Land-shackled

Posted On: 17 Oct 2014

Section: Perspectives

Topics: Land

Tags:

land reforms , land acquisition

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Devesh Kapur
University of Pennsylvania
dkapur@sas.upenn.edu

T.V. Somanathan
Prime Minister's Office
tvsomanathan@gmail.com
Arvind Subramanian
Ministry of Finance, Government of India
cea@nic.in

Rising land scarcity and land market distortions are increasingly becoming a binding constraint on
development in India. In the first of a two-part series, Kapur, Somanathan and Subramanian diagnose
India’s land problem. In the next part, they propose policy reforms for addressing the problem and
ensuring that land facilitates rather than impedes development.

Capital, labour, or land? Which of these is the binding constraint is one diagnostic question the new
government should be asking itself as it seeks to revive the sputtering Indian growth engine.

We ignore public institutions – a manifest binding constraint – because the issues they raise are too
complex to be addressed here. With that caveat, we would assert that capital is not the binding
development constraint today. Yes, there are multiple challenges. But considerable progress has been
made. India is awash with domestic savings even if the government is pre-empting them at the expense
of the private sector; there is virtually free access to foreign capital.

Labour markets are a serious problem, reflected in the poor performance of labour-intensive
manufacturing. The panoply of Indian laws and regulations, as well as the culture and the practices of
the inspector raj, have made the use of unskilled labour very difficult. And the shambolic education
system constrains the supply of skilled labour.

But with labour, at least there are ways around these problems. Business can use contract labour, shift
to services, or resort to capital and technology-intensive methods of production. And above all, labour
can move (at least to some extent) within India.

Land – a key binding constraint on India’s growth

Make no mistake. All such circumvention is costly and a drain on development. But with land, immobile
and fixed, even these options are not easily available. Land markets are arguably the most distorted
factor markets in India. Its issues are at the heart of India’s most pressing challenges from governance to
growth, education to manufacturing, taxation to urbanisation, and environment to energy.

Figure 1. Land-to-population ratios for major countries

In the chart, we plot the land-to-population ratios for some major countries. These ratios are shown for
1960 (on the vertical axis) and 2050 (on the horizontal axis), the latter using the United Nations
population projections. Virtually all the points are to the left of the 45-degree line — showing that, over
time, population growth has increased the pressure on land all around the world.

India was land-scarce relative to most countries in 1960. However, by 2050, its land-to-population ratio
will have declined fourfold, and India will be amongst the most land-scarce countries in the world (there
are only a handful of countries to the left of India, including Bangladesh, Mauritius and the
Netherlands). China in 2050 will have nearly four times as much land per person as India, and Brazil
nearly 20 times as much. This is not surprising. Consider, for example, that just between 1991 and 2011
India added more people than its entire population at the time of independence; or more people than
the entire population of the United States — in one-third of the land area.
But this problem of diminishing physical supply will be aggravated by endogenous economic forces. If
India grows at about 7-8% over the next two decades, the demand for land – for commercial and
industrial purposes, housing and infrastructure – will rise sharply, quite apart from the pressures of
adding another 200-million-odd people. The irony will be that the more prosperous India becomes, the
more serious will be the problem of relative land scarcity. In other words, India must plan as much for
the contingency of success as failure.

What rising land scarcity means for development

This rising relative scarcity of land has three major implications for development.

First, the cost of land as a factor of production will rise sharply, rendering all land-intensive activities,
including manufacturing, less competitive. Indeed, one of us has argued that land could well be a factor
contributing to high and persistent inflation.

Second, land scarcity will increase the rents from land (“terrestrial rents”, which are distinct from rising
legal costs of land). An iron law of development, to paraphrase Lord Acton, is that rents corrupt
economic and political institutions and large rents destroy them. Land-related scams, scandals and
scoundrels have severely distorted India’s political economy.

Third, an argument made by Chang-Tai Hsieh of Chicago is that distorted land markets, especially urban
ones, can fundamentally stymie the economic convergence process by rendering labour less mobile. A
big part of economic growth occurs from the structural transformation of an economy as labour moves
from low-productivity rural to higher-productivity urban activities. India’s distorted land markets have
stymied urbanisation, lowered rural to urban migration, and locked in large parts of the population in
low-productivity rural jobs. Urbanisation under these conditions will be more wretched sprawl than
glittering high-rise.

Distorted land markets could be a possible explanation of two puzzling and related phenomena in India
that one of us has written about: “premature de-industrialisation”, whereby even the poorest Indian
states have moved away from low levels of manufacturing very early in the development process; and
the co-existence of undervalued exchange rates and a weak manufacturing sector, suggesting that
structural impediments – including land – prevent the flow of resources into manufacturing despite
apparently favourable price signals. And recent legislation has only compounded these problems.

Problems of India’s land acquisition laws

The problems of India’s land acquisition laws are well known. The animating vision underlying the Raj’s
1894 law was: “The state must be allowed to acquire land as cheaply as possible; after all these native
landlords are themselves exploiters.” The post-Independence Indian state used this law to acquire vast
amounts of land for “public purpose”, often from marginalised tribal communities and offering scant
compensation.

It compounded this by a tragically flawed approach towards urbanisation, of which rent control was one
of the more obvious examples of high principles being laid low by banal realities. Intended to protect the
urban middle class, rent control has in fact reduced supply and prevented the emergence of a modern
rental housing market: existing houses are often left vacant (for fear of being unable to increase rents or
change tenants) and the corporate sector is discouraged from building apartments for rent. This hurts
the poor and the lower middle class, who are often at the mercy of grey-market landlords with the
physical and financial muscle to evict tenants.

In 2013, the United Progressive Alliance government passed a new Bill that in turn was animated by the
following vision: “The state can and must protect the weak landowner against rapacious private-sector
land acquirers.” This vision had two main weaknesses. In sharply raising the procedural hurdles in
acquiring land it forgot the most basic lesson of public policy in India: complexity is a guarantee of
agonisingly long delays and, often, implementation failures. At a minimum, lengthening implementation
lags will sharply increase project costs, which will feed into the rest of the economy.

Second, the vision was simple-minded and undiscriminating. It assumed that all cases were of the sort
where weak, defenceless and illiterate Odia tribals deal with a Vedanta-like giant multinational.

But as in most things, India is not only complex but evolving. The exploitation of the weak is
undoubtedly important. But increasingly, the problem is as much the relatively urban well-to-do ripping
off the state through exaggerated court awards. The cost of the law has been to strengthen the hands of
private landlords against a state that is already weak and now further burdened with overly complex
procedures.

What needs to be done?

That is the subject of our next column. But the key message is that land-related issues need to move to
the forefront of India’s policy agenda. India must mount nothing short of a war effort to address what is
becoming a binding constraint on India’s development. Generous geography has ensured that India is
not landlocked. Poor public policy should not make India land-shackled either.

How can India reduce the severe distortions in land regulation and acquisition to ensure that land
facilitates rather than impedes development? We propose four policy reforms.

Land use
Obtaining approvals for land-use change is a major source of corruption. The government must,
therefore, legislate to automatically allow non-irrigated agricultural land to be used for industrial
purposes, subject only to obtaining environmental clearances. This could be achieved by introducing a
new "general purpose" classification, which would provide that all dry land not currently classified as
industrial, commercial, etc., will be deemed "general purpose". This action alone could sharply increase
the supply of land for industrial purposes and stymie a key avenue of corruption, especially on the
outskirts of cities.

Floor space index

A second policy change relates to the artificial scarcity created by floor space index (FSI) limits, which
effectively determine the height of urban construction. Seeking approval for relaxations of the FSI limits
are, like those for land-use changes, a major source of corruption.

The romantic aversion to high-rise concrete jungles that drove this policy was flawed and has long been
overtaken by its adverse consequences, and by the imperatives and desirability of urbanisation. Our
proposal would be to eliminate the approval for relaxing the FSI to create something like a "choose your
FSI" policy.

Each builder or occupant could choose his/ her FSI with an important rider. The FSIs beyond the current
limits would have to be paid for, to reflect the marginal cost of providing infrastructure for such
urbanisation. Cities can calculate the "long-run marginal cost" of additional sewage, water, electricity
and other infrastructure per additional square foot deducting the long-run marginal savings in transport
infrastructure costs (denser cities require less transport).

This calculation is feasible, albeit not easy - but, in this case, unobtainable precision should not come in
the way of workable approximation. The planning authority would then distribute these funds to the
utilities in proportion to their financing needs. All of this has to be transparently accessible to any
citizen. The merit of this proposal is to remove government discretion in granting approval but also to
raise money for urban infrastructure development.

Tax incentives for home ownership

Third, India needs to do away with income tax concessions that encourage purchase of housing (which
were further increased in the latest Budget through a higher deduction for interest on home loans).
Effectively, the current tax law gives an incentive to buy land (and use scarce river sand) in a country
with inflated land prices. For example, there is now believed to be over 40% vacancy in the already
constructed flats in the information technology corridor of Chennai - but new employees continue
buying flats, because interest and principal are tax-deductible, while rents are not.
The economic case for encouraging home ownership is no more valid than for encouraging car
ownership or share ownership. Citizens should be encouraged to make their own "rent vs buy" housing
and investment decisions, and public policy should distort those decisions as little. This fiscal distortion
is favoured by powerful lobbies from banks to construction magnates.

Urban property taxation

Finally, India needs to improve and enforce urban property taxation and ensure that property values are
updated periodically. There are many reasons to increase property taxes from their derisory current
levels: it would be a progressive tax; it would foster democratic accountability and more effective
decentralisation; it would raise resources for urban infrastructure; it is imposed on a non-mobile good,
which can with today´s technologies be relatively easily identified and mapped; it is also a tax imposed
on a good (property) whose values can only increase, and, therefore, has in-built tax buoyancy; and,
finally, just as a financial transaction tax would put sand in the wheels of finance, it would do the same
for property speculation. In today´s India, there are few tax proposals that are as compelling.

Political feasibility?

But the key question that poses itself is whether these reforms are politically feasible. Clearly, all status
quo decisions have a rationale, and the fact that this has been the situation for decades suggests strong
interests favouring it. Our proposals fall into two categories: those within the purview of the Centre
(removing income tax concessions), and those controlled by the states and/ or local bodies (changing
land-use requirements and the FSI approvals, and increasing/ imposing property taxes).

Income taxes are a central subject. The new government can, therefore, on its own, eliminate the
income tax concession for housing. It will have to take on the vested interests described above. One way
to implement this policy would be to make the tax changes prospective, to soften their opposition. And,
if accompanied by a commensurate increase in the overall deduction for savings, it can also minimise
the opposition from middle-class taxpayers.

Another action that the Centre can take, since it controls wealth taxes, is to place ceilings on the current
very generous wealth tax exemptions for residential property (one piece of property is exempt
irrespective of value).

Our other proposals will encounter greater difficulty both because vested interests will be against them
(political and bureaucratic, as well as the politically connected builder lobby) and because the Centre
does not control the underlying policy instruments. So how will change happen?
One scenario involves a handful of strong state leaders and/ or bureaucrats taking the initiative to
implement change. Assisted by technology to improve methods of land valuation, assessment and
collection, a few successes can be achieved. And these successes can travel to other parts of India. But
this is a process of exogenous and probably slow change.

The Centre can play a role in providing incentives for such change mostly by granting or withholding
fiscal transfers - under the centrally-sponsored schemes - conditional on states simplifying land-use and
the FSI rules and on urban local bodies imposing property taxes along the lines we have proposed. The
Finance Commission could also play a role given its influence in determining Centre-to-state transfers.
(In a recent article, two of us elaborated on this idea).

In India, land´s life-giving, mothering and nurturing qualities are evoked in the common and popular
image of Dharthi Mata (Hindi for Mother Earth). But there can be a Mata only if there is some Dharthi in
the first place. Creating bountiful dharthi is a major challenge ahead.