Resolving the mystery of capital

Resolving the mystery of capital
Sunil Jain

Of all the budget proposals that have fired the imagination of the country's media, its industrialists and punters, the one that has received the least attention is that which seeks to galvanise the debt market, to make trading in debt as vibrant as it is for equity. If successful, this single move will provide Indian industry many times more funds than the budget can ever give, by way of cuts in corporate surcharges and import and excise duties.

But this too, unfortunately, is just scratching the surface. The problem, of shortage of capital, is a lot more serious. Not just in India, but in each and every developing country that's trying to embrace full-fledged capitalism. As a result, in each of these countries, we're witnessing a kind of backlash at capitalism having failed to deliver the goods. So why does capitalism succeed only in developed countries? Read the `Mystery of Capital' -- by Hernando de Soto who, as the Peruvian President's Principal Advisor, initiated that country's economic reforms -- and you'll get a lot of your answers, in the form of very stark real-life examples.

Hernando's principal point is that, despite the enormous wealth in each country, it is the inability to leverage this into productive capital that is responsible for this sorry state of affairs. Remember how, when in Opposition, the BJP's top leadership constantly criticised the Congress for going to the IMF/World Bank, saying that our women would give up part of their gold and we'd generate a lot more funds this way? Well, the BJP's now going to precisely the same World Bank for help, but it's not because it's hypocritical, but because it has realised the problem lies elsewhere.

Country after country, Hernando records, is trying to woo the same foreign investors, despite the fact that their population has assets worth several times more. In Egypt, the wealth of the poor is roughly 55 times the total foreign investment ever got there, including the Suez Canal and the Aswan Dam. In Haiti, the total assets of the poor are 150 times greater than the foreign investment received since the country's independence in 1804. To top it all, if the US were to hike its aid budget to 0.7 per cent of GDP, as suggested by the UN, it would take the world's richest country 150 years to transfer to the world's poor resources equal to what they already have.

So the issue is not of paucity of resources, it's that these resources are `defective' -- houses are built on land whose title is unclear, for instance. Clear title, by contrast, in the US, has not only allowed house-owners to mortgage their houses, there's an active market in trading these mortgages, and that creates a vibrant market for raising resources. Similarly, since banks can't usually foreclose loans in countries such as India, they can't sell these loan documents to other banks or traders. And since they can't do this, they can't raise fresh resources which can be used to make new loans. The problem is far more acute when it comes to illegal factories, workshops, or houses -- how do you raise resources from the formal market using these?

The reason for these factories or houses being illegal, of course, is the prohibitive cost of making them legal. High stamp duties and taxes, for instance, mean that each time a house is sold, you don't register it with the authorities -- a lot of the sales are on `power of attorney' basis which banks don't normally give loans against.

In Peru Hernando's team tried to register a small business, to calculate how expensive the process was. The team began filling up the forms, standing in the queues, and made the bus trips required to the government offices in central Lima. They spent six hours a day at it, and finally registered the business -- 289 days later! Calculate the cost of all this manpower to set up a garment workshop with just one worker, and it works out to $1,231 or, says Hernando, 31 times the monthly minimum wage! To obtain legal authorisation to build a house took six years and 11 months -- with 207 administrative steps in 52 government offices. In Egypt, legally acquiring a plot on the state-owned desert means 77 bureaucratic procedures at 31 public and private agencies, which can take between 5 and 14 years -- that's why around five million Egyptians have build their houses illegally.

What's this `dead' capital worth? In the Philippines, around 60 per cent of people live in housing that is `dead' capital, and this is 70 per cent in Peru -- in Peru, that's $74 bn, or 14 times the value of all foreign investment in its entire history! `Dead' real estate in the Philippines is valued at $133 bn, or seven times the deposits of the country's commercial banks. For the entire Third World, Hernando puts the `dead' capital at $9.3 trillion, or 46 times the World Bank assistance in the past three decades.

Hernando has not done any work on India, but the value of `dead' capital is obviously huge, given that around 40 per cent of the country's economy is estimated to be in black. Getting this into the mainstream is the real challenge. That's where mind-boggling growth will take place from. A great budget is nice, but it doesn't even begin to tackle the problem.