In its much criticised judgement, ordering the West Bengal Government to return the land acquired for the Tata factory, the Supreme Court has upheld the principles of private property. This benefits the citizen and the economy
On August 31, the Supreme Court of India issued a landmark decision and restituted 1,000 acres of land to farmers in West Bengal. The State Government had taken the land so that the Tatas could build a car factory. The apex court argued, “When the properties of a citizen is being compulsorily acquired by a State in exercise of its power of Eminent Domain, the essential ingredients thereof, namely, existence of a public purpose and payment of compensation are principal requisites therefore. In the case of acquisition of land for a private company, existence of a public purpose being not a requisite criteria, other statutory requirements call for strict compliance, being imperative in character.”
Many Indians regard the decision as judicial activism, impeding economic development. However, economic reasoning shows that on the contrary, private property, which can be expropriated only in exceptional cases after giving good reasons and strictly observing procedures, is supportive of economic development. The Supreme Court’s decision should be welcomed on economic grounds. Well protected private property rights reduce corruption, cronyism and misuse. And they maintain as much as possible the virtue that resources flow to the highest valued user by way of voluntary transactions.
A market economy depends on three legal institutions: The contract, the firm and private property. The latter concentrates all entitlements related to a resource — the user rights, the right to appropriate all of its fruits, the right to transfer the title of ownership or the right to use the resource as a credit collateral to one single owner or a group of owners. This concentration of competences over a resource is in contrast to other more diluted forms of property rights like indigenous or tribal rights, the law of the manor or the law of the commandery.
In a century long evolutionary legal development, private property crowded out other forms of property rights and developed to a central legal institution of the market economy. It guarantees that the owner, who invests on the land, gets all its fruits and need not share them with others, thus avoiding under-investment and under-use of the land. It guarantees that the land can be used as collateral and does not become dead capital. It guarantees that the owner is legally protected against encroachments by private predators and the state. Unlike the commandery, private property is not a privilege, which the ruler can give and take.
These features of private property give any owner an incentive to make good economic use of it. Equally important — if he or she cannot achieve this — and the resource is of higher value to a third party, the owner has incentives to sell the land to the highest valued user at a price which covers the full valuation of the present owner but is lower than the valuation of the highest valued user. The transfer of title is then a voluntary win-win transaction.
However, these economically benevolent and protective features of undiluted private property break down in constellations, which economists analysed under the heading ‘tragedy of the anti-commons’. If a higher valued user wants to buy land for a project not from one but from many, perhaps hundreds or thousands of owners, this gives each of them a veto position against the new project, which the individual might use for a hold-up. This increases the transactions costs of voluntary transactions so much that the transaction does not take place and the land is caught in inefficient use.
US scholars Steven Calabresi and Michael Heller have analysed this defect of private property and showed how it leads to inefficient, under-use and under-investment of land. Heller gives the example of the robber barons who owned the river Rhine in Europe. Each of them was entitled to put up a toll-house on his private stretch of the river. This made commercial use so costly that merchants preferred land transport even though the oxen cart was economically — but not commercially — much more expensive. The under-use of the river and the equally severe under-investment ended with the nationalisation of the river. The management of the river was taken over by an international agency which the Congress of Vienna established in 1815. This agency made the river one of Europe’s most important waterways.
In modern law, equivalent problems arise. The European patent agency has, in defiance of economic arguments, granted patents for snippets of decoded DNA sequences, forcing an investor, who needs a license for the whole sequence, to buy from dozens of patent holders. In contrast, the US patent agency grants a patent only for the decoding of the whole sequence, thus avoiding a tragedy of the anti-commons.
The research on high transaction costs and the tragedy of the anti-commons provide a strong and irrefutable argument to replace the voluntary by a forced transaction through the state in favour of a higher valued user. But any law, which encroaches on private property in favour of private investors, must apply the ‘cy près’ view of common law. The forced transaction by the Government should be as close as possible to the property rule to preserve its virtue — That a land transfer occurs if and only if the land goes to the higher valued user; thus, making the new owner, the economy at large and the old owner better of.
The practice of Indian land acquisition in favour of private investors fails by a wide margin to reach this goal. Even though India shifted from a socialist economy to a market economy, the mentality and practice of land acquisition still breaths the old spirit. The Government has often overstretched its power of Eminent Domain in favour of private investors. For instance, it contributed to the compensation money through a nominal amount of tax money.
Parts of the Indian public seem to think that such decisions by the Government promote economic development. Courts have been reluctant to sharply control the legality for fear of being regarded as an activist or even worse as impeding economic development. Now, it seems that this attitude is changing.
Strong judicial control of the Government favouring private investors does not impede economic development if the judges are loyal to the law and its economic rationale. In no democratic country is the elected Government a perfect agent of the common good — all regimes want re-election and consolidation of power. This is legitimate, but leads to practices like buying loyalty through campaign goodies and knitting networks with influential business people and party sponsors. A practice of land acquisition in which courts check misuse of power without second-guessing democratic decisions improves the economic function and enhances economic development.
Using insights and research results from comparative constitutional and administrative law and from economics, the following tests are advisable for a ‘taking’ decision in favour of private investors.
Such legal checks will not reduce the benevolent effects of ‘taking’ for private investors. Instead, they will bring ‘’taking’’ decisions, which always result in involuntary transactions, closer to the economically beneficial effects of private property. They will promote development but also protect citizens from decisions which might have a political reason but no economic rationale. They will align the principle of justice and equity with the necessities of economic development, and strengthen both.
(The writer is a professor of law and Economics at Bucerius law School, Hamburg, presently teaching the Government of India’s Global Initiative of Academic Networks programme at the Indian Institute of Technology in Kanpur)