Power and Plots

General Faiz Hameed, the once powerful head of Pakistan’s intelligence agency, was recently arrested on charges of intimidating a land developer to extort valuable land. Land is one of the favorite assets through which the powerful extract rents from the economy. The tactics used for extracting these rents range from the legal to what Gen. Faiz is alleged to have done. However, even if the means to acquire land by the powerful are legal, it does not necessarily make them desirable, or fair. In fact, the entrenched nexus between power and plots in Pakistan is seriously damaging the economy.

To understand why, a bit about the economics of land value. Land is a non-reproducible factor that comes in fixed supply - humans do not create it, it’s just there. The value of land in urban areas, where it is most valuable, comes largely from the economic and social activity that surrounds it. These two facts imply that the value of land is largely “public” in nature - it has less to do with individual effort or investment of the owner. In short, land value (not counting the structures that may be build on it) mostly reflects location rents.

Given the public nature of land value, there is a basic intuition in economics that it is efficient for government to generate revenue through land value. The revenue can then be used to invest back in the city, thus benefitting everyone without creating any tax distortions (because no one creates land). This basic insight is sometimes referred to as the “Henry George theorem” after the American political economist who famously proposed land value tax to replace other forms of taxation.

How can government raise revenue through land value? There are three practical ways of doing so: (i) any public land should be auctioned off in a competitive bidding process with proceeds going to public funds, (ii) the government can price the increase in market value from up-zoning, e.g. converting agricultural to urban land, and send proceeds to fund public expenditure, and (iii) the government can tax a fraction of the market value of land on an annual basis.

When it comes to generating revenue using land value in developing countries, China is the most noteworthy example. It financed a large share of its infrastructure needs via land sales by local governments to the private sector. Naturally, all land was in state hands before China embarked on the liberalization program in late ‘70s. The country chose to gradually auction off land to the private sector and use the proceeds to fund local governments - in effect following the insight of the Henry George Theorem. China has obviously benefitted greatly from this political choice.

Contrast this with Pakistan, where the powerful have focused on pocketing land value through a number of schemes. For example, elaborate off-balance sheet, special purpose vehicles exists with the sole purpose of acquiring land using public resources and transferring it to private hands under various forms of privilege and patronage. Unlike China, almost none of this value goes to the pubic exchequer.

The figure above shows that Pakistan generates one of the lowest revenues from property - both as a share of GDP, and as a share of total tax revenue. Rather than use land to raise much-needed public funds, an elaborate alliance of the powerful has developed over time to convert public land value into private property. This is also the likely reason land value is protected from taxation. For example, despite extreme pressure due to fiscal deficit, the recent budget protected property sales of army personnel and bureau­crats from taxation.

The macroeconomic consequences of rent-seeking via plots of land are bad. First, as mentioned earlier, land value represents “location rents” that are coming from the fruits of other peoples efforts. When the powerful grab these rents so they do not flow back to the public as tax revenue, it distorts the entire economy. For example, Pakistan has high consumption and very low investment rates partly due to this issue. When the unproductive elite grab rents via land value, they generate consumption demand in the economy, without adding to the economy’s productive capacity.

Second, taxing productive sectors (e.g. manufacturing) but not real estate sets in wrong incentives for investors. Why invest in risky manufacturing and pay taxes, when there is an easier way to invest in land? Third, low taxation makes land unaffordable for those young and productive professionals who do not have generational wealth. Proper land taxation helps to bring down the value of land relative to wages, and allocates it more efficiently toward those who are more productive in the economy.

Ultimately, the nexus between power and plots reveals why the political economy of bringing about change is so difficult. The macroeconomic costs of this nexus might be obvious, but who will bell the cat? Perhaps a similar predicament made Faiz - and now I am talking about the much more enlightened Faiz-the-poet - pen these words,

بنے ہیں اہل ہوس مدعی بھی منصف بھی
کسے وکیل کریں کس سے منصفی چاہیں