PROPERTY RIGHTS INSTITUTIONS IN

DEVELOPMENT

Yardstick International College (YIC)

Outline

• Property rights basic concepts

• Property rights theory

• The economic role of property rights

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 (Bromley 1991)
• Something is “property” if it has value to someone after costs
are considered
Property rights basic concepts

What is a property right?

• 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 labor 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
Property rights basic concepts

• Property Rights weak if transaction costs are high!

• The efficiency of property right institutions is thus depend on
their capacity to reduce these transaction costs.
• 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).
• The types of the rights, the assignment of the of the rights,
the time horizon for which the rights will be effective, etc.
depend on the existing the institutional environment and the
type of the properties.
• The efficiency of the exiting property rights can be judged
based on the following three important criteria:
I. universality—all scarce resources are owned by someone;
II. exclusivity—property rights are exclusive rights; and
III. transferability—to ensure that resources can be allocated
from low to high yield uses.
property rights criteria
• Universality criteria imply that property rights for all scarce
resources need to be clearly defined.
• If property rights for some resources is clearly defined
leaving others poorly defined or undefined, the inefficiency
in poorly defined resources can be transmitted into those
properties whose rights are clearly defined.
• For example, establishing a clear property rights on capital and labor
may not bring efficient utilizations of resources if for example the
property rights for land is poorly defined or left undefined.
• Moreover, property rights focus on physical resources ignoring intangible
property rights such as intellectual property rights. In a condition where
individuals cannot invest on their resource and effort if they cannot capture
the benefits of their inventions and creative works.
property rights criteria
• The other criteria is exclusivity.
• Non-exclusive right are rather meaningless. A given
resource is non-exclusive means anyone member outside
those to whom the property is assigned can also use the
resource, appropriate the benefits, etc.
• Unless the right holder is able to exclude other non-right
holders, the mere assignment of the right on given property
to an individual or group will not provide the right incentive
to exploit the full potential of the resource.
property rights criteria
• Transferability provide a great deal of incentive to the right
holders.
• The fact that one resource can be transferred means, it can be
used for collateral, future security and the like. It thus
provide right holders the incentive to make long term
investment to improve the resource.
• Land it a good example. If the owner of land cannot transfer
the land, it implies that the will have less incentive to invest
to improve the land. The result will be that the land will
rapidly degraded.
In sum, a full set of property rights consists of the following:
• the right to use the asset in any manner that the user wishes,
generally with the caveat that such use does not interfere
with someone else’s property right;
• The right to exclude others from the use of the same asset;
• The right to appropriate return/ benefits from the asset
owned;
• The right to sell the asset and transfer the asset to some one
of your choice
• The right to change its form, substance and locations
• Property rights can be assigned to individuals (firms), groups
or government. Though mix of these assignments always
exist in any society, the extent at which most properties are
assigned to individual or collective (group, public or state)
depend on the specific economic and political setting of the
country.
• In every society including advanced market economies, there
are some resources which are communally owned.
• The choice between individual rights and regulated common
property would probably depend on such factors as
transaction and enforcement costs, environmental and
technological factors, and distributional considerations.
• The classifications of economies into market, command
and mixed economic system is largely based on the
dominancy of private or common property rights and the
allocation mechanism that emanates from it
• A market economic system can then simply be described as one where
private property rights and the market mechanism dominate, while a
centrally planned economic system is dominated by state or collective
ownership and bureaucratic coordination.
• In the so-called market economies for instance, the institutions of private
property rights assign most of these rights for most of the properties
(including land) to individuals (or firms) and accordingly market forces
determine the allocation, the exchange and distribution processes.
Property rights basic concepts

Property regimes:

• Private: private, individual

• Common: as a private of a group of co-owners
• State (public): national or local state
• Open access: no property
Property rights basic concepts
Private Property Rights

• Assigns ownership to individuals-Individual or “legal individual”

holds rights
• A set of ordered institutional arrangements in which the state
protects the rights of certain individuals to access, control and
manipulate resource benefit steams.
• 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 appropriately
Private Property Rights

Advantages

• Private PRs can decrease transaction costs

• Private PRs have low administration costs & minimize
government price intervention
• Private PRs adjust automatically to market changes
Private Property Rights

Limitations

• Distribution of property rights is subject to rent-seeking,

corruption, & political interest
• Not suitable if the resource itself generates significant,
widespread externalities
• Private PRs are most applicable to land & soils, water,
and minerals but less applicable to mobile resources
Common Property Rights

Basics

• They could be defined as private rights to a group of co-

owners(Bromley1991)
• Owned by an identified group of people
• Owner group has right to exclude non-owners (exclusivity characteristic)
• Group(eg. community)holds rights
• 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
State Property rights

• Resources are nationalized and citizens may have use rights, while
the state has all forms of rights to the resources in question.
• State ownership implies that the state may exclude anyone from
the use of a right as long as the state follows accepted political
procedures for determining who may not use state-owned
property.
• A state property regime is a set of institutional arrangements in which
the state retains direct control of the benefits derived from a resource
by determining access and use rules.
• In many socialist countries, individuals are entitled to use
resources but not to transfer rights without the interference of the
state.
Limitations
• state property regime has limitations due to: Rigidity of the state agencies
in their application of rules;
• Ignorance of state agencies to indigenous political structures and
institutions;
• State agencies’ lack of power to implement rules; and

• Abuse of power by state employees (e.g. corruption and bribes).

Open Access

• When resources are owned by no one or are used by all without

any restriction, they exhibit to open access resources.
• Such lack of property regime leads to resource
destruction and increases behavioral uncertainty.
• Increases behavioral uncertainty, often termed as
“tragedy of open access” or formerly coined as “the
tragedy of the commons”.
Property rights theory

• The Tragedy of the Commons

• The Coase Theorem.
What Is the Tragedy of the Commons?
• The tragedy of the commons is a term coined by British
economist William Forster Lloyd in 1833.
• In a pamphlet, Lloyd illustrated a hypothetical wherein a
shared resource is gradually depleted by human beings
acting solely in their own interest.
• He used the example of a common property (or “commons”) shared by
local communities where herdsman led their cattle to graze. If each
herdsman acted in an economically rational way based solely on their
own wellbeing, they would each allow more than their fair share of
cattle to graze on the land, thus leading to overuse.
• Every rational herdsman would be acting in their own best interest, but
they would collectively be destroying the grazing land they all relied on.
Examples of the Tragedy of the Commons

• Examples of the tragedy of the commons can be seen throughout

environmental science, especially in discussions of the causes of climate
change.
• The original example of the tragedy of the commons had to do with
overgrazing cattle on public land. Though this hypothetical is a bit dated,
the principle can be easily applied to a growing human population that
is depleting the earth of its natural resources. Some specific examples
include:
• 1. Deforestation: Overexploitation of the earth’s forest has had
enormous consequences on the environment. As a result of a lack of
resource management, our forests have disappeared at a rapid rate over
the last century.
Examples..

• 2. Animal extinction: Overfishing and overhunting are

examples of a common pool resource being depleted by
individuals acting in their own self-interest.
• 3. Depletion of natural resources: When common resources are
consumed with an eye towards short-term gain, the result can be a
tragedy of the commons. For instance, when water is drawn from an
aquifer faster than it refills, the immediate gains are undercut by the
long-term danger of drought.
• 4. Climate change: Global warming is, on some level, a result of a
tragedy of the commons, as governments, corporations, and individuals
fail to consider the cumulative effect their actions have on our shared
environment.
Property rights theory
The Tragedy of the Commons
• The lack of clearly defined property rights and ownership can
lead to an inefficient allocation of resources
• If many people have the right to use a single shared resource,
then they have an incentive to overuse the resource
• If many people share the obligation to provide some
resource, then they have an incentive to undersupply that
resource.
• example over fishing
• An appropriate assignment of ownership or property rights
might alleviate this problem:
Property rights theory
The Tragedy of the Commons

• Group ownership A fishery association gains

exclusive right of control
• Rights to determine who may fish
• For how large a total catch, and
• Rules of fishing (hours and seasons when allowed, net size etc)
• Individuals are assigned rights to participate in
various ways
• They could share the total catch equally, or be assigned a quota
• The association has a collective incentive to safeguard the fish
population
Property rights theory
The Tragedy of the Commons
• Problems: it may be costly to keep out interlopers/midlers, there
may be severe moral hazard problems among the individual
members of the association (cheating on the quota), differing
ideas about how many can safely be taken, etc
• Single Ownership This approach works well with private
ownership (eg, private automobiles)
• Major problem: deciding who will be the lucky owner
• Rotating property rights is terribly inefficient, (permits over-
harvesting since current fisher doesn’t gain from preserving a
harvest for next year)
• Rights could be auctioned and the highest bidder could
compensate losers by distributing proceeds of the auction
among them–But it’s hard to determine.
Property rights theory
The Coase Theorem

What Is the Coase Theorem?

• The Coase Theorem is a legal and economic theory developed
by economist Ronald Coase regarding property rights.
• It basically asserts that bargaining between individuals or
groups related to property rights will lead to an optimal and
efficient outcome, no matter what that outcome is.
• The Coase Theorem argues that under the right conditions
parties to a dispute over property rights will be able to
negotiate an economically optimal solution, regardless of the
initial distribution of the property rights.
• The Coase Theorem offers a potentially useful way to think
about how to best resolve conflicts between competing
businesses or other economic uses of limited resources.
• In order for the Coase Theorem to apply fully, the conditions
of efficient, competitive markets, and most importantly
zero/insignificant transaction costs, must occur.
Example of the Coase Theorem

• The Coase Theorem is applied to situations where the

economic activities of one party impose a cost on or damage
to the property of another party.

• Based on the bargaining that occurs during the process, funds

may either be offered to compensate one party for the other's
activities or to pay the party whose activity inflicts the
damages in order to stop that activity.
For example: if a business that produces machines in a factory is
subject to a noise complaint initiated by neighboring households
who can hear the loud noises of machines being made, the Coase
Theorem would lead to two possible settlements.

• 1. The business may choose to offer financial compensation to the

affected parties in order to be allowed to continue producing the
noise or
• 2. The business might refrain from producing the noise if the
neighbors can be induced to pay the business to do so, in order to
compensate the business for additional costs or lost revenue
associated with stopping the noise.
The latter would not actually occur, so the result would be the
business continuing operations with no exchange of money.
• If the value of the business's output of making machines is
less than the cost imposed on the neighbors by the noise, then
the efficient outcome is that the business will stop making
machines and the neighbors would compensate the business
for doing so.
• In the real world, however, neighbors would not pay a
business to stop making machines because the cost of doing
so is higher than the value they place on the absence of the
noise.
Property rights theory
The Coase Theorem
Example 2: Smoking

• Two people are sitting in a room: A is smoker, B is non-smoker

• Smoking causes for A a benefit of 5 Birr, but for B a harm of 6
Birr The social optimum, therefore is Non-Smoking
• (1) A has the right to smoke. B negotiates with A and
offers 5 Birr if A doesn‘t smoke A accepts and doesn’t
smoke
• (2) B has the right to clean air. A negotiates with B and
offers B 5 Birr. if he is allowed to smoke B refuses and A
doesn’t smoke
Property rights theory
The Coase Theorem

• In both cases A doesn’t smoke! The allocation is the same

• However, the cases have very different distributional impacts
• (1) A has a net utility of 5 Birr, B of 1 Birr
• (2) A has a net utility of -0 Birr and B a net utility of 6 Birr
• If transaction costs are zero, the distribution of private property
rights is irrelevant for economic efficiency since negotiations
between the parties will always result in the same Pareto-efficient
level of the externality
• If there are no legal, strategic, or informational barriers to
bargaining, and if property rights are clearly defined,...... then
people can always negotiate to an efficient outcome.
Can the Coase Theorem Be Applied in the
Real World?

• In order for Coase Theorem to apply, conditions for efficient

competitive markets around the disputed property must occur.
If not, an efficient solution is unlikely to be reached.
• These assumptions: zero transaction (bargaining) costs, perfect
information, no market power differences, and efficient
markets for all related goods and production factors, are
obviously a high hurdle to pass in the real world where
transaction costs are ubiquitous, information is never perfect,
market power is the norm, and most markets for final goods
and production factors do not meet the requirements for
perfect competitive efficiency.
Property rights theory
The Coase Theorem

• Initial Assumption of Coase: Production and exchange can be solely

carried out through the price mechanism.
• (However) In the process of determining price rate, there is a cost
of discovering prices (Cheung 1983)
• The idea that “Perfect markets direct all production in the absence
of transaction costs (zero)” is a fiction, leading to the Coase
Theorem:
• “In the absence of transaction costs, the most efficient solution
to maximize aggregate income will be obtained irrespective of
the original distribution of resources or liability” (the Theorem)
Property rights theory
The Coase Theorem
Problems With The Coase Theorem

• Transaction Costs May Exist – bargaining may be expensive

• Property Rights may not be clearly assigned
• Sometimes there are legal impediments to what society considers
immoral. This can effect the achievement of an economically
efficient solution.
• Sometimes there are costs of determining, writing, and enforcing
an agreement in a world of bounded rationality, imperfect
communication, private information, observation and verification
difficulties, and opportunism
• If property rights are not secure, there will be no incentive to invest
in or improve assets
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)
The economic role of property rights
Empirical evidence
Question

• Thinkers in the last two decades have focused on the role of

institutions in long-term economic growth, and among them,
property rights (for example, 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 Acemoglu et al (ibid) singling out the security of
property rights as a predominant determinant of income level
differences
• Example of North and South Korea,
The economic role of property rights
empirical evidence

• Acemoglu, Daron and Simon Johnson. 2005. “Unbundling Institutions.”

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

• Instead it has documented the importance of “cluster” of

institutions.
• 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).
• This paper is an 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.
Unbundling Institutions
A. Property Rights and Contracting Institutions.

• Contracting institutions: are rules and regulations governing

contracting between ordinary citizens.
• The most important component is the functioning of the legal
system
• Difference in laws and implementation of laws across countries
introduce significant difference in the cost of enforcing contracts
and hence, equilibrium contract and transactions.

• The World Bank (2004), estimates that enforcing a simple

commercial debt contract costs over 440 percent of income per
capita and requires a process lasting, on average, 495 days in the
Dominican Republic, whereas in New Zealand, it costs less than 12
percent of income per capita and requires only 50 days.
Unbundling Institutions

A. Property Rights and Contracting Institutions

• Property rights institutions: rules and regulations protecting

citizens against the power of the government and elites.
• This institutions are related to political and state society relations.
• 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.
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 capitalization as percentage of GDP (measure of
equity finance)
Unbundling Institutions
Empirical Strategy and Data

Contracting Institution : 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 nonpayment of commercial debt :
• (3) number of distinct procedures to resolve a court case involved
in the same process (WB, 2004).
Unbundling Institutions
Empirical Strategy and Data

Property right institutions; 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
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 a step in that direction.
• found robust evidence that property rights institutions have a major
influence on long-run economic growth, investment, and financial
development.
Unbundling Institutions
Conclusion

• 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 the economy.
Thank you for your attention !!!