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Published: June 1, 2004

 
 

The Philosopher of Progress and Prosperity

Economic Formalization
Mr. de Soto and his associates at the ILD use the term “formalization” to refer to the conversion of economies from those in which shadow economies and inconsistent property rights predominate to those in which the legalities of home and business ownership are mostly clear, welcoming, and equally accessible to everyone. (See “Building a Bridge to the Formal Economy,” below.) In “formalized” economies, like those of North America and Western Europe, consistent and accessible property title systems and credit records are commonplace. This makes possible a lending and market infrastructure in which anyone can transfer property or start new enterprises with relative ease — giving people who would otherwise be stuck in the underground economy a chance at participating in the legitimate economic system and at elevating their living standard.

Building a Bridge to the Formal Economy

Moving a country from a feudal economy to the rule of law doesn’t happen overnight. It took 300 years in Britain and about 100 in the United States. Hernando de Soto believes that a concerted initiative could do the job in as little as five years in the modern developing nation. He portrays the work of formalizing an informal economy as a process of building a bridge in five stages — and over many years — from a dispersed extralegal economy filled with dead capital to a formal economy governed by the rule of law and reliable information on market characteristics and property status.

• Stage 1: Awareness. The ILD typically comes into a country at the invitation of a head of state or cabinet minister. ILD staff study the culture of the particular country they are working in, its history of property rights, and its leadership. Then they create a customized presentation explaining to the leadership how bringing informal economic activity and assets into the formal sector will resolve fundamental political and economic problems. The goal is to have high-level government support and sponsorship for their work in the reform and development process.

• Stage 2: Diagnosis. This involves detailed field research observing activity in the informal sector, and a diagnosis of property, settlement patterns, and livelihoods of the poor. How long, for example, does it take to start a bakery or a sewing shop? Where do the squatters in a city live, and how many are there? What drives people away from the formal economy?

• Stage 3: Designing Reform. Once the analysis and diagnosis is complete, the next step is putting new laws into place. In Peru, legal reforms included not just streamlining procedures (the cost of registering a title went from $2,000 to $45), but also instituting a public ombudsman and such good-government measures as transparency laws and a new system of conflict resolution. Instead of superseding the informal property-ownership documents that local communities develop for themselves, lawyers study them and codify them into formal, consistent arrangements.

• Stage 4: Implementation. Teams of researchers move into neighborhoods to interview residents, identify the most appropriate owners, delineate property rights, and issue titles. Development professionals sometimes see this stage as a typical “land-titling” exercise based on installing information technology systems, but it more closely resembles anthropological fieldwork. Community meetings are an important part of this step: As COFOPRI administrator Miguel Delgado notes, the critical test of the process occurs not when the title to a house is granted, but when the house is sold 10 years later — and the seller has been taught how to register that sale with the appropriate government office.

• Stage 5: Capital Formation and Good Governance. Not until this stage do banks, utilities, development agencies, and other organizations have a reliable platform to operate upon — to lend money, offer electricity and water, form partnerships with local residents, and ultimately create jobs. The fostering of vibrant stock markets, in which all citizens can invest, is part of this stage.

—A.K.

 
 
 
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Resources

  1. C.K. Prahalad and Stuart L. Hart, “The Fortune at the Bottom of the Pyramid,” s+b, First Quarter 2002; Click here.
  2. Hernando de Soto, The Mystery of Capital: Why Capitalism Triumphs in the West and Fails Everywhere Else (Basic Books, 2000)
  3. Hernando de Soto, The Other Path: The Economic Answer to Terrorism (Second ed., Basic Books, 1989)
  4. Francis Fukuyama, Trust: The Social Virtues and the Creation of Prosperity (Free Press, 1995).
  5. C.K. Prahalad, The Fortune at the Bottom of the Pyramid: Eradicating Poverty Through Profits (Wharton School Publishing, 2004)
  6. The World Bank, Doing Business in 2004: Understanding Regulation (Oxford University Press/World Bank, 2003), Click here.
  7. Erica Field, “Entitled to Work: Urban Property Rights and Labor Supply in Peru” (July 2003); Click here.
  8. Erica Field, “Property Rights, Community Public Goods and Household Time Allocation in Urban Squatter Communities” (September 2003); Click here.
  9. Erica Field with Maximo Torero, “Do Property Titles Increase Credit Access Among the Urban Poor? Evidence from a Nationwide Titling Program” (January 2004); Click here. 
  10. Center for International Private Enterprise: Click here. 
  11. Center for Sustainable Enterprise, University of North Carolina: Click here. 
  12. Institute for Liberty and Democracy: Click here.