Download A Review of Economic Literature on Development of

A Review of Economic Literature on Development of
Urbanization and Real Property Rights
1
Introduction
Secure property rights have been traditionally considered as a key determinant of economic development.
In his seminal paper Demsetz (1967) argues that weak property rights lead to underinvestment on individual level since a substantial risk exists that someone else will capture the returns of one’s investment.
Investment and land property rights may also be connected through the so-called credit channel. Feder
et al. (1988) were among the first ones to suggest that better land rights make it easier to use land as
a collateral, which in turn diminishes the constraints on funding investments and lowers the interest rate
that the bank charges1 . The main premise is that a better access to credit markets helps to transform
wealth into capital and, therefore, increases the labor productivity and income. In addition, it has been
argued that formal land rights can enhance possibilities for gains from trade because transferable rights
make it easier for individuals to either rent or sell their land (Besley, 1995).
Evidently the evolution of formal land tenure in developing countries is still in its early phases compared
to Western Europe and North America. Cai, Selod and Steinbuks (2015) connect this to differences in
timing and pace of urbanization. Also Feder et al. (1988) state that the evolution of individual land rights
and mechanisms to enforce such rights is closely related to the population density, especially in the rural
setting. Urbanization has been continuous in Western Europe and North America since the Industrial
Revolution (1760-1840). For developing countries the urbanization started only in the twentieth century.
Also the pace of urbanization has been recorded to be much higher in developing countries at similar
stages of urbanization. The growth in urban population is mostly due to migration from rural areas to
cities and decline in urban mortality. Often people arriving from rural areas end up living in squatter
settlements2 . Still today, the scope and persistence of squatting remain as unsolved, puzzling issues. Most
1
From a lender’s point of view, a person without secure legal title is, other things being equal, a riskier client, and thereby
the interest rate has to reflect a higher risk premium. However, due to asymmetric information and adverse selection problem
interest rates cannot be allowed to rise to a point where supply and demand equate. Consequently, credit rationing is an
optimal solution for a lender. (Stiglitz and Weiss, 1981.)
2
Squatting here means using someone else’s land without paying rent. It is estimated that over one-third of the total
urban population of developing countries lives in squatter settlements (UN Habitat).
1
1 Introduction
2
explanations point to some external constraints or market imperferctions as causes of squatting but no
univocal solution exists.
Figure 1 presents, following Feder and Nishio (1998), the conceptual framework for security of landownership and farm productivity. With a secure title, a farmer obtains credit at a lower cost and higher
amount, which enhances demand for investment. Increases in investment and input use in turn lead to
higher productivity per unit of land. In theory, this framework extends also to urban settings. Like in
rural setting, fear of eviction in urban squatter communities implies discounted returns to investment in
housing and infrastructure (Field, 2005). Therefore both the quality and quantity of housing is predicted
to rise with secure tenure. Besides the rationale presented in Figure 1, there is another aspect through
which land registration and title arrangements provide economic benefits to society. Better allocation of
land to the most efficient users is also supported via secure titling and registration systems. As Feder and
Nishio (1998) explain, land transactions are recognized as best way to resolve temporary inefficiences in
land allocation, and exchange of ownership or possession are more likely to take place when landowners
are provided with titles.
Evaluating the causal effects of property rights, i.e. performing empirical studies on subject, is by no means
straightforward. The problem lies in the fact that allocation of property rights is typically endogenous: in
many instances the emergence or reform of property rights institutions responds to the changing economic
context. Many historic examples illustrate this pattern. For example Acemoglu, Johnson and Robinson
(2005) show in their study that the pressure exerted by Atlantic traders in Western Europe post 1500 to
improve institutions that facilitated their activities. Also from a micro-perspective it has been argued that
reverse causation is an issue that should be considered, since many studies report that investments on a
piece of land can secure the owner’s right to the land (Besley, 1995).
Though the theory predicts that formal property rights will emerge once the gains exceed the costs of
maintaining a titling system (e.g. Miceli and Kieayh, 2003), the evidence shows that this has not happened
in many developing countries. Some authors argue that this lack of formal land property rights in informal
settlements further immobilizes capital that is ’locked’ and cannot be used for productive activities (de
Soto, 2000). On the other hand, some have argued that land registration and titling have no potential to
improve production in poor countries (Atwood, 1990; Bromley, 2008). Hence understanding the dynamics
between land property rights and economic development is a question of great importance - both for
researchers and practioners. This review aims to provide a comprehensive outlook on previous literature
of the subject. Section 2 focuses on empirical studies and Section 3 on theoretical model-based studies.
Section 4 summarizes the findings of previous literature.
1 Introduction
3
Titled land
More security to
farmer
More security to
lender
More demand for
investment
More supply of
cheaper long-term
credit
More investment
Input complementarity
More supply of
cheaper
short-term credit
More demand for
variable input
More variable
input use
Higher output per
acre
Higher land price
Higher income
Fig. 1: A conceptual framework for security of landownership and farm productivity (following Feder and
Nishio, 1998).
2 Empirical studies
2
4
Empirical studies
Even though the importance of institutional factors for economic growth is widely acknowledged, reliable
evidence on the mechanisms by which property rights to land improve economic performance is still in
deficiency. Microeconomic studies (e.g. Besley 1995; Banerjee et al., 2002) have mainly focused on the
statement of Demsetz (1967) about investment incentives. The empirical evidence on subject remains,
however, ambiguous. Both Besley (1995) and Banerjee, Gertler and Ghatak (2002) provide evidence
that titles increase investment, and in turn, farm productivity, while for example Place and Migot-Adholla
(1998) find no impact on agricultural productivity. The connection between property rights and investment
has been investigated mostly in rural settings. This might be due to more intuitive framework (see Figure
1) as well as availibility of data.
Banerjee et al. (2002) studied the effect of a major change in property rights on agricultural productivity
in the Indian state of West Bengal. After year 1977 a program called Operation Barga that targeted to
enforcing the long-dormant agricultural tenancy laws, was launched. Operation Barga involved a limited
transfer of property rights since it gave the incumbent tenant only the right to claim a higher share of the
output and permanent tenure. Thus the effects were less obvious in advance compared to a full transfer
of landownership that is likely to have positive effects on productivity. In their analytical framework, the
impact of limited transfer on productivity can be divided into two effects: (1) a bargaining power effect
and (2) a security of tenure effect3 . Banerjee et al. (2002) found empirical support for the hypothesis that
the transfer of property rights positively affects agricultural productivity. However, they also point out
that in this setting it is impossible to separate the direct and indirect effects of Operation Barga.
Using household and plot data in four Kenyan sites, Place and Migot-Adholla (1998) found in parts
contradictory results about effects of land registration and title on agricultural productivity. According to
them, there is no strong evidence to suggest that possession of title deed is related to land productivity as
measured by crop yields. They stress out that titles are acquired first and foremost for enhancing security
of rights rather than for increasing agricultural production. Furthermore, Place and Migot-Adholla (1998)
make a clear policy recommendation that scarce government resources should be instead targeted towards
providing better infrastructure and market opportunities. Their view is that these efforts should also foster
a greater demand for land titling.
Another branch of literature on urban and/or land property rights has concentrated on assessing the
capitalization of characteristics associated with formal vs. informal land tenure (Friedman et al.,1998;
Lanjouw & Levy, 2002; Kim, 2004). Friedman, Jimenez and Mayo (1998) examined the demand for
3
Security of tenure effect can be further divided into two opposing effects. On one hand, after cutting out the threat
of eviction the tenant has a lower incentive to work harder to since he no longer has to achieve some threshold output
determined by the landlord. On the other hand, greater security of tenure encourages the tenant to invest more because he
can more confidently assume that he will enjoy the fruits of his investment. (Banerjee et al., 2002.)
2 Empirical studies
5
tenure security with survey data from Manila, the Philippines. In order to measure potential benefits
from legalization, they develop a new methodology to estimate willingness-to-pay for secure tenure. In
addition, they assume that formal and informal housing markets function reasonably well, in which case
the secure tenure in a particular site must be reflected in the value of the dwelling. By estimating hedonic
functions for formal and squatter housing values, they show that on average, a formal sector unit could be
rented for 15 percent more compared to a squatter unit. Moreover, they found that older squatter units
are perceived to be safer than newer squatter units.
Lanjouw and Levy (2002) estimated the value of formal property rights to property owners by using survey
data from Ecuador, where households have both formal and informal claims to urban residential property.
Using a designed survey to collect data helps to avoid the standard selection problem; with that procedure
each household serves as a control for itself. Moreover, survey data provides a perfect matched sample for
assessing the value of the treatment, i.e. obtaining title. Lanjouw and Levy (2002) note that changes in
’rights’ refers in their study specifically to changes in the sources of rights rather than in the bundle of
rights. They find that there are two ways in which conferring formal rights might increase the welfare of
squatter households: (1) by increasing households’ security from eviction or boundary disputes and (2) by
reducing the transfer uncertainty associated with transactions that take place in an environment where
all rights are informal. Lanjouw and Levy (2002) conclude that the unconditional effect of title is to raise
properties’ value by over 20 %. They also find that informal property rights can substitute effectively
for formal property rights to low- and middle-income urban households. They identify several sources of
informal rights, such as a household’s authority or its ability to access other sources of rights.
Kim (2004) studied how legal title influences transitional property markets in Vietnam, where the economic growth has been rapid despite the insecure property rights situation. Kim (2004) explains that in
the capital city Ho Chi Minh City (HCMC) the majority of annual housing supply has been provided by
the private sector since mid-1990’s, raising a question of the nature and importance of property rights in
supporting the transition to a market economy. She further explains that in HCMC, several newspapers
publish real estate advertisement listings where people are offering real estate with various forms of property rights. These so-called ’legal papers’ can then be processed through various levels of government with
payment fees to obtain legal title to the property. In other words, despite a lack of development in the
court system and legal framework, alternative stabilizing and property rights enforcement institutions to
enable transactions exist. Kim (2004) analyses the real estate listings with hedonic regression in order
to examine how HCMC’s real estate market functions without the ’right’ property rights institutions.
The main conclusions in this study are twofold: First, it appears that multiple forms of property rights
are operational in HCMC’s real estate market. Second, legal title itself is not the most valuable form of
property right. Instead, having both a legal title and legal papers is recognized as more valuable. In light
of her findings, Kim (2004) argues that the informal/formal discourse in property rights is too simplistic
2 Empirical studies
6
to fit empirical cases, at least in transition economies such as Vietnam.
Also measuring the effect of formalization (i.e. transforming informal into formal tenure) on a variety of
social and economic outcomes, such as labor market participation, access to credit, and housing improvement, has been under discussion in empirical literature (Field, 2005; Field & Torero, 2006; Field, 2007;
Galiani and Schargrodsky, 2010). The issue of endogeneity has been usually solved in these studies by
using natural experiments in the allocation of land titles. In general, natural experiments are used in
social sciences (and in applied economics in particular) as an alternative to field or laboratory experiments
(see e.g. Angrist and Pischke, 2008). Natural experiment can be described as a historical episode that
provides observable and quasi-random variation in treatment subject to a plausible identifying assumption.
Thus, a treatment group and a control group4 must be identified for the analysis. In this context, natural
experiments are used in order to identify fundamental causes of growth. Luckily (as from the researcher’s
point of view), many nationwide titling programs have taken place during the past few decades, providing
a suitable natural experiment setting for studying the causal role of ownership rights.
Field (2005) compares the change in housing investment before and after a nationwide titling program in
Peru among participating households to the change in investment among two samples of non-participants.
In contrary to many previous studies that took place in rural settings, the focus in Field’s (2005) study is on
residential investment in urban areas. In theory the relationship between property rights and investment
extends easily to an urban setting; as with farm inputs, the quality and not just quantity of housing is
predicted to rise with expected duration of tenure. However, as Field (2005) points out, two potentially
important distinctions emerge in empirical settings. First, since most urban squatters reside illegally on
public land, it is expected that investment incentives increase greatly with secure tenure. Additionally,
the reverse effect of investment on household tenure security may be stronger in urban than rural areas
due to the political nature of ownership rights. Using difference-in-difference method in the analysis, she
shows that strengthening property rights in urban slums has a significant effect on residential investment.
Notably, most housing renovations are financed without the use of credit, which indicates that changes
over time reflect an increase in investment incentives related to lower threat eviction.
Continuing within the context of Peruvian reform, Field (2007) examined the labor market effects of
increases in tenure security resulting from the land titling program. The underlying theory predicts
that if untitled households expend human resources maintaining tenure security through informal means,
shifting the burden of protection away from individuals will reduce the opportunity cost of employment
and enable households to make unconstrained decisions about time allocation across labor activities. Field
(2007) found that titling results in a substantial increase in labour hours, a shift in labor supply away
from work at home to work in the outside market, and substitution of adult for child labor. Hence she
4
A control group estimates what would have happened to the treated group in the absence of intervention.
2 Empirical studies
7
was able to depict an additional channel of welfare gain that is particularly relevant to urban households
(the opportunity cost of spending time at home is expected to be higher in nonagricultural settings).
Galiani and Schargrodsky (2010) use data from two surveys performed in 2003 and 2007 in Buenos Aires,
Argentine. In this natural experiment, in 1981 a group of squatters occupied an area of wasteland in
Buenos Aires. Then in 1984, a law was passed expropriating the former owner’s land to entitle the
occupants. Only part of the original owners accepted the government compensation and, as a result,
a group of squatters obtained formal land rights while others continued living in the occupied parcels
without legal titles. Thus in this case, untitled and entitled households were extremely similar before
titling, the parcels they inhabit are identitical, and the allocation of property rights across households
was random. Galiani and Schargrodsky (2010) found evidence that formal titles substantially increased
housing investment, reduced household size as well as enhanced the education levels in families relative to
the control group. According to Galiani and Schargrodsky (2010), these effects take place mainly through
the channel of increased physical and human capital investment. Access to credit, in contrary, was not
recognized as an important driver of housing investment.
Utilising the same natural experiment in Buenos Aires, Di Tella et al. (2007) studied the formation of
beliefs in a squatter settlement. In the case of belief formation one has to again address a problem of
endogeneity. As Di Tella et al. (2007) explain, it is plausible to assume that the allocation of property
rights across families is not random but depends on effort, wealth, preferences or other selection mechanism.
Hence, different personal characteristics that determine the likelihood of having land titles are also likely
correlated with beliefs. Their results suggest that individuals report different beliefs when they hold
property rights. It seems that holding a land title shifts the beliefs in the direction of making them more
compatible with unregulated markets. In fact, their results imply that ending up with a title almost closes
the belief gap between the average population and the squatters. The authors themselves note that this
is a large estimated effect and raise the fact that it is conceivable that other aspects of the individual’s
mindset besides beliefs are affected.
Also the relation between property rights and trust has been studied within field experiment setting (see
e.g. Rubenson and Loewen (2015) who randomnly assign exclusive use rights to large plots of grazing land
to groups of Mongolian herders). Rubenson and Loewen (2015) remark that the notion of trust is closely
related to that of social capital. Evidence shows that trust improves for example trade (Greif, 1993) and
government efficiency (Putnam, 1993) and is important for economic growth. They divide interactions
between individuals into two types, (1) property-based interactions and (2) all other interactions. In this
framework generalized trust is a function of the interactions that an individual has with others. The
basic intuition is that granting some individuals property rights will reduce the likelihood of negative
interactions related to property and, consequently, increases their generalized trust. The results of this
study support the theory and show that mean level of trust is significantly higher for the treatment group
3 Theoretical studies
8
(i.e. the group that received exclusive use rights).
3
Theoretical studies
In contrast to empirical studies, theoretical studies are not bounded to availibility of data. Theoretical
models are of course merely simplifications of (endlessly) complex real world, and the results obtained
should be considered carefully and keeping in mind the underlying assumptions that the modeller has
chosen to use in that particular setting. Theoretical literature has mainly concentrated on explaining the
demand for informal land tenure in urban setting (Hoy and Jimenez, 1991; Turnbull, 2008; Brueckner and
Selod, 2008).
Hoy and Jimenez (1991) were among the first ones to develop a formal economic model in order to understand the dynamics of squatting in Third World cities. In this study, the landowner-squatter interaction
is presented as a principal-agent model. The model is build to being consistent with the observations
that (1) landowners often do not collect rent from squatters for use of the land, and (2) costly evictions
are sometimes used without subsequent development of the land. In particular, Hoy and Jimenez (1991)
aimed to enlighten certain aspects of socially optimal land management policy for squatter areas since
the empirical evidence points to a failure of the Coase theorem, and as a consequence, to a role for intervention in the relationship between landowner and squatter. They present that when a formal rental
market is lacking, landowners may apply an eviction option more often than is socially optimal. Hence
regulating this relationship either by reducing the level of instruments chosen by a private landowner or
acquiring land for transfer to squatters would be beneficial in some cases. They also point out that fear
of eviction generates a tendency for squatters to underinvest in housing capital (this conclusion is in line
with empirical evidence, as Field (2005) shows).
Also continuing in the context of squatting, Turnbull (2008) explains why introducing an informal land
market comprising potential squatters and owners does not necessarily resolve the inefficiency of squatter investment and owner eviction decisions. His main conclusion is that squatting arises from optimal
landowner decisions not to fully exercise property rights (or to physically defend property rights in response
to institutional restrictions that preclude complete real estate markets). Like in Hoy and Jimenez (1991),
his model assumes that institutional restrictions or high transaction costs preclude landowners from collecting rents from squatters. An important divider is that Turnbull’s model is dynamic by nature - he
explicitly explores the strategic choices of landowners regarding the timing of squatter eviction. Turnbull
(2008) emphasises that due to so-called clearing cost externality, there is a wedge between the owner’s
and squatter’s net marginal benefits from developing the land for the formal sector. Consequently, the
owner still has an incentive to evict more frequently and the squatter to invest more than is efficient. He
also asks whether internalizing this clearing cost externality by for example using some sort of land rent
3 Theoretical studies
9
agreement would solve the inefficiency problem. Most likely not, he concludes, since simple agreements
often fail in this respect and more complex agreements are too costly.
Brueckner and Selod (2009) present a different kind of analytical framework where eviction is absent in
equilibrium. Their view is that formal tenure and squatting represent two interlinked land uses within a
single market (where squatters and formal residents compete for land within a city) and should be modeled
as such. A key implication of the model is that squatters ’squeeze’ the formal housing market by raising
the price paid by formal residents. In this model, however, the formal price is not allowed to rise to a
level that invites eviction by landowners. Besides examining the mechanisms underlying squatting, they
also investigate the general equilibrium effects of formalization policies in the land market (in contrast
to empirical literature that has focused on improvements in tenure security, labor market participation,
access to credit etc.). As Brueckner and Selod (2009) point out, this is an important aspect since with
formalization programs the squatters may end up worse off when faced with the full market price of
housing. Their analysis implicates that the gains of formal residents (mostly in form of the reduction in
squeezing) are sufficient to compensate the squatters’ losses. In other words, formalization produces a
Pareto improvement to a city’s squatter equilibrium. This finding is of course significant from the funding
point of view; squatter formalization may not necessarily require external funding from development
agencies to succeed. The authors further present that the compensation from formal residents to squatters
could come for example in the form of infrastructure investments in squatter areas.
Miceli and Kieyah (2003) develop a simple model of land title reform that reveals some basic dynamics
of introducing a title system. They show formally that even when all landowners would gain from the
institution of a new formal title system, equilibrium usage may fall short of the optimal level due to a
fundamental externality5 . The economic theory traditionally implies that presence of externalities forms
a requirement for government intervention (since markets fail to produce socially optimal amount of the
good in question), and Miceli and Kieyah (2003) come to same conclusion; namely, they suggest that
a title system should provided and mainteined by government since even under favorable conditions for
reform, policies based on voluntary reform are very unlikely to achieve their full potential.
Cai et al. (2015) study the causes and consequences of the “urbanization without formalization” phenomenon with a DGE model6 that explicitly accounts for the joint dynamics of land property rights and
urbanization. Thus their study is among the first ones aiming to analytically understand the interaction
between urbanization and evolution of land property rights. In this setting, the calibrated baseline model
5
In this context externality prevents individual landowners from internalizing fully the social gains from reform (Miceli
and Kieyah, 2003).
6
Dynamic general equilibrium (DGE) models are these days the most commonly used macro models. DGE models are
often described as ’macro models with micro foundation’, which in short means that they are build on optimizing agents
(consumers maximize their utility and firms maximize their profit) as well as on rational expectations and market clearing
condition.
4 Summary
10
describes a city that first grows informally. In subsequent periods, the growth of individual incomes leads
to a phased-in purchase of property rights.
4
Summary
This review focuses on land property rights and their connection to economic development. Hardly anything is said about supporting technologies of land administration that have recently emerged to scale
up the capture and recording of land rights. For instance, Global Land Tool Network has relatively
short time ago launched Fit-for-Purpose Land Administration Guiding Principles, an overall framework
for quickly delivering affordable, nationwide land administration solutions (Enemark et al., 2015). Also
UN-FAO has published the Voluntary Guidelines on Responsible Governance of Tenure (UN-FAO, 2012).
In addition, it should be noted that thanks to technological and social innovations new valuable sources
of data to prioritise and implement security of tenure are arising quickly. Traditionally upgrading land
titling systems has been a gradual process due to the time-cosumig nature of the work7 . There is a great
premise in new sources of data to speed up the process and make (higher-quality) land registration more
accessible to larger crowds. Moreover, many ’sub-issues’ of land/property rights institution such as the
role of customary land rights in Africa (see e.g. Brasselle et al., 2002) or the gender bias in addressing
land titles (e.g. Newman et al., 2015) are not covered in this review.
Many empirical studies (Field, 2005; Galiani and Schargrodsky, 2010) have come to a conclusion that
increases in investment incentives most significantly explain why secure property rights prompt economic
development. Greater access to credit, in contrary, has not been found to have such a clear effect on the
rate of investments (for example credit rationing might reduce the rate of investments, as explained in
introduction chapter). Most recently Rubenson and Loewen (2015) examined the effects of secure property
rights on trust, and found that giving individuals property rights increases trust as well as decreases the
rate of predation in property-based interactions. Trust in turn has been found important for economic
growth, for facilitating better functioning firms and organizations as well as for improving trade (see
Rubenson and Loewen, 2015).
Theoretical models stress out that there are certain prerequisities for land registration to be economically
viable. In particular, the model simulations show that land tenure informality does not necessarily vanish
in the long-run, and that the social optimum does not necessarily imply a fully formal system of land
7
For example Bezu and Holden (2014) analyse what are the private benefits of ’second-stage’ land certification in Ethiopia.
They note that the ’first-stage’ certification done by field markings had positive effects in terms of increased investment, land
productivity and land rental market activities. Demand for the ’second-stage’ certification, involving technically advanced
land survey methods and computer registration, revealed to be very low in their study based on panel data from 600
households.
4 Summary
11
property rights. Miceli and Kieyah (2003) point out that the fundamental problem is an externality that
prevents individual land owners from internalizing fully the benefits of the new (formal) system.
In light of above, a severe problem in many studies is that they consider only the implications of changes
in land or property rights for their owners. For example Feder et al. (1998) suggest a number of reasons
why the private value of formalising property rights exceeds the social value. For instance, it might be
that owners overvalue having a lower risk of eviction because they do not take into account the utility of
those who replace them. Moreover, the value of title in facilitating access to the formal credit market can
also be overvalued if lower interest rates in the formal market are due to government subsidies. Likewise,
directing the full costs of establishing and maintaining a formal system of rights to title recipients is crucial
- otherwise the social costs of titling will be higher than the private costs. (Feder et al., 1998; Lanjouw &
Levy, 2002.)
4 Summary
12
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