Making Sustainable Development Work: Governance, Finance, and Public-Private Cooperation

You built it from the ground up. Many believe that you got your laws from the British common law. In many cases, however, the common law didn’t work and you had to improvise a series of things that are very useful lessons for the rest of the world. And although they are 19th century things, there are still important lessons to be learned from them.

Another group of people that contributed very much to how you put in place what is needed to bring about the rule of law and sustainable development were people who wrote in the 1930s and in the early 40s. This includes Walter Lippman, who wrote a fantastic book called Good Society. These people, who witnessed the crash of 1929 and then the rise of fascism and international communism, were trying to find out why a sustainable system -- or what appeared to be one -- seemed to be collapsing.

They tried to figure out what had caused the collapse and how to make development sustainable. These issues are very relevant today, yet, these books are no longer in print. Nonetheless, it’s really all there is, and what we in Peru -- as well as in those countries that have invited us in the Middle East, Asia, and now the former Soviet Union are doing -- is simply thinking about these situations in terms of our own reality; trying to adapt these lessons to our own reality.

One of the things that has been a constant in the course of this conference is our attempt to define what sustainable development is. I think Andrew Natsios said, "We’re really talking about good governance." The gentleman from Shell said, "We’re talking about institutional frameworks, rules." This was also mentioned at the Rio Summit where Stephan Schmidheiny said that it was a question of satisfying the needs of those living today without compromising the needs of future generations. The idea behind all of this is that to do anything, you need rules. What are the rules for getting sustainable development in place; what are the rules for conserving the environment and making it better?

These are the questions our organization, the Institute for Liberty and Democracy, the ILD, tackles. We essentially deal with rules. The principal questions put to us wherever we go, from Russia to Egypt, is always, why -- especially since the fall of the Berlin Wall -- haven’t we been able to implement the rules of a market economy?

My answer is, there is a market economy, but it is a black market economy. In fact, when I had the privilege of having a long conversation with President Putin not too long ago, our whole discussion revolved around the issue of why these black markets are so big and why we can’t make them perform according to universally fair and standardized rules.

It’s not that we don’t try. We have been trying to copy your rules for over two centuries. For example, we Peruvians have been trying to improve our traffic system for some time. In fact, 50 years ago some Peruvian legislators noticed the excellent Swiss traffic system, where everyone drove carefully and as a result had eleven times fewer accidents than we Peruvians did. So, we translated the traffic rules of Zurich from German into Spanish and that’s what we have in Lima today, the traffic rules of Zurich -- and we are still having as many accidents as before.

This taught us that though good rules are important, you can’t just copy them. Good rules need roots. They have to connect with what’s happening on the ground. And what our organization has been trying to do over the last 15 years or so is see why it is that the good rules that protect the environment, protect transactions, and give you a framework for investment don’t work in the majority of countries.

First, we have found that there isn’t a lack of rules; there are plenty of rules, even poor people have rules. But in most developing and former Soviet countries, the rules are fragmented into lots of little pieces. In some parts of Lima, for example, you’ve got rules that people abide by, literally for 10 blocks in one direction and five blocks in another direction.

The same was true in the United States, back in the 19th century. You had several ways of awarding property rights: the log cabin systems, the Miami River System, the California Gold Claim Association System -- you had thousands of little legal systems that you eventually brought together into standard rules and made law. The question is, how do we go about integrating our laws into one national system so that development becomes sustainable as it did for you?

Part of our strategy consists of going in and making the subject visible, making people aware of the problem. Really, there are huge black markets throughout the world. There are numerous and enormous markets where the official rules are not obeyed. Countries where no more than 5, 10, or 15% of the population obeys the rules. And though everybody sort of understands this hypothetically, they are not able to grasp its full significance.

One of the first things we six Peruvians and 30 or 40 local people do, is draw up a map of where the rules aren’t working. In Egypt, for example, after about a year, we went to the Head of State and his staff with four volumes of findings. For our discussions, however, we gave them one page with five illustrations on it instead, because Heads of State and their staff are very busy people. We said, okay, we have an idea of what your black market looks like. We know who the people that are outside the system are, who do not trade and hold assets according to law, who do not get credit according to law, whose property is not titled or represented in any legal form that is valid on a universal scale within Egypt.

We show them maps of where the extralegal real estate and businesses are located in Cairo. The first is a colored-coded map of Cairo with the nine principal ways that people hold assets outside the legal system, within their own legal agreements.

Category number one comprises extralegal constructions on agricultural land. When we showed these, one of the government officials came up and told us that these constructions were not only extralegal, but unconstitutional as well.

Yes, we said, but we’ve counted them and there are 4,700,000 buildings on agricultural land that are illegal and unconstitutional. If we calculate how much these buildings are worth at replacement value, we find that each of these constructions has an average value of $10,500. That’s $50 billion which you cannot burden with a mortgage. The industries inside cannot issue shares, get investment, or credit of any sort.

We keep on going down the different categories. In the center, you have public housing. That’s when another of the government officials gets up and says, now hold it, how can public housing be extralegal? We built that. We said, yes, but you may recall that you built two stories and these buildings have six. The people in the first two stories built the other four stories extralegally. Some of them are people who did such good business, that they went ahead and did the same for people in other buildings. The majority, however, are people who decided to build without official authorization because the cost of the procedures are prohibitive.

How much of the Egypt’s population lives extralegally? Well, in the urban sector it is 92% of the population. In the rural sector, it is 83%, and if you are talking about business, it’s 88% of all business. So, how much of the population is in the legal sector? It’s only about 10%. And, in my country, by the way, it’s about 20%; in Manila it’s some 28%.

How much are all of these extralegally held assets worth? In the case of real estate alone, it’s $241 billion. That is, it’s 30 times more than the Cairo stock exchange, 55 times more than all foreign investment in Egypt over the last 150 years, including the Suez Canal, 70 times more than all foreign aid, and 160 times more than all privatizations.

In the case of Mexico, we’re talking about roughly $315 billion in the hands of the poor, which is about seven times the value of the national oil company, PEMEX. And the people holding these assets make up about 78% of the population. In Mexico, the overwhelming majority lives and works outside of the system too.

The question is what gives rise to all of this extralegality and what does it mean? Let me explain. I’ve got an apple here, and it is mine. I’m sure you all believe it’s mine, because everybody around my table saw me walk in with the apple. Now, you look at that apple and probably all agree by now that it’s mine, but nowhere on that apple is it written that it belongs to Hernando De Soto -- nowhere. A stolen apple and a legitimate apple both look the same. The property of the apple and the functions we can attribute to it are not contained in the physical object itself. Nothing in the apple says whether I can pledge it, lend it, deposit it as a guarantee, use it as collateral, or whether I can cut it up among partners. In other words, the commercial and social life of my apple is not determined by the apple itself, but rather by the rules which we establish among ourselves to allow the apple to be traded and be attributed with commercial and financial functions that are accepted globally. That is, global transactions, whether commercial or financial, are possible not because we can make things travel physically, but because we can represent them in a manner acceptable to all and subject these transactions to rules we all recognize and accept.

The difference between developed and developing countries and those in transition from communism to market economies is that developed countries have a universally accepted, and accessible, standardized property system that allows you to leverage the value of your assets. There isn’t anything from a bicycle to a building to a power plant in the United States that isn’t titled, registered, and submitted to standardized rules.

Now, why is this important? Well, let me give you an example. In 1990, we in Peru followed, "The Washington Consensus." This basically meant carrying out three macroeconomic adjustments: stabilizing our currencies, balancing our budget, and privatizing our public assets. Regarding privatization, one of the first things we did was try to privatize the Peruvian Telephone Company, which was worth $53 million on the stock market at the time.

We went out to try and sell the telephone company to several firms, but they weren’t interested. Although the title to the company was acceptable on a local level, it was not recognized globally. So, we put together a top-notch international and local legal team that over the following 3 years structured the rules on the property of the telephone company in a way that foreigners also found acceptable.

The company was sold to Telefonica of Spain for $2 billion. That is to say, 37 times more than it was worth on the Lima Stock Exchange only 3 years before. And we didn’t even give it a single coat of paint, change the doors, or put in new windows, yet we sold it for 37 times as much. That’s what law can do for a country’s assets. If properly represented and ruled by universally accepted laws, property can be given multiple uses. And through this standardized and organized information, and appropriate laws, holders and investors can discover hidden values that could not be detected previously.

When you have standardized, legal representations, you can spot and extract the hidden or potential values of assets, as well as interconnect within the larger market.

You don’t have to go to markets with your cow to sell it. No. You can go to the Chicago Stock Exchange with a piece of paper that says you own 10,000 heads of steer with such and such characteristics. That paper will tell me much more about the 10,000 cattle than I can learn by looking at Betsy the cow, because the commercial life, the real life of things in the market economy, does not travel in physical objects, but in representations.

When you create a property system that everyone has access to, a system that represents things, with standardized rules anchored in a consensus, you have sustainable development and you have obedience of the law. Then you can really start addressing why the economies of Third World countries do not grow.

Whether you go to Cairo or to Kabul, you’ll find that people are buying and selling things. But they are doing it in micro markets, with no economies of scale, with no accessible property system with standardized representations.

The reason I can communicate my thoughts to you is that somebody invented representation through the alphabet, through rules of grammar. But there are no universally accepted rules to communicate commercially and to create capital on a wide scale in nine-tenths of the developing and former communist world.

What do you have to do to change this situation? First of all, you’ve got to go into the informal sector to look at the law from the point of view of those who are outside it. This is essential.

Now in Egypt, one of the government officials asked us, "Why do we Egyptians seem to prefer the extralegal sector? Is this dislike of the legal cultural?" We said, "Not at all, Sir." In one case that we studied, we found that to receive authorization to build a home or a building on a sand dune, the poor and middle classes have to visit 31 government agencies and carry out 77 bureaucratic procedures, all of which can take as many as 17 years. In Peru, it was 21 years; in Manila, it’s 54 years.

So before we make any further cultural conclusions, let’s look at the quality of our laws, at the existing legal systems in developing and former Soviet countries.

The first thing you’ll see is that we’ve been copying rules from abroad, like the wonderful traffic laws in Zurich. Yet, we’ve forgotten that the essential reason for which you are successful with your laws is that they are born from the bottom up and not like ours, from the top down.

The interesting thing is that these are things that the West knows well. Long before MacArthur arrived in Japan in 1945, for example, there had been a movement to change the property structures. In fact, between the early 20th century and 1945, there had been over 170 peasant revolts against the system in Japan. They were the people who lived underneath the feudal system, who worked parcels that belonged to the feudal lords. The only thing the feudal lords wanted was for the people to pay their taxes and their rent. Some of them had never even visited the lands they owned.

When MacArthur got to Japan, he saw that the big problem was that the feudal warlords had this vast peasant infrastructure ready to fight for them. He asked, how do we undo this whole thing? In the end, his solution, interestingly enough, was to invite the Japanese Government to change the law.

With the help of Wolf Ladejinsky, who worked for the United States Department of Agriculture, and with that of progressive Japanese technocrats, MacArthur arrived at the conclusion that the only way to neutralize the feudal force was by replacing it with a property based system that made all Japanese citizens stakeholders.

His arguments, of course, became much stronger as the months passed, because Mao Zedong was starting to win the Chinese war, moving down from Manchuria, disposing of the feudal sector, and giving the peasants more control over the land.

MacArthur had to move very quickly. His strategy was to give the people title to the land they were on and to give it to them according to the common law that they informally applied among themselves.

Now, a few years ago, we at the ILD saw we had an opportunity to talk to the people who had actually participated in the making of this new order and we jumped at it in order to confirm whether or not we were on the right track. We went to Japan and the International House of Japan brought together the seven remaining octogenarians who had managed the reform between 1945 and 1950. After two weeks, we confirmed that the Japanese had built their property rights system from the bottom up -- by codifying and standardizing grassroots social contracts that people understood and believed in.

The Japanese couldn’t have done it if they hadn’t had the necessary inside or underground information, because they wouldn’t have known who to give the titles to. They would have ended up like us Latin Americans who continually have grand reforms that everybody eventually disobeys because they don’t correspond to what people actually believe in.

To make the paper reality work one has to anchor it in the reality on the ground by way of participation. Participation is a very important part of development. How did the Japanese get this participation? To begin with, by using posters to communicate with the people. Posters can capture very complex ideas and transmit them simply. We found 350 posters and we’ve got a collection of these in Peru and I’m going to share two with you, because I think they tell the whole story.

The Japanese found that the people who really knew who owned what in Japan and what the rules for trading were were the 10,900 informal village or neighborhood associations called Burakus scattered throughout the country. The authorities made them official by converting them into legal land commissions with the necessary authority to determine who owned what and how property should be ruled.

Essentially, they legalized the informal law, the law that came from the bottom, with the active participation of the people themselves.

Once the people had the titles to their land, they elected representatives to inform the authorities in the next level about the titles. Those at the following level, who were the prefectures, wrote out the law. The Ministry of Agriculture, that was in charge of the registry system that had been set up by the Germans about 70 years earlier, then wrote it all up in the new record-keeping system, incorporating the new property laws. And that’s how today you have a Japan with a popular capitalism as opposed to my country, which has an elite capitalism.

In poster number two, the first thing we see is the Meiji restoration being dismantled, because what the Meiji restoration did was basically legalize the assets of the elites. As most of the reform programs we carry out in our countries more or less do. Second, we have the village organizations or Burakus, where people decide who owns what. Third, a new law and record system being drawn up and incorporated. And fourth, the people getting their titles. The entire process, by the way, was illustrated in posters by the Japanese as part of an anti-poverty program.

Now, all of this shows that at its genesis, property law has to have its roots in what people accept and understand. Creating the law from the bottom up is not just wishful thinking. This can be done.

Now then, what I would bring to the table of your discussions on sustainable development is that the hidden architecture of sustainable development -- the hidden architecture of a capitalist system -- is the law. And this law has to be grounded in the people. You have to make sure that everybody is represented and that everybody gets a legal hold on the assets they already own in most cases. Laws determine the costs of entry. But laws, or their absence, also affect the costs of remaining formal, and the transaction costs of operating within the formal sector. And for this you have to see if the laws are getting in the way, or if a certain type of law is not in place.

In the last 40 years, there have been mass migrations to the cities. The size of the population in Port-au-Prince in Haiti has multiplied 17 times, that of Cairo has increased 7 times, that of Guayaquil in Ecuador 11 times, and that of Lima six times. We’re into the industrial revolution. Oliver Twist has come to town, and he isn’t being accommodated by the system. And just as advanced countries once learned that they had to change the law to accept and harness this growing tide of energy by adapting the rules to the new society that is building up spontaneously on the ground, by giving the poor property rights, we too have to adapt the law and give the vast majority of people the property required for them to participate in the standardized world economy on an equal basis.

Thank you very much.