Land Acquisition: What would Ronald Coase have to say?

Written by  //  July 19, 2015  //  Economic & Social Policy  //  Comments Off on Land Acquisition: What would Ronald Coase have to say?


Let us consider a common scenario that arises when you travel by air. A lot of people like to complain about airline passengers who recline, taking away precious knee-room. A possible solution to this problem is to pay the person in front of you to not recline. If you value your knee space more than he values the option to lean back, the seat will stay upright where it belongs. There’s no need for the government, or the airline, to intervene to protect your knees. However, a solution will be difficult to reach if there are costs such as tax or restrictions imposed on the exchange of rights. Such costs, commonly known as transaction costs lie at the heart of economics. The utility of understanding and minimising transaction costs is best explained by the Coase theorem.

Simply put, the Coase theorem states that so long as property rights are well defined, the initial allocation of rights does not matter and the possibility of bargaining with a lack of transaction cost will lead to an efficient outcome. However, experience shows that zero transaction costs exist rarely, if at all. A workable restatement of the Coase theorem would, then be that fewer the transaction costs, the better are the chances of arriving at a pareto optimal outcome, namely, a state of affairs wherein the economic distribution of resources has been done in the most efficient manner.

Applying this principle to an instance of land acquisition, it can be said that if a private player is willing to set up shop on a piece of land and wants to buy it, the most efficient allocation would consist of allowing him to buy it in a free market transaction. The same is true because transaction costs are likely to be minimal in a free market transaction. However, there are several reasons for the failure of free market deals when it comes to land acquisition. A few prominent ones are fragmented land holdings, multiple ownership of land, lack of well-defined ownership rights, lack of well-defined use rights , information asymmetry and unequal bargaining power. Moreover, speculative holdouts, inadequate compensation, inordinate delays and the persistent threat of litigation and protests, too, contribute significantly to the prohibitive nature of transaction costs involved in the acquisition of land.

Let us consider a farmer who values his rights in his land at ₹1000. At the same time, an industrialist values that land at ₹1200. In a free market situation, they should be able to negotiate and arrive at a settlement between these two figures. However, due to the above-mentioned reasons, transaction costs greater than ₹200 might be necessary to affect a transfer. In such a scenario, the acquisition becomes impossible leading to an inefficient use of the land.

In 2013, the Government of India sought to minimise these transaction costs and  thereby, to improve overall efficiency by addressing these causative factors in the new Land Acquisition law. A provision for Social Impact Assessment was made to identify property ownership, use rights and to provide bargaining power to the land owners. An additional requirement of consent was introduced for Private and Public Private Partnership projects to reduce the potential for holdouts and the coercive element in land acquisition. Moreover, the same was proposed to be done through a consultative and representative mechanism and the overarching objective was to eliminate distrust and to subsequently, reduce the costs arising from delays due to future litigation or protests. Simply put, the aim was to reduce the transaction costs to an amount below ₹200 which would have made acquisition a reality in the above example.

Admittedly, SIA and consent requirements, too, could themselves be termed as transaction costs. However, as shown above, the net effect would have been a reduction in the overall transaction costs making land acquisition viable. Nonetheless, a major downside of the law enacted in 2013 was the long time period between the expression of interest and the final acquisition. A composite reading of the Act would reveal that the acquisition process can take anywhere between 3 to 5 years or more if extensions are granted. Naturally, these inflated transaction costs were a real possibility and would have nullified the efficiency gains achieved by the introduction of SIA and consent.

Amidst the clamour for reducing the prolonged process, the government through the promulgation of an Ordinance- a knee-jerk reaction, omitted the requirement for SIA and consent for practically all conceivable projects. Unfortunately, the Ordinance seems to have missed the point completely. SIA and consent, inarguably the most important provisions of the new land acquisition law and pre-requisites for acquisition, have to be completed within a time frame of 8 months. Thus, removing them would merely reduce the time frame to 2 ½ to 4 ½ years, which is still unlikely to lead to an optimal outcome.

More importantly, a Coase theorem analysis can show that the removal has the potential to increase transaction costs and will leave the buyers worse off than before. Experience shows that land acquisition becomes costly due to the subsequent protests and litigation over the determination of presence of public purpose and adequacy of compensation. The genesis of these controversies lies in the lack of consultative and participative processes encapsulated by the SIA. The Right to Fair Compensation and Transparency in Land Acquisition, Rehabilitation and Resettlement Act, 2013 attempted to remedy these inefficiencies.

However, instead of reducing the delays and hitting the final nail in the coffin, the Ordinance has done away with the efficiency gains achieved by the Act. The Ordinance has merely transferred certain present transaction costs to uncertain but highly likely future transaction costs. It is clear that the economic cost saved by the removal of SIA and consent is likely to be much lesser than the cost which the acquirer will have to bear in future due to claims of non-land owners, delays in the project, litigations by interested persons, protests by the affected parties and a downgraded public image.

The dichotomy between present and future transaction costs can be illustrated by recalling what happened with TATA Motors in Singur. Suppose that SIA and consent were the pre-requisites before acquisition was attempted in Singur. Undoubtedly, such processes would have involved additional costs. However, they would have minimised the possibility of wide scale dissatisfaction and protests that ultimately forced TATA Motors to leave a half built factory and move elsewhere. In fact, the requirement for consent would have allowed TATA to save costs and to move elsewhere much before. Clearly, the company might have saved costs at the time of acquisition if SIA was not required; however, the transaction costs it ended up with in the future were significantly higher.

The Government of India in its urgency to boost the economic growth of the nation seems to be in a haste to get the Land Bill passed by Parliament to replace the Ordinance. However, in the event that such a Bill would only convert present transaction costs into uncertain and possibly higher transaction costs that were to be incurred in the future, it is questionable whether and to what extent economic growth would be accelerated by the passage of this Bill.

– Dhruva Gandhi and Shubham Jain

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