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Hernando De Soto for Chief Economist

Monday, June 25, 2007

An insightful Peruvian could shake up the World Bank.

helpRobert Zoellick could use the bank’s influence to help revive dead capital in developing countries. To that end, he could do no better than to follow the advice of Mark Davis and appoint Peruvian economist Hernando de Soto as chief economist for the World Bank. De Soto believes that the combination of an overabundance of regulations and semi-official corruption frustrate the entrepreneurial spirit in developing countries. By instituting a formal property rights regime that ensures legal title to property for the poor, and allows them to use property as collateral, de Soto estimates that developing nations could liberate up to $9.3 trillion in untapped capital.

Absent de Soto’s reforms, the ranks of capitalist countries have remained relatively small. Foreigners do want to see capitalist, free market reforms implemented in their own countries. But most non-capitalist countries do not sufficiently respect the sanctity of property rights. A government of laws rather than of men may be attractive to the men in charge, but without such respect, without the existence of a robust property rights regime and legally protected ownership of property, capitalism cannot thrive. As de Soto puts it, capitalism is in danger of becoming “a private club, open only to a privileged few,” which “enrages the billions standing outside looking in. This capitalist apartheid will inevitably continue until we all come to terms with the critical flaw in many countries' legal and political systems that prevents the majority from entering the formal property system.” Even countries like China, which have experienced significant economic growth without a robust property rights regime, now see that they have to significantly expand property rights in order for economic growth to continue. India will also need to expand and protect property rights, especially as it seeks to balance economic growth with environmental protection.

De Soto has made a particular point of emphasizing the need for the existence of a formal and healthy property rights regime in Iraq. Without the existence of such a regime, Iraq will have a much harder time making the transition from an authoritarian dictatorship to a democratic republic.

As de Soto puts it, capitalism is in danger of becoming 'a private club, open only to a privileged few,' which 'enrages the billions standing outside looking in.'

Under Robert Zoellick, the World Bank can play a role in enhancing the protections afforded to property rights in other countries. In addition to making Hernando de Soto the chief economist for the Bank, as a precondition for loans, the Bank can insist on the implementation of a formal property rights regime aimed at liberating untapped capital. The bank can work with borrower countries to enhance the protection of property rights and the more cooperative borrower countries are in this effort, the more access they might have to World Bank loans. Apart from the general good it will do to give developing countries access to over $9 trillion in capital and to help them put free market policies in place, the Bank has a vested interest in encouraging the furtherance of de Soto’s ideas because untapped capital can be used as collateral to borrow against in seeking World Bank loans and the Bank will experience far fewer problems in encouraging borrower countries to pay back their loans.

Zoellick can also implement microcredit and microfinance loan policies. Microfinance policies have received a great deal of publicity since Muhammad Yunus won the Nobel Peace Prize last year for his work in microfinance and microfinance policies represent a promising way to help poor people gain access to bank loans that are given out through reliance on the market and without governmental subsidies. Yunus’s particular microfinance scheme—which is practiced by the Grameen Bank—has received a critical examination from Tom Bethell, who argues that more borrowers than were reported are behind on loan payments and that the Grameen Bank issues loans with interest as high as twenty percent.

As Bethell indicates, Yunus’s microfinance lending scheme may not be the ideal one to follow. But that doesn’t necessarily invalidate the idea of microfinance altogether. Bethell references as an alternative model the microfinance policies of the Bank Rakyat Indonesia. The Bank’s microfinance program is a model of efficiency and while its own lending rate is about as high as that of the Grameen Bank, it is projected that the Bank Rakyat can reduce its lending rate to 8.2% while remaining sustainable. The introduction of more microfinancing institutions and the resulting competition should help reduce the Bank’s lending rate.

By liberating capital and engaging in microfinance, the World Bank can make itself relevant to the challenges facing the international community.

Percy Barnevik offers a different microfinance system in which business consultants who work with borrowers to make the best use of the loans, and to keep default rates extremely low. This might explain why Barnevik’s charity, Hand in Hand—by his own account—gets banks lining up to loan them money at about 12% interest, thus giving Hand in Hand an opportunity to issue microloans with lower interest rates than those found at the Grameen Bank or at Bank Rakyat.

The World Bank can take a lesson from Barnevik’s model and use business consultants to help clients make the best use of loans, assist in paying back the loans and thus keep lending rates low. By entering into the microfinance world, the Bank can help foster the competition necessary to encourage other microfinance lending institutions to lower their interest rates. In addition to directly assisting microfinance borrowers, the Bank can also help keep down lending rates by serving as one of the lenders to institutions like Bank Rakyat or Hand in Hand. The more lending institutions there are to finance the activities of microfinance entities, the more competition there will be to lend at a lower rate to those entities, thus allowing the savings to be passed on to microfinance borrowers.

By liberating capital and engaging in microfinance, the World Bank can make itself relevant to the challenges facing the international community. It can help more countries join the capitalist club and it can give the poor access to startup capital that can help reinvigorate previously stagnant or shrinking economies. Robert Zoellick has a once-in-a-lifetime chance to put these policies into place and thus make the Bank a consequential player again on the international economic scene. He should make the most of this opportunity.

Pejman Yousefzadeh is an attorney living in Illinois. He blogs at A Chequer-board of Nights and Days, and Red State.

Image credit: Photo by Flickr user alykat

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