Property Rights and the Wealth of Nations: A Cross-Country Study
Heitger, Bernhard, The Cato Journal
Many studies suggest that the key determinants of economic development are the accumulation of physical and human capital and technological improvements. Traditional neoclassical growth theory (e.g., Solow 1956) emphasizes physical capital accumulation whereas endogenous growth theory (e.g., Romer 1986) presumes that investment in human capital and technological progress are the main sources of economic growth. In augmented neoclassical models, Mankiw, Romer, and Weil (1992) have shown that physical and human capital are important determinants of growth.
Nevertheless, it still remains an open question whether these factors are the real sources of economic development. There is reason to believe that if physical or human capital enlargements or technological improvements are taking place, the real growth factors must already have been unbound. (1) Accordingly, physical and human capital and technology should be seen as proximate causes of growth. (2) The still open questions are: What speeds up capital accumulation and what conditions are necessary for technological improvements? What are the ultimate causes of economic growth?
The present study hypothesizes that the missing ingredient in the theory of economic growth is incentives, which strongly depend on private property rights. Indeed, property rights are at the heart of any economic activity--nobody will become economically active if he can be cheated out of the fruits of his efforts. In addition, meaningful prices and efficient use of resources require secure property rights.
Traditional growth theory makes no mention of incentives and private property rights; they are simply taken as given. In reality this is not the case. Obviously, many countries of the Third World lack secure and well-established private property rights and there are many graduations between secure and insecure property rights, so that in fact there are diverging incentives to work, invest, and innovate. Even developed countries show distinct variations with respect to property rights.
The aim of this study is to analyze the impact of private property rights in the framework of an investigation into the causes of economic growth in an international context. The analysis is based on a modified neoclassical growth model. It is assumed that private property rights have a strong impact on economic efficiency. In addition, it is hypothesized that there may be positive feedbacks from increased efficiency to further improvements of the property rights system. The reason is that gains in economic efficiency may improve the prospects for institutional reforms. It therefore seems reasonable to investigate whether the assumed influence of private property rights on prosperity is only in one direction (i.e., purely exogenous) or whether there is also a positive feedback from improved economic development to the establishment of more efficient private property rights (i.e., simultaneous determination). In addition, the impact of property rights on the traditional determinants of economic growth will be considered to see whether private property should be treated as an ultimate source of economic growth.
Thoughts on Private Property
At first glance, it appears that classical economists, especially the English, neglected the importance of private property rights as a prerequisite for economic development. Although classical writers were not indifferent to private property, they appear to have taken it for granted. The reason may be that the legal situation in England in the 18th and 19th centuries--when even the tenant enjoyed legal security--was completely different from that on the European continent.
Adam Smith said relatively little about the importance of private property for economic development in The Wealth of Nations because he took it for granted. (3) Only at the end of his comprehensive work (Book V, Chapter III) did he state, "Commerce and manufactures can seldom flourish long in any state which does not enjoy a regular administration of justice, in which the people do not feel themselves secure in the possession of their property, in which the faith of contracts is not supported by law" (Smith  1976: 445). …