Institutions protecting assets

How can there be assets? Is it not easier to take than to make? Institutions that restrain the taking of assets-through norms or under threats of punishment-are essential for assets to thrive, whether the assets are human-made or natural, whether they are transacted in markets or not. For example, restraint is necessary for the forest and the aquifer to yield sustained benefits when population density, changes in technology or preferences, and other developments increase the demands on their use. Institutions ensuring such restraint allow assets to thrive; however, because they yield dispersed benefits, such institutions do not emerge easily.

Protective institutions are those that define and support control rights in terms of access to and use of assets central to human well-being; for example, who can graze their cows where, who controls a factory, who takes home eventual profits-or who is allowed to discharge emissions-when and where, and at what price. A special subset of protective institutions are private property rights. They entail well-delimited (and not too limited) rights of use and decisionmaking for an owner, typically including rights to sell or lease an asset. These institutions include a commitment from society (extended family, neighbors, villagers, or governments) to help protect these rights. In a modern state, this commitment requires an active obligation of enforcement from the government (police or judges) and the assurance that the government itself respects those rights. For this reason, the security of property rights is closely associated with the rule of law-so that people can make assumptions about what will be respected as theirs.

But protective institutions also arise to manage assets that are not amenable to private ownership. A pollution control agency defines and protects control rights to the air. A central bank protects the integrity of a currency and financial system. And communities can solve coordination problems and allow assets to thrive, as the literature on common property resource management and social capital demonstrates (the important interplay between community cooperation and modern society's formal institutions can be beneficial or detrimental).¹³

In the broader institutional environment, firms, government, and civil society organizations together give force to rules and norms. For instance, civil society can help keep the judiciary independent. Indeed, rules and norms are typically backed by sanctions, and many are effective only when agencies and organizations back them up.

Some assets protect other assets-and some are more vulnerable to predation than others (box 3.2). Land is protected by formal institutions (property rights, courts, and titling agencies) in a modern urban setting, but it is relatively less protected under periodic, nomadic grazing. Fisheries turn from needing no protection when stocks are abundant-to needing costly protective institutions as fishing technology and demand develop. Savings under mattresses need some protection, but those in banks need good vaults and such credible institutions as independent regulatory agencies and central banks.

Higher national income can contribute to better institutional quality (for example, through more expenditures on courts). But more importantly, better institutional quality can also contribute to higher national income, as when good institutions facilitate investments or curb overfishing. A large body of theoretical and empirical studies concludes that there are strong causal effects from good institutions, measured by such variables as rule of law to higher incomes per capita (figure 3.3). According to one study, better voice and accountability would raise national income per capita by a factor of 2.5.¹⁴ Another study suggests that per capita incomes would grow at least 2 percent per year in all countries if they would only protect property rights (public and private) and pursue more competitive market policies.¹⁵

So when institutions allow assets to thrive, an economy can flourish. But if good institutions are so important, why don't all countries have them? Why would a politician or leader not take steps to strengthen the judiciary and protect property rights? Because a leader who takes steps to build stronger institutions would reap benefits from the stronger economy and the better environment only in the long run, and this requires a stable setting with broad political support.¹⁶

Valuable assets cannot thrive, and can be in wasteful decline, if there is no social commitment to developing protective institutions (box 3.3). For agricultural land, two facts facilitate the emergence of protective institutions, as they may have come about historically. First, when land becomes scarce, competing users cannot avoid meeting face to face, and can choose to fight or negotiate. Second, when neighbors are settled, they can help each other defend their land in a reciprocal fashion. Therefore, even without a state or feudal lord, transgressors will face some deterrence.¹⁷

To see how protective institutions form under more challenging circumstances, consider fisheries.¹⁸ Fisheries account for 19 percent of total human consumption of animal protein, so good institutions for fisheries are important.¹⁹ A typical story of fisheries development starts with the discovery of new fish stock. As fishermen make good money, more capacity rushes in. Though scarcity and wasteful competition ensue, fishermen do not coordinate management. Over time, the catch falls, first per hour of effort, then in total, with individual fishermen barely breaking even.²⁰ This wasteful race to exploit the resource wastes labor and capital, since fish that should have been allowed to spawn and grow are caught. Government involvement can make matters worse, if subsidies distort signals and prolong overfishing (chapter 7).

Contrast this story-of waste and no profit-with alternatives in which the value of the resource is maximized. A cooperative of fishermen could manage a resource well if it could control its members, if its members could control their organization, and if the cooperative could control entry into the industry-all big ifs. In theory, a private monopoly could also manage a fishing resource efficiently. More often in practice, government regulates by denying access or enforcing restraint. Restraints that start with and build on existing resource users are more likely to be credible and successful-as seen in New Zealand and Iceland (see chapter 7).

The Law of the Sea , with 200-mile exclusive economic zones, reflects the idea that privatizing a resource can allow for better management-it "privatizes" ownership to coastal states, suitably linking the resource both to traditional interests and to a natural jurisdiction for enforcement. While not all fisheries' management problems are confined to national waters, nations can build on the law and negotiate. Many impressive fisheries management schemes would not have been possible without this law (chapter 7). In many other cases, however, management institutions have been only partly successful in limiting entry and stabilizing catches, and as a result there has not been enough reduction in excess capacity and harvesting to bring major benefits. The challenge is to win the industry's confidence that it can reap the benefits if capacity is reduced and profitability restored. If the commitment to rewarding restraint is not credible, overfishing continues.