Property rights and the wrong path to democracy

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There are two methods of allocating property rights: Top down – by the dictates of a central administration – or bottom up – rights to land are acquired by working it.

Boris Yeltsin’s greatest achievement was his defeat of the 1991 hardline coup. But the measure for which he will be best remembered was loans for shares, which transferred control of the main economic assets of the state to a small group of oligarchs. The first of these legacies will shape the economic and political development of Russia long after Yeltsin’s death. So will the second.

Not everyone shares that view of loans for shares. As assessment of the Yeltsin years filled the news last week, several commentators rushed to the defence, advancing the thesis that it is more important to establish property rights than to allocate them justly. But history shows both conditions need to be satisfied if markets are to work effectively.

A good place to start that historical lesson is as far away from Russia as possible. Argentina was the most spectacular economic failure of the 20th century. The elegant residences of Buenos Aires still provide evidence of a country once as rich as western Europe, while the slums of Buenos Aires provide evidence of a country that lost that status generations ago. Argentina’s dysfunctional politics, central to its economic decline, have their origin in economic history, most of all in an assignment of property rights that was definitive but unjust.

When settlers take occupation of empty land – or, as Europeans frequently did, treat land they occupy as empty – there are two methods of allocating property rights. Top down – by the dictates of a central administration – or bottom up – rights to land are acquired by working it.

In Argentina – as in Latin America generally – the top-down mechanism dominated. The beneficiaries were not, in the main, good landlords. The process of assignment established an indissoluble link between political influence and personal wealth. The rich were determined to maintain established property rights; the poor saw their best hope in upsetting that allocation. The resulting polarisation has characterised Argentinian politics ever since.

The English-speaking countries of settlement, rather than colonisation, were different. The bottom-up mechanism – the principle that the strongest claims to the land belonged to those who worked on them – came to dominate. That was, in a sense, the crucial issue of the American revolution. The Homestead Act passed during the civil war, and the war itself, settled the matter. In Australia, the Eureka Stockade, when miners asserted rights to the claims they worked, and the device of pastoral leases, which gave crown land to people who would farm it, were decisive.

These historical events arose from, and reinforced, a democratic political culture and an individualistic social one. Property rights were allocated, and personal success determined, by talent and effort not connections and ancestry.

After the collapse of communism, the issue was who would lay claim to the property owned by the failing state. The industrial assets owned by the regimes of eastern Europe turned out to be worth very little. But the resources in the ground of the former Soviet Union were worth a lot.

Juan Manuel de Rosas, Argentina’s autocratic ruler in its early years of independence, also rose beyond his populist origins. Like Rosas, Yeltsin realised that the connection between political influence and economic resources could, through patronage, become self-reinforcing. Loans for shares was a top-down allocation of property rights, in which government traded economic power for political support.

Bottom-up allocation supports democracy, consensual politics and economic development that emphasise enterprise over the search for political favour. Top-down allocation leads to polarisation and dictatorship, yielding short-run stability and occasional violent disruption: Argentina’s past and Russia’s likely future.

It does not matter who has property rights as long as they are clearly defined, says a prominent school of economists, citing an insight that won the Nobel Prize for Ronald Coase. But in Argentina, the wrong choice coloured politics and society for a very long time. The path unwisely chosen in the mid-1990s may be Yeltsin’s most enduring legacy.

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