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					Efficient and equitable compensation of agricultural land conversion: Theory and an
application for China

                 邹秀清 * and Arie J. Oskam†

Abstract
This paper explores the price development mechanism of agricultural land conversion during
the land taking process. Assuming bargaining power equal, the efficient and equitable
compensation is obtained under the hypotheses of a perfect market. The value of transferable
agricultural land’s development right is measured. From the state-of-the-art view of land
appraising, practical approximation of the theoretical optimal compensation will provide an
effective solution to the concerned problems. An example for China shows significant
practical and policy implications.

Keywords: agricultural land conversion, efficient and equitable compensation, land taking,
China




Acknowledgments: The authors wish to thank Dr. Louis Slangen and Dr. Roel Jongeneel at
the Group of Agricultural Economics and Rural Policy, Wageningen University, for helpful
comments on an earlier draft. Errors remain our own.




*
  邹秀清,江西财经大学旅游管理学院副教授、博士,330045 南昌 江西.E-mail: zxqing888@263.net 电
话:0791-3816438(办),0791-3893899(宅)。现在荷兰 Wageningen University 留学,9 月份回国。
该研究受国家社会科学基金(04CJL003) 和国家自然科学基金 ( 70373029) 资助。
†
  Professor of Agricultural Economics and Rural Policy, Wageningen University, The Netherlands. E-mail:
arie.oskam@wur.nl .


                                                  1
 Efficient and equitable compensation of agricultural land conversion: Theory and an
application for China



Abstract
This paper explores the price development mechanism of agricultural land conversion during
the land taking process. Assuming bargaining power equal, the efficient and equitable
compensation is obtained under the hypotheses of a perfect market. The value of transferable
agricultural land’s development right is measured. From the state-of-the-art view of land
appraising, practical approximation of the theoretical optimal compensation will provide an
effective solution to the concerned problems. An example for China shows significant
practical and policy implications.

Keywords: agricultural land conversion, efficient and equitable compensation, land taking,
China

1 Introduction

The phenomenon of agricultural land conversion is very common all over the world. The
process goes under different names and assumes (at least in theory) that the state has the
power to acquire the private land in the public interest, subject to the payment of
compensation (Larbi et al., 2004). However, in practice the compensation standard in terms of
property rights transfer is not the same in different countries. For example, in USA, farmers
will be compensated according to an open market price at the time of taking (Chen, 2004). In
France, the taking arbitrage agency decides the compensation standard with reference to other
agricultural lands’ market price in the neighborhood of the expropriated land or the enrolled
price of owners when the properties are taxed (Chen, 2004). In China, the revised Land
Management Law in 1998 states that compensation for state expropriation consists of
compensation for the loss of land, resettlement subsidies and compensation for young crops
and fixtures1. Standard compensation for the loss of land is set at six to ten times the value of
the average annual output of the land calculated over the three years prior to expropriation;
subsidies to assist the village collectively in relocating the agricultural population are four to
six times the value of the average annual output of the land calculated over the three years
prior to expropriation. The total amount of land compensation and resettlement subsidies is
capped at 30 times the value of the average annual output for the three prior years.




                                                2
Compensation standards for surface fixtures and young crops are stipulated by provinces,
autonomous regions, and provincial level municipalities.
       However, how much compensation is efficient and equitable for agricultural land
conversion? This paper attempts to answer this question. An essential element in determining
the compensation is the difference in the market price of land before taking and the market
price of land after creating the opportunities for a new development. This difference plays an
important role in this paper.


1.1 Literature review


The process of enforced transformation of agricultural land shows up in the literature under
different names: termed compulsory purchase, compulsory acquisition, expropriation,
eminent domain or (titular) taking. This also depends on the various jurisdictions. The process
supposes that the state has the power to acquire the private farm land in the public interest for
other purposes, e.g. industrial areas, infrastructure, public goods (Larbi et al., 2004)2. The
compensation paid for takings is the central element of this short literature review.
       In literature different conclusions have been reached due to different assumptions.
Blume et al. (1984) start their paper by elucidating four different rules: (1) zero
compensation; (2) compensation according to the current market value; (3) compensation
based on the fact that the risk of a taking cannot be insured; (4) compensation based on the
consideration that governments should also be informed via the budget about the opportunity
costs of land3. Based on a general equilibrium model with one consumer, two producers, a
government and two different types of land, they derive optimal compensation levels for land
takings. Using the standard neoclassical assumptions the most striking element is that zero
compensation can be optimal for a government taking motivated by the maximization of
social welfare. The reasoning boils down to the assumption that for land of type 1, the
compensation is based on the investment in capital goods. Because of the new destination of
land, every investment is suboptimal (Blume, et al., 1984). The zero compensation result is
also controversial because, in practice, courts have shown a preference for using market value
at the time of taking as the appropriate level of compensation (Giammarino and Nosal, 2005).
       Fischel and Shapiro (1988, 1989) consider a situation where the government’s takings
decision is determined by maximizing the welfare of the majority of voters, they conclude
that the compensation schedule will be some positive fraction of the expropriated property’s
market value at the time of taking.


                                                3
       Miceli and Segerson (1994) consider a model where the government suffers from
“fiscal illusion.” A government suffers from fiscal illusion if it does not correctly account for
all of the social costs or opportunity costs associated with its actions. Their ex post rule
requires that the government compensate the investor with market-value at the time of taking
only if the expropriation is not socially efficient; a socially efficient expropriation does not
require compensation.
       Hermalin’s (1995) model is motivated by informational asymmetries between the
government and investor. He assumes that the government takes private property only if the
benefit to society exceeds the price that the government must pay for the property. With these
kinds of preferences the government may end up taking private property when it is not
socially optimal to do so. Hermalin’s main conclusion is that “efficiency requires
compensating the citizen based not on what she loses, but rather on what society gains from
the taking.”
       Nosal (2001) is motivated by the observations that citizens form the government and a
citizen, acting as the government, may take actions that are beneficial for himself and not
necessarily for society. He proposes a very simple tax and compensation scheme that
implements the socially optimal allocation when a government’s expropriation decision may
be privately motivated and not in society’s best interest. An implication of his tax and
compensation policy is that an individual who has his property expropriated will receive its
full market value at the time of taking as compensation.
       Giammarino and Nosal (2005) examine how the compensation rule adopted by a
country affects both private investment decisions and takings decisions. They build on a
widely accepted argument that any lump sum compensation, including zero, is the socially
optimal compensation scheme. The lump sum compensation result hinges critically on the
assumptions that the government maximizes social welfare and that the level of private
investment does not affect the alternative use of the property rights. They find when either of
these assumptions is relaxed, the optimal compensation scheme will generally depend upon
market values. The model provides strong support for market value compensation at the time
of taking for the taking of property rights in modern societies. They have demonstrated what
is intuitively obvious: Requiring decision makers to pay market value forces them to
internalize economic costs that their political concerns would cause them to ignore.


1.2 Purpose and structure




                                                4
In market economies, agricultural land’s market price at the time of its taking basically
reflects both agricultural land price before expropriation and the value of transferable
agricultural land’s development right4. However, the compensation of its market price often
leads to problems of “holdout” and overinvestment (Blume, et al., 1984). Holdout occurs if at
least one of land owners is not prepared to sell his land in a voluntary exchange, when large
contiguous parcels of land are required to be taken. In market-developing countries, usually
there is no market price for agricultural land conversion in terms of property rights transfer.
The compensation is often regulated by the law and land price is greatly distorted (Guo, 2001;
Larbi et al., 2004). If regulated by law, the central question is: which compensation is both
efficient and equitable? Should it be based on the ‘pure’ agricultural land rent or the
commercial land rent or a compensation in between?
       The basic idea of this paper is to start from the highest price for which a willing
developer would buy the land and the lowest price for which a willing farmer would sell the
land. Keeping bargaining power equal, efficient and equitable compensation is obtained under
the hypothesis of a perfect market. From the state-of-the-art view of land appraising, a
practical approximation of the theoretical ‘optimal’ compensation will be derived.
       The remainder of the paper is composed as follows:
       Based on some basic assumptions, section 2 explores the agricultural land price
development mechanism during the taking process, which divides the process of agricultural
land conversion into four phases. On the basis of Ricardo’s “capitalization formula”, P  R i ,
where R is the annual rent and i the discount rate, we explore land price formation in different
phases accordingly.
       In section 3 we derive the theoretical efficient and equitable compensation price when
taking takes place under perfect market, keeping bargaining power equal. At the same time
the value of agricultural land’s development right is measured. Based on the First Welfare
Theorem, the Second Welfare Theorem and Coase Theorem, some conclusions are derived.
       Section 4 illustrates practical implications. From the state-of-the-art view of land
appraising, practical approximation of its theoretical optimal compensation price will be
derived.
       Section 5 gives an example for China and Section 6 provides a number of concluding
remarks.




                                               5
2 Agricultural land price development mechanism during land taking
process


2.1 Some basic assumptions


To explore agricultural land price development mechanism during land taking process, we
start with some assumptions. Fig.1 shows the location of Village C.

       <Fig.1>

       There are N units of agricultural lands in Village C, their property rights belong to the
farmers. The government represents the public interests and makes a decision according to
public interests. Moreover, we assume that: (1) land is homogeneous; (2) agricultural and
commercial land rent are both uniform; (3) there are no additional investment/disinvestment
during the period when the land is taken.
       During the process of urbanization and industrialization, the government decides all
the agricultural land in Village C will be developed for commercial use according to land use
planning. However, which parcels will be taken and in which round of the total development
period is not clear and might depend on arrangements made between the developer and the
government . In the first-round development period, n1 units are chosen to be taken according
to zoning. In the second-round development period, n2 units are to be taken…in all, all the
agricultural lands in village C are to be taken in the near future.
       The farmers have no right to veto land use planning and state taking5. They can only
bargain with the developer for the reasonable compensation in terms of land ownership loss.
The developer will pay the compensation and get land ownership for commercial use. After
land transaction the government can tax land increment value according to specific
circumstances.


2.2 Process of agricultural land conversion to commercial development

The process of the first-round agricultural land conversion to commercial development in
village C is divided into four phases: planning process, investment negotiation, construction
and commercial use (Fig.2).

       < Fig.2>


                                                 6
           Phase 1 ( t 0 — t1 ): N units of land in village C are used for agriculture. Government is
planning land use but doesn’t make a decision. Government’s planning process has no special
effects on farmers in village C. We denote the agricultural land price per unit in this phase
as P1N .

           t — At time t land use planning decision is made. All the agricultural lands in
            1                  1



Village C will be developed for commercial use.
           Phase 2 ( t1 — t 2 ): The government negotiates with the developer about the

investment. The agricultural land price per unit in phase 2 is denoted as P2N .

           t — At time t specific investment is decided. Only n1 units of agricultural lands in
            2              2



village C are chosen to be taken. The developer pays land price and farmers are compensated.
           Phase 3 ( t 2 — t ): Construction is in progress.
                           3



           The price per unit of n1 lands under construction in phase 3 is denoted as P3n1 .
           The price per unit of the other (N- n1) agricultural lands which are not expropriated in
phase 3 is denoted as P3N  n1 .

           t — At time t construction is completed. Developer begins to get net rents from
            3                  3



commercial use.
           Phase 4( t — ∞): The n1 units of land are used for commercial purpose and developer
                      3



gets continuous net land rents. We denote the price of n1 commercial lands per unit in phase 4
as P41 .
    n




2.3 Agricultural land price development mechanism during the taking process

Agricultural land price development mechanism during the taking process is illustrated in
Figure 2.
           Now we focus on the specific price development in the first-round development
period. The analysis of this section combines the approaches used in previous studies of
agricultural and developed land prices (Plantinga and Miller, 2001; Plantinga et al., 2002;
Cavailhes and Wavresky, 2003).
           Phase 1 ( t 0 — t1 ):    According to the Ricardo’s “capitalization formula”, in a
competitive land market the price of Land equals the present discounted value of the stream




                                                     7
of future rents. So in Phase 1 agricultural land price equals the present discounted value of the
stream of future agricultural net rents.
                                                          
                                     1
                                                                    R           a
                                                                                                       R       a
                                                                                                                                          (1)
                                     P   N
                                                     t
                                                          t0   1
                                                                    1 i  t         t
                                                                                           0                i

                                                  R —future agricultural net rents (constant assumption)
                                                          a



                                                  i —discount rate (constant assumption)
       Phase 2 ( t1 — t 2 ): At time t1 the agricultural land price in Village C is higher than in
Phase 1, as a result of potential capitalized rents from future commercial development due to
planning decision. However, because of uncertainty about the date of future development and
future returns from development, the agricultural land price in phase 2 will lie between the
price before planning decision in Phase 1 and the price at the time of taking in Phase 3.

                                  t2                                                                            t2                               
               2
                    E 1  1                          R        a                            3
                                                                                                            1        R  
                                                                                                                             a                  3
                                                                                                                                                                         (2)
           P                                                      P                                                            P
                                  1
                                                          1i t                                                1
                                                                                                                        1i t 
               N                                                             t                    N  n1                        t             n1
                                                                                  1                                                   1
                                 t1                                                                            t1             
                                     E—expectation operator
                                      1 —expected probability of taking at time                                                                             t   2



                                     P
                                         3
                                         N  n1
                                                     — The price per unit of N-n1 lands which are not taken in phase 3

                                     P — The price per unit of n1 lands under construction in phase 3
                                             3
                                             n1



       Phase 3 ( t 2 — t 3 ): The n1 agricultural lands are chosen and taken for commercial
development, but the other (N-n1) lands are not chosen in the first-round development period
for commercial use.
       For the n1 agricultural lands which are chosen and taken, their prices in phase 3 are:
                                 t                                                            t
                           R  C                                        3

                   P 
                       3                         m
                                                    (3)                                        m


                      t  i  t t  i  t
                       n1                            t                                            t
                         1  3
                                1
                                    1                      3
                                                                     2
                                                                         1                             2



                          R —future commercial net rents (constant assumption)
                                             m



                                     C —construction and development cost in t year (from t +1 to t )
                                             t
                                             m                                                                                                                                 2     3



       For the other (N-n1) agricultural lands which are not chosen and taken in the first-
round development period, their prices in the first-round development period are:
                                     t                                                                                 t                                  
                                                                       R                                                               R
             PN n1  E 1   2   1                                                                            2                                Pn 2     
                                         2                                                                                    2
                                                                                                    PN  n1n 2
                   3                                                                                            3                                           3
                                                                                      a                                                    a
                                                                                                                                                                               (4)
                                     
                                    t 2                             1i t              t
                                                                                               2                 
                                                                                                                 
                                                                                                                          1
                                                                                                                         t 2        1i t   t
                                                                                                                                                     2         
                                                                                                                                                               
                                                                                                                                 
             2 —expected probability of taking at time                                                                     t in second-round development period
                                                                                                                                 2


               
            t —expected taking time in second-round development period
               2




                                                                                                                    8
P
    3
    N  n1 n 2
                  — The price per unit of (N-n1-n2) lands which are not taken in second-round
development period

 P — The price per unit of n2 lands under construction in second-round development period
        3
        n2



                  Generally, due to higher expected taking probability over time, so P3N  n1 > P2N .
However, the other (N-n1) agricultural lands are still uncertain about the future development,
so P3N  n1 < P3n1 .

                  Phase 4( t 3 — ∞): Construction in the first-round is completed. Continuous commercial
net rents are produced from n1 taken lands.
                                                   
                                        4
                                                         R  m
                                                                                                        (5)
                                    P   n1
                                                 t 31   1 i  tt
                                                                       3




                                    R —future commercial net rents (constant assumption)
                                            m



                  Obviously,
                                                                           4             3
                                                                   P >P .  n1            n1



                  Summing up land price development of the above four phases in the first-round
development period, we get
                                                         1     2                3
                                                   P <P <P
                                                         N     N                N  n1
                                                                                         < P3n1 < P41
                                                                                                   n
                                                                                                                      (6)


3 Deriving a land taking price under equal bargaining power


Now it is assumed that farmers and the developer are bargaining for land transaction under
perfect market. Farmers know the highest price for a willing developer to buy the land is P3n1
(If the price would be higher there would be no profit). The developer knows the lowest price
for a willing farmers to sell the land is P3N  n1 (because at Phase 3 the other (N-n1) non-taken

agricultural land price in the first-round development period amounts to P3N  n1 . If the taken

land price is lower than P3N  n1 , farmers whose lands are taken will consider to be in a
disadvange position compared to a farmer whose lands is not taken.).
                  As a result, we can imagine farmers and developer will share the total land increment
value ( P3n1 - P3N  n1 ).
                  Keeping bargaining power equal, finally, the land transaction between farmers and
                                                                 
                                                                                                              3       3

developer will reach equilibrium at the price Pe, where P e  Pn1 PN n1 . In this situation
                                                                                                                  2




                                                                                             9
farmers and the developer each will get the half of the total land increment value Pd, where Pd
     
      3        3

= Pn1 P N  n1 , which is a measure of the value of transferable agricultural land’s development
          2

right. If bargaining powers are not equal, the total land increment value ( P3n1 - P3N  n1 ) will be
distributed for a larger share to the more powerful party. Then the transacted price will not be
Pe.
              Based on the First Welfare Theorem, we get
              Corollary 1: Keeping bargaining power equal, the compensation of Pe which farmers
get in terms of land ownership loss will be Pareto-efficient and equitable under perfect
market.
              Based on the Second Welfare Theorem, we get
              Corollary 2: If farmers can get the compensation of Pe in terms of land ownership loss,
the Pareto-efficient and equitable allocation can be achieved.
              Moreover, we assume that there is no transaction cost in this deal. Based on Coase
Theorem, we get
              Corollary 3: Regardless of who holds the agricultural land property rights initially, the
efficient and equitable outcome Pe will occur under perfect market, keeping bargaining power
equal.
              Combining Corollary 1, 2 with Corollary 3, we get
              Conclusion 1: If the individual farmer (the collective or state) owns the agricultural
land property rights, under perfect market the outcome Pe will occur during agricultural land
conversion, keeping bargaining power equal; and compensation price of Pe which the
individual farmer (the collective or state) gets in terms of land ownership loss will be Pareto-
efficient and equitable. The other way around, if the individual farmer (the collective or state)
can get the compensation of Pe in terms of land ownership loss, a Pareto-efficient and
equitable allocation can be achieved.


4 Significant practical and policy implications


In this section we try to derive a practical approximation of the theoretical optimal
compensation price Pe , which can be used as an alternative substitute of actual market price
in a market economy and can be used as a compensation standard for countries with no
market price for agricultural land conversion in terms of property rights transfer.



                                                     10
       From the state-of-the-art view of land appraising, appraiser can get P1N , P3n1 and
  4
P according to land appraisal method (the income approach, the cost approach or the
  n1



comparable sales approach). The appraisal is to be based on a market data analysis utilizing
all pertinent appraisal techniques. Appraisal price reflects the actual value in its highest and
best use of the property, which is “the amount that would have been paid for the interest if,
at the time of its taking, it had been sold in the open market by a willing seller to a willing
buyer”6. Accordingly their appraisal prices of P1N , P3n1 and P41 are denoted as AP1N , AP3n1
                                                               n



and AP41 .
      n


                      1       2           3
       because     P <P <P
                      N       N           N  n1
                                                   < P3n1 < P41
                                                             n
                                                                                     (6)
       We get

                                               
                                          3             1

                      P > AP
                          e               n1       AP       N
                                                                                          (7)
                                               2
                                       
                                                        4           1

                      Pe ≤ (or ≥ ) APn1 APN                                               (8)
                                                                2
                          
                                  3                 1

       That means, if APn1 APN is chosen to substitute the theoretical optimal price Pe in
                                      2
operation practice, farmers will get less than it, which reflects a balance in favor of the
                  
                  4           1

developer. If APn1 APN is chosen to substitute it, farmers may get less or more than it, or
                      2
equal to it. In the latter situation policy preference will be ambiguous.
                                                      
                                                                             3        1

       In operational practice the probability of APn1 APN chosen to substitute theoretical
                                                                                 2
optimal price Pe is higher considering implementation feasibility, for the developer usually
has more economic and social advantages than farmers.
       Now we make a conclusion that,
                                                                                    
                                                                                                3       1

       Conclusion 2: Practical approximation of theoretical optimal price Pe is APn1 APN ,
                                                                                                    2
considering implementation feasibility.
       According to conclusion 1 and 2, we get the significant practical and policy
implications:
       (1)In reality the compensation of its market price is difficult to reach both efficiency
and equity in the meantime, compared with Pe .
       First, due to lack of full information, farmers do not know the exact highest price P3n1

for willing developer to buy the land. Developer doesn’t know the lowest price P3N  n1 for



                                                                        11
willing farmers to sell the land either. Second, usually developer holds more bargaining
power because of its economic advantages. Third, taking behavior usually becomes
compulsory expropriation in the name of public interests after land use planning and zoning.
In the land development practice, the relationship between the government and developer
appears to be symbiotic, which usually leads to policy preferences towards developer during
taking process. As a result, the judicial compensation according to taking arbitrage agency
tends to be less than Pe when there is a conflict about the compensation.
                                                             
                                                                    3       1

        (2)For market economies, practical approximation APn1 APN of the actual market
                                                                        2
price provides an alternative effective solution with low transaction costs to the taking
problems of “holdout” and overinvestment. The possibility of holdout can lead to an increase
                                                                                          
                                                                                     3          1

in the transaction cost for the purchase of contiguous parcels. Because AP           n1       AP is
                                                                                                N

                                                                                          2
practical approximation of efficient and equitable compensation, we can directly compensate
farmers with it in place of a market price by voluntary deal.
       (3)For market-developing countries, especially for countries with no market price for
                                                          
                                                            3       1

agricultural land conversion, practical approximation APn1 APN solves the problems such as
                                                                2
low compensation, government rent-seeking and potential social unrest etc., to protect
peasants’ rights and obtain efficiency and equity through land price distribution (Guo, 2001;
Larbi et al., 2004).
                     APN
               3        1

       (4) AP  n1
                            is a practical measurement of the value of transferable agricultural
                    2
land’s development right Pd.
       (5) After land transaction, the government can tax part of the land increment value
according to specific circumstances.
       There are three main elements to contribute to the land increment value in agricultural
land conversion: farmers’ land property transfer, developer’s investment, government’s
planning decision and public infrastructure. According to contribution rule of price formation,
the government can get part of the land increment value. However, if the government directly
engages in the bargaining, land market will tend to be largely distorted. The better way is to
tax part of land increment value after transaction.


5 Approximation of optimal compensation: its application in China
5.1 Overview of land tenure system in China


                                                 12
China practices the system of public ownership for land (Fig.3). Urban land and natural
resources are state-owned, while suburban and rural lands are collectively-owned.


       < Fig.3>


5.1 1 State-owned land tenure system


The ownership of state-owned land is exercised by the State Council as representative of the
state. The Ministry of Land and Resources is uniformly charged with the management and
supervision of the nation’s land. Public sector and private agent can possess the use rights of
state-owned land through so-called double-track system (Ding, 2003). That is to say there are
two channels through which state-owned land use rights can be obtained. One is to obtain
state-owned land use rights by granting without payment or with a small amount of land use
fee, which is usually applied in the public interests’ situation for public entities. This kind of
land use rights is prohibited from transferring, or can be transferred after paying the state-
owned land use rights price. The other is to buy state-owned land use rights from the state
through auction, tender or negotiation, which is usually applied in the situation of commercial
development for developer. This kind of land use rights can be transferred, rented or
mortgaged in the land market.

5.1.2 Collective-owned land tenure system

Collective ownership can be represented by township, villagers’ committee or villagers’
group, but the collective as the land owner only has the right for making land readjustment
among the peasants. Agricultural land is allocated to each peasant household on the basis of
family size, and peasants have been given the right to use the contracted land for 30 years
since the late 1990s. This is called Household Responsibility System (HRS) which led to
agricultural decollectivization in the late 1970s and early 1980s.
       For the time being the villagers’ committee becomes the main representative of
collective ownership. Usually the village leadership consists of a Party secretary, a village
director and a book-keeper. They are appointed by the township government (some by
“nominal” village elections). The duration of each appointment is three years, during which
the village leaders are on the township government payroll (Guo, 2001).




                                                13
       According to the Rural Land Contracting Law (RLCL) issued on 29 August 2002—the
first modern Chinese law to deal exclusively with the issue of rural land tenure, peasants’
contracting and operation rights include “rights to use, profit from, and transfer land
contracting and operation rights, and the right of autonomy over production operations and
disposition of products” and “the right to receive the corresponding compensation” for any
land taken by the state or collective for non-agricultural purposes (Article 16). On the issue of
right to land transactions, RLCL further states that farmers’ land rights “may be transferred
[to other village households], leased [to non-village households], exchanged, assigned, or
transacted by other means in accordance with law” (Article 32). In order to safeguard farmers’
interests in land from being violated by local officials through various types of compulsory
land transactions, RLCL emphasizes the principle of “equal consultation, voluntariness and
with compensation” (Article 33), establishes farmers as “the party to any transactions” of
rural land use rights (Article 34) and explicitly prohibits local officials from acting to
“intercept or reduce” the proceeds from such land transactions (Article 35).
       The 1998 revised Land Management Law allows collective entities to withdraw
farmers’ land rights “for constructing township or village public utilities or public welfare
undertakings” upon the approval by the government that approves such land use (Article 65).
Any compulsory taking of land for commercial purposes should be prohibited. The law only
requires an ambiguous “appropriate compensation” for collective withdrawal (Li, 2003).


5.1.3 Land expropriation and land development in China


Land expropriation in China is known as a form of “government behavior” which is described
as “using coercive measures to acquire private land under compensatory arrangement by the
government in the public interest” (Guo, 2001). By law, the village collective has the right to
use and supervise the use of the land, but it has no right to transfer land for commercial use.
The state, on the other hand, “may, in accordance with the law, expropriate land which is
under collective ownership if it is in the public interest”.
       However, in practice collective-owned land is expropriated through nationalization for
both public interest and commercial development because the collective has no land
development right and urban land belongs to the State. Especially it is commonly claimed by
the local government that land development is to benefit the rural area and ultimately to
achieve modernization, because it helps develop tertiary industry and provide business and
employment opportunities for the rural population (Guo, 2001). This is also called public


                                                 14
interests by a number of local cadres during large-scaled urbanization and industrialization in
the present China.
         Land development generally proceeds in two steps: land expropriation through
nationalization by the government from villages, and state-owned land use rights transaction
between the government and developer (Guo, 2001). According to the 1998 revised Land
Management Law, compensation for state takings consists of land compensation, resettlement
subsidies and compensation for standing crops and fixtures. The standard of the two former
items can be at least 10 times to at most 30 times the value of the average annual output. This
standard applies not only to land takings for public purposes such as building roads and schools,
but also to land takings for commercial purposes. Although the law explicitly requires
compensation for standing crops and fixtures (which is very limited) to be paid directly to
peasants whose land is affected, it authorizes the collective entity to decide how to apportion
land compensation. Resettlement subsidies go to whoever is responsible for resettlement (Li,
2003).
         In November 2004 the Ministry of Land and Resources issued a new document on
compensation standard and relocating channels. The most significant difference from the
standard of the revised Land Management Law in 1998 is that, if land compensation and
relocating subsidies amount to 30 times the value of the average annual output, but still
insufficient to help the displaced peasants maintain their original living standard, local
government will increase the compensation from the state-owned land revenues till their
original living standard is satisfied. The newly issued relocating channels include agricultural
production relocating, new job provision, shareholding construction project and migration
according to specific circumstances. But how to define and guarantee “maintaining the
peasants’ original living standard” is a big problem during implementation. Moreover, the urban
residents’ living standard is improving over time while the peasants just maintain their original
living standard, which will increases income disparity between the urban residents and peasants.
         Then the developer obtains state-owned land use rights through paying land use rights
price by auction, tender or negotiation. In the present large-scaled land development process,
most local governments prefer negotiating with developer about it because negotiation lacks of
transparency. This point will be explicitly illustrated later.

5.2 Land price distribution during land expropriation and land development

         From the above analysis, it is not difficult to find that, local government’s land revenue
equals the total amount of urban land use rights price which the developer pays minus the total


                                                  15
amount of peasants’ compensation. These land revenue directly belongs to local government’s
income, not in the form of tax. Obviously, local government becomes an economic agent with
strong driving forces to maximize land revenue behind the conversion of agricultural land to
non-agricultural uses.
       However, in reality the actual payment of land use rights price will be much lower
than its real land value, because the relationship between local government and developer
seems to be symbiotic (Guo, 2001). In the present China local economic development
becomes the main political objective of local government. Urbanization and industrialization
are external performance embodiments of local leaders. Sometimes local cadres have the
quota to attract the investment. Sometimes the appointment of local cadres depends on the
performances of attracting the investment. Developer appears to be a particularly
distinguished guest for local government. Under this situation the local cadres’ demands for
land development is far beyond the supply of developer. In order to let developer invest in
their local region, local government tends to negotiate friendly with developer about land use
rights price. As a result the actual payment of land use rights price will be a discount of the
real land value.
       Concerning compensation, it tends to be as low as possible under law permission. First,
according to the 1998 revised Land Management Law, the standard of compensation for land
loss and resettlement subsidies can be between at least 10 times and at most 30 times the
value of the average annual output of the land calculated over the three years prior to
expropriation. Second, the preceding analysis shows that in fact the village leadership is the
subordinate bureaucratic arrangement although it is in the name of villagers’ committee.
Third, the present peasants’ cooperative is a loose organization without close common interests.
Peasants hardly have any political bargaining power during land expropriation. Fourth, the
collective (in fact the village leadership) has the right to decide how to apportion compensation
for land loss, and resettlement subsidies go to whoever is responsible for the resettlement.
      Kung and Liu (1997) indicate that although the amount of compensation paid to
collective owners has increased substantially over time, peasants continue to receive extremely
low levels of compensation, and in many cases no cash compensation whatsoever, in return for
their land rights. Often, the collective retains all of the cash compensation under the pretext of
expanding the collective economy, and simply spreads the burden of the land loss among all
village peasants by conducting a large readjustment. Thus, those peasants who initially lose all
or much of their land receive a somewhat smaller allocation at the expense of the land




                                                16
allocations for everybody else. This process has increasingly led to complaints by peasants. In
some areas, serious unrest has appeared (Li, 2003).

5.3 Main problems resulted from land expropriation


There are appearing some serious problems due to the present institutional arrangements:
       (1) Peasants’ landlessness and low compensation worsen their living condition. Social
unrest is appearing.
       In the present China land is not only a means of production but also a means (in fact,
the only means) of social security (Kung, 2002). This is especially the case at prevailing
levels of development, where the majority of peasants would still arguably assign greater
weight to the security-cum-insurance role provided by equal land access than to economic
efficiency, most notably investment certainty and other benefits accrued under a more private
ownership regime. At the same time, land also serves as a substitute for unemployment
insurance in the event a villager is dismissed from, or unable to find, off-farm employment.
To some extent the present land tenure system reflects much more preference for economic
security than economic efficiency.
       How about taking-resistant action of landless peasants? Activists whose lands were
expropriated in Banyan, in northeast Yunnan Province lodged petitions in Beijing and the
provincial capital, collecting a bulk of documents which included printed letters of formal
petition, personal denunciation letters against individual cadres, signatures of supporters,
photographs of government officials in action enforcing land expropriation, copies of land
expropriation notifications printed on the township government stationery, and detention
warrants issued by the township police to individual villagers (Guo, 2001).
       (2) Agricultural lands have been largely decreasing in recent years, which may affect
food security in China.
       Food security in China is bound to have a significant global implication. The central
government is anxious to ensure the success of its strategy for food self-reliance (Li and Sun,
1997). There are controversial arguments about food demand and supply in China for the next
30 years (Brown, 1995; Huang and Rozelle, 1995; Chen et al. ,1996). But many researchers
agree that arable land loss and land degradation are undermining China’s food production
capacity (Rozelle et al. ,1997). Considering the fact that primary farmland is mainly located in
those areas where the population and major economic activities have concentrated as well, the
land converted into other uses consists mainly of high-quality primary farmland.


                                               17
         In 1996 the total national arable land’s area was 1.951 billion mu (15mu=1hectare).
However, in 2003 it dropped to 1.851 billion mu. Arable land’s area per capita was 1.59 mu in
1996, and 1.43 mu in 2003. Table 1 shows the national arable land conversion since 19987.


         <Table 1>


         (3) Land markets are distorted.
         Peasants are deprived of equitable compensation for their land rights and provide land to
buyers or end users at a subsidized, less-than-market price. The result is also a corresponding
distortion of factor markets in the Chinese economy (Prosterman, 2004). Land as a factor of
production is then undervalued—in the most extreme cases, considered as virtually a free
input—with resulting distortions in investment decisions and the inappropriate allocation of
capital, as well as accompanying and frequent underutilization of the land acquired (Prosterman,
2004).
         (4) The present assignment of land property rights has caused government system-
endemic corruption (Yao, 2002).
         Low compensation paid to farmers for land takings in combination with the lack of
implementation transparency in the land takings process creates an opportunity for local
officials to pocket huge profit for their own, contributing to the widespread expansion of official
corruption (Prosterman, 2004).


5.4 Optional institutional arrangements to deal with problems resulted from land
expropriation


In the present institutional arrangements for land, both the collective (nominal owner of
agricultural land) and peasants (its actual users) do not possess agricultural land’s development
rights, but the state gets it through land expropriation. According to the preceding theoretical
analysis, we assume that transferable agricultural land’s development rights can be assigned to
peasants, and peasants are compensated according to market price in a perfect market. Keeping
bargaining power equal, a Pareto-efficient and equitable compensation can be achieved. So here
the key issue is how to assign transferable agricultural land’s development rights to peasants
under the presupposition that agricultural land conversion is inevitable due to urbanization and
industrialization. Theoretically, there are two main arguments about it: one is privatization of
agricultural land, the other is specify it to peasants within maintaining collective ownership8.


                                                18
        In the near future is it possible to privatization of agricultural land? The ruling answer is
no (Ho, 2001). First, under the ideological concept of a “socialist market economy with Chinese
characteristics”, the central government claims an alternative model of development that
ensures long-term economic growth without abandoning the principle of public land ownership.
Second, social stability and food security are very critical political objectives for central
government. If agricultural land is privatized, it may lead to more landless peasants and less
social stability. At the same time agricultural land conversion will be speeded up and the area of
arable land will decrease at a faster rate. Third, it will be inevitable to result in “holdout”
problems during the present large-scaled land development. The local government is afraid it
will reduce the economic development speed.
        So the most probable option in the near future may specify transferable agricultural
land’s development right to peasants maintaining collective ownership. However, it touches
upon the revision of the Constitution, Land Management Law and other related regulations. The
procedure is complex and legislative agreement is not easy to reach in a short time. In addition,
the strongest obstruction is from local government who benefits from the present land
institutional arrangement. Especially local government in western and middle regions will be
strongly against it because eastern and coastal regions have benefited a lot from land revenues
since 1980s.
        In sum, the central government is facing the difficulties of agricultural land’s property
rights arrangement.

5.5 An example for China: calculating approximation of optimal compensation

We suggest a practical approximation of the theoretical optimal compensation in China. Its
advantages are: (1) Income distribution from land increment value among peasants, developer
and local government will be efficient and equitable; (2)Appraisal prices are easy to implement,
which gives low transaction cost; (3) to reduce systematic speculation in those areas waiting for
development; (4) to reduce corruption related to land development; (5) to provide a temporary
solution to the central government’s dilemma of present land institutional arrangement.
        Now an example is given to calculate approximate optimal compensation.
        Assumption: in some location, agricultural land net rent for rice is 1260 $/ha•y 9 ,
commercial land ownership price under construction 80$/m², residential land ownership price
under construction 60 $/m², industrial land ownership price under construction 40 $/m², i equals
6%. It is assumed that 40% of the total land area (one hectare) is developed to commercial
(industrial or residential) use.


                                                 19
       The specific calculation process is illustrated in the appendix. Results are summarized as
follows (Table 2):


       <Table 2>


       Table 2 shows that for one-hectare agricultural land converted to 40-year commercial
use, approximate optimal compensation is 154948$. The value of transferable agricultural
land’s development right is 133948$. The local government can tax the developer at 46882$.
No matter which kind of usage agricultural land will be developed for, theoretical distribution
ratio of land increment value among peasants, developer and local government is 1: 0.65: 0.35.
       According to present compensation standard in 1998 revised Land Management Law,
the collective can get the compensation for land loss and resettlement subsidies [10*1920,
30*1920] $/ha, which is [19200, 57600] $/ha, no matter what kind of usage agricultural land
will be converted to. In fact peasants can only get its part depending on the collective’s
apportion. Concerning the state-owned land use rights price which developer pays the local
government after taking, basically there is no statistics for public data.
       Finally, we calculate the ratio of the present highest compensation standard by the law to
the lowest 50-year theoretical compensation for industrial use, which is 57600/86156=67%.


6 Concluding remarks

How much compensation is efficient and equitable for agricultural land conversion? Essentially
this question is oriented towards the distribution of land value increments among farmers, the
developer and the government, due to the difference in the market price of land before taking
and the market price of land after creating the opportunity for a new development. The reason is
that there are three main elements to contribute to incremental land value: farmers’ land
property transfer, developer’s investment, government’s planning decision and public
infrastructure. Concerning the compensation, this paper not only pays attention to the efficiency
point of view, but also to the reason of equity or income distribution effects.
       This paper has developed a method to analyse a compensation standard for state
expropriation. The basic idea is to get the highest price for willing developer to buy the land and
the lowest price for willing farmers to sell the land, through exploring the price development
mechanism of agricultural land conversion during the land taking process. Under a perfect
market the efficient and equitable compensation is obtained, keeping bargaining power equal.



                                                 20
After land transaction the government can tax part of the land increment value according to
specific circumstances. From the state-of-the-art view of land appraising, an approximation is
substituted for theoretical level of compensation.
       In present China, property rights of agricultural land are ill-specified and ambiguous.
There is no market price for agricultural land conversion. Therefore there is no perfect market
or equal bargaining power. The present compensation is inefficient or inequitable, compared to
the theoretical level of compensation. The difficulty of agricultural land’s property rights
arrangement in terms of agricultural land conversion is how to assign transferable agricultural
land’s development rights to peasants. The practical approximation of the theoretical level of
compensation provides a solution to a number of problems. According to the compensation
standard developed in this paper, an example for China shows peasants can get half of the land
value increments, developer 30 percent, local government 20 percent. This is mainly oriented
towards income distribution to the incompetent and poorest landless groups in the present China.
       Theoretically, this paper’s conclusion enriches property rights theory. The central thesis
of the property rights view is that the particular structure of the property rights in an economy
influences the allocation and utilization of economic resources in specific and predictable ways.
As a result, the value of traded assets depends on how the property rights over these goods are
defined (Furubotn and Pejovich, 1972). Property rights have a value and a function only if they
are specified, protected and enforceable. In this paper, we start with the hypothesis of well-
specified private land property rights, and reach an efficient and equitable compensation under
perfect market and equal bargaining power. However, an example for China is to directly utilize
theoretical optimal compensation (or its approximation) to obtain both efficiency and equity,
maintaining the ambiguous collective-owned property rights structure. Essentially, here
peasants have enjoyed the value of transferable agricultural land’s development rights although
this specific type of property right is not assigned to them by the law. This illustrates the value
or the price of traded assets is more essential than its nominal property rights structure. This
point has a significant policy implication. That is, the government can simultaneously use
policy combination of institutional arrangement of property rights structure and price
mechanism, to obtain specific policy objectives.
       In sum, for market economies, approximate appraisal price of the optimal compensation
developed in this paper provides an alternative solution with low transaction costs to the taking
problems of holdout and overinvestment. For market-developing countries, it can be used to
solve the problems such as low compensation, government rent-seeking and potential social
unrest etc., to obtain efficiency and equity.


                                                21
Appendix: Calculation process of approximate optimal compensation
                                      
                                                                     3               1

       According to Conclusion 2, APn1 APN is substituted for theoretical optimal price Pe
                                                                         2
considering policy preferences towards developer in China.
       Concerning developer, the ratio of land increment value to compensation price is:
                                                      
                                           3            1                    3             1              3                1

                ( AP3n1 - APn1 APN )/( APn1 APN )= AP3n1 AP1N <1
                                               2                                 2                 AP     n1
                                                                                                                  AP      N



       With reference to State Council’s ordinance on land increment value tax in 1993 (article
6, 7), developer for commercial use should be locally taxed
                               APN                                                          
                      3                1                                                       3               1
                AP    n1
                                           * 35%                                     if AP3n1 AP1N >50%
                              2                                                            AP   n1
                                                                                                         AP       N



                               APN                                                               
                      3                1                                                             3                 1
                AP    n1
                                           * 30%                                          if AP3n1 AP1N <50%
                              2                                                                AP    n1
                                                                                                             AP       N



       Concerning peasants, they can be exempted from taxation due to land loss (article 8).


       We use simplified capitalization formula,
                                   R
                          P                   for ownership price
                                   i

                                   R1  1
                                                                
                                                                
                              P                                    for n-year use rights price
                                   i 
                                        1 i             n   
                                                                

       Because agricultural land ownership is transferred due to land development, so
                                   1
                              AP =1260/6%=21000 $/ha
                                   N



       40-year commercial land use rights price/ha
                                          
                                           1
              APn1 = 1                    *80*104*0.4=0.9028*80*104*0.4=288896 $/ha
                  3

                          
                                  
                                   1 6% 
                                        40

                                                  
       70-year residential land use rights price/ha
                                          
                                           1       4                 4
              AP = 1                      *60*10 *0.4=0.9831*60*10 *0.4=235944 $/ha
                 3


                                  1  6% 
                 n1                                70
                          
                                          

       50-year industrial land use rights price/ha
                                          
                                           1       4                 4
              AP = 1                      *40*10 *0.4=0.9457*40*10 *0.4=151312 $/ha
                 3


                                  1  6% 
                 n1                                50
                          
                                          



                                                                                     22
For commercial development,
                 
                         3             1

        Pe = APn1 APN =(21000+288896)/2=154948 $/ha
                             2

                 
                         3             1

        Pd = APn1 APN =(288896-21000)/2=133948 $/ha
                             2
Commercial developer should be taxed locally
                
                     3             1

         T= APn1 APN * 35% =(288896-21000)/2*35%=46882 $/ha
                             2

                                                             
                                                        3             1

                                  because              AP
                                                        n1     AP =86% >50%
                                                                      N

                                                              AP
                                                        3             1
                                                       AP
                                                        n1            N



In this situation, the ratio of land increment value distribution is:
       peasants: developer : local government=
                  APN                               
            3                1             3       1              3           1
        AP  n1
                                 : APn1 APN *65%: APn1 APN *35%=1:0.65:0.35
                 2                             2                          2



Similarly, for residential development,
        Pe = (21000+235944)/2=138972 $/ha
        Pd = (235944-21000)/2=107472 $/ha
         T = (235944-21000)/2*35%=37615 $/ha
For industrial development,
        Pe = (21000+151312)/2=86156 $/ha
        Pd = (151312-21000)/2=65156 $/ha
        T = (151312-21000)/2*35%=22805 $/ha




                                                             23
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                                             24
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                                               25
            Table 1 Conversion of arable land in China          (1000 mu)
Year           1998         1999           2000          2001          2002          2003
Area           2643         3079           2449          2455          2947          3437


Source: http://www.chinado.cn/ReadNews.asp?NewsID=267




 Table 2 Approximate optimal compensation in China ($/ha)
                40-yearcommercial use       70-year residential use     50-year industrial use
       Pe                   154948                       138972                     86156
       Pd                   133948                       107472                     65156
       T                     46882                       37615                      22805
theoretical distribution ratio of land increment value
                                     peasants: developer: local government=1:0.65:0.35
Note: Pe —approximate optimal compensation; Pd —the value of transferable agricultural
land’s development right; T —local tax.




                                                26
Fig.1 The location of Village C


                                                                                                Country A


                              N-n1-n2
                                                                                                Township B

                             n1          n2                                                           Village C




 Fig.2 Agricultural land price development mechanism during the taking process


    First-round
    (n1 taken)
                              Planning                 Investment                        construction                          commercial
                     t   0    process          t   1   negotiation     t   2                                          t   3      use
                                                                                                                                                   ∞


                                                        1
                         1                     2                               3                                          4
                     P   N                 P   N                      P        n1                                    P    n1




                  Second-round    (n2 taken)
                                                                                                                                    
                                                        1-  1         Investment
                                                                                            t                construction
                                                                                                                                 t
                                                                                                                                          commercial
                                                                                                                                                       ∞
                                                                       negotiation              2                                    3      use


                                                                                    2
                                                                         3                      3                                    4
                                                                     P   N  n1            P    n2                              P    n2




                                                                     1-  2

                                                                                                3
                             Third round                                                    P       N  n1 n 2




                                                             27
Transferable after paying
land use rights price                                                                                             Rural construction land



                            Land use rights   Free of charge
                            granting          Or small land use fee
                                                                      Compensation                                                     ‘Appropriate’
 Non-transferable       (public entities:                             standard                                                         compensation
                        public interests)
                                                State-owned                                   Collective-owned    Collective
                                                urban land                                    rural land          withdrawal
                                                                      expropriation
                                                (State council/                        (Villagers’ cooperative:
                        Auction, tender or      Local government)                      Villagers’ committee)                                      Use right
                        negotiation
                                                                                                            HRS
                                              Land use
                                              rights price                                                        agricultural land
                                                                                                                   ( peasants’                    Right of benefit from use
                            Transferable                                                                          contracting and
  transferable              land use rights                                                                       operation rights)
                                                                                                                                                  Right of free production
                        (Developer:                                                                                                               and disposition of product
  rentable
                        commercial benefit)                             Study point
                                                                                                                                                  Transferable use right
                                                                                                                                                  within agriculture
  mortgagable


                                                                                                                                                  Right to receive the
                                                                                                                                                  corresponding compensation
                                                       Fig.3 Land ownership and tenure in China                                                   when sate expropriation or
                                                                                                                                                  collective withdrawal




                                                                                  28
Footnotes

1
    Fixtures are fixed capital goods connected with land, such as buildings, irrigation channels,
etc.

2
    In China agricultural land are collectively-owned.

3
    This is also called: ‘prevention of fiscal illusion’.

4
    The value of the development right is the present value of the additional rents accruing to the
land-owner when the parcel is developed in the future (Plantinga and Miller, 2001).

5
    A recent example might be farmers in Shengyou (Hebei) who won a trial against the provincial
government. They resisted land expropriation in favour of a power station. Here the developer
threatened the farmers (who felt undercompensated) with a strong-arms group of 100 persons (6
farmers were killed). A video of the action went to several media (Press bureau New China; 21
July, 2005)
6
     Available on http://www.pwgsc.gc.ca/appraisals/docs/pdf/chap_1c1.pdf:           The Uniform
Standards of Professional Appraisal Practice (USPAP) are the generally accepted standards for
professional appraisal practices in North America.

7
    Available on http://www.chinado.cn/ReadNews.asp?NewsID=267

8
    China Center for Economic Research, Peking University: international conference in 2004 on
institutional       reform      of      land     expropriation   in     China.     Available        on
http://www.ccer.edu.cn/cn/ReadNews.asp?NewsID=3061.

9
    Agricultural land is assumed to be used for rice production. Annual output 12000 kg/ha, with a
price of 0.16 $/kg, total output value 1920 $/ha•y .Economic costs are 660 $/ha, which include
fertilizer, seed and pesticides. Net rent is (1920-660)=1260$/ha•y. Labour cost is not
incorporated because it is considered as fixed cost of peasant households who often devote
nearly 75% of their working time to rice production.




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