What is the Economic Cost of Malfunctioning Indian Property Markets? The news and political debates about land often revolve around land acquisition by governments, such as the Tata Nano Singur case or the Land Acquisition, Rehabilitation, and Resettlement Act of 2013. But the use or lack of a significant area stems from underlying problems lead to a malfunction in the Indian property markets.
Sources of land friction
The causes of malfunctions or friction with the property markets are manifold. As in many South and Southeast Asian countries, India’s complicated inheritance system has resulted in small parcels of land, with land fragmentation increasing over time. The average land holding size among land designated for agricultural use was 1.1 hectares (2.7 acres) in 2015, up from 2.3 hectares (5.7 acres) in 1971.
Along with small parcels, unclear land titles and slow courts make buying land in India inherently risky. Additionally, regulations on land rezoning, particularly the purchase of land historically earmarked for agricultural use, come with lengthy bureaucratic and legal hurdles.
Frictions in the property markets are affecting many aspects of the Indian economy. For example, the poorly functioning land markets are affecting the growth and shape of Indian cities, internal migration, infrastructure development, crop choice, farm incomes, productivity and manufacturing growth, and structural changes in the economy.
Consequences in agriculture, manufacturing
Sixty-eight percent of farms in India are considered marginal farms – less than 1 hectare (or 2.5 acres) in size. In contrast, Pakistan and the United States have 36% and 0% marginal farms, respectively. Combined with policies and regulations, small farm sizes make land consolidation more difficult and have a negative impact on agricultural productivity.
For example, research has shown that tough land tenure laws passed after independence resulted in reduced participation in the tenement market, resulting in an average 38% reduction in agricultural productivity. Another consequence is that these marginal farms cannot adequately mechanize, grow cash crops efficiently, and benefit from economies of scale.
The growth of manufacturing companies in India is a key development challenge. Only 2% of Indian manufacturing firms have 10 or more employees, compared to 8% and 40% of firms in Mexico and the US, respectively. This is problematic as larger companies create more jobs, especially for workers with low levels of education. Larger companies (10 or more workers) employ 35% of Indian manufacturing workers compared to 78% of Mexican manufacturing workers.
One possible reason why manufacturing companies in India cannot grow is conflicts in the land market, among others. A company trying to expand or open a new factory unit must negotiate with hundreds of landowners with ambiguous land titles to acquire suitable land for their factories. This is especially true for companies in land-intensive industries such as transportation equipment and chemical manufacturing.
Consider an illustrative example of land aggregation for an automotive plant in the US and India. General Motors acquired 379 hectares (936 acres) of land from 29 owners in two months for its Fort Wayne auto plant in Indiana. In contrast, consider the infamous case of the Tata Nano facility, where the West Bengal government combined 404 hectares (997 acres) of land by amassing over 13,970 parcels of land owned by 12,000 landowners.
My research has found that in response to these land conflicts, manufacturing companies are accumulating what I call the Small Land Bite strategy. They slowly accumulate parcels in small tracts of land over time, sometimes waiting years before they have enough land to build on.
Private companies add land in smaller chunks than government-related companies. In addition, over the years, they will have to bite more land before they can build on it. Firms in states with smaller land parcels, such as Bihar and West Bengal, also employ the Small Land Bite strategy, in contrast to firms in states such as Punjab and Gujarat, where land fragmentation is less.
In addition, the companies have to bear significant aggregation costs in addition to the land sale price. These costs result from search costs, negotiation costs and legal fees. Land aggregation costs come in two forms: fixed and variable costs. If the mere effort to cultivate land is so costly that no matter how much land you get, it’s expensive, then the fixed costs are high. On the other hand, the variable costs increase with the size of the property.
With data on land purchases by manufacturing firms for two decades, we can quantify land aggregation costs for manufacturing firms. In Indian land aggregation, variable costs play a much larger role than fixed costs. The variable land aggregation cost per hectare increases with the size of the land required. Therefore, the costs are higher for larger companies. This is a consequence of both land fragmentation and unclear land titles.
Private companies pay up to three times higher costs than state-related companies. On average, companies in states with smaller parcels and more land-related litigation pay higher land aggregation costs. In some states, companies pay nearly double land aggregation costs on top of the selling price of the land. My research only quantifies the land aggregation cost for industry, but farmers and urban developers also pay similar land aggregation costs.
What is the way forward? First, we must recognize that substantial farming on marginal farmland provides economic security and is the sole source of income for millions of households, even when that land is not in productive use. But even if we were only concerned with maximizing the benefits of small farmers, there is no reason that policies that would encourage agricultural consolidation are illegal in India today.
However, suppose a hypothetical social planner would maximize the gross return on land across various potential land uses. In this case, it is important to recognize that multiple fringe operations are one of the main sources of friction.
This doesn’t mean we’re going back to the days of land acquisition, which was both unfair and politically challenging, but was a shortcut to bypass land aggregation costs. A market solution where agents negotiate and barter land until there are no more trade gains is unlikely to work in India given the scale of land accumulation conflicts. This leaves us with two perspectives.
The first perspective is a land-pooling policy, which many state governments are currently attempting on different scales. Land pooling strategies will certainly lower the overall costs of manufacturing companies and increase their growth rates.
However, under this policy, state governments will absorb land aggregation costs previously paid by manufacturing companies. These costs are only worthwhile if there is sufficient growth and employment generated by manufacturing companies to which communal land is leased. It’s also important to note that land pooling practices that allow for discretion are ripe for pitfalls when sourcing crony.
The second perspective is to reduce land aggregation costs, thereby lowering the overall costs for the government and private land aggregators alike. To this end, the government has already taken the first step of digitizing old paper documents. 94 percent of the 302 million population registers have already been digitized.
In addition, 13.5% of village maps were re-surveyed, although the linking of these map records to registry records and the court system varies from state to state. Once these fundamental hurdles of digitization and remapping are removed, land fragmentation will continue to pose significant challenges to land aggregation, albeit to a lesser extent.
Aradhya Sood is an Assistant Professor in the Department of Management at the University of Toronto at Scarborough and at the Rotman School of Management at the University of Toronto.
The article was first published on India in Transition, a publication of the Center for the Advanced Study of India, University of Pennsylvania.