February 3, 2011
More than 90% of Egyptians hold their property without legal title. No wonder they can't build wealth and have lost hope.
By Hernando de Soto
The headline that appeared on Al Jazeera on Jan. 14, a week before Egyptians took to the streets, affirmed that "[t]he real terror eating away at the Arab world is socio-economic marginalization."
The Egyptian government has long been concerned about the consequences of this marginalization. In 1997, with the financial support of the U.S. Agency for International Development, the government hired my organization, the Institute for Liberty and Democracy. It wanted to get the numbers on how many Egyptians were marginalized and how much of the economy operated "extralegally"—that is, without the protections of property rights or access to normal business tools, such as credit, that allow businesses to expand and prosper. The objective was to remove the legal impediments holding back people and their businesses.
After years of fieldwork and analysis—involving over 120 Egyptian and Peruvian technicians with the participation of 300 local leaders and interviews with thousands of ordinary people—we presented a 1,000-page report and a 20-point action plan to the 11-member economic cabinet in 2004. The report was championed by Minister of Finance Muhammad Medhat Hassanein, and the cabinet approved its policy recommendations.
Egypt's major newspaper, Al Ahram, declared that the reforms "would open the doors of history for Egypt." Then, as a result of a cabinet shakeup, Mr. Hassanein was ousted. Hidden forces of the status quo blocked crucial elements of the reforms.
Today, when the streets are filled with so many Egyptians calling for change, it is worth noting some of the key facts uncovered by our investigation and reported in 2004:
• Egypt's underground economy was the nation's biggest employer. The legal private sector employed 6.8 million people and the public sector employed 5.9 million, while 9.6 million people worked in the extralegal sector.
• As far as real estate is concerned, 92% of Egyptians hold their property without normal legal title.
• We estimated the value of all these extralegal businesses and property, rural as well as urban, to be $248 billion—30 times greater than the market value of the companies registered on the Cairo Stock Exchange and 55 times greater than the value of foreign direct investment in Egypt since Napoleon invaded—including the financing of the Suez Canal and the Aswan Dam. (Those same extralegal assets would be worth more than $400 billion in today's dollars.)
The entrepreneurs who operate outside the legal system are held back. They do not have access to the business organizational forms (partnerships, joint stock companies, corporations, etc.) that would enable them to grow the way legal enterprises do. Because such enterprises are not tied to standard contractual and enforcement rules, outsiders cannot trust that their owners can be held to their promises or contracts. This makes it difficult or impossible to employ the best technicians and professional managers—and the owners of these businesses cannot issue bonds or IOUs to obtain credit.
Nor can such enterprises benefit from the economies of scale available to those who can operate in the entire Egyptian market. The owners of extralegal enterprises are limited to employing their kin to produce for confined circles of customers.
Without clear legal title to their assets and real estate, in short, these entrepreneurs own what I have called "dead capital"—property that cannot be leveraged as collateral for loans, to obtain investment capital, or as security for long-term contractual deals. And so the majority of these Egyptian enterprises remain small and relatively poor. The only thing that can emancipate them is legal reform. And only the political leadership of Egypt can pull this off. Too many technocrats have been trained not to expand the rule of law, but to defend it as they find it. Emancipating people from bad law and devising strategies to overcome the inertia of the status quo is a political job.
The key question to be asked is why most Egyptians choose to remain outside the legal economy? The answer is that, as in most developing countries, Egypt's legal institutions fail the majority of the people. Due to burdensome, discriminatory and just plain bad laws, it is impossible for most people to legalize their property and businesses, no matter how well intentioned they might be.
The examples are legion. To open a small bakery, our investigators found, would take more than 500 days. To get legal title to a vacant piece of land would take more than 10 years of dealing with red tape. To do business in Egypt, an aspiring poor entrepreneur would have to deal with 56 government agencies and repetitive government inspections.
All this helps explain who so many ordinary Egyptians have been "smoldering" for decades. Despite hard work and savings, they can do little to improve their lives.
Bringing the majority of Egypt's people into an open legal system is what will break Egypt's economic apartheid. Empowering the poor begins with the legal system awarding clear property rights to the $400 billion-plus of assets that we found they had created. This would unlock an amount of capital hundreds of times greater than foreign direct investment and what Egypt receives in foreign aid.
Leaders and governments may change and more democracy might come to Egypt. But unless its existing legal institutions are reformed to allow economic growth from the bottom up, the aspirations for a better life that are motivating so many demonstrating in the streets will remain unfulfilled.
Mr. de Soto, author of "The Mystery of Capital" (Basic Books, 2000) and "The Other Path" (Harper and Row, 1989), is president of the Institute for Liberty and Democracy based in Lima, Peru.
For the original article on The Wall Street Journal click here (subscription required)