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strategy and business
 / Summer 2004 / Issue 35(originally published by Booz & Company)


The Philosopher of Progress and Prosperity

Economic formalization includes legal and political reforms — eliminating the hurdles that most governments unwittingly place before their citizens who wish to register property or start businesses. For example, a recent Cost of Doing Business survey conducted by the World Bank found that starting a business in Angola requires $5,531 (which is more than eight times the per capita income of that country). In New Zealand, it costs $28, or far less than 1 percent of the per capita income.

Successful formalization also requires significant cultural changes, including the fostering of a new trust in official systems among people who have lived for so long on the outside. Thus, the Peruvian formalization process, more or less overseen by Mr. de Soto and his colleagues at the ILD, took about 10 years. Though it was never quite completed, the ILD work transformed the country and made Mr. de Soto a national hero. Along the way, he also became a highly sought after advisor to governments in other developing countries and something of a political celebrity. In 2004, the ILD was one of seven think tanks that won the first annual Templeton Freedom Prize, funded by philanthropist John Templeton.

During the next two years, Mr. de Soto will see his theories undergo an unprecedented test, funded in part by the United States Agency for International Development. USAID, which got its start administering the Marshall Plan and was a primary conduit for development grants during the Cold War, is granting $25 million in seed money to ILD in 2004. This is a huge funding commitment for the agency, which has formerly granted ILD an average of about $1 million per year since 1986. Mr. de Soto and his colleagues, who have been invited into 30 countries by their political leaders — including Russia, Ghana, Guatemala, the Philippines, Mexico, Georgia, Kazakhstan, Madagascar, Mongolia, Thailand, Ethiopia, Nigeria, Tanzania, and (as of February 2004) Pakistan — will now be equipped to launch a coordinated training and formalization effort in all of these countries. If this major initiative succeeds, it could jump-start the emergence of a prosperous middle class on every continent.

That, in turn, could transform the environment for global businesses, both large and small. Although ILD has not successfully involved any private-sector companies in its work in the past (in part because of long-standing mistrust between many corporate and government leaders in the developing world), Mr. de Soto points out that multinational corporations are typically among the most direct beneficiaries of his work. Indeed, the formalization of developing country economies may well be the missing link that paves the way for multinational corporations in many industries to enter or expand in these countries, not in their stereotypical role as exploiters of cheap labor and extractors of raw materials, but as seekers of customers, talent, and capital.

“Trillions of dollars of dead capital are locked up in the developing world,” says Peter Schaefer, ILD senior fellow and head of its branch office in Washington, D.C. “If it were liberated, it could be used to consume and invest.”

One of the reasons Mr. de Soto’s theory is resonating with international development experts is that it represents an alternative to the Marxist conception of poor people as victims of the wealthy. “Instead of seeing the developing world as victims of capitalism, Hernando argues, ‘We’re inflicting our own wounds,’” says Andrew Natsios, administrator of USAID. “Since he is Peruvian, he can make this argument credibly.”

At the same time, business and policy elites (in both developing and industrialized nations) appear to be recognizing the limits of the world’s entrenched dependency on aid from governments and nonprofits, and the value of private-sector efforts to generate wealth in developing countries. In March 2004, the U.N. Commission on the Private Sector and Development (of which Mr. de Soto is a member) issued a report to the secretary-general calling for new approaches to “unleashing” the potential of the domestic private sector and entrepreneurship in developing countries. The report notes three facts of economic life: First, domestic private investment in developing countries averaged 10 to 12 percent of their GDP in the 1990s, which is almost twice as much as government funding and much more than the foreign direct investment (FDI). Second, the informal sector asset base, such as land value, is far larger in value than either cumulative FDI or private portfolio flows. Third, property rights and entrepreneurial momentum have been highly visible components of every stable, sustained economic development success.

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  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.
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