In Part I we walked down "Prosperity Street" and emphasized the risk imbalance between rich and poor countries. Let us call this situation “ the risk-sharing divide”. De Soto is right. Capital in poor countries is dead, but he should have hastened to add, risks in poor countries are live and deadly. When you leave Cairo’s Nile Hilton, you leave behind not only legally enforceable property rights but also the whole risk management panoply (financial derivatives, (re)insurance etc…) And, even if capital were to be freed and rights to be legally enforceable, this would not do much if risks were still as deadly as before. Worse, a sharp decline in national income after the occurrence of some unexpected events may even jeopardize or destroy law enforcement efforts. Life in the poor countries is plagued by risks. Fafchamps and Lund (2000) summarize the issue in quite vivid terms:
“ The vagaries of health, weather, crop pests, and job opportunities create large income variations over time. In addition, households must incur large expenditures such as medical costs and funeral celebration, the timing of which is not always foreseeable. With per capita incomes low in even the best times, unmitigated income and consumption shocks can have devastating consequences.”
The contrast with developed countries is sharp.
People in rich countries have access to a wide set of investment options that allows them to insure against many of the aforementioned risks. They can invest in stocks, bonds, cash, mutual funds, options and futures. They can buy life and P/C insurance. They have access to pension plans. In other words, the
risk-return menu they can buy into is quite rich. Still, some argue that this not enough. Athanasoulis, Shiller and van Wincoop (1999) write:
“ there is good reason to believe that most people’s wealth is not well diversified.” They, for instance, claim that although investors can diversify through equity markets (10% of national income), “ about 90% of an average person’s income is sensitive to sectoral, occupational and geographic uncertainty”.
Hess and Shin (2001) make the same point. They find based on consumption risk sharing regressions that the level of aggregate intra-national risk sharing in the United States is still too low. Somehow US households invest in “ the familiar” which does not lead to a sufficient level of aggregate risk sharing. It may help them get rid of some idiosyncratic risk but does not help on a broader risk scale. It is true that the fate of too many individuals and their standards of living are driven by chance.
Nevertheless, people in rich countries are much better off than their poor countries fellow counterparts since they have access to a richer set of risk sharing institutions and have the ability to enforce the rights attached to their risk-sharing claims. People and businesses in poor or developing countries are plagued by risks that they cannot efficiently share or transfer. In such a hostile environment, people and businesses that are always tangent to the survival level focus more on staying alive, getting by than getting ahead. The fundamental problem today is that this risk-sharing divide between poorer and richer countries is growing bigger and bigger.
Poor countries citizen are shunted around from good luck to bad luck and from fortune to misfortune – to even more misfortune.
This is sad for people. Despite their local efforts, their lives and businesses are still driven by chance. It would be an unfair description of reality, though, to assume that people in poor countries are simply victims of their countries’ latitude. The fact is that poor people are kept hostages of their own countries, not by latitude but by the very attitude of their governments. Closeness and self-interest often prevail. Governments are not held accountable. People are denied any rights whatsoever. Or, to have them
enforced, they have to go through so many red tape ambushes that they soon give up or hit the road. Yet, the arithmetic of prosperity is awfully simple. McGill University Professor of Economics Reuven Brenner (2002) extends De Soto’s point in his recent book “The Force of Finance”.
To prosper people must have access to capital. Talent must be matched with capital and the two sides of this wealth enhancing equation have to be held accountable.
There are only five ways to source capital: Natural resources, savings, capital markets, government and crime. The last two ones are somehow what’s left when the first three ones are unavailable. This is what we see in many poor countries: government and crime at their worst more often than not. Having a sound access to proper capital is not an easy thing. It is a complex and subtle construction that can be easily perverted. It requires a rich set of markets and institutions to channel funds and risks properly. It also necessitates a maze of checks and balances – both private and public – to make sure that mistakes are recognized and corrected with no delay. In other words, it takes an open-minded attitude and some hard work to get there.
Comments