May 26, 2004


Posted by shonk at 03:48 AM in Economics | TrackBack

Good news in Nairobi’s slums:

Last year, a group of Nairobi slum dwellers banded together and asked the city council to give them the land that they had been squatting on illegally. In return, they promised to build proper houses, schools, and community centers without any government money.

“We went to the council and said: ‘We know this land belongs to you, but we have lived here for 30 years and if you help us, we will make it a clean environment with good security,” says Peter Chege, secretary of the housing association. “In the end, they agreed to draw up title deeds to the land in our name.”

Not surprisingly (at least for those who have read Hernando de Soto’s The Other Path), things are looking up for the slum-dwellers in Nairobi, where plots are being marked out and three-story cement houses are rising from the cardboard wasteland. As pointed out in the article, the primary impetus for these new developments in Nairobi is Slum Dwellers International, “an Indian pressure group that encourages people living in slums to find their own solutions to housing problems”, but their inspiration almost certainly comes, at least in part, from de Soto’s seminal work, which was the first to effectively demonstrate that the primary impediments to wealth-creation in the third world are state restrictions on the acquisition and protection of property.

The Other Path is basically a detailed study of poverty in Peru which argues that this poverty is largely a result of the fact that government policy effectively prevents the majority of urban Peruvians from owning land or running legitimate businesses. As in Nairobi, a huge number of Peruvians (at least at the time of the book’s publication — the new government that came into power at about the same time has done much to reverse these situations) squatted on state-owned land, where they had constructed and maintained dwellings of varying quality, but the fact that the state refused to recognize title to this “property” meant that capital improvements were extremely minimal (this refusal wasn’t completely outright, as groups which had sought title to the land they occupied were occasionally granted it, but the average amount of time this process took was on the order of 7 years). Similar restrictions on entry into the retail and transportation market (to take the other two primary examples from the book) made it such that the majority of both retail and public transport was being conducted by black-market businesses which, since they were technically illegal, were not able to expand beyond very small operations and thus were denied the possibility of taking advantage of economies of scale. Or, as de Soto puts it:

Secure property rights, on the other hand, encourage holders to invest in their property because of their certainty that the property will not be usurped. From a strictly economic standpoint, therefore, the true purpose of property rights is not to benefit the individuals or entities holding those rights, but to give them the incentive to increase the value of their assets by investing, innovating, or combining them advantageously with other resources, something which would have beneficial results for society. (The Other Path, pp. 159-60)

De Soto concludes that the best thing Peru (and, by extension, other similar countries) could do to reduce poverty would be to liberalize economic regulations, making it easier for the poor to own the land they live on and operate their businesses without fear of police raids. This as opposed to, say, building more state-funded low-income housing (which was inevitably of poorer quality than even the squatter’s settlements). Based on the article, it seems that there are a number of parallels between today’s Kenya and the Peru de Soto describes (circa 1986) and it seems that precisely the sort of liberalized land policy de Soto advocates is working for Nairobi as well.

On the subject of de Soto, I wrote a response to someone who wanted to know if de Soto’s work implies that government recognition of property rights is a prerequisite of free-market wealth-creation. Since it provides a sort of general summary of The Other Path as well as a suggestion that de Soto’s work actually indicates that government isn’t strictly necessary (even though de Soto himself probably wouldn’t agree), I reproduce that response here (actually, before we get to that, let me just briefly mention that the complete title of the book is actually The Other Path: The Economic Answer to Terrorism; it might be interesting to think about de Soto’s arguments within the context of the terrorism problems we’re currently experiencing, both generally and specifically as those arguments might apply to the development of Iraq):

I don’t think DeSoto is arguing that capitalism can only flourish in the presence of property taxes, nor that government is necessarily required to enforce property rights (well, he would say it is, but applying his logic consistently doesn’t, in my opinion, yield that conclusion). Rather, he argues that the people of Peru and other third world countries want to be entrepreneurs, but the State actively prohibits them from doing so. For example, when the book was written, it took something on the order of 8 months and several thousands of dollars (this in a country where the average per capita income is in the neighborhood of $2000) to get a small business legally recognized. Researchers at the ILD (Instituto Libertad y Democracia) actually tried to set up such a business, approaching it as a small businessman would, paying bribes only when necessary, fulfilling all the legal requirements, etc. Similarly, acquiring title to previously unowned land took something on the order of seven years. As a result of the extremely high cost of achieving legal recognition, most business owners and land “owners” simply choose to operate in what DeSoto calls the “informal” sector. Most end up being street vendors, bus drivers (for informal bus companies), etc. and living in informal settlements which are, nonetheless, better than the publicly funded low-income housing. Given the uncertain nature of their continued existence, businesses and homeowners have developed elaborate solutions to the problems of titles, property rights, dispute resolution, and the like. In fact, these are excellent examples of so-called “private law” in effect. DeSoto himself even praises the ingenuity of these solutions, but notes their shortcomings: since they are still technically illegal, there’s a high degree of uncertainty involved in entrusting your livelihood or your home to these schemes. As such, informals have far less incentive than regular businessmen/homeowners to invest in capital improvements, and the opportunity for taking advantage of economies of scale is virtually non-existant.

Nonetheless, modern, concrete-and-glass buildings have been constructed illegally at a rate of seven times those constructed legally in Peru’s capital, Lima. The overwhelming majority of low-income housing is constructed illegally; in some cases the state eventually recognizes title in a way reminiscent of how California ended up dealing with Gold Rush claims, but many informal settlements remain technically illegal even 20 or 30 years after their initial settlement. About 95% of Lima’s “public” transportation is provided by informal bus/taxi systems, and a majority of retail is also informal. These statistics, along with a detailed description of specifically how the informal retail, housing and transportation markets work are used by DeSoto to demonstrate that the people of Peru want to be entrepreneurs and property-owners, that they aren’t simply lazy and/or Marxist types that want to live off welfare. However, the enormous legal restrictions that exist to entering these markets are daunting enough to prevent most from “going legal”, entailing the problems detailed above.

So what’s the big deal about “going legal”? Why would the Peruvian economy be so much better off if all these businesses were recognized by the government? Well, quite simply, because the government is the only game in town. The “private law” solutions developed by the informals do well amongst themselves (for example, street vendors tend to have “rights” to their particular patch of sidewalk, which are respected and defended by their neighbors), but outside of the informal realm, they don’t work so well, since the state still, ultimately, holds a monopoly on the legitimate use of force. If a “legitimate” businessman wants some competition shut down, he need only use his political connections to make it so (in fact, as a side note, DeSoto found that political connections, even for informals, are generally more important than almost any other factor in determining success). Similarly, informal landowners run the risk that government will grant title to the land beneath their feet to someone else with better political connections. Also, if an informal wants to shoot (actually, I’m not sure guns are legal in Peru, but that’s another issue) a burglar on his property, he can be prosecuted for murder, since the State doesn’t recognize his property rights and thus he can’t use defense of his property as a defense. The importance in getting recognized by the state is, ultimately, not to protect yourself from other private individuals (as mentioned above, the “private law” arrangements in place between informals tend to do well within that group), but rather to protect yourself from the state.