Mideast Miracle?

This article appeared on Forbes.com, February 16, 2004.

When it comes to the middle east, the eyes of the world focus mainly on Iraq and on the Israeli-Palestinian conflict. Yet in coming months Egypt will be initiating reforms that should dramatically transform its economy into a wealth-creating, wealth-distributing dynamo that will lead millions of Egyptians into avibrant, increasingly democratic middle class. The country is set to become an economic miracle rivaling Ireland or Hong Kong. In doing so, Egypt will deal a devastating blow to global terrorism.

The catalyst is something that's prosaic yet absolutely essential for a sustained, innovation-oriented economic takeoff: property rights. We in America and the rest of the West take our inclusive, easy-to-access property systems for granted. You own land, for instance, and everyone recognizes it. You can readily mortgage it. Want to start a business? The legal requirements are easy. Want to sell bonds or shares or use other capital-raising instruments? The legal structures to do so are open to anyone who can meet standard requirements. Commercial contracts? They're widespread, and the courts are there to enforce them and to adjudicate disputes.

Incredibly, most of the world has no such property rights or common rule-of-law system. Japan didn't until after World War II, when, under General Douglas MacArthur's occupation, it shucked off its medieval social structure and put in place institutions and laws with principles long familiar to Americans. This dramatic change played a critical, oft-overlooked role in Japan's rapid postwar modernization and economic expansion. After all, in the early 1900s Japan's per capita income was less than that of Peru.

After several years of preparation, Egypt is about to commence a Japanese-like makeover of its society, one that will profoundly and positively impact the rest of the Middle East and the developing world. Reforms will create easy access to private property for all Egyptians, including those in city slums. All enterprises will be able to easily turn themselves into legal entities; previously, obtaining a business license had been a costly process that could take nearly two years. Not surprisingly, most Egyptian businesses are extralegal, part of the country's shadow economy.

Most development experts ignore the elephant in the room--the fact that most people in the world operate outside their country's formal legal systems. In Egypt's case, 88% of all enterprises are extralegal, as is 92% of the country's housing. Egypt and other developing countries do not lack for entrepreneurs; they lack institutions and legal structures that would enable theirentrepreneurs to expand and truly flourish. The Peru-basedInstitute for Liberty and Democracy, which spurred this project and is headed by economist Hernando de Soto, estimates that Egypt's shadow economy has accumulated $248 billion in assets. But as De Soto notes, "All this activity and all the assets in theextralegal economy are dead capital--assets that cannot be leveraged to obtain credit and investment. To convert all of this dead capital into live capital requires the two cornerstones of a market-based rule of law: legal property rights that cover all of Egypt'sassets and good business law for entrepreneurs."

Too often, Western aid programs assume that codifying property rights means documenting existing formal properties and businesses; they overlook the fact that most such assets are outside the system--they are informal. In the U.S. property laws often followed what people did informally. American property law history can be summed up as having turned squatters into pioneers.

The system prevalent in most of the rest of the world is immensely costly. It hampers the ability of businesspeople to expand. There is too little accountability for performance, and this also hobbles growth. When people are brought into the formal economy and legal system, the rule of law takes on real life. People then know who owns what. Losses can be tracked and fraud attacked. Contracts and rules can be enforced. The current informal system effectively excludes most businesspeople from having access to their national economies, not to mention the global economy. In effect, Egypt will be doing what Japan did in the late 1940s--it will be legalizing what's already there.

The massive informal economies in Egypt and elsewhere resoundingly put paid to the hand-wringing conclusion of many Western experts that certain cultures and religions are incompatible with Western-style free enterprise.

The kind of survey Egypt engaged in several years ago to discover what its informal commercial and housing patterns and systems actually were should be replicated in Iraq and other nations. Societies evolve differently, so no one-size-fits-all approach will work. What will work is to legalize, to make transparent the systems that hundreds of millions of businesspeople and homeowners around the world have already created.

Steve Forbes