-This article was originally published by Dhruba Bhandari in The Himalayan Times on 10 April 2016.
Poverty is not a voluntary phenomenon. Then why are some people rich, and some poor? It appears as though, only western countries have benefitted from capitalism and for much of the developing countries and least developed ones (like ours); capitalism in itself is a mystery.
CHALLENGES TO CREATING CAPITAL
We seem to have missed an important lesson on how developed countries got there. It is not from the lack of entrepreneurial skills, assets, savings and spirit of trade that the poor people/countries lag behind, but because of lack of fundamental process of creating the capital in the first place. The lack of capital comes from lack of structural or institutional support systems that can convert assets and savings into capital. In the context of Nepal, just as well as Hernando De Soto explains in his book ‘Mystery of Capital,’ lack of clearly defined property rights is one of the challenges to creating capital. What creates capital from assets and savings is the properly defined property rights and proper institutions like contract enforcement.
POORLY DEFINED PROPERTY RIGHTS
You know there is lack of clearly defined property rights when you see a house built on land that neither the house-owner has a title to, and nor is the land adequately recorded. Because the rights to these possessions are not clearly defined, these assets cannot be traded outside of narrow local circles where people know and trust each other. When there is no secured title to an asset, the asset cannot be used as a collateral for loan. The asset here is effectively dead capital. Since the land has no clear title, the banks and financial institutions will not extend loans against its guarantee. Since the individual who is living on this kind of land has no formal title over the land, and consequently no way to access finance by using it as collateral, he is forced to operate business outside the law, should he choose to run an enterprise. This way, he joins the informal economy.
From here on, he will only enter into trust-based and not-formallybinding arrangements to protect and mobilise his assets. Now, he has no possibility of growth, as every alternative to scale up his business would require him to present legally-recognised documents which he does not have. In contrast, in developed countries every land, building or equipment has a clearly defined and secure title represented in property document. This connects these assets to rest of the economy with well supported institutions. These assets can be used for credit easily and confidently, for example: entrepreneur using mortgage on entrepreneur’s house, and eventually for the production of goods and services. This is the process of converting assets to capital.
STRONG RULE OF LAW
Converting a physical asset to capital requires well defined property rights and other supporting institutions — strong rule of law that can honour the property right, well-functioning financial institutions that can accept the assets and savings and convert them into capital by channeling it to willing entrepreneurs. All these processes must also be supported by strong contract enforcement, which will ensure that people have an incentive to honour their contracts.
If this happens in Nepal, we will see people investing in the production processes of goods and services rather than seeking job opportunities elsewhere. In addition, informal businesses like street vendors, unregistered labours et cetera could also be incorporated into the formal economy and would be able to work and innovate without fear of being apprehended for engaging in illegal activities. This would also expand the tax base for the government and the additional revenues as a result of bringing the players of the informal sector to the formal would boost the government’s capital investment capacity. Given the fact that Nepal has to boost investment to meet its commitments in terms of graduating from Least Developed Country status by 2022, become a middle-income country by 2030 and attain the Sustainable Development Goals, this is an opportune moment to change our ways of doing things.
What is required is a structural change that will allow converting dead capital into ‘live’ capital — capital that can be invested in production processes. To uphold that, there will have to be protection of property rights, strong contract enforcement and rule of law. In addition to creation of capital, the reduction of the informal economy will be another bonus of this structural change.