Mahoshada

“Our resolve, and the aspirations of all those who are struggling to convert the assets they hold into valuable properties, must not be left in doubt.” Benjamin William Nkapa, former President of the United Republic of Tanzania

Eliminating poverty remains a central economic goal for the country. While Sri Lanka may not be burdened with the extent of extreme poverty that is the case in some countries, it is generally agreed that the number of people that continue to be stuck in poverty remains far larger than it ought to be. And there is particular concern about the relatively higher levels of poverty that persist in the rural areas of the country.

While the politics of fighting poverty have become increasingly important in the international community, it has become an even more potent force in domestic politics. During the last general election the current government certainly worked very hard to convince voters that it would be better placed to focus on the needs of the poor. And this is no doubt why the current government seeks to advertise much of what it talks about doing on the economic front as contributing to its goal of achieving increased rates of “pro-poor growth”. However, since 2004 it has mostly been talk with little or no substantial economic reform actually taking place.

Getting to the Root Causes of Poverty
It does not take an expert to recognize that the only way to make substantial headway in reducing poverty will require getting to the root of the problem. And in recent years, thanks to the pioneering work of the Peruvian economist, Hernando de Soto, economists and policy makers have become aware that one of the core problems leading to persistent poverty has been the inability of the poor to make use of the assets they already have in hand. Mr de Soto is the founder of the Institute for Liberty and Democracy (ILD) in Lima, Peru and has authored two internationally influential books, The Other Path and The Mystery of Capital.

The central focus of Mr de Soto’s work has been to point out the fundamental importance of ensuring adequate protection of property rights through a reliable and accessible legal system. He argues convincingly that it is the poor in developing countries that suffer the most when the laws and institutions meant to protect property rights fail. (In this context the property rights we are most concerned with are those that relate to assets that may be held by the poor, including many small businesses, particularly land and houses, but also assets such as inventories and machinery and equipment.)

One of the sharpest differences in way economies work between the wealthy developed world and the much poorer developing countries is the ease with which business transactions can take place. In the developed countries, business transactions are made possible by accepted and enforceable rules governing legally defined property. For example, in these countries it is not uncommon for the entrepreneurs starting small businesses to borrow needed capital using their personal property as collateral. In developing countries there are typically significant difficulties in these sorts of transactions related to hurdles in establishing clear title to land and other assets and inefficiency in the legal system. For the poor, these hurdles may well be impossible to overcome.

More generally, de Soto and his ILD colleagues point out that “unlike assets in Western nations, real estate and equipment in the developing and former Soviet world act only as physical shelter or tools; they cannot be leveraged to produce additional wealth.” In other words, they cannot be readily used as collateral. De Soto terms assets that cannot be effectively utilized economically as “dead capital”.

What was surprising to many economists and policy makers concerned with poverty alleviation was the extent of “dead capital” held mainly by the poor in developing countries. It has been estimated that the total real value of this “dead capital” amounts to $9.3 trillion globally. This is nearly equal to the gross national product of the US (about $11.5 trillion in 2005). This is also far more than the value of all donor assistance provided to developing countries.

In other words, de Soto suggests that developing countries already have the assets they need to eliminate poverty in their hands. The obvious question is, If this is the case, why are these assets “dead” and not being used to help stimulate economic growth and generate employment?

The Legal System and the Informal Sector
A key part of the puzzle is the legal system, more specifically the legal property system, which de Soto has described as the “hidden architecture” of a successful economy. This effectively determines whether individual entrepreneurs and national economies have any chance of success.

What happens when this hidden economic architecture is not in place? The answer is all around us. It is not that economic activity does not take place. It is that it takes place outside of the legal system or in what economists call the informal sector. It is likely that a great many of the commercial activities that you come into contact on a daily basis fall into the informal sector, including cafés, boutiques, three wheeler operators and mini-bus services.

It has been estimated that the informal sector in Sri Lanka comprises about one-third of all economic activity. (Friedrich Schneider, for example, estimated that the informal sector equaled 47.2 percent of reported GDP in 2003.) This suggests that Sri Lanka has proportionally one of the highest informal sectors in Asia.

One of the defining characteristics of the informal sector is that these activities take place largely outside of the protection of the legal system. As a result, informal businesses are unable to make fully effective use of the assets that they may have available, and they are constrained in the types of transactions they can enter into. As a result, these entrepreneurs and their employees are denied the opportunity to participate in and benefit from economic activity. They are locked out of the system in their own countries and in the global marketplace.

One essential step towards the elimination of poverty is therefore the development and strengthening of the legal system, especially as it related to the recognition and protection of property rights for assets that are widely held by the poor. The system must also be made more accessible to the poor. This means that it must not be costly to seek legal determination of disputes and that it must be done in a timely way without corruption. From houses with no title to unincorporated businesses, the absence of legal representation means that the property of the poor cannot be protected or leveraged to create opportunities and growth.

Mr de Soto and the ILD have worked in many countries to address these fundamental economic problems. In his country of Peru, this work led to the legalization of an estimated 300,000 enterprises that previously operated off the books. This led to an estimated 560,000 workers moving from the underground economy to the legal economy and generated some $300 million a year in new tax revenues. Not surprisingly, this increase in tax revenues has caught the attention of many governments in search of additional revenues.

A New UN High Level Commission
The first formal meeting of a new United Nations High Level Commission on Legal Empowerment of the Poor took place in New York recently. One could be forgiven for thinking that this Commission is but one more in a seemingly endless proliferation of UN bodies aimed at solving the world’s problems – usually with little or nothing to show for the time and money invested. This Commission holds out a chance that it may be different from many of the others launched by the UN previously.

One reason to be optimistic is that the work of the Commission will be narrowly focused on one of the core causes of poverty. As the work of de Soto and ILD has shown, even modest improvements in the legal property system can lead to substantial improvements even in the short run.

Another reason is that this Commission will be co-chaired by Mr de Soto and Madeleine Albright, former US Secretary of State. Mr de Soto will, it is to be hoped, ensure that the Commission remains focused on key technical issues. Mrs Albright will help to provide political credibility and access for their work. When she was appointed, she made the point that, “While many worthy initiatives are under way to fight global poverty, our commission will focus on a unique and overlooked aspect of the problem: the inexorable link between pervasive poverty and the absence of legal protections for the poor.”

Mrs Albright and Mr de Soto will be joined by a number of people with extensive firsthand experience in dealing with these issues, including among others, former President of Tanzania Mkapa (cited above), Gordon Brown, UK Chancellor of the Exchequer, Fernando Cardoso, former President of Brazil, Mike Moore, former PM of New Zealand and former head of the WTO, Mary Robinson, former President of Ireland, Larry Summers, President of Harvard University and former US Secretary of Treasury and Arjun Sengupta Chairman of the National Commission for Enterprises in the Unorganized Sector of India. From Sri Lanka, Milinda Moragoda, MP and former Minister of Economic Reform is also a member of the Commission.

One of the Commission’s tasks is to provide developing countries a “tool box” with which to address these problems. It will be important to pay close attention to what this Commission does over the next two and one-half years to see whether its work will be useful for Sri Lanka’s efforts to reduce poverty and improve economic development.

It should be recognized that making improvements in the legal system, even very substantial improvements, will not by itself lead to the elimination of poverty. While it would do much, there are other factors that contribute to the economic environment, such as the nature of the regulations and policies, including tax policies, which determine how well the economy can perform.

Although this Commission will not provide all of the answers, if it helps to provide just one of the important answers, it can make a major contribution. As Alejandro Chafeun from the Atlas Foundation wrote in the Washington Times about the formation of this Commission, “Even the United Nations on occasion does something right.”