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The real problem with India’s land market lies in its extremely restrictive nature, particularly with the case of land ceiling laws. Photo: Indranil Bhoumik/ Mint
The real problem with India’s land market lies in its extremely restrictive nature, particularly with the case of land ceiling laws. Photo: Indranil Bhoumik/ Mint

The flawed economics of land grab

It is a myth that economic growth will suffer without laws enabling the expropriation of land

In the ongoing national debate on land acquisition, a strong assumption underlies the argument of supporters of the act sanctioning land grab. Simply stated, it is that economic growth in many cases can just not be achieved without the use of eminent domain laws. Expropriation of property without private consent is considered as unfortunate, yet essential for the sake of common good. Any argument about fairness in the meanwhile is reserved solely for the question of the compensation provided.

Economists in particular point to the presence of transaction costs that without government intervention will hold back growth. Their favourite example, especially in cases of multiple parcels of land being required for the completion of projects, is the holdout problem. An individual landowner may holdout from selling his parcel of land that is crucial to a project by demanding exorbitant prices. Thus, they believe, coercion is warranted to uphold the much greater concerns of the community.

The fact that a seller holds out asking a better price for his land, however, cannot be sufficient reason to take his land forcibly even from the economic point of view.

One reason to holdout on the sale of land could be higher returns in the future or from alternative use. In fact, such speculative holding is a common feature in the land market. Land speculation, when successfully done, improves economic efficiency by allocating land towards its most highly valued end. Land grab, on the other hand, adversely affects economic efficiency by discouraging speculation.

Often it is just the roads and the bridges built on expropriated land holdings that are seen; adding to the belief that land expropriation can be justified given its benefits. The alternative uses to which the land could have been used usually go unseen, although the opportunity cost may be higher.

Another reason to hold out could be motivated plainly by bargaining concerns. Like in the market for any other good, both buyers and sellers try their best to maximize their own benefits through tough negotiation. Yet, unlike economists whose imagination in thinking about ways of dealing with such transaction costs is limited, entrepreneurs in the real world have found numerous ways to deal with it.

The most obvious way to prevent holdout situations in the purchase of large parcels of land is to engage in disguised purchase. This prevents the problem of mischievous individual landowners increasing their asking price in light of information on the crucial importance of their own parcel of land. Quite often, it is when public pronouncements of acquisition are made that potential holdouts rise to the occasion.

The other way out is the purchase of alternative parcels of land that could serve the purpose of the project. The justification for expropriating land is often based on the rare assumption that a single parcel of land is extremely crucial to the viability of the entire project. In most cases, it is not. This is especially true in the case of India where land is expropriated for private industrial projects more for reasons of satisfying the demand for cheap land rather than to overcome transaction costs. It also brings forth the huge problem that government failure in resource allocation poses compared with market failure.

Lastly, even in holdout situations where the bargaining demands of sellers threaten the viability of projects, buyers have designed ways to solve them.

A buyer could, for instance, agree only to the collective purchase of multiple parcels of land with all landowners agreeing to the sale. Owners who are otherwise willing to sell at the offered price, but holding out strategically with hopes of demanding a higher price by creating a situational monopoly, will either have to budge and accept the offer or lose out since the buyer does not wish to deal with the uncertainty of a future holdout.

Even if the buyer engages in gradual acquisition of factors, the market for any factor consists of multiple sellers trying to maximize their own gains. What transpires then is not a race to the bottom with factor owners holding out opportunistically, but the exact opposite: Sellers compete to sell their goods, breaking the dreams of the holdout. Eventually, factor price is determined by buyer demand based on discounted marginal productivity.

The real problem with India’s land market lies in its extremely restrictive nature, particularly with the case of land ceiling laws. It hinders not only the honest acquisition of land by businesses but also limits the ability of poor landowners to sell their land at competitive prices. The current drama over the land law has thus once again deflected attention from the more fundamental problems of the land market.

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

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