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Missing capital: India’s trillions-dollar wealth is chained in slums. Time to unlock it

The slums and shanties represent a huge drain on our wealth for what really requires nothing more than a clear-headed policy towards urban property.

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India needs an investment of around $1 trillion a year over the next five years, if Indian GDP is to grow above 10 per cent to create about 70 to 80 lakh new jobs annually to absorb all new entrants to the job market. Finding the required pool of savings, and, more crucially, the entrepreneurs to use this pool of capital productively is a herculean task.

However, as I show below using ideas generated by Peruvian economist Hernando de Soto, a substantial pool of this capital, something like $2-3 trillion, already exists in the country but remains not fully tapped. More than that, some two-three million small entrepreneurs have this capital in their possession but cannot fully deploy it, although they have tremendous experience in running small businesses successfully.

As a first step to finding the additional $1 trillion in new capital, we could also look at unleashing the army of these small entrepreneurs with their $2-3 trillion in potential capital through a system of reforms in our property markets that recognises the enterprise and the savings built up by these entrepreneurs over the last 50 years or so. Here is how we can do that.

Also read: How to build future cities? The answer lies in the slums of India, Brazil & Indonesia

India’s unproductive capital wealth

In his book, The Mystery of Missing Capital, Hernando de Soto writes: “Capital is the force that raises the productivity of labour and creates the wealth of nations. It is the lifeblood of the capitalist system, the foundation of progress, and the one thing that the poor countries of the world cannot seem to produce for themselves, no matter how eagerly their people engage in all the other activities that characterize a capitalist economy.”

Developed countries, on the other hand, are awash with capital despite lower GDP growth and abysmally lower savings rates. Why is it that millions of hardworking, self-employed entrepreneurs, who save as much as 35 per cent of their earnings, are short of capital for expanding their businesses, and are unable to break out of the chains that bind them? What keeps them from greater prosperity despite such hard work and extraordinary risk-taking? This is the paradox that Hernando sets out to demystify.

Before we can get set to this task, we need to understand the link between property and capital on one hand, and how and when property becomes full-fledged capital that can be put to multiple uses in the economy, on the other. Property here means any asset an individual possesses – bank account, financial asset, or real estate. We will focus on real estate since self-employed entrepreneurs mostly use this asset for savings.

Also read: India’s crony capitalism claims another victim — the RBI

Savings create property. To understand this, let us consider a taxi driver in Cuffe Parade, Mumbai, who lives in a rented shanty, drives two shifts in a rented taxi, and puts away in bank whatever he saves in the hope of buying his own shanty, which, though illegal, are bought, sold and owned like any other property in the informal markets of the slums. These shanties even have “titles” in the form of electricity bills, with property rights well recognised and protected by custom and the slumlord. The slumlord even collects hafta or tax for such services. Sales and purchases are recorded with the slumlord and in time with utility services like power, although this can take years. In short, a whole system of governing property exists in the slums independent of formal laws. These assets are real. No formal law, short of a revolution, can force eviction in established slums.

What is the problem with holding such a property in a slum? As Hernando explains, these resources are held “in defective forms: houses built on land whose ownership rights are not adequately recorded, unincorporated businesses with undefined liability, industries located where financiers and investors cannot see them. Because the rights to these possessions are not adequately documented, these assets cannot readily be turned into capital, cannot be traded outside of narrow local circles where people know and trust each other, cannot be used as collateral for a loan, and cannot be used as a share against an investment.”

Applying Hernando’s model to our taxi driver’s case makes three points clear:

1. The taxi driver’s ownership of the shanty is not visible to anybody in the larger economy due to the absence of a formal title and its registration in his name. He owns the shanty, he has put years of savings in it, but he cannot use it outside of the local slum’s knowledge. The important point to note is that no asset can become property, and eventually a capital that is fungible with other capital stock in the economy, unless it is legally tied to an individual. That is the irreducible minimum in the process of converting property into capital.

2. The taxi driver’s property has a single use. The owner and his family can use it among themselves but cannot use the shanty as, say, collateral for a bank loan to buy another taxi and expand his business or develop his farm back home in Bihar or finance his child’s study in a good professional college. The utility or productivity of his property is, thus, not going to be fully exploited. In other words, the self-employed entrepreneur is hugely handicapped because he cannot reap the full benefit of his savings for want of a formal property system that can recognise the value of his savings – which, incidentally, are real and as hard-earned as any legally recognised savings.

3. The taxi driver’s property is not fungible with his other assets or with other such assets in the economy as a whole. His property is neither proper capital for himself nor others in the economy. In other words, his capital, created out of hard-earned savings, is hobbled, chained and cannot become productive to create wealth for him or others unless we find a way to make it fungible with other capital stock in the economy. That is the mystery of missing capital stock in the third world. It is there but we have not yet learned how to unlock it and bring it into use as full-fledged capital stock.

Not capitalism, but Indian capitalism’s fault

Hernando says that it is this handicap – lack of visibility, missing individual identity tied to title, and lack of fungibility with other capital stock – that makes it look as though capitalism doesn’t work for the poor in third world countries.

“The enterprises of the poor are very much like corporations that cannot issue shares or bonds to obtain new investment and finance. Without representations, their assets are dead capital. The poor inhabitants of these nations — five-sixths of humanity — do have things, but they lack the process to represent their property and create capital. They have houses but not titles; crops but not deeds; businesses but not statutes of incorporation. It is the unavailability of these essential representations that explains why people who have adapted every other Western invention, from the paper clip to the nuclear reactor, have not been able to produce sufficient capital to make their domestic capitalism work,” Hernando explains.

Also read: Lesson from Jet Airways crash – Save Indian capitalism from Indian capitalists

How can these defects in Indian property systems that prevent recognition of invisible and hobbled pools of capital be cured in order to make them as productive as any other capital?

It requires attitudinal changes and deep reforms in our systems that govern property.

Hernando explains why the process is simple but again not so visible to us. “But only the West has the conversion process required to transform the invisible to the visible. It is this disparity that explains why Western nations can create capital and the Third World and former communist nations cannot. The absence of this process in the poorer regions of the world –where two-thirds of humanity lives – is not the consequence of some Western monopolistic conspiracy. It is rather that Westerners take this mechanism so completely for granted that they have lost all awareness of its existence. Although it is huge, nobody sees it, including the Americans, Europeans, and Japanese who owe all their wealth to their ability to use it. It is an implicit legal infrastructure hidden deep within their property systems – of which ownership is but the tip of the iceberg. The rest of the iceberg is an intricate man-made process that can transform assets and labour into capital. This process was not created from a blueprint and is not described in a glossy brochure. Its origins are obscure and its significance buried in the economic subconscious of Western capitalist nations.”

What is clear is that property systems to govern property and convert it into productive capital stock were invented by Western nations long ago when they faced similar problems as we face in our shanties and slums today. The so-called squatter problem that bedevilled the USA for 100 years in the 19th century is one such example. So, we do have templates to resolve the problem:

“Western politicians once faced the same dramatic challenges that leaders of the developing and former communist countries are facing today. But their successors have lost contact with the days when the pioneers who opened the American West were undercapitalized because they seldom possessed title to the lands they settled and the goods they owned, when Adam Smith did his shopping in black markets and English street urchins plucked pennies cast by laughing tourists into the mud banks of the Thames, when Jean-Baptiste Colbert’s technocrats executed 16,000 small entrepreneurs whose only crime was manufacturing and importing cotton cloth in violation of France’s industrial codes. That past is many nations’ present. The Western nations have so successfully integrated their poor into their economies that they have lost even the memory of how it was done, how the creation of capital began back when, as the American historian Gordon Wood has written, “something momentous was happening in the society and culture that released the aspirations and energies of common people as never before in American history.” The “something momentous” was that Americans and Europeans were on the verge of establishing widespread formal property law and inventing the conversion process in that law that allowed them to create capital. This was the moment when the West crossed the demarcation line that led to successful capitalism – when it ceased being a private club and became a popular culture, when George Washington’s dreaded “banditti” were transformed into the beloved pioneers that American culture now venerates.”

Also read: Modi govt didn’t address jobs crisis in the first term. India’s progress depends on it now

Unshackle locked up wealth

How was it done? Quite simply by recognising that formal law follows custom and what is created by custom in slums and shanties is as valid as any other economic process that converts savings into property and then useable capital. These laws have their own logic, validity, and set of practices that we need to recognise and incorporate into our formal systems. These slums and shanties are decades old. The one at Cuffe Parade is more than 50 years old. The original squatters are all gone. The current owners are third generation occupants who bought these properties with hard-earned savings with legitimate income. These shanties represent a significant portion of their life savings. By keeping them out of the formal property system, we are neither going to get rid of the slums nor can we find a way to use the locked up idle capital productively to create more income and wealth.

Also read: Capitalism needs reform, not the risk of revolution

Such locked up but idle wealth/capital is huge by any measure. A rough estimate – the total capital lying idle at just one of the slums next to Navy Nagar, Mumbai, is in excess of $3-5 billion. The total wealth lying idle in the Dharavi slum is estimated to be upwards of $200 billion. Multiply these slums across metros and major towns and the unused and untapped hidden capital could be upwards of $2-3 trillion. The slums and shanties represent a huge drain on our wealth for what really requires nothing more than a clear-headed policy towards urban property.

If we can find the political will to integrate the property already present but locked up and idle in the shanties and slums across India, we could set free some $2 trillion worth of additional capital to work for creating more wealth and capital for our self-employed and other entrepreneurs. This is not difficult given the requisite political will.

In the second part of this article, we will return to examine the specific in which this hobbled wealth can be put to use in the economy to boost its productivity and increase our GDP growth rate.

Sonali Ranade tweets @sonaliranade. Sheilja Sharma tweets @ArguingIndian. Views are personal.

This article has been updated to reflect a change. Hernando de Soto is a Peruvian economist.

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  1. Many people have responded to our article. We have taken salient points into consideration and here is our reply:

    1. Staffan Granér finds de Soto’s methods unreliable and his theories over-simplified. De Soto claims that if “dead capital” were legalized, it would elevate the poor out of poverty. In reality, de Soto’s formalization of the economy aims to protect rights of ownership and ease the way for free market transactions, not to create regulations and a social safety net.

    This criticism is mere rhetoric and based on misrepresenting De Soto’s argument. The basic argument of De Soto is to bring all property, that of the rich and the poor, formal or informal, into a formal integrated property system that enables conversion of the property into effective capital stock in the economy capable of being put to multiple uses at the choice of the owner. The main incremental value to the economy comes from making the hobbled & idle capital stock, that can only be used in very limited ways by the owner, into full blown capital that can be used anywhere in the economy.

    That this helps the poor, or the self-employed entrepreneurs in shanties, to graduate out of slums or to expand their business, educate their children or even dissolve the slum altogether is incidental to the main purpose.

    Consider an example to get the difference. A self-employed person saves money by putting away 30% of his income in a mattress for over 10 years to buy a shanty for him. The money he puts into the mattress is real capital but of little use either to himself or the rest of the society. It vanishes from the capital stock of the economy. In contrast if that savings were in a bank, not only would he earn interest, but also others could use the capital in the economy until needed by the person. Property outside the system is money in the mattress that can be used by the owner himself but is not capable of being put to multiple uses by the owner, nor can the others in the economy access it. By bringing the property in the formal system you enable multiple uses and increase its productivity creating more wealth for the owners & others.

    De Sato does not advocate doing this to set up safety nets for the poor or to distribute property more fairly & equitably in society. Instead he is mainly interested in making potential capital in the economy more productive by plugging loopholes that drain it into sinkholes in informal systems. That it also helps some poor people should be welcome. But equitable distribution of wealth isn’t the goal here. Augmenting & making existing stock of capital & enhancing its productivity is the goal. It helps alleviate the poverty of those in slums. Surely that shouldn’t hold up the program because it leaves out other poor. That should be addressed independently in other ways.

    2. Second, de Soto explicitly distances himself from the old Weberian idea that poor people’s ability to achieve prosperity and advancement is restricted by cultural dispositions and patterns of behaviour. People in developing countries are, de Soto claims, just as capable of innovation, creativity, and entrepreneurism as those in the West. The poor are not the problem; they are the solution.

    I am not sure how valid the Weberian assumption was in the first place. To my mind, if the proposition were true it would deny agency to individuals making a self-made entrepreneur impossible. On the contrary, what we have in most slums are people, who unmoored from their niches, set out to make a living for themselves with little or no assets to begin with. Over decades they find odd jobs to do from rag picking, recycling waste to processing leather & then textiles until some 30 to 50 years later they are running enterprises that feed value chains above them. Dharvi is a classic example. What is the validity of the Weberian assumption in face of this reality? On the contrary, these poor people succeed despite the lack of formal capital. They have to be 2 to 3 times as productive & efficient in order to survive competition from firms that have access to formal capital. Of all the disingenuous criticism of De Sato, this perhaps is the most stupid of all. I amounts to telling the poor sorry you can’t be successful & rich because you are poor & therefore lack the ability to succeed. Nothing could be more nihilist.

    3. The results of the case studies have served as the basis for assumptions about global averages for the share of informal real estate and its value in 179 developing nations and former Soviet states. The presented sum is tremendous: 9.34 trillion dollars, of which 6.74 trillion is the appraised value of the property in shantytowns.

    The criticism here is that De Sato’s estimates of dead capital locked up in informal markets like slums may be an over estimate. De Sato puts the world number at $9 to 11 Trillion based on studies in Peru & Philippines. The estimate by its nature is a ballpark figure to dimension the problem and what benefits may flow out of bring it back into a formal system.
    In India we need only look at the area the slum covers in say Mumbai or Delhi and the potential real estate value in the market to get an idea of the benefits that would accrue eventually from bring these assets back into the real formal economy. However, there is another dimension to this as well. Whatever be market value of the real estate, the fact is that the millions living there are putting roughly one-third of their saving into a black hole draining away value from the economy into single use hobbled capital. This income stream by itself is large enough to channel back into the economy for multiple uses as capital stock. Note this is a continuing, ever increasing income stream disappearing into a sinkhole.

    4. But a society’s potential to produce material wealth is not determined primarily by a pile of assets, with or without a price tag. The decisive thing is rather the flow of utility that these assets might yield when they are combined with human and natural resources, and how this flow is distributed. So-called dead capital is in this sense far from sterile. There are people living in the shacks and houses of the shantytowns. Even in unregistered companies, goods and services are produced. If these assets were to be accorded formal legal status, it would not automatically mean that the flow of utilities to which they contribute would be changed. We should certainly attain a more realistic notion of national accounting, but formal bread doesn’t weigh any more than the informal kind.

    I am not sure this argument even deserves a response. It isn’t anybody’s case that the assets that are locked away outside the formal system are not productive. But they could be a lot more productive if they were within the formal property system. They would yield more revenue to the state, they would have multiple uses and the productivity would be a lot higher.

    I would like to illustrate this with an example. Suppose you have a business idea. Say reprocessing old family photographs and converting them into digital albums. What do you do? The rigmarole starts with preparing some sort of a project report, going to a bank, convincing the banker that the idea is valid & waiting interminably for a loan. You will be surprised how many people consider this to be the “normal” way to do business in India. This is precisely the problem that capital solves in developed economies and is at the heart of real capitalism. Let us say the would-be photographer has a house with a clear marketable title in a modern property system. What happens? Now your photographer walks into bank, lays down is his copy of demat title, & says I want X amount of money against it. I will repay after 3 years. If not, you have my property. About an hour later he walks out with the loan because liens are now marked online.

    What does capital do here? It does 3 things we should carefully note. [1] It identifies who you are in the system by tying your name to a unique & identifiable asset in the economy with a readily ascertainable value. [2] It makes the owner truly independent answerable only to himself. The banker doesn’t sit on his head trying to second-guess him. He has the collateral. He only gets to set the margin & the repayment terms along with interest rate. In short capital empowers entrepreneurs. [3] It makes the photographer accountable to the market for his performance. If he fails he stands to lose his asset. So he thinks far more carefully where to put his money than in a system where he doesn’t’

    have to put up collateral. That is the function of fully representational capital. It identifies, it empowers, it makes you accountable & it makes you an independent economic agent. The enhanced productivity & efficiency is nothing but fallout of these invisible processes that govern an economy based on capital.

    5. The argument upon which de Soto places the greatest emphasis is, however, that formalization and registration of property facilitates the mobilization of credit. This too is in some respects reasonable. A requirement for a bank or other lender to accept real estate or other capital as security for a loan is of course that the asset can be sold if the borrower cannot pay. Probably the lender also wants to be able to verify the legitimacy of the borrower’s ownership of the property, for instance that it is not being lent to someone else. The more difficult it is to obtain this information, the more dubious the security, which reasonably enough puts upward pressure on the rate of interest.

    I have more or less discussed this point under [4] above. Capital does a lot more than simply enable mobilization of credit. It makes an entrepreneur more accountable reducing systemic risk in the economy in a number of ways. Firstly, the very reason our photographer has a identifiable capital is that he has been doing something right. That process by itself weeds out a large number of the frivolous. Second, having put down his house as his stake, the entrepreneur makes himself accountable that nobody else can. So he will take only such prudent risks as necessary for his venture & no more increasing the likelihood of success. That way the system avoids waste & makes the capital stock in the economy more productive. To list out all the not so visible ways in which capital serves to lubricate economic activity would be silly. But the larger point is that we are aiming at enhanced efficiency & productivity, not merely credit mobilization.

    6. A point that has come up in discussions in India is the notion that De Sato’s ideas will help eradicate slums. They might help in dissolving slums over time. They won’t prevent new slums from coming up unless we take other concomitant measures. But De Sato’s ideas are about unleashing the potential of unproductive capital & not about clearing slums. The latter will happen automatically as the slum gets more prosperity & upgrades itself. The idea is about kick-starting the virtuous growth potential locked up in slums that enable entrepreneurs there to more prosperous. The process will need both regulation & policing. But it is far better to let dwellers be more prosperous by them rather than throw taxpayers’ money at them, which helps no one.

    Sonali Ranade & Shealja Sharma

  2. The title deed is not the only governing factor. Capital entrepreneurship is no problem. Historically, the West could market its products. They first found a captive market and cheap resources from their colonies or by chasing away the indigenous inhabitants to a walled enclosure and occupying their land or through the slave market. Add to this the restriction of resource crunch, pollution and global warming. Now we have newer laws. Copy-paste is no solution.

  3. Excellent piece, bravo! I hope in the second article, which is promised, the authors will also address the mirror image of this problem in the rural property market, which is frozen on account of the most antiquated approach to land titles. Am mailing this link to friends in Niti Aayog, they need to see this.

  4. Bombay’s slums are located on land owned by the central and state governments, the BMC, MHADA, also private owners, who are generally more diligent in saving their lands from encroachment. The best example of a vast privately owned, largely vacant piece of land is the Godrej holding in Vikhroli. Since the land does not lawfully belong to the families – roughly half of the city’s population – that live on it, converting it into a piece of collateral for a bank loan would be difficult. 2. Families that have documentary proof of having lived in the slum since 1.1.1995 – mainly the electoral roll, supplemented with other documents like ration cards – are eligible to participate in the scheme for redevelopment. Once completed, they get a conventional apartment of 300 square feet free of cost, the entire project made financially viable by grant of higher FSI, with roughly one half of the construction being apartments for sale in the market. 3. It was the promise of free houses to four million slum dwellers in Bombay within a period of five years that brought the Shiv Sena – BJP to power in 1995. 25 years later, the scheme remains a work in progress, with perhaps a hundred thousand families accommodated. The slowdown in real estate is also a constraint. In the meantime, slums have continued to grow, and there is a demand that the cutoff date should be extended beyond 1.1.1995. 4. Many models have been experimented with for the redevelopment of Dharavi. The state government itself wants to play a leading role as a developer, with funding supposedly tied up with deep pocketed financiers from the Middle East. At the moment, almost entirely on the drawing board.

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