Case Study: A Toolbox for Today’s Visionary Leaders: How to Transform Property Rights for a Robust Formal Economy

by Dr. Elena Panaritis[1], Thought For Action

 The lack of reliable property rights is a boundless problem. No country is immune.

In a world of informality, people live and work outside the formal market structures. Though not well understood and even less well addressed, informal property (land and real estate) affects markets and society. Awareness of the problem is rising, but not so awareness of the appropriate solutions. The way in which informality is conceptualized is a big part of this problem. Often, informality is lumped together with illegality and the black market. Though all three may exist together, they are not the same.

It is a fallacy to assume that informality in markets is the same as illegality. As I have explained in Prosperity Unbound; Building Property Markets with Trust (New York, N.Y., Palgrave MacMillan, 2007), informality does not imply a violation of the law. In fact, informal markets grow out of the formal system when it becomes too difficult or impossible to “play by the rules” because the rules are arbitrary and inconsistent – overly restrictive, unclear, unpredictable or costly to follow[i]. As such, informality is a survival mechanism, because there is an absence of choice for those who find themselves unable to join the formal markets. This is not the case with illegality[ii] in which there is a choice – a choice to cheat the system.

This brings us to a second fallacy – that of confusing the term informal market with black market. According to the Oxford English Dictionary (Oxford University Press 2016), the black market is defined as “an illegal traffic or trade in officially controlled or scarce commodities”.

Given this uncertainty in defining informality and distinguishing it from illegality and the black market, policymakers often fall into the trap of perceiving informality as essentially unsolvable. And so, they try to patch it with conventional efforts, such as government housing policies and titling programs. But these fail to address the fundamental causes of informal property ownership in the long-term[iii].

Transforming informality requires looking at the problem of informality through different lenses – ones that view the root cause of informality and ones that explain why there is such a mismatch between citizens’ demands and the formal rules of the State.

For a thorough diagnosis of the reasons of informality and its implications, Reality Check Analysis[iv] (RCA) can be applied. RCA takes into account the history and the incentives in place when formal rules (written rules, agreements and norms) were first established. This analysis may reveal that the formal rules served all or part of society’s needs at the time of their inception, but no longer do so. Or it could reveal that formal rules were imported, imposed or adapted in ways that are not appropriate for the local reality. Another possibility is that formal rules were abruptly disrupted by other ones due to colonization, civil war or a dictatorship – a major event that affects the behavior of citizens and the community regarding any social or economic exchange[v].

Overall, RCA reveals the types of policies that were historically applied by the State. By doing so, it provides the tools to reverse rules that create bottlenecks and push people to informality. A serious State approaches citizens regarding “who” they are, “what” they have (own), “how” they relate with what they have (land, home, property etc.) and “who” is responsible for securing what they have (what part of the State). It is this key set of relations that allows for a well-functioning and efficient State – one that is also attractive to invest in and live in. This is what distinguishes a serious State from others that base their power on short-term entitlement provisions and populism.

The purpose of this case study is to provide a guide for political leaders concerned about the extent of the informal sector in their country and who are searching for the right solutions. Since the necessary reform can be overwhelming – often deemed impossible with no quick wins, this study will address the five major concerns shared by most leaders.

A starting question is why property rights[vi] are necessary to transform informality.

The multi-facility of the characteristics of property is remarkable. It is striking how property hosts us, confines us and defines us – our communities and our nations. Property is also a source of honor and pride. Under this view, the process and the system through which property rights are managed and property titles issued is key to ensuring basic rights for all. In this sense, a successful property rights system, by definition, is one that provides efficiency and security.

A property rights system can provide stability and predictability in social relationships, and builds a strong middle class. It is a sanctuary for children, the backbone of small business investment, and the vehicle for community growth. It serves as a catalyst for people to gain more freedoms, such as: freedom to best use ones time, freedom to grow and protect one’s wealth, freedom to travel, freedom to apply one’s skills to the best jobs allowing for labor mobility, freedom to choose and have a civic voice and thus civic engagement. Property rights (ownership and usage of land and real estate) constitute the cornerstone of all the other defining features of the just, efficient and prosperous society that we wish to create and live in.

On the ground, informality weakens the middle class – the engine of prosperity – and widens the gap between rich and poor, increasing marginalization and incubating poverty. All this can be avoided if the State reverses the rules that perpetuate informal markets. Any country that does not allow secure access to shared prosperity for all is a poorly performing one.

It is important to outline the main socioeconomic benefits of property rights developed in some of the most unlikely places. Approximately 3,000 Peruvian households were used for a baseline survey in 2000[vii] to measure the socio-economic impacts of transforming informal property to formal secure property with clear rights and enforcement. The findings showed the following measurable impacts:

  • Stronger middle class
  • Higher levels of social mobility
  • Reduction of child labor
  • Higher levels of involvement of women in civic engagements
  • Reduction of insecurity in investing in property (improving it or pursuing farming investment)
  • Increased levels of trust towards the State and to the community, as well as to the services provided by the State
  • Reduction of cottage industries and the creation of more efficient, large-scale local productions
  • Increased land and property values (resulting from a reduction in the amount of risk and insecurity)
  • Increased financial wealth base creation due to the fact that the asset is now lendable and guarranteeable at cheap rates.

A well-established system of property rights also serves as the basis for establishing and guaranteeing positive state-building. In this way, property rights allow for a just and efficient way to begin tapping resources so that they benefit individuals, as well as private and public groups within societies and economies. This can be achieved by increasing security and predictability, and creating an attractive ecosystem for residents, investors, entrepreneurs, locals and foreigners.

As such, a visionary leader is the one who fills the role of catalyst and partner for all the above mentioned relationships, establishing the correct incentives for all participants to engage in the prosperity for all.

What are the implications for political leaders who introduce a property rights-based transformation in their country?

It requires a visionary political leader to be able to understand the problem and capture its solution in a “holistic[viii]” manner. It is a challenge to do so and a rarity because informality, property, property rights, economic growth and state-building are all interconnected issues for ensuring how the basics of a property rights system functions.

Traditionally, however, post-WWII academics, policymakers and even the development paradigm have not treated it as such. They do NOT look at the problem in a holistic manner, but segmented, and discourage anything different. They make it harder to see the process of fixing property rights as a process of fixing incentives in agreements and rules of the State. Fixing property rights has been fragmented, inviting technicians, engineers, lawyers and administrators, but rarely institutional economists who can see the synthesis of the breakdown and can fix it through the use of incentives (RCA is such a model). Therefore, today’s politicians will have to prove smarter than traditional economic policy thinkers.

The seeds of transformation can only be sown when political leaders surpass their traditional roles and stop trying to muddle through. Only the political leader who becomes a catalyst for deep change will be able to reap an abundance of rewards and benefits. And the biggest reward is that of gaining the trust of his or her constituents.

The benefits are a fusion of the following: (i) gaining the trust of his/her constituents; (ii) turning constituents into his/her partners in pushing further for reforms; and (iii) adding to the impetus and ownership of the reform. The change is the one that directly benefits the people, making it their change and not that of their leader. This is the point when the leader has WON, as the change has become self-sustainable.

When I led the implementation of property rights reform in Peru, the biggest challenge was to quantify the impact, both socially and economically. The World Bank Quality at Entry Review rated the reform as “innovative”.

An overwhelming majority (94%) of Peruvians with formal property rights said they benefited in a multitude of ways.

  • They began to trust the State, which offers them the freedom to own property and be able to prove ownership at the lowest cost and with the greatest possible efficiency. They trust that under the new system, the State will enforce their ownership rights.[ix]
  • As people began to participate in the formal market, the middle class strengthened. When this occurs, the popularity of leaders who lead such reforms is high and takes on heroic proportions in the eyes of citizens, who have secured the basic level of their savings and investments, their current existence and their future plans. They respect their leader, who has changed the system of rights emission so that they have gained their dignity (their home).

This is the highest element of impact generation – enhancing citizens’ trust toward the State and its leaders.

What’s needed to apply the reform and what is the key for a successful outcome?

First and foremost, a visionary leader should head a team that has an appetite for change. This is a prerequisite for the overall process to have a possible successful outcome. It’s not enough to simply have a political leader who speaks with “political will”. In fact, it should not even be considered a sufficient condition since one can only be certain of a leader’s genuine intentions when he or she is able to mobilize staff with a deep urge and a positive appetite for change.

The second element is to have good diagnostics. Making the correct diagnosis will allow for the best solution – one that is tailored to meet a country’s specific needs. For the leader and his or her team to be able to design the correct solution, they need to be clear about the distinctions between informality and illegality, as well as the formal institutions and organizations, and what are the ingredients for a proper property rights system. RCA could prove to be very helpful in making these distinctions, which lead to the correct diagnosis of the problem. This is key to designing an appropriate and efficient country-tailored solution.

RCA can uncover how past policies have affected the formal rules in place, as well as, people's behavior and incentives. It can help practitioners understand how the country’s institutions and organizations developed over time and determine whether the problems are chronic, recent, deep or superficial. It can also help identify partners to work with – those who have a stake in the outcome and a strong interest in the changes.

The main goals of RCA are outlined below:

  • To connect the public and private sectors and to promote their working together in profitable partnerships.
  • To introduce a different relationship among investors, policymakers, economists and technocrats without eliminating or reducing the richness of their analysis and rigor.
  • To identify levels and layers of opposition (visible, latent and potential – simple or perplexed) and understand that these cannot be ignored nor underestimated. Reformers need to identify the sources of its strength and devise a plan to counter any resistance.
  • To iron out the wrinkles created by how the segmented parts of the property rights process have resulted in overlapping, friction and mismatching. This is precisely why reforms that affect only organizations and create "cookie-cut" solutions do not work.
  • To take a holistic approach that allows for the broadest view of the problem. This means handling the asset of property as a financial asset and as a social asset too.
  • To restore trust among market participants and create the impetus for a more dynamic real estate market (change makers).

The third element is to understand that the political leader and his or her team, working at different levels, need to have a thorough understanding of the key principles that make up a property rights system[x]. These are:

  • Cost-effective ensuring asset tradability
  • Legitimate and enduring
  • Catalytic for social and economic transactions
  • Reliable provision of public information
  • Dynamic and adaptable to social change

This is at the level of the homework that the reform team should conduct in order to be able to best assess the impacts of its solution design and the level of assistance, as well as the advisers they ought to recruit.

As for the actual launch of the new property rights system, the fourth element is that of sequencing economic policies and reforms that need to precede the actual property rights reform. Certain macroeconomic conditions and financial reforms need to be in place. For instance, inflation must be controlled, currency must be stable and private sector investment and finance must not be crowded out by government policies that create unfair competition and market distortions. If capital markets have not been fully developed and a country's fundamental macroeconomic conditions are poor, its property market will not become vibrant even after property rights reform.

Timing and strategy represent the fifth element in organizing a successful property rights reform. The timing of entry to start the reform is critical. It is important to be able to identify when and where to begin, as well as when to let go and transform the reform to normality. It is also important to realize when the principles have been compromised. This is a most unfortunate scenario, because it means the reform can no longer be sustained. However, in order to control the damage and avoid any loss of trust and confidence, the reform needs to be enveloped by new partnerships. But even in this case, there must be continuity in the institutional change, regardless of whether it is being pushed from the top-down or from the bottom-up.

As long as the strategy encompasses these elements, reformers can drive the change from inception to successful completion.

How can one identify the effective advisors?

Ultimately, success hinges on the quality of the advice provided for such non-traditional reforms. There are some rather unfortunate situations in which the advice does not yield the desired results. This confuses political leaders and further erodes the trust between the citizens and the State, maximizing market confusion. It also weakens the leader’s leverage. This is why political leaders need to have the skill tips to steer away from this dangerous path.

Watch out! Even though property rights serve as the foundation for market development and for effective and long-term economic growth, the principle of formal property rights is still not a core business of the Traditional Development Paradigm. Although, it is presented as a major issue of reform (especially after the enormous success of informal property rights transformation in Peru in the late 1990s) and much of the policy prescriptions, and development policy language suggest that governments apply property rights reform, there is no manual. Among a plethora of books written about economic policy, Prosperity Unbound fills some of the knowledge gap as regards to property rights reform.

Also there are several indexes that provide some soft-scale comparison of reform effort. Examples are the annual World Bank - Doing Business Report[xi] that measures the ease and time it takes to register a property per country, and the Index of Economic Freedom (IEF)[xii]–  indicators that measure in an indirect way the efficiency of the land market (such as how secure is the application of contracts). It is important to understand what can be done and how to study, diagnose, correctly implement, and ultimately resolve the problem.

It remains a challenge to identify the proper advisors. Evaluations are difficult to be carried out because there are few success stories in the area of a holistic property rights system reforms (examples include Peru, New Zealand, Bulgaria and Thailand). What is more, even if there is lots to claim by advisors, very few have been the actual implementers. On the contrary, there are many projects that look as though they had conducted a thorough holistic reform yet they have tackled the issue in the traditional technical and segmented fashion that does not really strengthen trust, the middle class and the property market at large.

In any case, the market is packed with advisors who do not always fit the bill. A rather easy way to make a first cut is by asking the following questions:

-          In which countries were they involved? What was their level of involvement? What was the result?

-          What were the difficulties they identified?

-          Ask them to provide a quick assessment of your country’s problem and see how it fits with the reality you know?

It has been proven that this type of reform will only lead to a “holistic” transformation if there is a long-term commitment from the expert-advisors and a strong leader with a healthy appetite for reform. Peru is a unique case. Even though there have been some repeats, none are at the same level due to a lack of all the above mentioned characteristics.

The final section of the case study will provide examples of countries where property rights reforms were successful and countries where they failed.

This section reviews and analyzes indicators measuring the evolution of property rights integration in Albania, Brazil, Bulgaria, Haiti, New Zealand, Peru and Russia. More specifically, it will help identify the effectiveness of the work undertaken by providing an overview of the cost of loans issued to a country compared to the level of informality that still exists (i.e. the level of difficulty in registering property).

Taking Albania as a starting point, it is evident that no amount of funding can ever fully guarantee a successful outcome if the malfunctioning institutions are not repaired. Success can be guaranteed only when reformers address the fundamental causes of informal property ownership in a way that is both long-term and sustainable.

In Albania, the current property rights system brings about serious economic costs[xiii]. A lack of a concerted and comprehensive approach to address the property rights issue prevented an increase in foreign investment, which is risk-averse when it comes to property rights, legal uncertainty, and social stability.

According to the World Bank’s Doing Business 2016[xiv], registering property in Albania requires 6 procedures, takes 22 days and fees are 10.2% of the property value. The 2016 Index of Economic Freedom[xv]also notes weak property ownership protection, a highly inefficient judiciary with delays so long that they deter the use of the court system. Expropriation is also possible.

A similar analysis can be carried out for other countries, including Russia, Haiti and Brazil. For instance, the lesson learned from Russia’s experience is that conditions can erode rather quickly when institutions are malfunctioning and trust in the market and society is weak[xvi]. In 1991, Russia[xvii]embarked on a massive economic transformation towards privatizations and freeing prices from State control. The problem, however, was that the new Russia had inherited a rather challenging legacy from the Soviet Union, including ineffective public services, weak public organizations, contracts and compliance obligated by force and inadequate fiscal discipline. Underneath this was a popular skepticism and distrust of the country’s organizations and bureaucracies.

According to data collected by the World Bank’s Doing Business 2016[xviii], registering property in Russia requires 3 procedures, takes 15 days and fees are only 0.2% of the property value. According to the 2016 Index of Economic Freedom[xix], private property is weakly protected. The court system is also so inefficient and corrupt that outside settlement and arbitration is the norm. Property rights are difficult to enforce. Judicial corruption is extensive. Expropriation is common.

Haiti is another example of a country that has failed to turn the tables on informal property rights. According to data collected by the World Bank’s Doing Business 2016[xx], registering property there requires 5 procedures, takes 312 days and fees are 7.1% of the property value. The 2016 Index of Economic Freedom[xxi]notes that private property is rarely protected and almost all property belongs to the State. In fact, the country is in such chaos (for example, because of ongoing war) that protection of property is almost impossible to enforce. The judiciary is also so corrupt that property is not protected effectively.

Brazil is yet another case in point. According to data collected by Doing Business 2016[xxii], registering property there requires 13.60 procedures, takes 31.70 days and costs 3.10% of the property value. According to the 2016 Index of Economic Freedom[xxiii], the court system is inefficient and subject to delays. Corruption may be present, and the judiciary may be influenced by other branches of government. While expropriation is possible, it is rare.

The stories of Peru and Bulgaria are different. For instance, Peru[xxiv] embarked on a massive institutional reform of the very foundation of its property rights system. The reform changed the rules of the game so that property could be transformed into a tradable asset, giving individuals the freedom of choice to use what is theirs in ways that best serves their interests. According to data collected by Doing Business 2016[xxv], registering property there requires 4 procedures, takes 6.5 days and fees are 3.3% of the property value. In its 2004[xxvi] Doing Business report, the World Bank noted that Peru had issued property titles to 1.2 million urban households. As a result, there was a substantial increase, of almost 20%, in the number of work hours away from home, and a nearly 30% reduction in the incidence of child labor. Secure property rights enabled parents to leave their homes and find jobs instead of staying in to protect the property.

Similarly, Bulgaria has made strides in property rights reform, though far from perfect. Registering property there requires 8 procedures, takes 11 days and fees are 2.90% of the property value, according to the World Bank’s Doing Business 2016[xxvii]. Also, the 2016 Index of Economic Freedom[xxviii] notes that Property ownership is weakly protected. Expropriation is possible.

As for New Zealand, it is by far in a league of its own. Globally, New Zealand stands at 1 in the ranking of 189 economies on the ease of registering property, according to the World Bank’s Doing Business[xxix] 2016 report. According to the data, registering property there requires 2 procedures, takes 1 day and the fees are 0.1% of the property value. Also, the strength of New Zealand’s economic and social institutions is enhanced by robust protection of property rights, according to the 2016 Index of Economic Freedom[xxx]. Property rights are strongly protected, and contracts are notably secure.

In conclusion, if there is something to learn from this cross-country comparison it is that success hinges on the reformers’ abilities to identify the type of market in which they are working. They must understand social behavior. They must have a firm grasp of all the incentives that existed historically because it is these that have lead citizens to act – or not.

The approach that has worked in countries like Peru can be repeated in other countries. Done right, institutional reform of property rights can reduce risk, ambiguity, costs of transactions, and create new possibilities for those who hold assets informally by turning them liquid. In such cases, what seemed “unreal” can become real.

 

 

 

 



[1] Elena Panaritis is an institutional economist who has successfully pioneered the transformation of informal markets into vibrant, growing formal economic and social entities. She has been awarded innovation and international best practice for her work and for her method “Reality Check Analysis”. Her book “Prosperity Unbound: Building Property Markets with Trust” recounts her experience and expands on her methodology, which is widely considered one of the best practical applications of institutional economics to property rights issues. She has served as an economist at the World Bank, introducing non-traditional economic reforms such as institutional reforms starting with property rights. She founded Panel Group and Thought for Action to invest and apply such institutional reforms. She has worked on implementing strategies of institutional reforms and property rights reforms in various countries. Most recently, she served as the senior economic advisor to the Prime Minister and Minister of Finance of two Greek Governments during the Euro-Crisis. She has been teaching economic development and international comparatives of property rights. She speaks five languages and holds degrees from Insead, Johns Hopkins University and the American College of Greece.

 



[i]Prosperity Unbound; Building Property Markets with Trust (New York, N.Y., Palgrave MacMillan, 2007), p. 129

[ii]In June 2015, the International Labor Conference adopted a recommendation proposed by the International Trade Union Confederation (ITUC) for “transitioning from the informal to the formal economy”. The recommendation explicitly stated that the term “informal economy” should not include “criminal activities, such as production and smuggling of illegal drugs, the illicit manufacturing and trafficking in firearms, trafficking in persons and money laundering”.

[iii]Prosperity Unbound; Building Property Markets with Trust (New York, N.Y., Palgrave MacMillan, 2007), introduction, xviii

[iv]Prosperity Unbound; Building Property Markets with Trust (New York, N.Y., Palgrave MacMillan, 2007), p. 38

[v]Prosperity Unbound; Building Property Markets with Trust (New York, N.Y., Palgrave MacMillan, 2007), p. 41

[vi]Universal Declaration of Human Rights: Article 17 states that “1. Everyone has the right to own property alone as well as in association with others. 2. No one shall be arbitrarily deprived of his property”.  Article 25 (1) states that “Everyone has the right to a standard of living adequate for the health and well-being of himself and of his family, including food, clothing, housing, and medical care and necessary social services, and the right to security in the event of unemployment, sickness, disability, widowhood, old age or other lack of livelihood in circumstances beyond his control.”http://www.ohchr.org/EN/UDHR/Documents/UDHR_Translations/eng.pdf

[vii]Prosperity Unbound; Building Property Markets with Trust (New York, N.Y., Palgrave MacMillan, 2007), p. 106; also see Socio-Economic Baseline Assessment World Bank, 2000 by Instituto Apoyo

[viii]This term was used originally by E. Panaritis for the purpose of describing the type of property rights reform needed to transform informality

[ix]Prosperity Unbound; Building Property Markets with Trust (New York, N.Y., Palgrave MacMillan, 2007), p. 106

[x]Prosperity Unbound; Building Property Markets with Trust (New York, N.Y., Palgrave MacMillan, 2007), p. 129

[xii]2016 Index of Economic Freedom. A series of 10 economic measurements created by the Wall Street Journal and The Heritage Foundation to measure the degree of economic freedom in the world's nations. It uses statistics from a wide range of published data sources as well as organizations like the World Bank, the IMF, and the Economist Intelligence Unit. First issued in 1995, the Index defines the highest form of economic freedom as "an absolute right of property ownership, fully realized freedoms of movement for labor, capital, and goods, and an absolute absence of coercion or constraint of economic liberty beyond the extent necessary for citizens to protect and maintain liberty itself." http://www.heritage.org/index/

[xiii]Prosperity Unbound; Building Property Markets with Trust (New York, N.Y., Palgrave MacMillan, 2007), p. 137

[xvi]Prosperity Unbound; Building Property Markets with Trust (New York, N.Y., Palgrave MacMillan, 2007), p. 137

[xvii]Prosperity Unbound; Building Property Markets with Trust (New York, N.Y., Palgrave MacMillan, 2007), p. 135

[xxiv]Prosperity Unbound; Building Property Markets with Trust (New York, N.Y., Palgrave MacMillan, 2007), p. 74

 

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