Big questions in this lecture

Stockholm Doctoral Course Program in Economics

Development Economics II — Lecture 1

Property Rights

Masayuki Kudamatsu IIES, Stockholm University

Motivations

• Institutions matter for development

• Property rights: often at the core of this argument

• Acemoglu-Johnson-Robinson (2001): measure institutions with risk of

expropriation of assets by government

• Acemoglu-Johnson (2005): show property rights, not contract

Big questions in this lecture

1. How & When do secure

property rights promote

development?

Conceptual issues

Conceptual issues

Two aspects of (private) property rights: 1. Protection against expropriation

2. Facilitating market transactions • Land rental markets

Conceptual issues

Two aspects of (private) property rights: 1. Protection against expropriation

• Expropriation by whom?

2. Facilitating market transactions • Land rental markets

Conceptual issues

Two aspects of (private) property rights: 1. Protection against expropriation

• Expropriation by whom?

• Other private agents • Government

2. Facilitating market transactions • Land rental markets

Conceptual issues

Two aspects of (private) property rights: 1. Protection against expropriation

• Expropriation by whom?

• Other private agents • Government

• How different from taxation?

2. Facilitating market transactions • Land rental markets

1. Impact on development

4 mechanisms (Besley-Ghatak 2009a) 1. Expropriation risk _↓

⇒ Return to investment _↑ 2. Guard labor _↓

⇒ Productive use of labor _↑ 3. Trade of assets _↑

⇒ Asset manager’s productivity _↑ 4. Assets used as collateral _↑

1-1 Expropriation risk

• Property rights: how much of investment return you actually receive

• Including bribe payments out of profit (Johnson-McMillan-Woodruff 2002)

• Conceptually same as sharecropping

• Does secure property rights always

Model 1

• One producer-consumer

• Endowed w/ 1 unit of land & e¯ _≤ 1 units of time

• Technology: y = A√e

• A _≤ 2 assumed (so e∗ _≤ 1)

• Preference: u(c,l) = c +l where

Model 1 (cont.)

Property rights

• w/ prob. τ, outputs/land expropriated after e is sunk

• How τ affects the optimal

Analysis

Optimal investment level:

e∗ = min!"(1 − τ)A 2

#2

• If interior solution, producer’s indirect utility is also "(1−₂τ)A#2

Impact of property rights

Secure property rights _⇒ Investment _↑ unless

• e∗ = ¯e (e.g. imperfect labor market) • Lump-sum transfer available

1-2 Guard labor

• Model 1 assumes protection against expropriation by govt.

• Private agents can protect their properties on their own

• Insecure property rights ⇒ Need to guard your property

⇒ Less time/resources for productive activities

2 cases to consider

• When insecure properties are used for production

• When insecure properties are NOT used for production (e.g. residential property)

Model 2A

• e1 ∈ [0,1]: productive labor

• e2 ∈ [0,1]: guard labor • e1+ e2+ l = ¯e

• Prob. of expropriation: τ(1 ₋ γ√e2) • γ _∈ [0,1]: effectiveness of guard labor

• With resource constraint binding,

τ _{↓ ⇒} e2 ↓ always

• Summary: Simple intuition holds

Evidence: Hornbeck (2009)

• Late 19c American Plains

• Marginal cost of e2 ↓ by barbed wire

• This cost reduction: larger for counties with less woodland

Results

• Counties w/ less woodland: (1)

invest in land _↑, (2) land value _↑, (3) productivity _↑, (4) share of crops in need of protection _↑

• Only during the period in which

An interpretation

• τ: Probability that other private

agents (cattle owners) “expropriate” your investment return

• No formal right to compensation for damages by cattle encroachment

Model 2B

• Productive assets: no risk of expropriation

e.g. Human capital

⇒ e1 yields A√e1

• h: Value of non-productive assets facing risk of expropriation:

• h = h > 0 if not expropriated

• h = h = 0 if expropriated

Analysis

• Producer solves

max

e₁,e₂ (1 −τ(1 − γ

√

e2))h

+A√e1 + ¯e − e1 − e2

• Not surprisingly, e₁∗ unaffected by τ

• e2 goes up with τ

Model 2B’

• Suppose consumption & utility from

assets are complements

u(c,h,l) = cαhβ + l

where α +β < 1, α > 0, β > 0

• In this case, if τ is small,

∂e1

Summary

∂e₁

∂τ < 0 unless

• No binding resource constraint & expropriation risk for non-productive assets

∂e₂

∂τ > 0 unless

Evidence: Field (2007)

• Exploit phase-in nature of land

titling program of urban squatters in Lima, Peru

• Cross-sectional micro data & estimate

yid = αSi +βTd +γSi ×Td+x′_idδ+εid

• yid: labor supply / indicator for

working away from home

• Si: squatter indicator

• γ: Program effect

• Compare squatters between program districts and non-program districts

• They are comparable in observables

• Program covered all districts eventually

• Result: γ >ˆ 0

• For subsample, 2-period panel data available

• First-difference estimates giveγˆ of similar size

Interpretation

• Land titling on residential assets _⇒ Model 2B relevant

• Resource constraint binding (hard

to employ guard labor)

GE effect of guard labor

• If you protect your property, thieves target other people’s property

⇒ Guard labor has negative externality

• Same logic suggests γˆ was overestimated in Field (2007)?

• Non-program squatters more likely to start business at home after the

1-3 Barriers to trade

• Secure property rights: encourage sale/rental of assets

⇒ Assets managed by those who use them most productively

Model 3

• A continuum of agents

• δ of them: landed, 1 ₋δ: landless

Technology: y = θA√e (w/ land)

• θ: agent’s productivity

• θ = θ w/ prob. p • θ = θ w/ prob. 1 − p • 0 _≤ θ < θ _≤ 1

• If landed agent w/ θ rents land out to landless agent w/ θ, output _↑

• Consider rental contracts where • Landless pays rent upfront

• Contract duration: one period

Those landed or renting land (w/ fixed rent) solve

max

e θA

√

e + ¯e ₋ e

which yields (if interior solution)

e∗ = (θA) 2 4

Assumptions

• π∗(θ) > u

• There’s gain from trade

• (1 −p)(1 −δ) > pδ

• Gain from trade accrues to landed

Analysis

Compare the payoffs of a landowner from the following 2 strategies:

• When θ = θ, rent land to landless w/

θ. When θ = θ, cultivate on his own

• Irrespective of θ, cultivate on his own

Denote the payoffs when θ = θ & θ = θ

Payoff from renting land

V = π∗(θ) + β(1 ₋ τ)[(1 ₋ p)W + pV]

W = π∗(θ) + β[(1 ₋ p)W + pV] Solving for V yields

V = 1 − βτ(1 − p) 1 ₋ (1 ₋ τp)βπ

Payoff from not renting land

V′ = π∗(θ) + β[(1 ₋ p)W′ + pV′]

W′ = π∗(θ) + β[(1 ₋ p)W′ + pV′] Solving for V′ yields

Comparison

• τ = 0 ⇒ V > V′

• τ = 1 _⇒ V < V′, if β > ₂₋1_p

• V decreases w/ τ while V′ does not depend on τ

⇒ ∃τˆ _∈ (0,1), V < V′ if τ > τˆ

1-4 Collateralizability

de Soto (1989, 2000)’s “dead capital”

• Poor people do have assets

• But they don’t formally register

them

⇐ Very costly do to so in LDCs

• So they cannot use them as

collateral to borrow money & stay poor

Model 4

(A simplified version of Besley-Ghatak 2009b)

• Producer/borrower & lender

• e: borrower’s private information

• Limited liability

• In case of default, borrowers don’t need to repay more than their assets

• w: value of borrower’s illiquid asset

• Property rights: w/ prob. τ, lender

Analysis: 1st best

If producer has capital, then he solves

max

e,x A(1 + ∆x)

√

e ₋e ₋ ρx

which yields (assuming A(1₂+∆) < 1 for interior solution)

• Assume x = 1 is profitable under 1st-best

(A(1 + ∆))2

4 − ρ >

A2

Analysis: 2nd-best

• Consider a debt contract (r,c) • r: interest payment

• c: collateral

• Under this contract, borrower solves

Lender’s problem

max

r,c r

√

e + c(1 ₋ √e)) ₋ ρ

subject to

• Incentive Compatibility (IC): e = e∗∗ • Participation Constraint (PC):

√

e_{A(1+∆)₋r_}−(1₋√e)c₋e > A₄2

Ignoring PC for a moment, solve the lender’s problem with IC & LL:

max

which yields optimal loan contract

r∗ = A(1 + ∆)

2 + (1 −τ)w

• Under (r∗,c∗), borrower’s effort is

e∗∗ = [A(1 + ∆)] 2 16 < e

∗ ₌ [A(1 + ∆)]2 4

• Notice τ does not affect e∗∗ in this

case

• But do borrowers accept this loan contract?

• Borrower’s payoff under (r∗,c∗): [A(1 + ∆)]2

Intuition in case of

w

(

1

₋

τ

)

_≤

ω

• PC not binding.

• Cost of lowering r for borrowers w/

lower (1 ₋ τ)w: outweighed by benefit of keeping borrower’s incentive to exert effort

If

w

(

1

₋

τ

)

>

ω

• As w(1 ₋ τ) _↑, r∗ must be lowered to satisfy PC, which yields

r∗ = A(1 + ∆) + w(1 ₋τ) − 2

,

A2

4 + w(1 −τ) with e∗∗ = A₄2 + w(1 ₋ τ)

When 1st-best achievable?

• r = c = (1 ₋ τ)w will achieve 1st-best effort e∗

• This will be the case if

Impact of

τ

_↑

1. If (1 ₋ τ)w < ω, e∗∗ not affected. Borrower’s share of total surplus _↑ 2. If (1 ₋ τ)w _∈ [ω,ω], e∗∗ _↓. Marginal

effect: larger

Impact of

τ

_↑

⇒ Impact of property rights: heterogenous across w

Impact of

τ

_↑

(cont.)

• For countries with

(1) only very poor, (2) only very rich, (3) extremely unequal

property rights have little impact on aggregate investment

• If (1 ₋ τ)w < ω, borrower’s share of total surplus _↑

⇒ Political institutions where poor borrowers have power

Evidence

Galiani-Schargrodsky (2005)

• Exploit variation in actual

implementation of the govt program to transfer land titles to urban

squatters in Buenos Aires

• Only some original landowners gave up land

• Which has nothing to do w/ squatter/parcel characteristics

• No impact on access to credit • By law, squatters cannot transfer

Field-Torero (2006)

• Exploit the same Peruvian urban

land titling program as Field (2007)

• Observe whether loan applicants required to provide collateral (Ci)

• yi = αTi +βCi + γTi × Ci + εi

• Approval rates on public sector loans _↑ (ˆγ > 0)

• But no impact on approval rates on

Wang (2008)

• China after 1994: state employees can buy their rented houses from the state at subsidized prices

• DID estimation w/ control group being state employees living in private houses or private sector employees

• After reform, self-employment rate doubles (2% to 4%)

1-5 Other evidence:

Goldstein-Udry (2008)

• Villages in southern Ghana

• Fallowing: important investment in land

• Land rights determined by paramount chief

• Fallowing _⇒ Prob. of losing land _↑

Findings

• Fallowing: longer for individuals

who hold powerful positions in local political hierarchy

• conditional on household FE & plot characteristics

• Same individual fallows longer for

2. Endogenous property rights

3 sources of insecure property rights

• Predatory states

• Govt expropriates assets

• Anarchic states

• Govt cannot prevent private expropriation

• Ineffective states

• Govt does not invest in legal

Below we focus on predatory states (ie. assuming govt has capacity to

expropriate)

• Theoretical frameworks for anarchic states: will be covered in my lecture on conflict

• Ineffective states: take Political Economics III or read

2-1 Commitment problem

• In Model 1 above, govt commits to τ

• After producers choose e, however, govt has incentive to set τ = 1

• If govt cannot commit, producers choose e = 0 by anticipating this

• This is Pareto inferior.

• Let producer choose e to maximize output

• Then divide the surplus between govt & producer

3 ways to achieve

τ

<

1 w/o

commitment

• Reputation

• Exit

• Voice

2-2 Reputation

• If govt in power for a long time, repeated interactions between govt & producers possible

• Producers can punish govt taking

τ = 1 by setting e = 0 from next period on

• Let y(τ) = (1−₂τ)A2 = A√e∗ (expected output given τ) and

• Govt’s deviation payoff: y(τ)

• Govt’s equilibrium payoff:

τy(τ)/(1 ₋ β)

• Credible τ satisfies

τy(τ)/(1 ₋ β) _≥ y(τ) or τ _≥ 1 ₋ β

• Govt solves

maxττ

(1 ₋ τ)A2

2 s.t. τ ≥ 1 − β which yields τ∗ = 1/2 if β _≥ 1/2 &

• This mechanism to restrain

predatory state requires a stable government

cf. Olson (1993) "stationary bandit"

• Empirically, however, long-lasting govts appear be predatory

2-3 Exit

• Suppose producers can hide fraction µ _∈ (0,1) of output from govt

⇒ τ _≤ 1 ₋ µ in non-commitment case

• This also reduces govt’s deviation payoff in the reputation mechanism ⇒ Credible τ satisfies

2-4 Voice

• Democracy supposed to be key for secure property rights

• North & Weingast (1989): the Glorious Revolution in England in 1688_⇒ Checks & balances against the King by Parliament_⇒ Secure property rights

• Acemoglu-Johnson-Robinson (2001): Settler mortality _⇒Checks &

• Suppose political institutions (e.g.

elections) make govt put some positive weight on producer’s utility (λ _∈ (0,1))

• From FOC, govt wants to commit to

τ∗ = 1 −λ 2 ₋λ

• This decreases with λ

• Same logic as in the reputation

mechanism implies the lower bound of credible τ is

ˆ

τ∗ = 1 ₋ β

1 ₋ λ+ βλ/2

• This also decreases with λ

• So λ _{↑ ⇒} τ _↓ for any given β

Implication: A Theory of

Democratization

• This logic implies govt has an

incentive to increase λ when β is high so it cannot commit to τ = 1/2

• Paltseva (2006) proposes a variant of democratization theory of this type

2-5 Expropriation vs Taxation

• Taxation: τ clearly specified ex ante

• Why govt can commit then?

• Expropriation: govt confiscates assets to produce on its own

⇒ Lower bound of credibleτ: higher

References for the lecture on property rights

Acemoglu, Daron, and Simon Johnson. 2005. “Unbundling Institutions.” Journal of Political Economy 113(5): 949-95. !

Acemoglu, Daron, Simon Johnson, and James A. Robinson. 2001. “The Colonial Origins of Comparative Development: An Empirical Investigation.” American Economic Review 91(5): 1369-1401. _!

Besley, Timothy, and Maitreesh Ghatak. 2009a. “Property Rights and Economic Development.” Available at: http://econ.lse.ac.uk/staff/tbesley/papers/pred.pdf.

Besley, Timothy, and Maitreesh Ghatak. 2009b. “The de Soto Effect.” Available at: http:// econ.lse.ac.uk/staff/tbesley/papers/thedeSotoeffect.pdf.

Besley, Timothy, and Torsten Persson. 2009. “The Origins of State Capacity: Property Rights, Taxation, and Politics.” American Economic Review 99(4): 1218-1244. _!

De Soto, Hernando. 2000. The Mystery of Capital: Why Capitalism Triumphs in the West and Fails Everywhere Else. New York: Basic Books. _!

Field, Erica. 2007. “Entitled to Work: Urban Property Rights and Labor Supply in Peru.”

Quarterly Journal of Economics 122(4): 1561-1602. !

Field, Erica, and Maximo Torero. 2006. “Do Property Titles Increase Credit Access Among the Urban Poor? Evidence from a Nationwide Titling Program.” Available at: http://

www.economics.harvard.edu/faculty/field/files/FieldTorerocs.pdf.

Goldstein, Markus, and Christopher Udry. 2008. “The Profits of Power: Land Rights and Agricultural Investment in Ghana.” Journal of Political Economy 116(6): 981-1022. _!

Hornbeck, Richard. “Barbed Wire: Property Rights and Agricultural Development.” Quarterly Journal of Economics forthcoming. !

Johnson, Simon, John McMillan, and Christopher Woodruff. 2002. “Property Rights and Finance.” American Economic Review 92(5): 1335-1356. !

North, Douglass C., and Barry R. Weingast. 1989. “Constitutions and Commitment: The Evolution of Institutions Governing Public Choice in Seventeenth-century England.” Journal of Economic History 49(4): 803-832. !

Olson, Mancur. 1993. “Dictatorship, Democracy, and Development.” American Political Science Review 87(3): 567-576. !

Paltseva, Elena. 2006. “Autocracy, Devolution and Growth.”

Persson, Torsten, and Guido Tabellini. 2000. Political Economics: Explaining Economic Policy. Cambridge, Massachusetts: MIT Press. !

Land Titling. Universidad Torcuato Di Tella. Available at: http://ideas.repec.org/p/udt/wpbsdt/ proprightspoor.html