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De Soto's Path: Impediments to and potentials of the informal sector

Alexandra Fasola, Manaswi Shrestha, Camilo Palacios

Alexandra Fasola

on 23 April 2010

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Transcript of De Soto's Path: Impediments to and potentials of the informal sector

The Costs of Formality

Procedure very cumbersome

Paying bribes is the only option for some procedures

Unnecessarily lengthy and costly procedure

Costs directly imposed by the law

The firm’s profits, savings and investment are reduced by one-fourth

Tremendous waste of resources; approximately 40% of employees involved in bureaucratic procedures

Large investment to avoid detection

Operate outside legally established markets and trade affairs

10-15% of gross income used to corrupt the authorities

Lose purchasing power during inflation

Victims of higher interest rates
Invest more on movable assets than fixed assets

Cannot transfer their property easily, so there is less incentive for investment

Difficult to establish the validity of a claim

Due to the inefficiency of extracontractual law

Informal activities affect the community as a whole Significant part of the businesses of one nation
Entrepreneurial class and are forceful pioneers
Proliferation of labor-intensive undertakings
IS inversely proportional to economic growth
Contribute to GDP beyond the minimum wage
The ‘upper-tier informal sector
Employment opportunities for women

Potentials of Informal Sector Costs of access Costs of remaining in the formal sector The Costs of Informality Costs of Illegality Costs of the absence of good law Do not invest in large business due to high risk of business

Tremendous investment of time, effort and money to look for trustable partners

No legal documents for back up, in case of betrayal by one of the parties

Occasional use of violence Absence of property rights Inability to use the contract system 1. Definition and Characteristics
2. The Informal Sector in Peru
3. Costs of Formality and Informality
4. Potentials of the Informal Sector
5. Policy Implications
6. Criticism
7. Conclusion
De Soto's Path:
Costs and Potentials of the Informal Sector The Informal Sector "A mode of organisation different from the unit of production most familiar in economic theory, the firm or corporation. These activities are also likely to be unregulated by the state and excluded from standard economic accounts of national income"

(Swaminathan/WIDER, 1991, p.1)
Ease of entry, low resource based
Labor intensive, adapted technology
Family ownerships, small-scale businesses
Contribution to GDP: beyond minimum wage

Officially mentioned by Hart – 1971
Marginal or basic sector

Mainly in the urban areas
Voluntary & non-voluntary participation

De Soto The Shining Path The Other Path Maoist guerrilla movement in Peru in the 80s and early 90s
“the bloodiest and most murderous guerrilla group ever to operate in the Western hemisphere”
Written by De Soto and the ILD (Instituto de Libertad y Democracia) to counter the Shining Path‘s stance against liberal democracy and capitalism
Peru Policy Implications Policies have to take into account the different needs and causes of the IS
They should be designed to systematically adress the issues of:
Education and training
Policy makers must also bear in mind the heterogeneity of the sector
Blunch et al (2001)
Policies addressing the IS should: “Informalization” is a process of economic development – therefore policies should not forcefully eradicate the IS
Harness the gains of the IS in relation to employment and output
Address complex employer-employee relations
Encourage women‘s participation in the FS
Pool resources for IS policies and poverty reduction programs
Address the rural IS
Blunch et al (2001)
de Soto (1989) de Soto (1989) de Soto (1989) de Soto (1989) Listening to the Excluded Due to bad law, the poor were facing huge entry and operational costs in Peru.

But, how does one identify a bad law?

Answer: do what few governments in history have ever done: listen carefully to the excluded

The ILD designed rules, procedures, and organizations to help the government listen to its own people

The ILD initiated some four hundred major laws and regulations and managed one of the world's largest property-creation projects
de Soto (1989) The Result Real Estate By 1990: decreased the administrative time needed to record property from more than a dozen years to one month, and cut the costs by 99 percent
By 1995: brought into the legal system some 300,000 owners whose property on average doubled in value.
By 2000, some 1.2 million buildings on urban land had entered the legal system, about 75 percent of the extralegal market.
Business Cut the cost of entering business from some three hundred days down to one
Put registration offices in the right places and made the government bureaucracy more user-friendly for small entrepreneurs
By 1994, over 270,000 formerly extralegal entrepreneurs entered the legal economy, creating over half a million new jobs and increasing tax revenues by US$ 1.2 billion

de Soto (1989) de Soto (1989) Legal recognition of coca farmers
The farmers then provided the Peruvian government with most of the information and maps required erradicate the terrorists and drug traffickers from the area
As farmers switched to legal crops, Peru‘s participation in the cocaine market fell from 60% to 25%

de Soto (1989) Peru ranks 56th worldwide and 7th in the LAC region in the ease of doing business
World Bank (2009) Criticism Methodology Lack of scientific rigour:

Focus on selling ideas
Property titles
Land titling - inneffective (Bogotá, Colombia)
Violence and forced eviction (Phnom Penh, Cambodia)
Selective target group

Policies De Soto's Path: Costs and Potentials of the Informal Sector Alexandra Fasola
Camilo Palacios
Manaswi Shrestha Development Economics
Prof. Dr. Hans H. Bass Jacobs University
April 22, 2010 De Soto's Path: Costs and Potentials of the Informal Sector Thank you for your attention! Migration Reception From Migrants to Informals “Informal activities burgeon when the legal system imposes rules which exceed the socially accepted legal framework – does not honor the expectation, choices, and preferences of those whom it does not admit within its framework – and when the State does not have sufficient coercive authority”
de Soto (1989) de Soto (1989) de Soto (1989)
Blunch, N. H., Canagarajah, S., & Raju, D. (2001). The informal sector revisited: A synthesis across space and time. Washington: World Bank.

De Soto, H. (1989). The other path: The invisible revolution in the third world. New York: Harper and Row.

De Soto, H. (2002). The other path: New preface. Retrieved 04/19, 2010, from http://ild.org.pe/books/otherpath/introduction

Gravois, J. (2005, Jan. 29). The de soto delusion. Slate,

Swaminathan, M. S. (1991). Understanding the informal sector: A survey No. WP 95). Finland: Wider.

Woodruff, C. (2001). Review of de soto's "mystery of capital". Journal of Economic Literature, 39(4), 1215-1224.

World Bank. (2009). Doing business 2010: Reforming through difficult times. Washington: A Copublication of the World Bank, IFC and Palgrave MacMillan.

References April, 22, 2010
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