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Prosperity and property rights are inextrica- bly linked. The importance of having well- defined and strongly protected property rights is now widely recognized among economists and policymakers. A private property system gives individuals the exclusive right to use their resources as they see fit. That dominion over what is theirs leads property users to take full account of all the benefits and costs of employ- ing those resources in a particular manner. The process of weighing costs and benefits produces what economists call efficient outcomes. That translates into higher standards of living for all. It is only in the last few decades, however, that
economists have accepted the importance of property rights. Throughout much of the histo- ry of modern economics, the subject was given short shrift. Even stalwart supporters of the mar- ket economy glossed over the subject. Not sur- prisingly, much bad development policy resulted from that neglect. Even if policymakers in devel- oped countries and international institutions now recognize the critical role played by a system of private property in economic development, they are limited in what they can do to help developing countries evolve such a system. Policymakers can, however, avoid recommend- ing policies that undermine private property.
Property Rights
The Key to Economic Development
by Gerald P. O’Driscoll Jr. and Lee Hoskins
Gerald P. O’Driscoll Jr. is senior fellow at the Cato Institute and Lee Hoskins is senior fellow at the Pacific Research Institute._
Executive Summary
No. 482 August 7, 2003
Why Property Rights?
The excuses for development failure are legion: lack of natural resources; insufficient funding of education, culture, religion, and history; and, recently, geographical location. As Friedrich Hayek, Nobel laureate in eco- nomics, taught us in another context, we cannot explain success by examining failure: “Before we can explain why people commit mistakes, we must first explain why they should ever be right.”^1 The question that we need to ask is why should nations prosper? We argue that the difference between prosperity and poverty is property. Nations prosper when private prop- erty rights are well defined and enforced.
The Wealth of Nations
UCLA researchers Richard Roll and John Talbott provocatively titled a paper, “Why Many Developing Countries Just Aren’t.”^2 Economic development has been exceptional rather than typical. As Peruvian economist Hernando de Soto points out, capitalism has been successful mainly in the West.^3 The result is incredible disparities in living stan- dards around the world. Depending on the measure, real income varies across countries by a factor of more than 100. In 2000, real per-capita GDP was $50,061 in Luxembourg and $490 in Sierra Leone. Those figures are measured in pur- chasing power parity (PPP). Using 1995 con- stant dollars produces even more extreme variations across countries. 4 Differences between neighboring countries can be huge. Depending on the income measure used, real per-capita GDP in the United States is about four to eight times that of Mexico. The socioeconomic consequences of that differ- ence are huge and well-known. Conserva- tively measured, South Koreans have 17 times the income of North Koreans. That dif- ference surely has something to do with the current tensions on the Korean Peninsula.
In the 1930s, the Finns and Estonians enjoyed a similar standard of living. The two countries are virtually neighbors. Their lan- guages share a common linguistic root, and they are culturally similar and share many values. (Despite being a Baltic country geo- graphically, Estonians consider themselves to be a Nordic people.) Depending on the mea- sure employed, in 2000 the average Finn earned two and a half times to more than seven times what the average Estonian earned. Fifty years of Communist rule surely had something to do with the gap in incomes that opened between the two countries. In the past, substantial differences existed between the standard of living in East and West Germany—two countries with essential- ly the same resources, education, culture, lan- guage, religion, history, and geography.^5 Why the tremendous income differences? Hong Kong and Singapore are city states, almost completely lacking in natural resources. They border much larger and poorer neighbors. Hong Kong in particular experienced long periods of immigration from its poorer neighbor, mainland China. Yet both island nations sustained periods of annual growth of real per-capita GDP at 5 percent for a long period. Singapore’s real per-capita GDP doubled from 1962 to 1971.^6 The real per-capita GDP of Hong Kong, a for- mer colony of Great Britain, now exceeds that of the mother country ($25,153 vs. $23,509 at PPP in 2000). The paradoxes abound. Despite its own recent economic miracle, China’s real per-capita GDP in 2000 was still just under $4,000. Taiwan’s is over $17,000, more than four times China’s. (Both measured in PPP.) Prof. Allan Meltzer has recently commented on these near-laborato- ry experiments in development:
In each of these comparisons, cul- ture, language, and traditions are the same. Outcomes are markedly differ- ent. The countries with capitalist institutions and the market system grew richer; the others faltered or went backwards. A South Korean
Nations prosper
when private property rights are well defined and enforced.
society from incroaching on one another’s property, or seizing what is not their own. The design here is to give each one the secure and peacable possession of his own property.^15
Smith’s statement of the purpose of gov- ernment is 18th century in its formulation. It is as descriptive as normative. Protecting pri- vate property is just what government did first and foremost. As Bethell explains, economists “assumed a political and legal framework comparable to that found in eighteenth-cen- tury Britain, but they neither insisted on the point, not did they spell it out in detail.”^16 In France, Jean-Baptiste Say had a chapter on property in his Treatise on Political Economy. Apparently, the experience of the French Revolution motivated Smith to focus on the importance of property rights.^17 That experi- ence also profoundly affected such English political thinkers as Edmund Burke. The neglect by the British political economists that Bethell chronicles remains puzzling. According to Bethell, “the phrase ‘private property’ barely entered the language before the nineteenth century.” The 18th century Scottish philosopher Adam Ferguson spoke of “property,” but without the qualification. Bethell counted a couple of uses of “private property” in The Wealth of Nations, and one in the first edition of Malthus’ Principles of Political Economy. “On the whole, though, it seemed unnecessary to specify more precisely an institution that was not thought to have any workable alternative.”^18 Of course, the great legal theorists were very much concerned with property and its protection. Blackstone defined property as “that despotic dominion that one man claims and exercises over the external things of the world, in total exclusion of the right of any other individual in the universe.” But he could think of nothing “which so generally engages the affections of mankind, as the right to property.” Jeremy Bentham, who dis- agreed with Blackstone on almost all other issues, agreed with the jurist on property, say- ing that the law securing property is “the
noblest triumph of humanity over itself.”^19 By the middle of the 19th century, howev- er, private property was under intellectual attack. The assault came from many direc- tions. Bethell identifies an unholy trinity of economists: Mill, Marx, and Marshall. John Stuart Mill’s famous distinction between the laws of production and the laws of distribution was the source of much subse- quent mischief. The laws of production were scientific and immutable, while those of dis- tribution were the product of man and changeable through legislation. Mill included the discussion of property under distribution. Science, not ownership, shaped production.^20 In a market economy, however, there is no distribution separate from production and exchange. The redistributive impulse under- mines the system of private property that undergirds production and exchange. The production process, meant to operate by immutable laws, is undermined when private property is insecure. There is no production mechanism running independently of the system of rewards and penalties accruing to owners of factors of production (land, labor, and capital) in a market.^21 Mill’s bloodless account of production contrasts sharply with that of von Mises, offered 100 years later:
Ownership of the means of produc- tion is not a privilege, but a social lia- bility. Capitalists and landowners are compelled to employ their property for the best possible satisfaction of the consumers. If they are slow and inept in the performance of their duties, they are penalized by losses. If they do not learn the lesson and do not reform their conduct of affairs, they lose their wealth. No investment is safe forever.^22
In Mises’ account, production is an active, risky, and entrepreneurial venture. Produc- tion is a protean process, and the only per- manent law of production is change. Mises’ final observation that “no investment is safe
By the 20th century, we had the paradox that,
in economics, the
defenders of markets had said comparatively little about property.
forever” refutes the classical economic doc- trine of economic rent: there are no perma- nent income streams. John Stuart Mill was among the first in a line of thinkers who believed they were wit- nessing the transformation of human nature. That transformation would enable a commu- nist form of ownership to substitute for pri- vate property. As man’s nature was sponta- neously transformed, everyone would learn “to feel the public interest as their own.” Mill was certainly a good enough economist to understand the shirking problem when prop- erty is owned in common. In a socialist farm or “manufactury,” however, people would be working “under the eye, not of one master, but of the whole community.”^23 We know how that system ends: in the gulag. In the mid-19th century, however, such ideas were progressive. And the younger Mill was an immensely influential thinker not only in his own century but into the next one. He authored “the most successful and most influential treatise of that age.”^24 And, according to Pipes, Mill “moved liberal ideol- ogy closer to socialism.”^25 Alfred Marshall’s Principles of Economics strongly influenced the course of thinking among English-speaking economists. Marshall also believed in the idea of progress. While Mill looked forward to the possibility of improvement in human nature, Marshall believed that “changes in human nature” had for the last fifty years been “rapid.” Omi- nously, he believed that the need for private property “doubtless reaches no deeper than the qualities of human nature.”^26 Marshall subscribed to the idea of pro- gressive social change. “Men’s collective instincts, their sense of duty and their public spirit” would be better developed. Legislation would “fortify” this trend.^27 With the per- fectibility of man, private property became unimportant.^28 Karl Marx, who temporally bridged Mill and Marshall, openly attacked private proper- ty. He called for its abolition. What all three agreed on was the need for human nature to change if private property were to be abol-
ished. “Marx believed it was in fact changing. So did Marshall. So their view of property was at least coherent. Today, very few people believe that human nature is changing. And we can see that such statements as Marshall’s, claiming that it had already changed, were misguided.”^29 The practice of 20th century communism attempted to effect a change in human nature. “Everything the Communist Party has done since the Revolution, despite changes and apparent departures from origi- nal ideas and replacement of leaders, has been directed at the transformation of human beings,”^30 explains Russian historian Mikhail Heller. We know the consequences of this effort. By the 20th century, we had the paradox that, in economics, the defenders of markets had said comparatively little about property. When economists addressed private property, it was often to criticize it. Schumpeter spoke of classical liberalism’s “defeat,” and noted that “on the whole, the economic professions of all countries were politically supporters of the counter-tendencies to liberalism rather than of the still dominating liberal ones. In this sense, we can say the alliance between eco- nomics and liberalism—and, with exceptions, between economics and utilitarianism—was broken.”^31 No one focused more on private property than Marx, but in the context of its denunci- ation. The Marxian view of property tri- umphed in much of the world in the second half of the last century. Where were the 20th century economists in the debate?
Property’s Neglect in the 20th Century
Today, it is a commonplace to observe that neoclassical economics neglected the role of property rights. What is amazing, however, is how little was written about prop- erty rights by those economists recognized as defenders of the market economy. In 1935 Hayek edited a collection of essays on the
It is the absence of legal protection of private property that has blocked the democratiza- tion of both property and capitalism in Latin America.
though he may be, cannot be blamed for Venezuela’s predicament. It is a problem of institutional failure, not the character defi- ciencies of an individual.^38 The rights against both the state and the powerful were secured for early Americans, such as the 18th century German settlers described above, by the protection of their per- son and property. That protection in turn made it possible for them to invest and take risks. More generally, the stronger the set of property rights, the stronger the incentive to work, save, and invest, and the more effective the operation of the economy. The more effectively an econo- my operates, the more growth it will produce for any set of resources.^39 Once stated, the intellectual argument for the importance of property rights is com- pelling. Why does an individual invest unless to gain something for himself and his family? How can he ensure that gains flowing from his activity be appropriated and secured other than through a system of well-defined property rights? To suppose otherwise, is to suppose that human nature will change. That road is a dead end. Yet theories of economic growth still fall back on laws of production and relationships among things rather than interactions among people governed by institutions. Economists still debate whether returns to scale are increasing, decreasing, or constant. That debate, however, deals with physical laws of production, not the system of incen- tives and rewards shaping economic growth. Within an economic model, there may be diminishing returns. Yet the real world looks like one of increasing returns. Adam Smith believed that returns decline in the short run, while costs decline in the long run. The short run mimicked the world of diminishing returns associated with David Ricardo and other classical economists. In the long run, entrepreneurs innovated, capitalists invested, and costs declined. Smith himself thought the pin factory provided the rationale for this pattern, while property rights theorists look elsewhere.^40 In the 20th century, one economist did
stand against the tide on the issue of property rights: Ludwig von Mises. His views on prop- erty rights anticipated many of the positions adopted by economists many years later. “Carried through consistently, the right of property would entitle the proprietor to claim all the advantages which the good’s employ- ment may generate on the one hand and would burden him with all the disadvantages resulting from its employment on the other hand.”^41 Rewards and costs are not internal- ized when laws are deficient or there are “loop- holes” in liability protection. In this situation, the problem of external costs arises.^42 Mises analyzes the process by which individ- uals come to establish property rights over nat- ural resources. He examines the costs and bene- fits of establishing private property rights. When land is abundant and a frontier exists, as in 19th century America, it may not pay to establish private property rights. In that envi- ronment, settlers cut down trees without regard to replenishing them. Similarly, they hunt and fish until the stocks are depleted, then moved on to unsettled areas. “It was only when a coun- try was more densely settled and unoccupied first class land was no longer available for appropriation, that people began to consider such predatory methods wasteful. At that time they consolidated the institution of property in land.”^43 In central and western Europe, by con- trast, no such process was observed in mod- ern times. There was no soil erosion, no deforestation. Why? “The institution of pri- vate property had been rigidly established for many centuries.” Forests were privately owned, and the owners “were impelled to conservation by their own selfish interests. In the most densely inhabited and industrial- ized areas up to a few years ago between a fifth and a third of the surface was still cov- ered by first-class forests managed according to the methods of scientific forestry.”^44 Private property rights are only secured when the benefits of doing so outweigh the costs. That approach is familiar today. Mises’ analysis, however, predates Demsetz’s well- known presentation.^45 The modern property
The real world looks like one of increasing returns.
rights literature largely overlooked Mises’ analysis. It would have benefited from it, since Mises had a more thorough under- standing of the critical role of property rights than did most of his 20th century contem- poraries. In sum, with some conspicuous excep- tions, neglect of property rights characterizes all too much the history of economics. As Pipes summarized it, “professional econo- mists have paid little attention to property rights, being principally concerned with material factors making for economic growth, such as capital formation and technological innovation.”^46 The emergence of a more coher- ent economic theory of property rights is a fairly recent phenomenon.
Economics, Property Rights, and Development
Armen Alchian, Ronald Coase, and Harold Demsetz founded the modern prop- erty rights school of economics. They sought not only to delineate the importance of a sys- tem of private property rights to the effective functioning of an economy but to identify the circumstances that lead to the assign- ment and formation of property rights. Alchian stated:
By a system of property rights I mean a method of assigning to particular individuals the “authority” to select, for specific goods, any use from a nonprohibited class of uses. As sug- gested in the preceding remarks the concepts of “authority” and of “non- prohibited” rely on some concept of enforcement or inducement to respect the assignment and scope of prohibit- ed choice. A property right for me means some protection against other people’s choosing against my will one of the uses of resources said to be “mine.”^47
Coase shows that the way rights are initial-
ly assigned or partitioned does not affect the way resources are used when there are no transaction costs associated with voluntary exchanges of property and no policing costs.^48 Since there are policing costs and transactions costs associated with defining and protecting property rights, such rights will be defined and protected only when the benefits of doing so are greater than the costs. It is a mistake to assume that the task of assigning, defining, and protecting property rights is the exclusive job of the state. Property rights developed from custom and tradition long before we had nations. In Property and Freedom, Richard Pipes provides an overview of the evolution of the institutions of property from primitive times to the emergence of the state. He noted that “in most countries proper- ty took the form of possession, claims to which rested not on documented legal title but on prolonged tenure, which custom acknowl- edged as proof of ownership.”^49 Only later did property become regularized with the emer- gence of the state.^50 Today, property rights are often worked out among individuals or firms first and then recognized by law. However, govern- ments at all levels continue to weaken or attenuate property rights on a daily basis with a barrage of regulations affecting the use of private property. The two essential elements of property rights are (1) the exclusive right of individuals to use their resources as they see fit as long as they do not violate someone else’s rights and (2) the ability of individuals to transfer or exchange those rights on a voluntary basis. The extent to which those elements are hon- ored and enforced will determine how effec- tively prices in an economy will allocate goods and services. Both experience and theory indi- cate that economies with effective price sys- tems are better at producing wealth. In short, the stronger the private property rights sys- tem, the better the economy is at efficiently allocating resources and expanding wealth- creating opportunities.^51 Individuals in all societies have conflicts of interest. One way conflicts are resolved is
The emergence of a more coherent economic theory
of property rights
is a fairly recent phenomenon.
finally in lightly governed England, i.e., under the rule of the bourgeoisie rather than warriors, that modern industrialism grew. Protection of several property, not the direction of its use by government, laid the foun- dations for the growth of the dense network of exchange of services that shaped the extended order.^59
What would most benefit less-developed countries would be a focus on establishing and protecting property rights. Yet most aid from the United Nations, International Monetary Fund, and World Bank is directed toward other goals, and often undermines property rights. Protecting property, letting individuals pursue their own self-interest, and opening up trade offer the best chance for economic growth.
Corruption
Pro-growth development officials increas- ingly focus on corruption as an impediment to development. Traditionally economists have held two distinct opinions about cor- ruption. Robert Barro has suggested that, under some circumstances, corruption can have beneficial effects.
In some circumstances, corruption may be preferable to honest enforce- ment of bad rules. For example, out- comes may be worse if a regulation that prohibits some useful economic activity is thoroughly enforced rather than circumvented through bribes. However, the economy will be hampered when few legitimate activ- ities can be undertaken without bribes. Thus, the overall impact of more official corruption may be ambiguous.^60
Many economists would agree with the cost/benefit approach to corruption, if not the moral ambiguity seemingly underlying
the position. Under that approach, there is an optimal amount of law-abiding behavior. Economists would tend to agree even more strongly with Barro’s position on black mar- ket activity, which he sees as an adaptation to poorly defined property rights, high tax rates, and oppressive regulation. By operating in the informal sector, individuals are able to engage in economic activity that would oth- erwise be lost to weak institutions and bad policies. Still, there are recognized costs in terms of inefficiency, inability to enforce con- tracts, and lost tax revenue.^61 Hernando de Soto graphically outlined the costs to the entrepreneurs operating in the black market:
Contrary to popular wisdom, operat- ing in the underground economy is hardly cost-free. Extralegal business- es are taxed by the lack of good prop- erty law and continually having to hide their operations from the authorities. Because they are not incorporated, extralegal entrepre- neurs cannot lure investors by selling shares; they cannot secure low-inter- est formal credit because they do not even have legal addresses. They can- not reduce risks by declaring limited liability or obtaining insurance cov- erage. The only “insurance” available to them is that provided by their neighbors and the protection that local bullies or mafias are willing to sell them. Moreover, because extrale- gal entrepreneurs live in constant fear of government detection and extortion from corrupt officials, they are forced to split and compartmen- talize their production facilities between many locations, thereby rarely achieving important econo- mies of scale. In Peru, 15 percent of gross income from manufacturing in the extralegal sector is paid out in bribes, ranging from “free samples” and special “gifts” of merchandise to outright cash. With one eye always
Establishing a democratic form of government is
no guarantee of a
strong private property rights system.
on the outlook for police, under- ground entrepreneurs cannot openly advertise to build up their clientele or make less costly bulk deliveries to customers.^62
De Soto’s research led him to conclude that, when it is possible for entrepreneurs to obtain title to their property and operate legal- ly, it is worth paying taxes to avoid the costs associated with operating underground. The poor do not choose to operate illegally out of predisposition to lawless behavior. Speaking of the urban migration process in developing countries, De Soto wrote that “in every coun- try we investigated, we found that it is very nearly as difficult to stay legal as it is to become legal. Inevitably, migrants do not so much break the law as the law breaks them—and they opt out of the system.”^63 An increasing number of observers of developing countries decry the effects of per- vasive corruption. Alejandro Chafuen and Eugenio Guzmán wrote :
Nevertheless, the same corrupt activ- ity that might enable one person to avoid the burden of an unjust law might also allow someone else to avoid complying with just laws. The bureaucrat who accepts a bribe to help one person with a contract might also accept a bribe to leave someone else out of business. Officials who accept bribes to accel- erate a regular business errand might also accept a bribe to leave someone defenseless against blackmail. Execu- tives of U.S.-based corporations find themselves frequent victims of such bureaucratic behavior.^64
There is ample evidence that Chafuen and Guzmán were on the mark. In Roll and Talbott’s recent study, corruption (the “black market” factor of the Heritage Index of Economic Freedom ) has a large and statistically significant negative effect on per-capita real gross national income. That variable is sec-
ond only to property rights in its influence on the standard of living in a country. Once corruption takes root, it is difficult to stamp out. The illicit payments received by government officials become part of their expected compensation. Customs agencies can become little more than schemes for col- lecting bribes. One way out of this problem has been for governments to employ private firms, such as the Swiss Firm Societe General de Surveillance, to enforce the rules or even collect customs imposts. In Peru the Fujimori government licensed several inspection companies to con- duct pre-shipment inspection of import com- modities, which would be used as a valid refer- ence for settlement of duties and clearance charges. This private competitive scheme enhanced customs revenue collection and reduced clearance delays.^65 The government establishes the tariff schedules and rules, but the profit-seeking firm enforces them. Its “rep- utational capital” at stake, the firm will employ resources to combat corruption. Alternatively, a country can diminish the incentives for bribe payments by altering policies. Complex tariff schedules containing large variations in rates create incentives for importers to seek favorable treatment by cus- toms officials on the category into which a good falls. Chile introduced a flat tariff schedule for most goods, which greatly diminished rent seeking. That still left a high tariff rate of 10 percent. In 1991, the govern- ment announced a policy of reducing the flat rate by one percentage point per year until the flat rate hit 6 percent in 2003.^66 Although not impossible, weeding out corruption that has taken root challenges the political system. That consideration surely led Thomas Jefferson to argue that preven- tion is the best cure:
Human nature is the same on every side of the Atlantic, and will be alike influenced by the same causes. The time to guard against corruption and tyranny, is before they shall have gotten hold of us. It is better to keep
If they could operate in an environment of secure property rights, the world’s poor would have the solution to their own plight.
corrupt institutions.^74 What Melvyn Krauss has labeled the “con- sensus of expert opinion” on development in the 1950s, 1960s, and 1970s has largely been proven wrong. 75 Development nostrums have lead not to prosperity but to penury in all too many developing countries. Private property was omitted from the development consensus.^76 The official assistance policy of the United States, and that of many multilateral institutions, is now directed at helping devel- oping countries develop the rule of law and a system of private property. The problem is that those efforts largely ignore the history of private property in the United States and other countries in which private rights are strongly protected. In the Mystery of Capital, Hernando de Soto looked for lessons from U.S. history that could be applied to develop- ing countries. The lesson he gleaned was that each country must evolve its own property rights system according to its own history.^77 Richard Pipes focused on the history of property in two countries: England and Russia. He also presented evidence for a number of other countries, such as France, Spain, Portugal, Sweden, and the Nether- lands.^78 One theme emerges from all the his- tories. Property and freedom emerged from a struggle over finances between a representa- tive body and a king or ruler. When the ruler was compelled to rely on parliament or its equivalent for a permanent source of rev- enue, property was protected and liberty flourished. When the ruler was not so com- pelled, the converse resulted. In Russia, sovereignty and property merged. Consequently, the Russian despotic ruler had no need of a representative assem- bly for revenue. The story was mixed in other countries. The English king became increas- ingly dependent on Parliament for revenue, and Parliament thereby gained supremacy. The struggle was always couched in terms of protecting property and liberty from encroachment by the king:
The originality of the English parlia-
ment, therefore, lies not in its antiq- uity and function but in its longevi- ty, for it went from strength to strength, whereas its continental counterparts, with few exceptions (notably Poland, Sweden, and the Netherlands) did not survive the era of royal absolutism.^79
Exporting a country’s system of private property rights ultimately entails exporting its history and political culture. That has not been done successfully, other than through colonial- ism, and then only effectively in the case of the British Empire. History does not repeat itself, and the American political culture finds colo- nialism alien. So the scope for effective official assistance in this process is limited. Following de Soto, we see the need for each developing country to work out the problem of evolving a system of private prop- erty in terms of its own history. The transi- tion economies of Central and Eastern Europe had the advantage, to different degrees, of a pre-Soviet history of free eco- nomic and political institutions on which to build. In some cases, such as the Baltic coun- tries (especially Estonia), and Poland, the transition has been truly rapid. For countries without such a history of freedom, the process will necessarily be longer. It is unlikely to be a process attractive to outsiders. Russia is a prime example. U.S. policy is constrained in its ability to aid directly the evolution of the rule of law and private property in such countries. Getting from Magna Carta to parliamen- tary supremacy in England took roughly half a millennium. Is it reasonable to assume that a country such as Russia could attain the same degree of protection of private property under a rule of law in less than a century? What the Bush administration can and should do is to vigorously pursue trade liber- alization with developing countries. Tariff and nontariff barriers hit the exports of developing countries particularly heavily, notably on agricultural, and textile and apparel exports. Many of the benefits
Getting from Magna Carta to parliamentary supremacy in England took roughly half a millennium.
claimed by advocates of aid, which are sel- dom realized through aid, actually accrue to international trade. Moreover, developing countries that open their markets to trade set in motion a process of institutional change that can lead to the establishment of the rule of law. Robert Zoellick, the United States Trade Representative, has proposed a num- ber of trade initiatives to help developing countries, and the Bush Administration should pursue these.^80
Conclusion
Historical economic development can only be explained by private property, the rule of law, and other key institutions. Classical economists understood this, but didn’t emphasize what they took to be obvi- ous. As economics matured as a discipline in the 19th century, ideas critical of property rights began to take hold. In the 20th centu- ry, economists became enamored of macro- economics and technique over microeco- nomics and institutions. The rise of the omnipotent nation state in the 20th century, accompanied by the decline of classical liberal ideas, caused economists to lose sight of the fundamentals of develop- ment. Economists came to accept absurdities as fact. “‘Measured Soviet real GNP has grown more rapidly over the long run than have most of the major market economies,’ Paul Samuelson wrote in the 13th (1989) edi- tion of his famous textbook, even as the Berlin Wall was coming down.”^81 The lessons learned from the economics of property rights have yet to be effectively incorporated into policy by bilateral and multilateral aid agencies. Shifting aid resources away from fashionable develop- ment programs toward institutional arrange- ments that protect property, improve market price systems, and reduce trade barriers may give the poor a shot at a better economic future. More likely, the countries themselves will need to evolve the needed institutions. Promoting free trade is one practical way to
advance the rule of law and protection of pri- vate property.
Notes A version of this paper was presented at the annu- al meeting of the Association of Private Enterprise Education, April 6–8, 2003. We thank the participants at our session for their com- ments. We also thank Ian Vásquez, Richard Ebeling, Leonard Liggio, Maralene Martin, and Walker Todd for their comments on earlier drafts.
- Friedrich A. Hayek, “Economics and Know- ledge,” in Individualism and Economic Order (Chicago: University of Chicago Press, 1948), p. 34.
- Richard Roll and John Talbott, “Why Many Developing Countries Just Aren’t,” Los Angeles, UCLA, Nov. 2001 (unpublished manuscript).
- Hernando de Soto, The Mystery of Capital: Why Capitalism Triumphs in the West and Fails Everywhere Else (New York: Basic Books, 2000).
- See Gerald P. O’Driscoll Jr., Edwin J. Feulner, and Mary Anastasia O’Grady, 2003 Index of Economic Freedom (Washington: The Heritage Foundation and Dow Jones, 2003), see table entitled “Per Capita Income throughout the World,” pp. 432–35. This table is used for the subsequent comparisons.
- Official U.S. statistics missed these differences. In 1989, the year the Berlin Wall fell, per-capita income was reported to be higher in East Ger- many ($10,330) than in West Germany ($10,320). U.S. Department of Commerce, Statistical Abstract of the United States (Washington: GPO, 1989), p. 822. Cited in Bethell, p. 12.
- World Bank, World Development Indicators Online, www.worldbank.org/data. See also Gerald P. O’Driscoll Jr. and Sara J. Fitzgerald, “Trade Promotes Prosperity and Security,” Heritage Foundation Backgrounder no. 1617, December 19, 2002, Tables 1 and 2 and pp. 6–7.
- Allan H. Meltzer, “Leadership and Progress,” The Irving Kristol Lecture of the American Enterprise Institute, Washington, February 26, 2003, p. 5. Meltzer’s comparisons were the two Germanys, the two Koreas, and between China and “the Chinese diaspora in Taiwan, Hong Kong, and Singapore.” Richard Pipes, the distin- guished historian of Russia, makes a similar com- parison in Property and Freedom (New York: Alfred A. Knopf, 1999), pp. 286–87.
- Sachs and Warner found a negative correlation
Rights: The Key to Economic Growth,” in Gerald P. O’Driscoll Jr., Kim R. Holmes, and Mary Anastasia O’Grady, 2002 Index of Economic Freedom (Washington: The Heritage Foundation and Dow Jones, 2002), pp. 37–38.
- In the Wealth of Nations, marginal costs are an increasing function of output. Innovation pro- duces outward shifts in the cost function and the appearance of declining costs (increasing returns). At each moment in time, however, there are diminishing returns. Adam Smith, An Inquiry into the Nature and Causes of the Wealth of Nations (New York: The Modern Library, 1937 [1776]).
- Mises, Human Action, p. 655.
- Ibid. 655–56.
- Ibid., p. 656.
- Ibid., p. 657.
- Harold Demsetz, “Toward a Theory of Property Rights,” American Economic Review 57 (May 1967): 347–59. According to Professor Richard Ebeling of Hillsdale College, the discus- sion of externalities, property rights, and the tragedy of the commons in the 3rd edition (1966) of Mises’ Human Action is the same in the first edi- tion (1949) and, indeed, in Nationalokonomie (1940). Private communication, March 25, 2003.
- Pipes, p. 61.
- Armen A. Alchian, Economic Forces at Work (Liberty Press, 1977), p. 130.
- Ronald Coase, “The Problem of Social Costs,” Journal of Law and Economics (1960), pp. 1–5.
- Pipes, p. 65.
- Ibid., pp. 97-98. Possession, inheritance and cus- tomary law precede the state. This view is consistent with Hayek’s. See, for instance, F. A. Hayek, Law, Legislation and Liberty: Volume I: Rules and Order (Chicago: University of Chicago press, 1973). De Soto focuses on the absence of legal title to property in developing countries, despite the presence of well- developed states. He concludes that “the only way to find the extralegal social contract on property in a particular area is by contacting those who live and work by it.” That is, look to who possesses it and is accepted as customary owner. De Soto, p. 182.
- See James Gwartney and Robert Lawson, Eco- nomic Freedom of the World: 2002 Annual Report (Vancouver, B.C.: The Fraser Institute), pp. 6–7.
- Alchian, pp. 127–29.
- Mises, pp. 143–45.
- Hoskins and Eiras, p. 40.
- This is the essential lesson of Public Choice Theory. James Buchanan and Gordan Tullock, The Calculus of Consent: Logical Foundations of Consti-tution- al Democracy (Ann Arbor, Mich: University of Michigan Press, 1962), see also www.econlib.org/ library/Buchanan/buchCv3c1.html. This spawned a vast literature on “market failure” and “political failure.” In 1986, Buchanan won the Nobel Prize in economics partly for that contribution.
- Hoskins and Eiras, p. 40.
- Ibid., p. 46.
- Fareed Zakaria, “The Rise of Illiberal Democra- cy,” Foreign Affairs (November/December, 1967), pp. 22–43. See also Fareed Zakaria, The Future of Freedom (New York: W. W. Norton, 2003).
- Hayek, The Fatal Conceit, p. 33.
- Robert J. Barro, “Rule of Law, Democracy, and Economic Performance,” in Gerald P. O’Driscoll, Jr., Kim R. Holmes, and Melanie Kirkpatrick, 2000 Index of Economic Freedom (Washington: The Heritage Foundation and Dow Jones, 2000), p. 36. Compare David Osterfield, Prosperity versus Planning: How Government Stifles Economic Growth (New York: Oxford University Press, 1992), pp. 204–18.
- Barro, p. 32. Compare Enrique Ghersi, Teoría de la Corrupción (Lima: Cecosami Editores, 2003); and Enrique Ghersi, “Economía de la Corrupción,” Centro de Divulgación del Conocimiento Eco- nómico, Caracas, Monografía 73, no date, www. cedice.org.ve/archivos/ghersi3.doc.
- De Soto, p. 155.
- Ibid., p. 21.
- Alejandro Chafuen and Eugenio Guzmán, in Driscoll, Holmes and Kirkpatrick, p. 61. Compare John Mukum Mbaku, “Bureaucratic Corruption in Africa: The Futility of Cleanups,” Cato Journal 16, no. 1 (Spring/Summer 1996).
- Roberto Abusada Salah, Javier Illescas Mucha, Sara Taboada Peña, Integrando el Perú al Mundo, (Lima, Peru: Centro de Investigación de la Universidad del Pacífico e Instituto Peruano de Economía, 1st. ed., 2001), p. 93; Richard Webb, quoted in “Mar de Fondo”, Caretas May 25, 1995, Lima, Peru; “Congreso Eliminó Régimen de Supervisión de Importaciones” in Diario Gestión May 21, 2003, Lima, Peru. We thank Alejandro Caballero Aste for his research help on this point.
The Peruvian Congress has recently decided to renationalize import supervision.
- José Piñera and Aaron Lukas, “Chile Takes a Bold Step Toward Freer Trade,” Wall Street Journal, January 15, 1999.
- Thomas Jefferson, Autobiography, Notes on the State of Virginia, Public and Private Papers, Addresses, Letters (New York: Literary Classics of the United States, 1984), p. 671. Quoted in Chafuen and Guzmán, p. 61.
- Sara J. Fitzgerald, “Scandinavia’s Changing Political and Economic Landscape,” in O’Driscoll, Feulner, and O’Grady, pp. 39–47. Compare Gwartney and Lawson.
- Chafuen and Guzmán (pp. 55–61) found a strong negative correlation between economic freedom and corruption.
- De Soto, p. 6.
- Ibid., p. 35.
- Ibid, p. 5.
- Ibid., p. 5.
- See the relevant discussions in the Report of the International Financial Institution Advisory Commis- sion, Allan H. Meltzer, chairman, submitted to the U.S. Congress and the U.S. Department of the Treasury, March 8, 2000. Also, David Dollar and Lant Pritchett, “Assessing Aid: What Works, What Doesn’t and Why,” World Bank Policy Research Report, 1998; and William Easterly, The Elusive Quest for Growth: Economists’ Adventures and Misadventures in the Tropics (Cambridge, Mass.: MIT Press, 2001).
- Melvyn Krauss, How Nations Grow Rich: The Case for Free Trade (New York: Oxford University Press, 1997), p. 86.
- Krauss, p. 94.
- De Soto,” pp. 105–51.
- See Pipes, pp. 151–58.
- Pipes, p. 151.
- Gerald P. O’Driscoll Jr. and Sara J. Fitzgerald, “Trade, Aid and Economic Growth,” forthcom- ing.
- Bethell, p. 28.
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