Easter Economics: The Resurrection of Dead Capital: Winning Essay

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CONTEST ESSAY

Easter Economics: The Resurrection of Dead Capital

October 10, 2007

By James Estes

The 2007 Garvey Fellowship Essay Contest

Student Winner. Second Prize ($1,500)

[1]

Prologue

The stories and statistics that flow from the most impoverished two-thirds of the world are nearly overwhelming. Multitudes are dying across Africa, Central Asia, and South America from treatable or preventable disease,[2] unemployment ravishes entire regions, and genocide rages against unrepresented minorities. These realities reach beyond the scope of simple humanitarian need. The unsettling inevitability is that the developing world, should it remain impoverished, will become the Achilles heel of capitalism, dragging the global economy into recession.[3] For these reasons, among others, the Western nations have been pouring resources into the developing world for well over 50 years.[4]

Of course not all of this money is intended to help lift developing nations out of poverty. Much of the foreign aid is designated as humanitarian aid which may be motivated more by politics than love of humanity. There is, however, no long-range vision for the developing world that does not attempt to address economic development. It has become clear that past methodologies for supporting economic growth are falling short. Thorough evaluation of the systems at work demonstrates an irony in the role of foreign aid to the developing world. The developing world does not need the money of the West. Indeed, the collected capital of the developing world dwarfs the massive foreign aid distributed in the twentieth century.[5] The developing nations need our institutions for representation of value. Should the institutions be established to unlock the capital in the developing world the basic laws of supply and demand would enable even the poorest nations to leave poverty behind. Much foreign aid has been distributed in the past based upon a misunderstanding of the character of developing nations. The developing world is, in fact, the greatest untapped investment of our time.

Arrogant Aid

The flow of money and resources from the West in the form of foreign aid has become so common that Westerners think nothing of dollars and euros flowing into the developing world in the billions. Yet, whether motivated by altruism, guilt, or self-interest the liberal flow of money to the poorest segments of humanity has yet to result in a vibrant economy among developing nations.[6] William Easterly notes, despite the fact that the typical African nation could attribute more than 15 percent of its income to foreign donors through the 1990s, still that “Surge in aid was not successful in reversing or halting the slide in growth of income per capita toward zero.”[7] The West is not without compassion and is not stingy, notes writer Virginia Postrel, but it is ineffective.[8]

The attempts to understand the failure of Western aid to vitalize the economic condition of the developing world are varied. Some argue that developing nations are not suited for wealth because of being somehow intrinsically inadequate for the task, that the entrepreneurial spirit is repressed or that developing populations cannot compete in a modern economy. These arguments, in addition to being arrogant and condescending, have been disproved time and time again for 25 years.[9] Another postulate is that the developing world is “backward” or corrupt, that popular poverty benefits the interests of self-serving leaders in scarecrow democracies.

Easterly criticizes the “fundamental elitist arrogance” of many foreign aid systems for ignoring the process by which the developed world came into being and having instead championed a series of ineffective cause-centered handouts[10] that ignore the widely applicable basic elements of supply and demand.[11] One of Easterly’s examples of this point is mosquito nets. Aid-financed pushes to distribute insecticide-treated mosquito nets for children, in order to curb childhood malaria, have been widely distributed throughout Africa but are often diverted to the black market, become fishing nets or veils in weddings. In rural Malawi, however, a program developed by local Malawians, sells these bed nets for 50 cents each. In Malawi’s cities, the group sells nets for $5 each, using the profits to subsidize rural projects. According to Easterly this initiative increased the average number of children sleeping under nets nation wide by 47 percent in 4 years and follow-up surveys found a nearly universal use of nets when purchased. To contrast, a program in Zambia handed out free nets and 70 percent of the recipients did not use them. [12]

Easterly expands his criticism pointing out that the distribution of foreign aid is based on what he calls “legend.” The first part of the legend is the claim that the poorest nations are caught in a “poverty trap” from which they cannot escape without a big aid-financed push. He sites Columbia University professor, Jeffery Sachs, as a propagator of this philosophy in writing that “When people are utterly destitute, they need their entire income just to survive. They are too poor to save for the future and thereby accumulate the capital that could pull them out of their current misery.” Peter T. Bauer writes that this sentiment is clearly untrue based upon the plain observation that every developed country rose from the squalor of underdevelopment. Furthermore, it is clear that the big aid-financed push is not necessary because without it many underdeveloped countries in recent decades have experienced rapid economic gains.[13] Part two of Easterly’s “legend” is the claim that poor economic growth is a result of the poverty trap rather than bad institutions or poor government policy. Clearly this cannot be true if the poverty trap, in fact, does not exist. Easterly echoes Bauer in the verdict that foreign aid is both insufficient and unnecessary to raise the living standards in developing countries.[14]

Replete with Resources

In his book, The Mystery of Capital: Why Capitalism Triumphs in the West and Fails Everywhere Else, Peruvian economist Hernando de Soto also refutes the “legend” of the poverty trap; he argues that the people of the Developing world are not stereotypical poverty-stricken beggars. On the contrary, de Soto asserts that the entrepreneurial spirit thrives in developing world economies. As Peter T. Bauer wrote, the “Driving force of self-interest in pursuit of well-being is of universal application.”[15] Furthermore, Israel Kirzner, Professor of Economics at New York University, names this universal drive “human purposefulness” and with it explores the DNA of a small business owner in any market, in any square, on any corner in the earth. The roadside Togolese woman with the loaves of bread balanced on her head and the Nepali man with a mobile rickshaw dry goods store both evidence three aspects of this human purposefulness: “(a) chosen objectives, [...] (b) the systematic manipulation of available scarce means in order to achieve chosen ends, and (c) human alertness to new possibilities of achieving objectives.”[16] To simplify these terms we could say that a small business owner is vigilant, resourceful and creative in the pursuit of a chosen goal.

In addition to the entrepreneurial drive, de Soto also demonstrates that if the world’s poor have nothing else, they have capital. The world’s poor have capital in abundance, far in excess of the foreign aid pouring in from developed nations: “The value of savings among the poor is [...] immense - forty times all the foreign aid received throughout the world since 1945.”[17] The problem in the developing world, claims de Soto, is that the capital is hidden away in property which cannot be turned by social institutions into loans or mortgages. De Soto calls this “dead capital” because though it is real is cannot be accessed. De Soto says it like this:

[18]

The mass of savings is inaccessible because the institutions necessary for extracting equity from tangible things do not exist, are not accessible, or are not secure.

Institutions and Incentives

In a classic 1986 illustration of obtaining a statute of incorporation in Peru, Enrique Ghersi attempted to incorporate a small clothing workshop. Keeping in strict compliance with legal requirements, including refusal to pay bribes, even if it prolonged the process, Ghersi wanted to understand the experience of the Peruvian entrepreneur. The paperwork was delayed for almost a year. In the process, 12 bribes were requested and two were paid because failure to pay would have halted the experiment. To get a comparative idea about the process Ghersi had “An American professor [conduct] the same experiment in Tampa, Florida. What took [...] a year to accomplish [in Peru] took him two hours.”[19] He incorporated through the mail one morning before lunch.

This disturbing scenario is common in developing countries and demonstrates the inadequacies of the institutions throughout the developing world. There are at least two problematic results of this congested process. Because a small business owner in Nairobi or Colombo cannot afford the time delays or funds for bribery, an easier option is to become what de Soto calls “extralegal.” Seventy-eight percent of the Mexican population, for instance, are “Either living or working illegally, which is to say they are working in the informal economy.”[20] This informal economy restricts funds to a localized community based on interpersonal relationships instead of formalized, legal rights. These informal economies are largely under the table and as such are unregulated, untaxed, and unprotected under the law. If squatters move in, how can the business owner argue for the ownership, for instance, of a parcel of land that has no deed? What if the land has never actually been deeded to anyone?

In addition to being isolated from the larger formalized economy the small business owner does not participate in the legal benefits of incorporation. In addition to protection of personal assets, legal transferable ownership, and the ability to raise funds through sale of stock, a business that is legally owned has equity that can be legally borrowed against.[21] This is a system by which the dead capital of the business owner could be brought to life. However, because of burdensome and corrupt processes incentive to become legal is stifled and capital remains inaccessible.

De Soto notes that these struggles are not the exclusive experience of today’s developing nations. In 1783 George Washington voiced complaints over squatters in the post-revolutionary United States. What Washington termed “banditti” were squatters and small entrepreneurs occupying land they did not own. The legal claims of lands inhabited by banditti were contested for a hundred years because of differing property laws between states. This scenario is indicative of many developing nations where land rights that are respected in local informal economies are not legal and so offer none of the benefits of legal ownership. This is only one instance of the way in which the developing world today faces many of the same challenges the United States faced as little as 100 years ago and of Western Europe as far back as Jean-Baptiste Colbert and Adam Smith in the seventeenth and eighteenth centuries.[22]

At it was in centuries past, so now the developing world is teeming with human purposefulness. Without institutions to create security and incentive, however, this army of small business owners will remain frustrated in their inability to access a wealth of dead capital and ascend to economic affluence. As mentioned, the institutions that create security and incentive are difficult to quantify or measure, yet they “Serve as the social rules and patterns of human conduct that make material and cultural improvement possible for mankind.”[23] De Soto argues that the United State in particular has forgotten how it established the institutions that have empowered it to rise to economic prominence; that the establishment of these institutions is a part of capitalism’s forgotten history and that this history must be reclaimed for the sake of the developing world.

Invigorating Incentive

In 1990 the Washington Consensus on U.S Latin American policy listed as one of the top 10 items the recommendation to secure property rights; to legally formalize the ownership within many informal economies.[24] In a 2003 interview, de Soto recalls a project run in Peru in the early 1990s. “We went into towns to legalize housing, evaluate property, and give owners titles and deeds for their properties. More than 400,000 companies moved from the informal to the formal sector.”[25] Between 1993 and 1995 tax income increased by $400 million a year and over half a million jobs were created. The cost of this initiative was $77 million supplied by the World Bank and the Peruvian government. Shortly after these gains de Soto and his associates were run out of the country by President Alberto Fujimori’s government. Nonetheless, it is clear that enfranchising the populace of developing nations will pay for itself.

In its 2007 fiscal report on methodology for determining the eligibility of candidate countries the Millennium Challenge Corporation (MCC) requires of recipient nations a, “Demonstrated commitment to [ruling justly...] economic freedom, [...] investing in their people and the opportunity to reduce poverty and generate growth.”[26] The report goes on to list 16 criteria within three broad categories that qualify a developing nation for assistance through MCC. Of the 16 criteria six fall under the heading “Economic Freedom” and include tracking costs of starting a business, control of inflation rates, days to start a business, trade policy, regulatory quality, fiscal policy and land rights access.[27] It is clear that some in the West have become enlightened to the necessity of encouraging political and economic representational processes.

The empowerment of representational processes has also caught the attention of the private sector, which may be the best hope for helping the developing world to develop itself. In 2006 Muhammad Yunus and Grameen Bank, the for-profit microfinance corporation that he started, were jointly awarded the Nobel Peace Prize For their efforts to create economic and social development from below.[28] Yunus has privatized the systems of representation through the Grameen Bank Project (GBP) for the landless. GBP aims to: “1) extend banking facilities to the poorest segment of society, 2) bypass moneylenders, 3) create self-employment for unutilized man/woman power, and 4) bring the disadvantaged into an organization they can understand and operate.”[29] All loans are made to groups of five, of which two are given loans with the other three eligible when the weekly repayments of the first two have begun. These groups monitor each member’s performance and often function as co-ops for local economic progress. Repayment of loans on schedule under this system has exceeded 98 percent. Over 100,000 villagers who were once submerged in poverty have begun to experience greater productivity through the resurrection of their dead capital. “They have built small mustard seed oil mills, bought cows and goats for fattening, begun weaving saris and making fish nets, started pottery works and betel nut growing, purchased fertilizer for rice growing, and expanded the inventory of their small shops.”[30]

Yunus is giving scores of poor entrepreneurs the opportunity to prove the dynamic power of capitalism, to breathe fresh life into dead capital through representational institutions. Grameen has inspired many capitalists to see that “Business interests will not come at the expense of social goals, but rather will be the necessary enablers of these very goals.”[31] Indeed, many for-profit microfinance institutions are investing into developing nations because the poor of the world are a good investment; as Henry Hazlitt wrote, “[Capitalism] maximizes production because it allows a man [...] freedom to earn and to keep the fruits of his labor.”[32] Microloans are resurrecting capital throughout the developing world and because it is profitable this trend can be expected to continue.

Luigi Zingales, Graduate Professor of Entrepreneurship at the University of Chicago asserts that microfinanciers see the potential to grow into a significant, profitable industry:

[33]

Capitalism itself is profiting from the resurrection of capital across the developing world because “Every inefficiency in the world creates a business opportunity.”[34] The millions of hard working, motivated entrepreneurs entrenched in poverty, which is perhaps the greatest inefficiency in human history, has led to tremendous business opportunities. Supply and demand capitalism in the West has begun to recognize one of the great economic demands of our time, institutions of economic representation. At once microfinance is finding innovative ways to provide supply for this demand and bring vitality to the capital of the developing world.

Conclusion

While institutions which represent property as capital have been identified as the deeper need of the developing world, millions continue to struggle in systems where even microfinance is a bleak option. Because microfinance is profit-motivated, it is still a tremendous risk to lend to a shopkeeper in Baghdad or a cobbler working on contested land in Gaza. In these situations the difficulties that surround the establishment of institutions of representations are deeply rooted in culture, war, and politics. In many regions of the developing world the means by which these systems of representations may be established remains a mystery.[35]

Millions of impoverished people across the globe are carrying the weight of dead capital and only institutions of representation can put that dead weight to work. Foreign humanitarian aid may help to feed the hungry of the developing world and fight disease, but it can never give poor nations what is needed to develop vibrant, stable economies. The supplanted successes of enfranchisement to legal institutions in Peru and the repayment rates of microfinance corporations is an encouraging sign that capitalism truly is of universal application. Hazlitt’s observations of capitalism written nearly 40 years ago have been proven true by de Soto, Yunus, and the proliferating microfinance industry:

general

[36]

Hazlitt’s freedoms include the institutions of representation that resurrect dead capital. Given such institutions, the universally applicable forces of supply and demand will continue to work these miracles throughout the developing world. The resurrection of the world’s dead capital will forever alter the global economic landscape and power structure so that developing nations will finally achieve the hope and prosperity so long denied them.

Works Cited

Bauer, P. T. (1981). Western Guilt and Third World Poverty. Retrieved April 5, 2007 from http://www.valt.helsinki.fi/atk/gpe/texts/bauer.htm

De Soto, H. The Mystery of Capital: Why Capitalism Triumphs in the West and Fails EverywhereElse. New York, N.Y.: Basic Books, (2000) [Electronic version]. Retrieved April 5, 2007 from http://www.nytimes.com/books/first/d/desoto-
capital.html?_r=6&oref=slogin&oref=slogin&oref=slogin&oref=login&oref=login

Hazlitt, H. Man vs. the Welfare State. Rochelle, N.Y.: Arlington House, (1969) [Electronic version]. Retrieved April 5, 2007 from http://www.mises.org/books/manwelfarestate.pdf

Ebeling, R. M. (2002). Book Review: The Elusive Quest for Growth: Economists’ Adventures and Misadventures in the Tropics. Retrieved April 29, 2007 from http://www.fff.org/freedom/fd0205g.asp

Ghersi, E. (1997). The Informal Economy in Latin America [Electronic version]. The Cato Journal. vol. 17, no. 1. Retrieved April 29, 2007 from http://www.cato.org/pubs/journal/cj17n1/cj17n1-8.pdf

Kirzner, I. M. (2005). Human Attitudes and Economic Growth [Electronic version]. The Cato Journal. vol. 25, no. 3. Retrieved April 5, 2007 from http://www.cato.org/pubs/journal/cj25n3/cj25n3-6.pdf

Loungani, P. (2006). The White Man’s Burden: Why the West’s Efforts to Aid the Rest Have Done So Much Ill and So Little Good [Electronic version]. The Cato Journal. vol. 26, no. 2. Retrieved April 5, 2007 from http://www.cato.org/pubs/journal/cj26n2/cj26n2.html

McNaught, F. C. (2006). Report on the Criteria and Methodology for Determining the Eligibility of Candidate Countries for Millennium Challenge Account Assistance in Fiscal Year 2007. Retrieved April 5, 2007 from http://www.mcc.gov/selection/reports/FY07_Criteria_Methodology.pdf

Postrel, V. (2006). The Poverty Puzzle. Retrieved April 5, 2007 from http://www.nytimes.com/2006/03/19/books/review/19postrel.
html?ex=1300424400&en=bf78548078668e88&ei=5088&partner=rssnyt&emc=rss

Rapoza, K. (2003). Interniev: Peruvian Economist Hernando de Soto. Retrieved April 5, 2007 from http://www.worldpress.org/Americas/1602.cfm

Williams, D. (2007). Incorporate: For Your Long Term Protection. Retrieved April 29, 2007 from http://www.a-irco.org/content/view/127/43/

Anonymous. (2006). The Nobel Peace Prize 2006. Retrieved April 5, 2007 from http://nobelprize.org/nobel_prizes/peace/laureates/2006/

Anonymous. (1984). The 1984 Ramon Magsaysay Award for Community Leadership. Retrieved April 29, 2007 from http://www.rmaf.org.ph/Awardees/Citation/CitationYunusMuh.htm

Notes

[1] Hazlitt, Man vs. the Welfare State, pg. 95.

[2] URL: http://www.nytimes.com/2006/03/19/books/review/19postrel.
html?ex=1300424400&en=bf78548078668e88&ei=5088&partner=rssnyt&emc=rss

[3] URL: http://www.nytimes.com/books/first/d/desoto-
capital.html?_r=6&oref=slogin&oref=slogin&oref=slogin&oref=login&oref=login

[4] URL: http://www.valt.helsinki.fi/atk/gpe/texts/bauer.htm

[5] URL: http://www.nytimes.com/books/first/d/desoto-
capital.html?_r=6&oref=slogin&oref=slogin&oref=slogin&oref=login&oref=login

[6] Lougani, P. Loungani, P. The Cato Journal. pg. 383.

[7] Lougani, P. Loungani, P. The Cato Journal. pg. 382. (quoting The White Man’s Burden: Why the West’s Efforts to Aid the Rest Have Done So Much Ill and So Little Good, William Easterly)

[8] URL: http://www.nytimes.com/2006/03/19/books/review/
19postrel.html?ex=1300424400&en=bf78548078668e88&ei
=5088&partner=rssnyt&emc=rss

[9] Kirzner, I. M. The Cato Journal. pg. 466.

[10] URL: http://www.fff.org/freedom/fd0205g.asp

[11] Kirzner, I. M. The Cato Journal. pg. 465.

[12] URL: http://www.nytimes.com/2006/03/19/books/review
/19postrel.html?ex=1300424400&en=bf78548078668e88&ei
=5088&partner=rssnyt&emc=rss

[13] Loungani, P. The Cato Journal. pg. 383. (quoting Economic Analysis and Policy in Underdeveloped Countries, Peter T. Bauer)

[14] Loungani, P. The Cato Journal. pg. 382.

[15] Kirzner, I. M. The Cato Journal. pg. 466. (quoting Economic Analysis and Policy in Underdeveloped Countries, Peter T. Bauer)

[16] Kirzner, I. M. The Cato Journal. pg. 469.

[17] URL: http://www.nytimes.com/books/first/d/desoto-
capital.html?_r=6&oref=slogin&oref=slogin&oref=slogin&oref=login&oref=login

[18] URL: http://www.nytimes.com/books/first/d/desoto-
capital.html?_r=6&oref=slogin&oref=slogin&oref=slogin&oref=login&oref=login

[19] URL: http://www.cato.org/pubs/journal/cj17n1/cj17n1-8.pdf