Ending poverty means abandoning charity and accepting reality

Benin Mwangi, who blogs about doing business in Africa, asked me recently: "should the discussion be about how to get the informal sector to become part of the formal sector or should it be how to cater to the informal sector?" This in an excursion into the morass of African poverty and development.

The short answer is: neither; ending poverty has nothing to do with the informal sector.

This is not to dismiss the question, which is an important one. With the failure of most centralised economic policies and governments in Africa the informal sector is the largest employer and service provider in most of the continent.

However the question conflates symptoms with causes. For starters, how do informal markets even come to be?

The break-down of property rights

A centralised state exists largely to protect contract and the enforcement of property rights. Individual rights and the welfare state are a relatively recent development. And you can't have these without taxes. And taxes don't exist without businesses and incomes to tax. And those incomes and businesses require contract protection and the enforcement of their property rights.

When individuals believe that the cost of supporting the state is less than the benefits they derive from that state then a central government is stable. When the state starts intervening in the economy and property rights are under threat then investors and business owners withdraw their support.

If they are capable of flight they will travel to other nations where they feel safer. If they are not they remove their investments to the informal market.

Informal vs Formal is subjective; technically we're discussing third-party property rights. By that I mean that, any contractual dispute (whether about the ownership of property, ideas or products, or a legal wrangle) can be sorted out by a recognised third-party whose decision is recognised and respected by both. Normally that is a government. When the government is not respected, or when the cost of getting the protection of that government is too high, then the relationships between market players breaks down. An informal market is really a fragmented localised market where only people who trust one another directly are prepared to trade with each other.

Any central state wanting to represent the interests of its people should be doing its best to set up a fair and equitable legal and economic framework. If corrupt politicians are rewarded and kept in office then no amount of incentives is going to make businesses who abandoned the state come back. Corruption breeds corruption.

What the state should do is ignore the informal sector and do their level best to make the formal sector as powerful, dynamic, flexible and simple-to-use as is humanly possible. If I have to spend five hours in a queue to get a form to register my company, and another 12 months to wait for registration approval (if the form isn't lost) ... guess what, I'm not going to bother trying to register in the first place.

A state should realise that - as with any competitive environment - business owners and investors have the choice not to participate if they so choose.

Charity supports the state but does nothing for the market

If there was a joke about charity it would go like this: "Why do the poor hate charity? Because it makes the donors look and feel good, it gives jobs to otherwise unemployable aid workers, it lends credibility to corrupt governments, but does bugger-all for the poor."

We can debate about whether or not a short-term bail-out is of use for the victim of a random disaster. What is starting to become beyond debate is that long-term charity is not – by any stretch of the imagination – the path to economic prosperity.

"We find little evidence of a robust positive correlation between aid and growth," write two ex-IMF economists, Raghuram Rajan, who stepped down as IMF chief economist at the end of 2006, and Arvind Subramanian, who left the IMF this year.

"One of the most enduring and important questions in economics is whether foreign aid helps countries grow ... There is a moral imperative to this question: it is a travesty for so many countries to remain poor if a relatively small transfer of resources from rich countries could set them on the path to growth ... But if there is no clear evidence that aid boosts growth, then handing out more money makes little sense," they conclude.

In a failed state, such as Nigeria or Sierra Leone or Myanmar or Zimbabwe, there is a clear government. What is not clear is who that government governs.

When most people living in a country choose to opt out of being governed, either by migrating or by maintaining cash links only with the informal sector then the state has no resources. It can maintain itself through possession of oil or mining or even forestry reserves. What it does not have is a middle-class tax base which is the only thing that gives wealthy nations and governments legitimacy.

Charity used to go directly to aid agencies. After experiences of duplication and astonishing corruption, along with outright incompetence, major aid donors decided that they would only work from government to government. Of course, if the government has no legitimacy then that doesn't help either.

I think it was the Swiss government who insist on making payments in Krone directly to the Zimbabwean government to fund their aid efforts. Since the official exchange rate is 10% of the real exchange rate 90% of Swiss aid goes directly to supporting the dictatorship.

Yet central states are not necessary for investment to take place. Somalia has an extensive cellular network that is amongst the cheapest and most effective in the world. No government licence fees, no protection from the state, just isolated towers protected by a negotiated network of local militia.

No bridge from Charity to Wealth

Consider a man who, although healthy, is brought up indolent. He never walks but is wheeled around; he is fed and cleaned. He will lose the ability to walk. Given sufficient inactivity muscles atrophy. There is no physiological reason for him not to walk but it will take time to train his muscles. He has to do it himself.

It will be hard and it will require that the wheelchair – the life of indolence – be abandoned. There is no bridge from paralysis to movement that doesn't involve abandoning the old life. You can't wheel across and then magically stand up.

Proto-societies end up in particular places based on the choices made during their lifetimes. If one society has to be self-sufficient – if everything it wants it either has to make, buy, or do without if it cannot be afford – then it, of necessity, will come to look like some form of free-market economy.

If the same proto-society received material support and charitable donations at every step of its evolution it would be like a man in a wheel-chair. Should that support suddenly be cut then the society is helpless and will fall apart.

There is no amount of charity or support that can be given to a long-term supplicant that doesn't reinforce the need for that charity or support. The more charity available, the less opportunity there is for the recipient to become self-sufficient.

A government that has become so corrupt that it is incapable of supporting rules of law, recognition of property rights and defence of those rights is going to have a large and intractable informal sector.

It's like having a cough when you're sick. You can rage against the cough, try and incorporate the cough into your life, write poems for the cough, don ear-muffs to deafen the cough. It remains a symptom.

Abandoning charity does not mean embracing mature free-market policies

When the Soviet Union collapsed Boris Yeltsin, then Russia's president, attempted to launch the ex-communist state directly into a free-market economy. He disbanded the central state, sold off the nationalised services and created the direct form of a free-market state.

It was a disaster and resulted in the backlash that installed Vladimir Putin and cemented authoritarian rule.

The results of imposing a democratic order on Iraq have been so appalling that they need no repetition here.

The requirements for transition are more nuanced and depend on the society itself. Hurling our indolent man directly out of his wheelchair and demanding that he dance may so traumatise him that he may never recover and desire nothing more than to remain in his wheelchair. Forever. Like Russia.

The "trade not aid" position - so favoured by international rock stars and politicians - is also naive. Yet he must abandon his wheelchair.

Every single step along the path to economic sustainability and wealth creation must be internally consistent. Once the wheelchair is abandoned every step must be functional, must be just within the abilities of the previously indolent person and must result in a self-reflective reward.

The only way this can be achieved is if the person abandon also the idea of direct comparison with those who are already successful. If the best you can do is crawl across the floor then the last thing you need is for others to be performing aerial acrobatics around you.

In the short term the crawling should result in a reward. A society learning how to work on its own must set itself meaningful goals that are of immediate value.

For instance, simply building a useful and well-maintained highway between the principal cities of the Democratic Republic of Congo will require immense internal coordination, skills development and private business support. And even a partially built road has immediate local benefits in increased internal trade.

They don't need a space programme.

The evolution of economic success

The informal sector is a distraction. It is not the cause of poverty or a market to be bound within the central state. It is the way that people survive in the absence of a central state.

The way to create a nation with a stable and outward-focused growing economy is for the central state to abandon itself and to focus on the ways it can facilitate the interactions of its own people. Link the greatest concentrations of those people. Support and protect those interactions. Ensure there is no force or fraud.

And ensure that every step is based exclusively on the premise that it must pay for itself. Any step based on charity, no matter how attractive or well-meaning, will lead back to the oft-abandoned wheelchair.