Category Archives: Legal and Policy

Dead Capital in Latin America

Latin American De



ILD Research indicates: Fully 65.0% of houses also exist outside of the formal market, lacking access to full legal title or other legal descriptions that enable housing to serve as a store of value and the basis of accumulating family wealth.

91.7% of enterprises are outside of the formal economy, lacking access to the legal protections and instruments that enable enterprises to productively use all of their assets.

The bad bureaucracy ratio is the amount of dead capital relative to per capita GDP.  Dead capital represents wealth that could be in the hands of citizens but isn’t due to poor policies and procedures.  Redesigning policies and procedures, the software of governance is one of the cheapest and easiest way to help people lift themselves out of poverty.

Map and data above are available upon request.  Source material ILD document and CLC Latin American Dead Capital spreadsheet

Defining the Issue of Dead Capital

“Dead Capital” is capital in the form of unregistered real property, and is considered lost value because the landholder is unable to transfer or leverage his property for capital or capital access.  For instance, homes that are unregistered and extra-legal receive little or no infrastructure, are valued less, receive less investment and represent potentially areas of vulnerability for those who dwell in them. Globally, the estimated value of unregistered, yet inhabited property is $9.3 trillion in value held by primarily poor people.

The issue of “dead capital” is one that is particularly interesting because it has been treated as a human rights policy issue for a long time, as a “right” to housing for example, under the economic, social and cultural rights framework of international treaties like the ICESCR (International Covenant on Social, Economic, and Cultural Rights). However, in exploring the topic in greater detail, it is questionable whether “rights” frameworks are in fact that most effective way to ameliorate the problem. For instance, what happens when a justiciable “right” has weak (or no) enforcement mechanisms at a governance level? It is interesting to ponder why there hasn’t been a greater shift in the human rights world toward an economic development-oriented / market-based approach that would create value out of “dead capital.”

The causes of dead capital are complex and culturally unique, yet there are several overarching themes that extend across regions. Generally, as explained by economist Hernando de Soto, 4 billion people in the world actually live outside of the formal legal system and formal economy. These people run businesses that are extralegal in nature, belong to a host of informal economic and social relationships, and live on land that has not been registered. This land may be lacking title completely, be squatter-settled privately owned land (though the title holder may have been absent from the land for many years) or may be technically public land. One problem common to formalizing private and publicly owned squatter land is that governments prefer the ambiguous legal standing of the land, as they may evict tenants arbitrarily and opportunistically. (This is particularly problematic in the context of mega events or private investment).

Urban slums have grown exponentially in recent years, largely as a result of FDI entering developing world economies. With the lure of jobs to cities through the boom in overseas manufacturing and the global corporatization of traditionally rural, agricultural areas, the flow of people to urban slums has grown. At the same time, many of the smallholder farmers remaining in rural areas are left with ambiguous land status, and are extremely vulnerable to displacement by global agribusiness firms.  Many of these developing countries are plagued with poor and inefficient governance that has failed to evolve alongside marketplace actors. (For instance, when the United States’ property law system evolved, the new government rather quickly adopted the informal land practices that developed among settler-squatters, paving the way for a robust feedback system between market participants and the government).

Additionally, these same governments often suffer from a lack of institutional capacity to reform the system. The time, money, and process required to survey, map and record densely populated plots of land is resource-intensive and the economic incentives for doing so are not immediately apparent.

The benefits of land formalization are dramatic. With formal title, residents are more likely to improve their own land, and invest in local businesses and communities. In urban areas, formal land ownership can result in increased community infrastructure, such as sewage lines, street lights, and paved roads. In both urban and rural areas, titled land means better food security, as local farms can continue to thrive and feed local economies without being ejected by a bad government policy or a foreign investor (Note: these things still happen, in contravention to the law, of course, but formal title ownership serves as an additional layer of protection for small farmers).

Perhaps the most exciting benefit are those that are secondary in nature. With title, people can sell their homes and relocate for opportunity elsewhere. They can leverage their property for security to invest in a business or pay for a child to go to school. Additionally, formalization leads to an increase in collateral service industries, including home surveying, mortgaging and home construction. As security grows, long-arm market trust can grow—a crucial ingredient for long-term economic development. Finally, with greater market trust, and the availability of security, comes a more welcoming investment climate for foreign and medium sized enterprises.

The single most important factor in addressing dead capital is one of education for stakeholders and international policy influencers. As described, dead capital is complex, varies greatly with regional and cultural variations and is “unsexy” in nature because it is a largely a problem of bureaucratic and legal process and procedure. (It is also a heavily political issue, which is another reason why education and awareness is so important). As western policy makers, the issue is particular difficult to grasp, because the property system has been so reliant on extralegal relationships. These community-based relationships have developed to provide access to capital, provide protection and security around extralegal business arrangements, and facilitate transactions. While these relationships are important sources of stability in an otherwise uncertain business climate, they often impede market efficiency by skewing the value (sometimes arbitrarily) of services being delivered. Although the ultimate goal in improving the land registration system is to streamline process and procedure, these networks must be taken into account and integrated into the legal system (this is exactly what happened in the US example).

Streamlining process will also lead to much needed transparency and government accountability. By creating digital land records repositories (read about the Andhra Pradesh example), human error is eliminated, the time spent doing title searches and manual registrations is minimized, and any middle man or government official who could charge a bribe to perform the registration is cut out of the picture. The digitizing process (i.e., digital fee assessments with built in assessment algorithms) also cut out the opportunity for selective value assessment. Finally, records may be accessed in local languages.

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At Live Capital,  our first project is to prepare a submission for the Center for Urban Pedagogy’s “Making Public Policy” poster project.  The poster would be a visualization of the problem of dead capital globally, societal implications of the problem, and possible solutions. I am very excited about the opportunity to mash up a very traditional policy and legal issue with design and a design thinking perspective. Please feel free to share any thought, opinions or ideas with us / me about dead capital or another policy issue that would benefit from a design perspective.

The 2010 International Property Rights Index. A gripping read :)

Property rights and the rule of law are an economy’s soft infrastructure, they are measures of development and civility.  The IPRI is set up a bit like Transparency International with a normalized 0-10 ranking for property rights in various countries.  As with all normalized and arguable qualitatively derived data sets, your opinions of veracity may vary, but hey what a great conversation starter about the vital nature of soft infrastructure.

From the report: “The IPRI is an annual study that compares countries in terms of their protection of property rights – both physical and intellectual.

Like previous editions of the IPRI, the 2010 report seeks to investigate the effects of a country’s strong legal and political environment, recognition, and enforcement of physical and intellectual property rights on the economic development of a country. This year’s report compares 125 economies using these three variables as core components and ranks them accordingly.”

“If history could teach us anything, it would be that private property is inextricably linked with civilization.”

—Ludwig Von Mises

International Property Rights Index 2010

Take a look at the International Property Rights Index Site.  We think it is quite cool.

World Bank: Protecting Land Rights

Using investments to strengthen rural land rights for small holder farmers is possible, the World Bank reports in this video. The video explains that property dwellers / owners with weak covenants to the land are the most likely to be targeted by investments, as are lands that have a high rate of cultivation.  Developing governments must be active players in working with investors to help small land holders to increase the sustainability (environmental and community) of land acquisition projects. The accessibility of information (i.e., making investment agreements and other contracts public) will be an integral ingredient in ensuring fairness in land transactions moving forward.

Streamlining Process and Procedure for Economic Development

In the area of human rights, the problem of violations usually isn’t about inadequacy of current laws.  Many developing countries with relatively new constitutions have laws that are even more protective of our own in the US, but they are not enforced. This can happen for a number of reasons, whether lack of institutional / agency capacity, political forces, corruption, etc.

In other fields that touch upon non-constitutional / basic “rights” issues, regulatory structures and laws conducive to economic development simply are not in place. In a McKinsey study cited by C.K. Prahalad, the cost of microregulations in the areas of import-export, labor laws, and transactions involving land can be as high as 2 to 3% of GDP growth. “Microregulations” are not the laws themselves, but are the often arbitrary bureaucratic interpretation of the laws and how they should be implemented. “Arbitrary” is a signal for unfairness. In the U.S., it invokes an Equal Protection question of unequal application of a law, and in the developing world, arbitrariness often is a precursor to corruption. Additionally, as Prahalad explains, “The consequence of proliferation of microregulations can be the same as not having laws in the first place. An informal sector emerges outside of the law of the land. The private-sector businesses remain small and local. For large firms, corruption becomes the cost of doing business.”

In discussing the importance of building transaction governance capacity (TGC), Prahalad outlines four essential criteria in eliminating systemic arbitrariness. (Government capacity is essential for legal economies to function):

  1. Access to information and transparency for all transactions
  2. Clear process so that selective interpretation by bureaucrats is reduced, if not eliminated
  3. Speed with which the processes can be completed by citizens
  4. Trust in the system (with its faults). Trust is a result of the first three criteria, and is a crucial component of TGC. (See my other writing on the importance of trust)

One exciting project in the Andhra Pradesh region of India integrated these principles in creating an e-Government system around property rights.  As government records, and processes were brought online, the property registration system (the same laws remained on the books) was dramatically streamlined. Again, Prahalad chronicles the key changes:

  1. All the steps that are required are now transparent and easy to access. The sequence of steps to be followed is also clear. All interdependent steps are completed automatically.
  2. In the old system, the officials calculated the value of the land and the associated fees for registration. There were opportunities for selective vale assessment. Now the entire process of calculation is automated with market value assessment algorithms built in. The documents are scanned and stored digitally, reducing the opportunities for them to be lost or displaced.
  3. The entire process of registration of land now takes one hour (from initiation to completion), compared to 7 to 15 days in the old system. Title searches over the past 20 years from 50 different offices can be done in 15 minutes versus 3 days. Certified copies of documents can be obtained in 30 minutes against the three days of the conventional system.

The key question this example brings to mind is what are the mechanisms that can be scaled to other regions? How can we share these best practices and figure out what project aspects can be applied to different areas were land formalization procedures can literally take years?

 

Why Governments and Legal Systems Matter

 

Whether clean water distribution and deliveryinfrastructure development in local communities, or educational programs to teach kids the virtues of hand washing, private endeavors often have innovative, agile business-oriented strategies that are conducive to quick and efficient implementation.

Taking a dynamist, often anti-government perspective to social change, author Virginia Postrel offers an interesting discussion of the role of trust in the evolution of modern societies. In the context of contract creation, Postrel explains, “a dynamic society, then depends not only on preserving fluidity, but on permitting permanence. To learn, we must experiment. But to experiment, we must commit ourselves. And we must find ways to cooperate with others, to extend trust.” By creating clear and predictable rules that are enforceable – i.e., through a legal system – people can take those risks to experiment and innovate.

Postrel (to my great pleasure) calls on the work of economist Hernando de Soto in speaking of the “virtual frontiers” of the third world. While “bad” legal systems often create impediments to business success (In Lima, creation of a small garment factory required 289 days, 11 permits and $1,231 – 32 times the monthly living wage), they are still necessary to create trust between strangers transacting at arms-length. Non-registered business owners will experience a limit on growth with the inability to enforce contracts, as many of them rely on family ties. Homeowners lacking title cannot sell their land, will be hesitant to make improvements, and cannot mortgage it to secure financing for a business.

In a 1989 publication of “What’s Wrong with Latin American Economies,” in Reason magazine (cited by Postrel), de Soto gives an illustrative example of the problem with informal economies in the context of two friends looking to start a button factory:

My friend goes very happily to his home and sees his wife. She says, “now wait a second. Think it over. This fellow, De Soto, you barely know him. This fellow, De Soto, after a year, will know who your clients are, whom to sell to, when to sell, and how to sell them. After a year, he won’t need you…”

As a result, my friend will choose instead to associate with a relative—someone in his extended family. And that person won’t produce buttons as good as mine. So they will have a little company that isn’t going to be very prosperous. I’ll have to do the same. I’ll have to find someone to sell buttons who trusts me because he happens to be family of mine. But he just doesn’t sell buttons the way my friend sells buttons. And, therefore, the two talents that were required to make a successful industry in Lima will not be able to merge. Then some anthropologists from Cornell University will come to Peru and say, “Look at Peruvians. They like to work in small family units.”

De Soto’s story demonstrates that without functioning governments, market efficiencies fail, because people will not contract outside of their trusted social networks. They do not have incentives to improve their land or create new economic opportunity because legal structures that offer protection are often ill-functioning or lacking entirely. While governments may be slow and cumbersome at times, they are an essential building block to sustainable economic development. By strengthening structures that respect property rights, private contracts and individual rights, private parties will be given a greater opportunity to thrive in the developing world.