Monday, March 1, 2010

What Finance & Law Have to Say About Economic Development

I just finished reading two books which are very helpful about thinking about the "development problem" in a new light: The Mystery of Capital, by Peruvian economist Hernando DeSoto (, and Dead Aid by Zambian economist Damibas Moyo ( More important than the fact that these books are written by someone other than your stock western development economist (no ad hominen argument commited here), these thinkers write from novel perspectives (financing and law) which give us refreshing, market-oriented approaches to economic development.

Ultimately the problem with economic development is not its goals or activities, but the way its financed. Aid money-- particularly government-to-government transactions-- isn't just ineffective to achieve development goals, but is positively harmful, says Moyo. Aid encourages corruption, hampers good citizenry and government accountability, and can be economically harmful to an economy (as it tends to reduce savings and investment, encourages inflation, and chokes off the export sector, among other things).

Moyo proposes a "menu" of financing options to replace aid and enable states raise their own funds for development. The participation in international bond markets and the development of local ones. More Foreign Direct Investment (FDI) in infrastructure and institutions from companies and governments (like China) who see opportunities in Africa. More trade, which brings a country foreign earnings, and makes an economy more productive. Better banking services for the poor should expand micro-financing opportunities, lower the costs of remitances and other money transfer services, and enable the poor to more easily turn their assets into usable savings.

DeSoto's book--again, written from the same market-driven development perspective--is all about this last point: turning the poor's assets into capital. While Moyo writes from a broad finance perspective (among other things she spent 8 years as a strategist with Goldman Sachs), DeSoto focuses on the legal reform that is necessary to enable the poor to begin leveraging their savings and fund their own development.

The problem is that many developing countries have property legal systems that do not reflect the informal or extralegal sector, which often is the world in which most of the population lives and works. The consequence is not only that these extralegal property owners can't physically secure their assets, but that they also can't leverage these assets as capital to improve and develop their livelihoods. Consider, for example, how important mortgages are as a loan source for many Americans, or the important role that a residential address plays in allowing someone to access credit or making them "accountable" enought to enact a business transaction.

The solution, says DeSoto, is hidden in the histories of many western nations, all of which at some point in had to begin recognizing and absorbing the extralegal sector into their formal legal system. This happens by reform, which requires the vision and initiation of political leaders.