such projects are widely known well before they get underway, implies that, contrary to private developers, the public sector will not be able to acquire land quietly and thus be subject to a holdout problem whereby individual land owners refuse to part with their land, except at highly exaggerated prices (Miceli and Segerson 2000). To prevent this from undermining or delaying projects, virtually all countries allow land to be acquired compulsorily through eminent domain ‘for public purpose’ and with ‘fair’ compensation, two requirements that have been widely debated in the literature.

Although legal scholars differ on how narrowly to define the ‘public purpose’ requirement (Harrington 2002), the dangers posed by an excessively wide interpretation in terms of creating incentives for corruption by private investors trying to influence processes to their own advantage, are well recognized in the literature (Kelly 2006). The prevailing legal opinion is thus that expropriation under eminent domain needs to be limited to specific and well-defined projects and that the possibility for those affected to appeal to the judiciary is essential to prevent abuse of state powers by the bureaucracy.

It is well known that, in an economy with an impartial state and well-developed capital and insurance markets, requiring the state to fully compensate land and any improvements that are taken may convey perverse incentives for owners to invest beyond the socially optimal level (Blume _et al._ 1984, Kaplow 1986).<sup>4</sup> However, such conditions rarely hold even in developed countries and are especially rare in developing ones where widespread market and informational imperfections are combined with a large potential for rent seeking and abuse of state power. Together with the fact that other mechanisms, e.g. use of tax records or previous valuations can help limit or eliminate such outcomes (Shavell 2003), this has led to a consensus that requiring payment of compensation will help prevent the state -or the bureaucrats representing it- from abusing the powers of land acquisition beyond the socially optimal level merely for individual gain (Farber 1992, Shavell 2003, Giammarino and Nosal 2005).

# **2.2 Application to China’s land tenure system**

Although private use rights to rural land have become well established and a market for exchanging them has emerged, rapidly increasing demand for conversion of land from agricultural to non-agricultural uses, e.g. for infrastructure or industrial developments, poses challenges to property rights security. While property rights to urban land are relatively secure<sup>5</sup> and a market for rural use rights has also evolved, the scope for conversion threatens to undermine rights to rural land that continue to be of critical importance

> 4 A well-known theoretical argument is that the scope of receiving compensation for land plus associated investments at market values may induce individuals to invest beyond the socially optimal level. If the deadweight loss from tax collection is high or if administrative and transaction costs incurred by the public sector are significantly above those by private agents but individuals have perfect foresight and can operate in well-functioning markets, this could be avoided by privately run insurance against land takings (Calandrillo 2003).

> 5 In urban areas, land could either be allocated by the state or long term leases be acquired by private users upon payment of a conveyancing fee. Such acquisition provided considerable advantages by giving owners the ability to participate in the secondary market, use the land as mortgage, and rent it to others. It has led to a rapidly growing land market: Between 1993 and 1998 the amount transacted annually increased from about 11,000 to almost 1.1 million ha and the amount of land mortgaged rose from about 1,000 to 884,000 ha (Ho and Lin 2003).

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