markets benefit the poor
he World Bank and donor agencies like the United Kingdom’s Department for International Development (DFID) have adopted the theme “making markets work” when delineating their private sector development strategies to reduce poverty. In South Africa FinMark Trust has adopted the mission “making financial markets for the poor”. This article picks up this theme and considers how the capital market can be made to work for the poor. The supposition is that capital markets have an impressive record of financial innovation and if this could be directed towards issues such as dead capital it would contribute towards achieving the Millennium Development Goal of halving the number of poor by 2015.
1. Capital and dead
According to de Soto in his seminal work “The Mystery of Capital“, the major impediment that prevents the developing world from benefiting from capitalism is its inability to produce capital. He states that “capital is the force that raises the productivity of labour and creates the wealth of nations. It is the lifeblood of the capitalist system, the foundation of progress and the one thing that the poor countries of the world cannot seem to produce for themselves no matter how eagerly their people engage in all other activities that characterise a capitalist economy”.
The basic tenet of de Soto's (2000) work is that the poor in developing countries, in spite of holding considerable property, do not have a system for property rights that can turn these assets into capital. The poor possess property not in the formal property system, but in the extralegal, underground system that has its own laws and customs. Thus because they do not have formal title to the assets, the assets represent dead capital as the poor cannot use them as collateral to obtain credit i.e., for capital formation.
De Soto estimates that about 85% of urban land tracts in developing countries and between 40% and 53% of their tracts of rural land represent dead capital. He further estimates that the total latent value of the real estate held but not legally owned by the poor in the developing world and in transition countries is in the order of about $9.3 trillion.
Clearly the answer to capital formation in developing countries would be to formalise informal ownership. This implies adequate and appropriate laws that establish property, tenurial and foreclosure rights, a sound mortgage insurance system, and information systems to record credit scoring data and loan default rates. However without enforcement, property rights for the poor are meaningless.
2. The capital market
There are isolated incidents of the capital market being used to mobilise dead capital. For example:
In poorer developing countries and in outreach to underprivileged sections of the population in particular, the private sector is often not prepared to make longer-term commitments without for example guarantees by government or official development agencies.
3. Capital market innovations
Could asset-backed securitization be used to mobilise dead capital by securitising the loans of a community or rural village? Group lending of this ilk will enable a community or rural village to provide additional collateral for a number of loans through a pledge by the group to repay the loans. The incentive to repay the loan is based on peer pressure i.e., if one group member defaults the other group members make up the payment amount. However mortgage securitization rests on a complex matrix of legal and institutional structures that may not and must be addressed in this context.
It is possible to form a company with the property of a community or village as the asset of the company and members of the community or village as shareholders? The company could raise a loan using both the property and group lending repayment pledge as collateral. However should the company default on the loan, would the lender be able to take possession of the collateral?
It is not clear whether the poor would want to borrow money with their property or houses as collateral. There may be reluctance to endanger a household's / community’s / village’s financial viability. Many may fear the consequences of failing to repay the loan and would prefer to use informal savings facilities like stokvels to obtain credit. This raises the question: is it possible to securitise the cash flow of a stokvels?
In developing countries, the poor possess capital, but it cannot be put to use to generate additional capital – something that is essential for economic growth. And herein lies the challenge for participants in the capital market. Can they use their creativity and expertise to create the tools necessary to mobile dead capital?