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Individuals in a free market will possess not only absolute right over their property, but also the freedom to exchange their produce without barriers imposed by the state. Photo: iStock
Individuals in a free market will possess not only absolute right over their property, but also the freedom to exchange their produce without barriers imposed by the state. Photo: iStock

Reforms that really matter

Economic prosperity is largely linked to the degree of respect for private property rights

In the run up to the general election in May and after, the question of economic reforms attracted a lot of attention. Yet all public debates on reforms have ignored the core element of any meaningful structural reform programme: security of private property rights. This is particularly surprising since it is unquestionably the first principle of any real capitalist, market economy.

Private property is a prerequisite for individuals to engage in productive economic activity. As an institution, it assures that people enjoy the fruits and bear the costs of their own actions. In the absence of stable property rights—be it due to state control of resources or outright appropriation—the “rules of the game" (to use economist Douglass C. North’s term) become restrictive as well as unreliable.

Contrary to common belief, respect for property rights goes well beyond simply the protection of one’s personal property from private aggression. It includes the freedom to peacefully exchange one’s property without any hindrance from parties including the state. Thus, curbing the power of the state to aggress against citizens’ private property and its free transfer is crucial to a market economy.

Individuals in a free market will possess not only absolute right over their property, but also the freedom to exchange their produce without barriers imposed by the state. Individuals that serve the market are allowed to prosper, while those that do not are allowed to fail. Thus taxes, subsidies, state regulation etc., have no place in an economy guided purely by the principle of property rights.

While the importance of property rights to attain prosperity can be deduced from common sense, the empirical support for it is huge too. Peruvian economist Hernando de Soto in The Mystery of Capital has provided the most popular account of the importance of property rights, explaining that the lack of well-defined property rights prevents the poor in developing countries from generating capital.

Daron Acemoglu and James A. Robinson explained the importance of private property in their bestselling book Why Nations Fail. A huge collection of academic empirical data too has become available in recent times showing the positive correlation between property rights and growth.

Apart from these, some near perfect natural experiments help to extrapolate the importance of institutions to growth. Countries with similar endowments differing in their economic performance due to the quality of their institutions provide the best examples to make a comparative study. The former east and west Germany, Hong Kong and mainland China, North Korea and South Korea, Zimbabwe and Botswana and the US and Mexico tell us the difference that institutions make in the living standards of countries that are endowed with similar natural and other resources.

Now, how does India fare when it comes to respect for property rights? As many have pointed out in the past, even the formal ownership of property is not recognized as a fundamental right by the Indian Constitution. State action blatantly transgressing against the economic rights of citizens is even considered justified to serve the common good. For instance, while retrospective taxation has broken the confidence of many foreign investors no government seems to be keen on revoking it.

Yet today, many believe more of good legislation can save India from the regressive nature of the current set of legislation. Thus, it is believed, land titling will solve our problems through clear formal definition of property. Such beliefs, however, are likely to be pipe-dreams. For they draw from the fallacious notion that property rights flow from state legislation rather than from the market itself.

Despite its drawbacks, the works of American economist Harold Demsetz in this regard are particularly useful. In his 1967 paper Toward a Theory of Private Property Rights, to cite an instance, Demsetz showed the natural origin of property in response to resource scarcity.

The link between economic prosperity and property rights was well known even during the age of the classical economists, if not before. But in the 20th century the mainstream largely ignored its importance to achieving high growth and prosperity. It would eventually take economists of New Institutional Economics in the latter half of the century to revive an old idea. Similarly, if India is really to grow into a developed economy, it cannot come without recognition of the importance of private property rights.

Natural Order runs every Monday, with a libertarian take on the world of economics and finance.

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