all people who take cover in the extralegal or underground sectors do so to avoid paying taxes;
real estate assets are not held legally because they have not been properly surveyed, mapped, and recorded;
enacting mandatory law on property is sufficient, and governments can ignore the costs of compliance with that law;
existing extralegal arrangements or “social contracts” can be ignored;
you can change something as fundamental as people’s conventions on how they can hold their assets, both legal and extralegal, without high-level political leadership.
To explain these countries’ underground economies, in which typically 50 to 80 percent of the people operate, in terms of tax evasion is partially incorrect at best. Most people do not resort to the extralegal sector because it is a tax haven but because existing law, however elegantly written, does not address their needs or aspirations. In Peru, where my team designed the program for bringing small extralegal entrepreneurs into the legal system, some 276,000 of those entrepreneurs recorded their businesses voluntarily in new registry offices we set up to accommodate them—with no promise of tax reductions. Their underground businesses had paid no taxes at all. Four years later, tax revenues from formerly extralegal businesses totaled US$1.2 billion.
We were successful because we modified company and property law to adapt to the needs of entrepreneurs accustomed to extralegal rules. We also cut dramatically the costs of the red tape to enroll businesses. This is not to say that people do not care about their tax bill. But extralegal manufacturers and shopkeepers—who operate on razor-thin profit margins, in cents rather than dollars—know basic arithmetic. All we had to do was make sure the costs of operating legally were below those of surviving in the extralegal sector, facilitate the paperwork for legalization, make a strong effort to communicate the advantages of the program, and then watch hundreds of thousands of entrepreneurs happily quit the underground.
Contrary to popular wisdom, operating in the underground is hardly cost-free. Extralegal businesses are taxed by the lack of good property law and continually having to hide their operations from the authorities. Because they are not incorporated, extralegal entrepreneurs cannot lure investors by selling shares; they cannot secure low-interest formal credit because they do not even have legal addresses. They cannot reduce risks by declaring limited liability or obtaining insurance coverage. The only “insurance” available to them is that provided by their neighbors and the protection that local bullies or mafias are willing to sell them. Moreover, because extralegal entrepreneurs live in constant fear of government detection and extortion from corrupt officials, they are forced to split and compartmentalize their production facilities between many locations, thereby rarely achieving important economies of scale. In Peru, 15 percent of gross income from manufacturing in the extralegal sector is paid out in bribes, ranging from “free samples” and special “gifts” of merchandise to outright cash. With one eye always on the lookout for the police, underground entrepreneurs cannot openly advertise to build up their clientele or make less costly bulk deliveries to customers.
Our research in the countries we have worked with has confirmed that being free from the costs and nuisance of the extralegal sector generally compensates for paying taxes. Whether you are inside the bell jar or outside, you will be taxed. What determines whether you remain outside is the relative cost of being legal.
Another prime misconception is that real estate assets cannot be legally registered unless they have been surveyed, mapped, and recorded with state-of-the-art geographic information technology. This, too, is at best partially true. Europeans and Americans managed to record all their real estate assets decades before computers and geographical information systems were invented. As we saw in the last chapter, throughout the nineteenth century the surveying of newly settled land in the United States lagged many years behind the conveyance of property rights. In Japan, I examined the documentation available in registry offices and saw how some land assets had been recorded after World War II using maps from the Edo period—three to four centuries before the invention of aerial photography and global positioning systems.
This does not mean that state-of-the-art computing and geographical information systems are not extremely important to any government’s efforts to open up its property system to the poor. What it does mean is that the widespread undercapitalization, informal squatting, and illegal housing throughout the non-Western world are hardly caused by a lack of advanced information and mapping technology.
Braudel’s bell jar is made not of taxes, maps, and computers but of laws. What keeps most people in developing and former communist nations from using modern formal property to create capital is a bad legal and administrative system. Inside the bell jar are elites who hold property using codified law borrowed from the West. Outside the bell jar, where most people live, property is used and protected by all sorts of extralegal arrangements firmly rooted in informal consensus dispersed through large areas. These local social contracts represent collective understandings of how things are owned and how owners relate to each other. Creating one national social contract on property involves understanding the psychological and social processes—the beliefs, desires, intentions, customs, and rules—that are contained in these local social contracts and then using the tools that professional law provides to weave them into one formal national social contract. This is what Western nations achieved not so long ago.
The crucial point to understand is that property is not a physical thing that can be photographed or mapped. Property is not a primary quality of assets but the legal expression of an economically meaningful consensus about assets. Law is the instrument that fixes and realizes capital. In the West, the law is less concerned with representing the physical reality of buildings or real estate than with providing a process or rules that will allow society to extract potential surplus value from those assets. Property is not the assets themselves but a consensus between people as to how those assets should be held, used, and exchanged. The challenge today in most non-Western countries is not to put all the nation’s land and buildings into the same map (which has probably already been done) but to integrate the formal legal conventions inside the bell jar with the extralegal ones outside it.
No amount of surveying and mapping will accomplish this. No amount of computerizing will convert assets into a form that allows them to enter expanded markets and become capital. As we saw in Chapter 3, assets themselves have no effect on social behavior: They do not produce incentives, they make no person accountable, no contract enforceable. Assets are not intrinsically “fungible”—capable of being divided, combined, or mobilized to suit any transaction. All of these qualities grow out of modern property law. It is law that detaches and fixes the economic potential of assets as a value separate from the material assets themselves and allows humans to discover and realize that potential. It is law that connects assets into financial and investment circuits. And it is the representation of assets fixed in legal property documents that gives them the power to create surplus value.
More than sixty years ago, the eminent legal historian C. Reinold Noyes wrote:
The chips in the economic game today are not so much the physical goods and actual services that are almost exclusively considered in economic text books, as they are that elaboration of legal relations which we call property…. One is led, by studying its development, to conceive the social reality as a web of intangible bonds—a cobweb of invisible filaments—which surround and engage the individual and which thereby organize society…. And the process of coming to grips with the actual world we live in is the process of objectivizing these relations.1
Lifting the bell jar, then, is principally a legal challenge. The official legal order must interact with extralegal arrangements outside the bell jar to create a social contract on property and capital. To achieve this integration, many other disciplines are of course necessary: Economists have to g
et the costs and numbers right; urban planners and agronomists must assign priorities; mappers, surveyors, and computer experts are indispensable to make the information systems work. But ultimately, an integrated national social contract will be concretized only in laws. All other disciplines play only a supporting role.
Does that mean that lawyers should lead the integration process? No. Implementing major legal change is a political responsibility. There are various reasons for this. First, law is generally concerned with protecting property rights. However, the real task in developing and former communist countries is not so much to perfect existing rights as to give everyone a right to property rights—“meta-rights,” if you will. Bestowing such meta-rights, emancipating people from bad law, is a political job. Second, very small but powerful vested interests—mostly represented by the countries’ best commercial lawyers—are likely to oppose change unless they are convinced otherwise. Bringing well-connected and moneyed people onto the bandwagon requires not consultants committed to serving their clients but talented politicians committed to serving their people. Third, creating an integrated system is not about drafting laws and regulations that look good on paper but rather about designing norms that are rooted in people’s beliefs and are thus more likely to be obeyed and enforced. Being in touch with real people is a politician’s task. Fourth, prodding underground economies to become legal is a major political sales job. Governments must convince poorer citizens—who mistrust government and survive on tight parochial arrangements—and some of the mafias who protect them to buy an entry ticket into a much bigger and looser game. Governments must also convince influential leftists, who in many countries are close to the grass roots, that enabling their constituencies to produce capital is the best way to help them. Citizens inside and outside the bell jar need government to make a strong case that a redesigned, integrated property system is less costly, more efficient, and better for the nation than the existing anarchical arrangements.
Without succeeding on these legal and political fronts, no nation can overcome the legal apartheid between those who can create capital and those who cannot. Without formal property, no matter how many assets they accumulate or how hard they work, most people will not be able to prosper in a capitalist society. They will continue to remain beyond the radar of policymakers, out of the reach of official records, and thus economically invisible.
FIGURE 6.1
Western governments succeeded in lifting the bell jar, but it was an erratic, unconscious process that took hundreds of years. My colleagues and I have synthesized what we think they did right into a formula we call the “capitalization process,” with which we are assisting various governments throughout the world. The formula is outlined in Figure 6.1. Explaining the details is not part of this book, but readers who would like a technical description of the entire plan are invited to consult unpublished documentation in the Institute for Liberty and Democracy archives. In the rest of this chapter I will focus on the two indispensable components of the formula: the legal challenge and the political challenge.
Part I: The Legal Challenge
As things stand, the creation of one integrated property system in non-Western nations is impossible. Extralegal property arrangements are dispersed among dozens, sometimes hundreds, of communities; rights and other information are known only to insiders or neighbors. All the separate, loose extralegal property arrangements characteristic of most Third World and former communist nations must be woven into a single system from which general principles of law can be drawn. In short, the many social contracts “out there” must be integrated into one, all-encompassing social contract.
How can this be accomplished? How can governments find out what the extralegal property arrangements are? That was precisely the question put to me by five members of the Indonesian cabinet. I was in Indonesia to launch the translation of my previous book into Bahasa Indonesian, and they took that opportunity to invite me to talk about how they could find out who owns what among the 90 percent of Indonesians who live in the extralegal sector. Fearing that I would lose my audience if I went into a drawn-out technical explanation on how to structure a bridge between the extralegal and legal sectors, I came up with another way, an Indonesian way, to answer their question. During my book tour, I had taken a few days off to visit Bali, one of the most beautiful places on earth. As I strolled through rice fields, I had no idea where the property boundaries were. But the dogs knew. Every time I crossed from one farm to another, a different dog barked. Those Indonesian dogs may have been ignorant of formal law, but they were positive about which assets their masters controlled.
I told the ministers that Indonesian dogs had the basic information they needed to set up a formal property system. By traveling their city streets and countryside and listening to the barking dogs, they could gradually work upward, through the vine of extralegal representations dispersed throughout their country, until they made contact with the ruling social contract. “Ah,” responded one of the ministers, “Jukum Adat (the people’s law)!”
Discovering “the people’s law” is how Western nations built their formal property systems. Any government that is serious about reengineering the ruling informal agreements into one national formal property social contract needs to listen to its barking dogs. To integrate all forms of property into a unified system, governments must find out how and why the local conventions work and how strong they actually are.
The failure to do so explains why past attempts at legal change in developing and former communist countries have not worked. People tend to look upon the “social contract” as an invisible, godlike abstraction that resides only in the minds of visionaries like Locke, Hume, and Rousseau. But my colleagues and I have discovered that the social contracts of the extralegal sector are not merely implied social obligations that can be inferred from societal behavior; they are also arrangements that are explicitly documented by real people. As a result, these extralegal social contracts can actually be touched, and they can also be assembled to build a property and capital formation system that will be recognized and enforced by society itself.
The Move from a Precapitalist to a Capitalist Property System
Without an integrated formal property system, a modern market economy is inconceivable. Had the advanced nations of the West not integrated all representations into one standardized property system and made it accessible to all, they could not have specialized and divided labor to create the expanded market network and capital that have produced their present wealth. The inefficiencies of non-Western markets have a lot to do with the fragmentation of their property arrangements and the unavailability of standard representations. This lack of integration restricts interaction not only between the legal and the extralegal sector but among the poor themselves. Extralegal communities do interchange with each other, but only with great difficulty. They are like flotillas of ships that remain in formation by navigating with reference to each other rather than to some common and objective standard, such as the stars or the magnetic compass.
Common standards in one body of law are necessary to create a modern market economy.2 As C. Reinold Noyes has pointed out:
Human nature demands regularity and certainty and this demand requires that these primitive judgments be consistent and thus be permitted to crystallize into certain rules—into “this body of dogma or systematized prediction which we call law.”…The practical convenience of the public…leads to the recurrent efforts to systematize the body of laws. The demand for codification is a demand of the people to be released from the mystery and uncertainty of unwritten or even of case law.3
To make the transition from a condition where people already rely on a diversity of extralegal practices established by mutual consent to one codified legal system is a daunting challenge. As we have seen, this is what the nations of the West had to do to move from precapitalist “primitive judgments” to a systematized body of laws. That is how they lifted their bell jars
. However, as successful as those nations have been, they were not always conscious of what they were doing and left behind no clear blueprint. Even in Britain, eager to extend the benefits of the Industrial Revolution, reform efforts went on for almost a full century (from 1829 to 1925) before the government was in a position to make sure that real estate assets could be centrally recorded and easily transferred. John C. Payne sums up how difficult and erratic property reform was for England:
A great many statutes were passed, and English property law was made over from top to bottom. Much of this reform was ad hoc improvisation, and one gets the impression that the leaders of the movement did not always have a clear idea of what they were doing or why they were doing it. English land law had become so technical and had gained so many accretions through the centuries that the task must initially have seemed almost overwhelming. The difficulty was that there was so much detail to be attended to that it was hard to get to the heart of the matter. So the English reformers began to strike about them with all good will but with more energy than clarity of concept. In the long run they did their work well, but it took them a century to do it, and in the interim they attempted many unsuccessful experiments and were ultimately forced into a number of compromises.4
The Failure of Mandatory Law
One might assume that today it would be relatively easy for developing and former communist nations to lift their bell jars. After all, the right of universal access to property is now recognized by nearly every national constitution in the world and by many international conventions. Programs to endow the poor with property exist in almost all developing and former communist countries. Whereas the reforms of the West during the eighteenth and nineteenth centuries encountered widespread intellectual and moral resistance against sharing formal property rights, access to property is today considered part and parcel of the fundamental rights of humankind. A wide array of contemporary international treaties, ranging from the Universal Declaration of Human Rights of 1948 and the catechism of the Catholic Church to the 169th Covenant of the International Labor Office on Indigenous and Tribal People in Independent Countries of 1989, insist on property as a basic and stable human right. In different degrees, courts and laws all over the world see this right as an important legal principle. The invading army’s age-old custom of plundering property has been explicitly forbidden by international law since the International Convention of The Hague of 1899. International law thus treats the property rights of individuals as more sacred than the sovereign rights of states, providing that even if governments lose lands, property owners in those same territories shall not lose theirs.
The Mystery of Capital Page 15