
North (1990): Institutions, Institutional Change
and Economic Performance

 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.

37
North (1990): Institutions, Institutional Change
and Economic Performance

 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.
38
North (1990): Institutions, Institutional Change
and Economic Performance

 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.

39
 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.
40
 Eggertsson (1990):
Economic Behavior and Institutions

 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).

41
 Eggertsson (1990):
Economic Behavior and Institutions
 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.

42
 Eggertsson (1990):
Economic Behavior and Institutions
 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.

43
 Eggertsson (1990):
Economic Behavior and Institutions

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 costs.

44
 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.

45
 Hart (1995):
Firms, Contracts, and Financial Structure
 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.

46
 Hart (1995):
Firms, Contracts, and Financial Structure
 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.

47
 Hart (1995):
Firms, Contracts, and Financial Structure
 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.

48
 Hart (1995):
Firms, Contracts, and Financial Structure
 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.
49
 The END!

Contact me @: misgie2008@yahoo.com
Misgina A. (Ph.D.), Asst. Prof. of Agricultural Economics and Management at
ECSU l Migration and Development

50