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Not losing the plot

The land acquisition process can’t be left to voluntary transactions. The State must have a role, writes Kaushik Basu.

india Updated: Aug 14, 2009 22:23 IST

The Land Acquisition Bill, currently on hold with the Lok Sabha, has given rise to deep political fissures. At the heart of it is the following question: in harnessing land for large-scale industrialisation, should we leave it all to the free market, whereby industrialists and farmers are left to discuss land price and voluntarily come to an agreement, or should we have provision for government to utilise state power, fix a reasonable price and acquire land?

Modern economic theory sheds light on this; and, somewhat unexpectedly, comes out on the side of government intervention. As a consequence, even some of the most aggressively market-oriented nations in the world, such as the US, have provisions that allow the State to intervene and acquire land for large-scale industrial or commercial use.

The economic argument shows that, left entirely to voluntary transactions, many socially desirable industrialisation projects would never get implemented. This so-called “hold-up problem” was briefly touched upon by Amartya Sen in his Penguin Lecture on ‘Justice and India,’ in Kolkata on August 5, though he did not elaborate on it.

The essential idea is simple, though it has an impressive intellectual heritage in game theory and, in particular, the work of John Nash.

We know that for big industrial projects, such as a new automobile factory, a large amount of contiguous land is needed. Getting some parts of this land and not others would make the project unviable. Suppose a large project is being considered by an industrialist called ‘T’ for which he needs to buy two plots of neighbouring land, currently owned by farmers M and B (I am trying to use letters which are meaningful).

Assume the industrial project can generate gross profit of Rs 10 and the farms are fallow and yield no benefit to the farmers. Hence, this is clearly a viable project. If, for instance, T gives Rs 3 to each of the farmers, they gain (Rs 3 each) and T gains (Rs 4).

Since, in reality, hundreds of farmers are likely to be involved, it is reasonable to assume that all the bargaining cannot be done simultaneously. I shall mimic this here by assuming that T has to first strike a deal first with M and then with B.

Assume that each farmer demands the maximum she can get within the limits of what the industrialist will be willing to pay. It can be proved that the project will, nevertheless, not be undertaken. For ease of exposition, I shall assume that all payments are made in integers, in other words, there is never any payment in paisas.

In the first stage the bargain is between T and M. The argument will go through no matter what M asks for. Note that if M asks for more than 9, T will reject it and if he asks for less than 1 it is not in her own interest. So let me simply assume that M asks for some amount between 1 and 9.

Next — in stage 2 — he talks to B, who knows that, if she says no, the project will not occur. Recall that T needs both plots for the project to be viable. So, if B agrees to a deal, the profit generated is 10 and, if B does not, then the profit is 0. In brief, B has the power to hold up the entire project. So as long as B charges any amount less than Rs. 10, it is in T’s interest to accept the offer. Recall that whatever T spent in stage one is now sunk cost and cannot be recovered. Therefore, B will charge 9, and T will accept the deal.

However, this means that over the two stages T would have spent 10 or more acquiring the land and so his net profit will be zero or negative. Interestingly, we know this even without knowing the exact deal struck in stage one. Since a loss or, at best, zero profit is foretold for the industrialist, he will not start the process of negotiation with the first farmer. Hence, no industrialisation occurs even though all of them could have gained from it. Q.E.D.

Some may counter that large-scale land acquisitions have taken place, prominently in Gujarat, with no State interventions. I have two words of caution on this. First, many seemingly voluntary land acquisitions are actually based on subtle intimidations and threats to poor farmers. Second, for every such deal that goes through, there are many that never get initiated for the above reasons.

My argument must not be construed as giving government licence to acquire land at will. China’s policy of using the strong arm of the State to confiscate large amounts of agricultural land that the farmers cannot question is not worth emulating. We must have a law that specifies the limits of State engagement. The industrial project has to be of demonstrable social worth. And it should be mandatory that the land-owners are compensated handsomely, well above the market price.

India’s labour-intensive industrial sector is poised for development. Once a proper legal and institutional backdrop is provided, we should see enormous growth in this sector, which can have a larger impact on poverty alleviation and the mitigation of unemployment than many a piecemeal intervention.

Kaushik Basu is Professor of Economics and Chairman, Department of Economics, Cornell University