Hernando de Soto
He has led a heroic struggle on behalf of people trapped without property rights or the ability to earn a living legally. It started in Peru and has spread to the broader world.
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Living in the border with Peru for more than 30 years I think that Hernando de Soto Influence has been negative for his country. Peruvian economy is losing much of his competitiveness due the move to legalization of informal economy forced by the Government. Well, It´s just my opinion,
Well, is a long story but I may explain my point comparing two border cities as Arica (Chile) and Tacna (Peru) who are located just some 40 miles away. Arica is ideal in De Soto´s view much of the small business are formal and legal, pay taxes and there are wide access to credit (maybe too wide), strict labor laws who everybody respect and so on. Tacna is much more unregulated and informal, evryone works even childs and old people, very few pay all taxes, most of them underpay, there are no mandatory holidays as in Chile, anyone can start and operate a business with no license, there are not minimun wage, etc. In sum Tacna is more like Hong Kong in the 80s and Arica like some town in Spain. Everything is cheaper in Tacna and thousend of us, Chileans, go there to purchase or just spend some money. Tacna is far cheaper and there are everything that there are not in Arica due the economic regulations: bars, restaurants, stores, small manufactures, etc.In figures the numbers of Arica are much better than in Tacna but in the real life experience and commutativity Tacna overcomes Arica.
Laws and regulations are pretty much the same in both cities, but in Tacna are less respected. I think De Soto was very clever to grasp the power of informal economy to overcome an over regulated system as in Peru, but he missed completely the point with his diagnostic, who is the "standard solution" applied in most of Latin America. He stress the lack of access to capital and lack of legal entitling as the limits for grow, but in the real life of the small entrepreneur those are no the biggest problems, but their limited capacity of commercialization.
In Chile, based in De Soto ideas, the government spent lots of money every year funding small entrepreneurs with "seed capital" programs, encouraging them to formalize and finance with loan from banks, this has been a huge failure because is based in the underlying idea that "formel" (regulated by law) is good per se and "informal" is bad. This is true in wonderland, not in Latin America where laws are made by and to benefit the rent seekers. In my opinion, informality is the only way for small business to grow in Latin America and convince them to formalize under certain volume is a big scam. By the way Mr. De Soto was economic advisor of the past Peruvian government from Mr. Alan García and didn´t do so well.
What both de Soto and the Doing Business Indicators ignore is to measure the benefits of formalization. By focussing on the costs of starting a business, they miss This is a crucial point. To ignore it is to get only a partial answer to what the issues really are. Work that I did on the informal sector in Peru in the 1990s revealed that most people who ran informal businesses would rather have had proper jobs. In many cases, the informal sector is not teeming with heroic entrepreneurs but with people who engage in informal business in order to stay alive. Informality was a substitute for formal sector employment. A substantial amount of empirical investigation has revealed that businesses in the informal sector is far less productive than formal business and that the larger formal businesses are, the more productive they are. Yet a major thrust of development policy is to promote SMEs. Small business fundamentalism", which is practiced by both governments and aid situations in developing countries, is doing a lot of Harm. policy needs to focus on is to ensure that the small number of small businesses that are successful do not have serious barriers to growing bigger. And I could not disagree more with Alex about the value of the Doing Business Indicators. In most cases they are wildly inaccurate due to faulty methodology and poor data collection, (as a World Bank internal evaluation pointed out in 2008). While they do have some use in getting politicians to focus on institutional reform issues, as an analytical tool, they are of little value.
I am not advocating for no laws or chaos as a solution to increase productivity of small business, but laws are made with big business in mind, at least in Latin America, and the excess of regulations made impossible for small business to take off. This is very clear comparing the situation in the real life between Tacna and Arica as I described above. The logic of small business is fundamentally different of "normal" business in poor countries, informal business are starving and they would be better with a fix job? Sure! but this is not a choice, formal jobs in poor countries are not precisely abundant. Obviously informal business are much less productive than bigger formals, there are no point of comparison in scale. It is like compare apples with oranges.
My point is that with the legal framework who is common in Latin America, aimed to over regulate and tax heavily the "rich businessmen" very few small business can work into this framework, if any.
And the legalization doesn´t help the fundamental problems of small business: a typical small business has huge margins but tiny sales. The old lady who sell food in the street profit above 100% but her sales are so few that she is always near bankruptcy. This problem is not solved with more capital nor with loans or legal entitlements but with help to sell the production. Government seldom gives this kind of help.
The 90s was an horrible decade for Peru for many reasons, but now the informal economy is strong, healty and very competitive if we compare at the same scale with similar business in Chile, pity that this seldom appears in studies or official figures because informal earnings are not registered.
"the excess of regulations made impossible for small business to take off." Thats exactly what De Soto wants to resolve. If you have good institutions converting the informal sector to a formal sector of course is beneficial for society. This has to do with standards and rights at work, employment creation, social protection and social recognition. Please also see the decent work debate. http://en.wikipedia.org/wiki/Decent_work
Very interesting and thanks for the link. However I strongly disagree. Terms as "decent" are completely subjective and impossible to apply under general basis. What if I agree -by my free will- to work under terms that any 3rd party consider not-decent? May I be obligated by force to not accept to work under those conditions? Why must I be obligated to obey the subjective preferences of someone who has nothing to do with me and my own preferences?.
I remark: regulations are prohibitions enforced by law and the repressive mechanism of state, created by well intentioned people (sometimes) forbidding to me to set a contract as my will. I don´t say that all regulations are bad but, as prohibitions they are a necessary evil and the less we have the better. Rich countries tend to over regulate and this lead them to the decay, in poor countries unregulated as Hong Kong or Singapore in the past century the freedom and prosperity flourish. Poor countries over regulated or regulated with bad laws often lost competitivity
I'm not sure I am following you: How would legalizing the informal economy would make a country lose its competitiveness (I'm not being snide here, I really want to know how one thing would follow from the other)