The cost-benefit of land reform

The populist land reform package announced by Nepal's prime minister is preoccupied with the politics of setting new reduced ceilings on agricultural land holdings. Economic considerations targeted towards boosting agricultural productivity are largely ignored. What is required is not a "revolutionary" perspective on determining the maximum amount of agricultural land that one person can own but instead a genuine revolution in the way we approach the justification for and the design of land reform.. Land reform is back in the public policy spotlight in Nepal after many decades. This time it comes with a "revolutionary" tag. But alas, there is hardly anything new, much less revolutionary, in the objectives and basic design of the land reform programme that has been outlined so far. The central focus is a significant lowering of the ceilings on the maximum amount of agricultural land an individual or family can own, with the excess land to be acquired by the government and distributed to those whom it sees as worthy recipients among Nepal's rural poor..Perhaps the "revolutionary" tag is only a political ruse. The new land reform programme, announced in August this year, is a key plank in the eight-point Special Programme announced by the recently installed Sher Bahadur Deuba government of the Nepali Congress party, which is now in the midst of delicate negotiations with the Maoist rebels in search of a political resolution to the latter's six-year-old "people's war"..Land reform may be a populist platform through which the "revolutionaries" of the present Congress government seek to win the hearts and minds of Nepal's rural poor from the armed Maoist revolutionaries. Any Nepali Congress government must also cope with the legacy of another group of "revolutionaries"-the parliamentary -opposition of the Nepal Communist Party (United Marxist-Leninist), also called the UML. When the UML formed a minority government in 1994, it created a Land Reform Commission whose report (referred to as the Badal Commission Report) is now treated as the holy book on land reform in Nepal by most left political parties. While the coverage of the Badal Commission report is quite wide-ranging on land ownership and tenure issues, its main focus is on setting drastically reduced ownership ceilings on agricultural land that were first enacted in the initial phase of Nepal's land reform programme by King Mahendra in 1964..While various land reform packages may thus appear only as vehicles to prove the revolutionary credentials of various political groupings, it is essential, of course, to pay attention to the economic issues that surround such reforms. Indeed, the current and past fixation with specifying what is the appropriate land ceiling in Nepal, and the inference that a revolutionary land reform programme must embrace rather low levels of ceilings, is most counter-productive..Land ceilings are only the means to an end. But what are those ends and how are they affected by different levels of the ceiling and other aspects of the land reform programme? How does a land reform package compare with alternative means of achieving those same objectives? The proponents of land reform, past and present, have not paid sufficient attention to these underlying matters. In the present context, perhaps there is even a perception in the Congress party circles that the core economic issues really do not matter now that the difficult question of setting new land ceiling levels has been achieved through political give-and-take among its factions..This has been a most unfortunate way to revisit a fundamental policy matter that was ineffective in its previous guise, and which remains so critical to the livelihood of the majority of Nepalis, and also for the long-term structural transformation of the Nepali economy..Any land reform programme, revolutionary or not, raises many complex legal and philosophical issues about property rights, the balance between the rights of individuals and the rights of the community, and the role of the state. In order for land reform to be effectively implemented, these complex issues must be addressed in a satisfactory manner through the political process, and by upholding existing laws. Ignoring these wider concerns initially, let us focus instead on the pure economic arguments for and against the specific aspects of the proposed land reform..Land reform, like any other public policy, must pass an economic cost-benefit test, and its efficacy in achieving its desired objectives must be clearly demonstrated. Otherwise a land reform programme, if based on arbitrary land ceilings and inadequate compensation, will just be a form of expropriating the principal economic asset of a certain group of people in a clearly discriminatory way..The setting.Nepal is one of the poorest countries in the world, with an estimated per capita income of USD 210 and a Human Development Index ranking of 129 (out of the main list of 162 countries). Almost half of Nepal's rural population is estimated to be below a minimally estimated poverty line, and all of Nepal's main socioeconomic indicators-literacy, life expectancy, public infrastructure-are unsatisfactory even in a South Asian setting. A critical structural weakness of the Nepali economy is the heavy reliance of the population on the agricultural sector as their source of livelihood. While the agricultural sector accounts for between 40-0 45 percent of GDP, roughly 80 percent of the population is still mainly employed in agriculture..Because of the increasing population pressure on land resources, substantial deforestation has occurred, and agricultural yields have declined because of destructive environmental effects and the cultivation of marginal lands. The periodic Agricultural Census conducted by the Central Bureau of Statistics reveal that in the 30 years after 1961/62, the number of agricultural holdings in Nepal has increased from 1.5 million (with an average land size of 1.1 hectares) to 2.7 million holdings (with an average land size of 0.96 hectares). This increase in the number of holdings is at a rate almost commensurate with the doubling of the population from 9 to 18 million in this period..The consequence is an agrarian structure that, while still unequal in terms of land ownership and operational control, has been squeezed by population pressure through sub-division and partial sales into a range of small sizes. As indicated in Table 1, while 43.2°/ of land holdings in Nepal in 1991/92 were smaller than, 0.5 hectares, at the upper end only 0.3% of all holdings, occupying a mere 5.8% of total land area, were more than 10 hectares in size..The land ceiling levels that currently exist and those that have been proposed in the new land reform programme are indicated in Table 2. Since the 1964 Land Act, it has been an anomaly of Nepali land reform legislation that differing arbitrary ceilings have been prescribed for three geographical regions: the northern hill regions, the southern plain (tarsi) region, and the capital area of the Kathmandu Valley (of which a substantial part is still agricultural land)..No effort has been made to relate the different regional land ceiling levels to land productivity or market value of the land, nor to regional income differences. The ceilings are based essentially on perceived differences in regional population density, but substantial intraregional variation in density exists within the hill and tarai regions, which are ignored in these ceiling levels. Over the last two or three decades, internal migration in Nepal has been from the hill to the tarai region. The tarai region still has, on average, larger land holdings than the other regions. As the relative population share of the tarai region has grown, there is more political pressure now to reduce tarai land ceilings, which on a direct area basis are more generous than the land ceilings in the other regions. Nevertheless, the different ratios by which the new proposed ceilings differ from the existing ones— with the most dramatic reduction being made for tarai region land ownership—can be genuine grounds for the perception of discriminatory treatment by tarai landowners of plains' rather than hill origin..Structural transformation .The main justification for the proposed programme announced by Prime Minister Deuba is "social justice". An economic interpretation would be that the land reform programme is focused on the immediate goal of poverty alleviation through land redistribution. This is a worthy goal given Nepal's current economic context and the extent of rural poverty. But, as indicated in Table 1, the limited amount of land distribution that is feasible, no matter where the land ceilings are pegged, and the inordinate amount of resources required for the government to act as land broker between excess land holders and worthy recipients, are critical constraints. There are considerable doubts about how imposing ceilings on agricultural land will be an efficient way to achieve meaningful poverty reduction..If excess land is to be sold to the landless and other marginal farmers at more or less the just level of compensation provided to the former owners, is such a programme even feasible from a poverty-reduction perspective? Even if land redistribution is based on minimal compensation to owners, and more or less free distribution to a selected few recipients, the net effect on rural poverty could be negligible. On the other hand, there is scope for many poor rural households to be negatively affected by redistributive land reforms. As the demand for labour on big farms collapses with land redistribution, the economic well-being of many.landless and marginal farmers, themselves not the beneficiaries of the land distribution, could be gravely jeopardised..Certainly there must be more thorough analysis of how the excess land is going to be acquired and rationed to various worthy recipients, and how different segments within the rural poor are likely to affected by the proposed land ceilings. But the poverty alleviation impact is likely to be minimal. The direct recipients of land will have benefited, but even then the extent will depend on the way their land purchase is to be financed and on the returns from alternative investments that could have been made on-their behalf. And there will be segments of the rural poor who will be hurt. In terms of nudging a large number of poor people above a reasonably defined poverty line, this writer does not see much promise in the proposed land reform programme. Nor would the Badal Commission ceilings have made much difference if one thinks of the additional resources that would now be tied up in acquiring substantially more land for re-distribution. Alternative approaches to rural poverty alleviation would end up giving more bang for the bucks that will be tied up in any proposed land redistribution scheme which is not purely expropriatory..No matter what the short-term effect on poverty alleviation will be, one should never lose sight of a more fundamental objective of land reform in Nepal's context—an effective land reform programme must boost agricultural production. In the long term it must promote the structural transformation of the Nepali economy whereby the number of people engaged in the agricultural sector is reduced, while at the same time agricultural productivity is increased. One of the immutable facts of economic development is that higher levels of national income per capita can be sustained only by transferring more and more people out of agriculture into the industrial and service sectors. It is essential that a land reform programme, even if focussed on a short-term objective of poverty alleviation, not hinder this long-term goal of structural transformation of the entire economy..While the share of agriculture in Nepal's GDP has diminished considerably in recent decades, the share of employment is still high by world standards, even in comparison to poorer countries. The challenge for Nepal's development planning is to facilitate this movement of agricultural labour into other sectors— whether urban or rural. The average income of Nepali farmers will increase significantly only when the number of people dependent on Nepal's limited land resources is substantially reduced and the average holding size and the capital investment that goes with it is increased dramatically, instead of being reduced further..The 'who' question.From this long-term perspective, clearly the more critical element of an effective land reform programme is to determine how many people Nepal's agricultural sector should be supporting, rather than how much land someone can own at any time. Once we ask the 'how many' people question, then the obvious corollary is the 'who' question: who should receive priority for owning and operating the land?.This is what would lie at the heart of an effective land reform programme—designing legislative and market strategies to influence the relations of production in Nepali agriculture so that land ownership and cultivation are targeted to the 'right' kinds of owners, and that others are helped to exit the agricultural sector permanently. Land ceilings should be a means to achieve this objective and not a primary objective in and of themselves..Who, then, are the right types of landowners? It is difficult to answer this question without bringing in personal views and political perspective. Nevertheless, there is a simple economic answer: land ownership should be targeted towards those who will use it most productively. From this perspective, one group often identified as the 'wrong' type of owners for not using their land resources productively is the Kathmandu based urban elites with their maujas in the tarai, often given to them by Rana rulers for services rendered. Although hard data is difficult to come by, this common conjecture seems valid for this group of mostly absentee owners who depend primarily on tenant farmers. Between both owner and tenants in the maujas, there is little physical or human capital applied for improving land productivity..However, this does not mean that most land holdings in the tarai in excess of the proposed 10 bigha ceiling are being used inefficiently. There is a group of local tarai landowners that have large holdings but who provide the required local managerial inputs and ancillary capital. One has to ask to what extent this group has to be discouraged from long-term involvement in Nepal's agricultural sector..An indiscriminate breaking up of large farms is often justified on the grounds of the technological advantage of small-scale farming. There is considerable international literature, particularly from South Asia, to suggest that land is cultivated more intensively on small farms, leading to higher productivity per hectare. While direct evidence for the higher efficiency of small farms in Nepal is limited, it is important to study carefully what is the exact cause of the higher productivity of smaller holdings and whether these underlying causes can be maintained with re-distributive land transfers. There would be many mitigating factors that operate the other way round, that is, economies of scale that make production more efficient on bigger farms, as is normally the case with most economic activities..To the extent that small farms are more productive, a legislative approach to the break up of big farms into smaller farms is desirable. But surely the 'who' question is once again paramount. An arbitrary and ad hoc break up of big farms is not going to lead to efficiency gains. Who gains access to the land and how the common property resources such as irrigation systems are maintained intact, will have to be considered. Also there probably are clear limits to the efficiency gained by continually lowering farm size. Certainly, the productivity benefit of breaking a 20 bigha farm into 200 small two-katha plots, which will used mainly for a homestead and vegetable garden, is not going to be the long term answer to increasing productivity in Nepali agriculture..Farm size may not be as critical as the right type farming and management skills that make small farms more productive, but which are difficult to duplicate upon the breaking up of bigger farms. All these concerns reinforce the argument that the main objective of a well designed land reform programme should be to address the 'who' and not the 'how much' question..Market-mediated redistribution.So if the core land reform issue is who should be left behind in the agriculture sector to increase the efficiency of production can we really expect the politicians and bureaucrats to be able to prioritise satisfactorily who are going to be the more productive landowners? Readers will have to form their own opinion on the matter. Economic logic, however, dictates a simple alternative approach to land re-distribution: excess land should go to those who are willing to bid the highest price to acquire ownership rights. Those who are able to use the land most productively should be willing to Ala bid the highest price to acquire it. Of course, willingness and ability to bid are two very different things. With access to credit markets being imperfect, and people's attitude to risk-taking being different, a lot of poor farmers who would be productive cultivators would be left out of this bidding process. It is in these areas of access to credit and risk amelioration that the government has a more important role to play to ensure that the poor can bid competitively, rather than in devising administrative rules for the direct allocation of excess land to those whom it nominates as being worthy recipients..One can go a step further along this competitive bidding process for allocating excess land by making it a direct transaction between holders of excess land and those bidding to acquire it. The main role of the government would then be to facilitate a market mediated approach to land transfers from those holding more than the ceiling to those who are below the ceiling. Such an approach also gets around the tricky question of how the compensation for excess land is going to be determined. The compensation will be based on what the bidders are willing to pay. It is not necessary for owners to get exactly what the buyers are paying. But the important point is that there is no administrative price set for the acquisition of excess land. It is almost impossible to get that price right by administrative fiat..The above argument for a market-price based mechanism is based on the efficiency argument of channelling excess land to those who are likely to use it productively. It is not meant to promote a backhanded effort to ensure that owners of excess land receive fair market-based compensation for their assets. It is quite obvious that a market price-based mechanism will not produce an equitable result on post-reform land ownership by any means. On the other hand, it is also just as obvious that equity objectives should be tackled through other means, and should focus on equity of total income or total assets and not just agricultural land..It is often claimed that agricultural land has one distinguishing feature that warrants its rationing— because it is in fixed supply. This is not necessarily so. There is plenty of evidence that the amount of land that is brought into cultivation, and more importantly, the extent of multiple cropping, can be changed dramatically through infrastructure investments in irrigation and by providing proper economic incentives to farmers to cultivate land more intensively. The Agricultural Census data show that the total physical area of agricultural holdings in Nepal increased from 1.7 million hectares in 1961/62 to 2.6 million hectares in 1991/92. (A lot of this was due to forest encroachment which is neither desirable nor sustainable in the long run, but certainly there has been and will continue to be some scope for increasing the supply of cultivated land)..Even if we ignore this possibility of the supply of effective land under cultivation being somewhat elastic, the fixed supply nature of agricultural land is no different from that of urban property or the human capital inherent in a medical doctor's education/ experience. Using the human capital comparison, imagine a law that said no family could have more than one medical doctor among its members. If there were more than one, the income earned from their human capital would be expropriated by the state or, worse still, the extra doctor in a family would be assigned to other families that did not have any medical doctors! This is the logical extension of what is being proposed by way of a land reform fixated on land ceiling levels..The case for market-based compensation .It is of course not just desirable but also necessary to provide fair compensation for the owners of excess land, based principally on the market value of their land, less any taxes or administrative charges the government levies to cover some of the costs of the land reform programme. The need for fair compensation comes from the necessity for non-discriminatory treatment vis-à-vis the holders of alternative assets..Land is an economic asset in the same way as other forms of holding wealth, such as ownership of factories, urban property, savings deposits, and human capital through higher/professional education. In a democratic and civil society where private property rights are constitutionally guaranteed, it is difficult to make the case for discriminatory treatment of alternative assets. While it may be desirable to impose restrictions on how much economic assets an individual or family can own in total, in the interests of reducing overall income or wealth inequality, there is little social or economic justification for treating different kinds of assets in a discriminatory manner. Why should one type of economic capital have ownership ceilings while other forms of capital—industrial or urban property— do not, especially when inequality in ownership may be even more extreme for these other assets?.There is perhaps no better example of the arbitrarily discriminatory nature of land ceilings than the vastly different amounts of land a family can own based on the timeline of its demographic lifecycle. Under Nepal's prevailing inheritance laws, which allow sons aged 16 and above to be recognised as a separate coparcener in ancestral property, a husband and wife with two sons, aged 16 and 18, would be allowed to hold three times as much land as a couple with two sons, aged 15 and 13. Is there any economic or social justification for discriminating against the second family so that their income and welfare level over the family life cycle should be less than the first family's? If not, then it necessarily follows that any excess land that the second family has, must be "sold" at market prices. This way it can maintain the same wealth level as the first, but in a different composition between land and non-land assets..A related reason for market-based compensation is that all regional land ceiling levels, no matter how they are derived, are eventually arbitrary. There is no such thing as an "ideal" farm size nor even a "minimal" farm size which land ceilings are meant to attain through land redistribution. It is almost impossible to give a scientific basis to land ceilings. If one cannot give sound economic reasons as to why one person's farm size should be limited to 10 bigha and not 5 bigha, then it is also imperative that the economic consequences to that person of having either of the ceiling levels imposed should not be of much significance. Fair compensation relying on market-based prices for any land acquired above the ceiling—whatever it is— accomplishes this goal..If the general principal of non-discriminatory treatment of large landowners is accepted, then the whole debate about what is the appropriate level of land ceilings in Nepal's different regions, and whether these levels are 'revolutionary' or not, really becomes a moot point. With appropriate compensation, the ceilings do not become a way to expropriate the wealth of a select group only. The main role that land ceilings take on is to artificially promote an active market in land transactions, whereby land can be transferred from less productive to more productive use, relying on market price signals..Restricting monopoly.In addition to resolving the 'who' question through an artificial stimulus to land transactions, land ceilings can be relevant from a quite different perspective. Limiting the size of agricultural land holdings is an effective way to restricting the monopoly power that landowners would otherwise obtain in their individual villages. Given the limited nature and size of rural markets, especially local labour markets, the concentration of land ownership among a few large landowners, or in the worst case, with a single landlord in a village, can lead to undesirable outcomes. For instance, large landowners could exploit their monopsony power in the labour hiring market in terms of the wages paid to labourers and the conditions of their employment. Also economic power from land ownership often gets translated into monopoly power in other sectors as well, including local politics, with unfavourable outcomes to the land-poor..There is always an economic logic to limiting monopoly/monopsony power in any market. But again the argument must be properly understood. Concentration of land ownership does not necessarily give rise to monopoly power in the production of agricultural goods. A traditional monopolist takes advantage of his market power by reducing the supply of what he produces in order to charge a higher price. This sort of monopoly behaviour is unlikely from large landlords, except perhaps in a few very remote communities in the mountain region, because agricultural product prices are usually not determined in local village markets but are linked to the wider region and, indeed, in Nepal's case, to the Indian market just across the border..The real source of the monopoly power of large landlords comes from inter-linked markets for labour and credit where the individual actions of the landlords can affect the local village level wage rates and interest rates for loans. The monopoly power concerns are probably much less important now than in the early 1960s when the first round of land ownership limits ' were being determined. Rural communities in Nepal are now more closely intertwined with the larger regional and national markets. As transportation/ communication and labour migration networks expand, the monopoly power of big local landowners tend to diminish but may still be significant enough to be an issue to justify further controls on land holding limits..Unfortunately, there is very little analysis of this problem in order to understand what the economic costs of the present land ownership structures in Nepal are. Without this background analysis, it is difficult to prescribe how far one needs to go in dismantling the existing structure in a way that ensures that the economic benefits of any particular policy exceed the costs it is likely to impose. This means the relative merits of alternative means of restricting the economic power of large landlords, short of mandating a break-up of the large farms, needs to be carefully assessed. The argument is exactly analogous to the US government's anti-trust case against Microsoft. Should Microsoft be broken up into smaller separate companies to limit its monopoly power derived from the inter-linking of its Windows operating system with its application software? That answer, as well as the one for land reform options in Nepal, is not easy. But we must first do the underlying homework into the costs and benefits of alternative policy choices, and carefully assess alternative designs of specific options to make the land reform package effective..Conclusions.The need of the hour is not a politically motivated "revolutionary" land reform package, but effective land reform to boost agricultural production and long term structural change of the economy. The needless fixation on what is an appropriate land ceiling in Nepal's special context, including its regional dimension, detracts from a sound approach to analysing and designing an effective land reform programme. In fact, what is required is not a revolutionary perspective on what should be the maximum ceiling levels but instead a revolution in the way we approach the justification for and the design of land reform..The economic mechanism through which the pros and cons of breaking up large farms should be clearly understood and a net cost-benefit assessment made. e success of any land reform programme will depend crucially on what mechanisms are designed to allocate excess land. Priority must be given to those who are likely to use the land most productively. This objective can be met effectively through market-mediated transactions between holders of excess land and potential buyers in a time-bound framework..Land reform should not be viewed as a tax on the assets of large landowners to fund rural poverty alleviation. Rural poverty in Nepal is indeed severe; but it should be tackled with the resources available from all sectors of the economy, including taxes on all types of assets that wealthier individuals own. What is the economic or, indeed, the social logic of taxing only one type of asset holder and not others whose relative wealth may actually be much larger, for funding poverty reduction measures? Just because large landowners and the landless live side by side in a village, it does not follow that a re-assignment of property rights within that village only is the most effective way of alleviating rural poverty..One really has to look beyond the local village economy and its assets for the long-term welfare of the truly disadvantaged sections of the rural population. Should we be thinking of providing every landless family with one katha of land and condemn them forever to a marginal existence of subsistence farming? Would they not be better off if we were to provide them with two rooms in a lodge in an urban setting in the tarai or even in Kathmandu and encourage them to take the plunge into the urban semi-proletariat?.In a free society, the direction to be taken on this difficult choice will have to reflect the wishes of the poor that we all are trying to help. But we must keep in mind that these individual choices also have very significant economy-wide consequences..If, 10 to 15 years later, more than two-thirds of Nepal's population is still dependent on the agricultural sector, then the fruits of the current round of revolutionary land reform will have been just as disappointing as that of the 1960s round. The main game is to reduce significantly the number of workers in the agricultural sector, and so increase the average productivity of each person who remains engaged in agriculture. The economic prosperity of all Nepalis, not just of the owner-cultivator farmer or the agricultural labourer, depends on that one single variable. It does not really matter how many more new factories are built in the tarai or luxury hotels in Kathmandu by local or foreign investors. If the average return of a day's work in the agricultural sector is to remain at about NR 60, then the average income to be earned from a day's work for unskilled labour in any factory or luxury hotel, or indeed in any sector of the economy, will not be much more than that NR 60. So it really is worth everyone's while to get beyond the revolutionary rhetoric of the current round of the land reform package and pay more attention to the underlying economic analysis required to design an effective programme..What is required is a careful and open-minded consideration of alternative options for achieving both the objectives of alleviating rural poverty in a sustainable way, and of laying the foundations for an agrarian structure that promotes a dynamic and more commer-cially oriented agricultural sector with larger farm sizes and fewer people. The starting point should be a land reform programme that accepts in principle full compen-sation for any excess land acquired by the government or required to be sold. This alone ensures that all aspects of a land reform package, including the land ceiling levels, will be considered on the basis of the economic benefits it confers to the nation, and not on the political advantages of parties trying to outdo each other on expressing their revolutionary zeal. The latter road is indeed fraught with danger. A haphazardly developed land reform package can do immense harm to Nepal's economy and polity; and ultimately it is the poor who tend to suffer the most in such situations..History of land reform in Nepal.The political changes of 1951 led to the first expression of interest in land reform in Nepal. After the overthrow of the Rana rule, various land reform commissions were established, and laws relating to land tenure and tenancy were enacted between 1951 and 1960. Land reform in the sense of re-distributing ownership of agricultural land was an important plank in Nepal's first democratically elected government of the Nepali Congress under B.P. Koirala, in 1959. However, the first legislative programme on re-distributive land reform was formulated after the royal coup of 1960 when King Mahendra dismissed the B.P. Koirala government and initiated a period of direct rule under the partyless panchayat system. The main element of the 1964 Land Act was to establish ceilings on agricultural land that one individual or family could own..The success of the land reform package of 1964 was limited. Very little excess land was acquired and re-distributed because large landowners were able to register their excess land in the names of others, and there was inadequate administrative rigour in checking up land ownership across.the country. If nothing else, this earlier experience showed that basing a land reform programme on arbitrary land ceilings with inadequate compensation to the landowners, creates an administrative nightmare and leads to very little change in the effective control of agricultural land, even if a few very big farms are seen to be broken up.