Deregulate the Poor

In his book  The Science of Liberty, Timothy Ferris discusses the Dickensian London and then has this passage, which I hope Indian planners think about.

The new megacities have no real alternative—and no brighter prospect—than to do the same {as London eventually did}, by absorbing their shantytown compatriots rather than locking them outside the (figurative) city gates.  How might this be done without recapitulating generations of Dickensian suffering along the way?

This question has been ingeniously investigated by the Peruvian economist Hernando de Soto. Born in Lima, de Soto was educated in Switzerland before returning to Peru in 1980. There he studied the relationship between government, the law, and urban poverty, interviewing the poor and studying their economic situation with everything from satellite imagery to the barking of dogs—which roughly demarks the property lines of squatters' undeeded homes. De Soto found that the newly arrived poor typically want to work, pay taxes, and own or lease their dwellings, but are discouraged from doing so by dense thickets of laws and regulations that function rather like the stone walls confronted by the suburbanites of seventeenth-century Europe.

When he and his colleages tried to obtain the necessary permits to legalize a small Lima garment-making shop containing only two sewing machines, they discovered that even though with the help of a lawyer, a luxury few squatters could afford, the process took 289 days, and cost thirty-one times the monthly minimum wage. For a family to obtain legal title to the shack where they lived or worked required more than two hundred bureaucratic steps taking twenty-one years of effort.

The effect of all this red tape, de Soto argues, is to erect a "legal apartheid between those who can create capital and those who cannot." Peru "had become two nations: one where the legal system bestowed privileges on a select few, and another where the majority of the Peruvian people lived and worked outside the law, according to their own local arrangements."

A "paper wall," de Soto concluded stops the poor from being able to develop private legal enterprise."

These obstacles many times don't exist for the wealthier parts of the population, because they're continually plugged into lawmakers. Something goes wrong, you talk to your friend the minister, you're well organized in the chamber of commerce and the local manufacturers association, some kind of a guild. The poor don't have a voice, at least not a business voice.

Borrowing a phrase from the French historian Fernand Braudel, de Soto portrayed the established urban elites as living inside a "bell jar". "The bell jar makes capitalism a private club, open only to a privileged few, and enrages the billions standing outside looking in," de Soto wrote in the The Mystery of Capital. Those inside the bell jar—in twentieth-century Lima as in seventeenth-century London—might claim that the poor don't want to work, but when de Sot's team set up storefront offices in the slums of Peru to register previously extralegal businesses, over 276,000 squatters took advantage of it. During the first four years of the experiment, the taxes paid by these newly enfranchised and self-nominated businessmen and women, who previously had paid no taxes at all, totaled $1.2 billion.

This is not isolated to Peru. De Soto examined other developing countries.

In every country we have examined, the entrepreneurial ingenuity of the poor has created wealth on a vast scale—wealth that also constitutes by far the largest source of potential capital for development. These assets not only far exceed the holdings of the government, the local stock exchanges and foreign direct investment; they are many times greater than all the aid from advanced nations and all the loans extended by the World Bank.

But the extralegal poor cannot leverage their assets. Lacking title to the land they occupy and official permission to engage in the businesses that support them, they are unable to obtain loans, credit, or mortgages. Nor can they build up a business much past family-scale, for fear of attracting official scrutiny. Their assets are what de Soto calls "dead capital", money unavailable for investment. The potential of small-scale "live capital" often escapes those of us in the developed world who tend to think of forming a company as a high-finance proposition, but the average US start-up has one employee, under $25,000 in assets, and is funded by a home mortgage.

De Soto urges that legal systems adapt to conditions as they are (a million squatters at the gates) rather than as a ruling elite might prefer them to be....

This lesson, I have little doubt, applies to India as well.