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.

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.

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.

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.”

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.

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.

Missing capital: India’s trillions-dollar…

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