Informal Developers, Patrons, and the State:
Institutions and Regulatory Mechanisms in Popular Housing
Paper presented at the ESF/N-AERUS Workshop ‘Coping with informality and illegality in human settlements in developing cities’, Leuven, 23 - 36 May, 2000
Dr Erhard Berner is a Senior Lecturer in Local and Regional Development at the Institute of Social Studies, The Hague, The Netherlands, and a Visiting Professor in Sociology of Development at the University of Bielefeld, Germany. He has done extensive research on urban poverty and community responses in the Philippines, and published a book and numerous articles on the subject. He has also served as a consultant to Philippine NGOs and government institutions in the field of housing, and is at present advising UNCHS (Habitat) in their programme in Northern Iraq. Current research focuses on local effects of globalization, urban governance, the informal sector and poverty alleviation. Teaching experience includes Ateneo de Manila University, San Carlos University in Cebu City, Tribhuvan University in Kathmandu, and University of Namibia in Windhoek.
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Informal Developers, Patrons, and the State:
Institutions and Regulatory Mechanisms in Popular Housing
Black markets and shadow economies are coming into the bright light of research and policy making (not only) in the sector of popular housing. Now termed ‘self-help housing’, squatting in the cities of developing countries is increasingly seen as a solution much rather than a problem. Based on John Turner’s seminal work, state regulation of the sector and public provision of housing in particular, are criticized as unrealistic, unacceptable to large parts of society, and highly counterproductive. In this neopopulist perspective (that has striking parallels to a neoliberal one), it is the informal sector that offers the main potential for fulfilling the shelter needs of rapidly growing urban populations. Its promotion is a centerpiece of ‘enabling’ or ‘assisted self-help’ strategies now promoted by many agencies headed by the World Bank (though in hardly any place translated into systematic policies). Apart from boosting supply, one objective of interventions is the upgrading and eventual legalization of illegal settlements. At the same time we observe a certain weariness: Would not the mainstreaming of informal enterprises make them lose their main competitive advantage, their not being subject to cumbersome rules and procedures imposed by state bureaucracies?
The paper puts some of the assumptions underlying self-help housing promotion under scrutiny by looking at the context of informal economic activities in general. It starts by analyzing developers’ decision to operate outside the legal framework as based on a rational preference. That the costs of formality are prohibitive for all but a few privileged groups–and thus acceptable for rent-seekers rather than genuine entrepreneurs–is nowhere demonstrated more clearly than in the housing sector. According to our hypothesis, however, is not a clear-cut choice between a regulated and an irregular environment, but one between different sets of constraints. This is because various and modes of regulations–emphatically called a ‘system of extralegal norms’ by Hernando de Soto–exist in different segments of the informal sector which are not necessarily, and not for all types of enterprises, less complex and more appropriate than the state apparatus. Outside interventions are then unlikely to succeed if not accompanied by changes in the formal and/or informal regulatory framework.
Informal Developers, Patrons, and the State:
Institutions and Regulatory Mechanisms in Popular Housing
There is no free squatting.
Three decades after John Turner’s seminal work, squatting is still the only ‘architecture that works’ (1968) for low-income groups in developing cities. Failures of both the state and formal markets are widely recognized and identified as systematic ones (Berner 2001). In the large cities in the developing world, between 30 and 70% of the population live in irregular settlements and up to 85% of the new housing stock is produced in an extra-legal manner (Durand-Lasserve 1997: 11; UNCHS 1996: 200f.). Although the extent and the characteristics of informal development vary from country to country (as well as between cities and even between settlements) it can be safely stated that it serves a large share of the low income population, and of incoming migrants in particular: ‘Illegal or informal land markets … have provided the land sites for most additions to the housing stock in most cities of the South over the last 30 or 40 years’ (UNCHS 1996: 239). Among the major influencing factors, all of them interrelated, are a) economic development and political system of a country; b) size and growth of a city; c) availability, quality and ownership status of unsettled land in and around the city; and d) governments’ ability and willingness to enforce the law and implement its policies. Of course the constellation also varies over time.
Turner himself had pointed to state regulation of the formal housing sector as a key factor in its underperformance. Often being mere carbon copies of colonial ordinance, standards in terms of size, quality and required services are still pegged at unrealistically high levels while often ignoring cultural preferences (Hardoy and Satterthwaite 1989: 8ff.). Deregularization and ‘setting the incentives right’ for the housing industry to move downmarket (Baken and van der Linden 1993) thus became the order of the day. At the same time, more attention is paid to the functioning of black markets and shadow economies. Now termed ‘self-help housing’, squatting is increasingly seen as a solution much rather than a problem. For neopopulists in Turner’s and Hernando de Soto’s tradition (whose perspective has striking parallels to a neoliberal one, Weyland 1996), it is the informal sector that offers the main potential for fulfilling the shelter needs of rapidly growing urban populations. Its promotion is a centerpiece of ‘enabling’ or ‘assisted self-help’ strategies now promoted by many agencies headed by the World Bank (though in hardly any place translated into systematic policies). Apart from boosting supply, one objective of interventions is the upgrading and eventual legalization of illegal settlements. At the same time we observe a certain weariness: Would not the mainstreaming of informal enterprises make them lose their main competitive advantage, their not being subject to cumbersome rules and procedures imposed by state bureaucracies?
The paper puts some of the assumptions underlying self-help housing promotion under scrutiny by looking at the context of informal economic activities in general. It starts by analyzing developers’ decision to operate outside the legal framework as based on a rational preference. That the costs of formality are prohibitive for all but a few privileged groups–and thus acceptable for rent-seekers rather than genuine entrepreneurs–is nowhere demonstrated more clearly than in the housing sector. According to our hypothesis, however, is not a clear-cut choice between a regulated and an irregular environment, but one between different sets of constraints. This is because various and modes of regulations–emphatically called a ‘system of extralegal norms’ by de Soto (1989)–exist in different segments of the informal sector which are not necessarily, and not for all types of enterprises, less complex and more appropriate than the state apparatus.1 Outside interventions are then unlikely to succeed if not accompanied by changes in the formal and/or informal regulatory framework.
Being the basis of a proposed research project, the paper poses questions rather than providing answers. Among these are the following:
What are the rules of the game in various segments of the informal economy, and in illegal housing in particular?
Which agents (actors, institutions) are imposing and implementing these rules, and which instruments do they apply in order to do so?
How are formal and informal systems of regulation interlocked?
What are the specific chances and constraints of a certain regime in terms of capital accumulation, investment, growth, and equity?
How can policymakers intervene in a system that is principally closed to them?
Are there examples of successful adaptation of formal regulation in order to accommodate a larger share of economic activities?
The role of the state in regulating economic activities is one of the principal themes in economics and political economy alike. Essentially there is agreement that such a role does exist; of course, there are far-reaching differences concerning its quality and extent. Even radical proponents of a minimalist state concede that the market mechanism cannot set all rules of the game itself. It does not bring about the preconditions for its own functioning, among them rule of law, guarantee of private property, generally accepted currency, contract enforcement etc. Another need for regulation arises from the fact that consensus about what the rules of the game are, and how they should be interpreted in specific cases, is not guaranteed. This is what companies have legal departments for, and these refer to the legal system as a matter of course. If two (or more) parties disagree about who has not fulfilled its obligations they need a mechanism of arbitration which is (to a degree) beyond the suspicion of partisanship.
Historically, exchange in markets could only become dominant when other forms of appropriation, e.g. forced extraction and personal dependency, were effectively contained. As exemplarily argued by both Marx and Weber, the rise of capitalism was closely connected to the emergence of the modern state. Marx emphasized the granting of fundamental liberties, like choice of occupation and freedom to trade, which did not exist in pre-capitalist societies (of course criticizing the loss of control over the means of production as the other side of the process). Weber has stated that unregulated markets are impossible because they render economic action too uncertain and arbitrary, and that the bureaucratic state proved to be the superior instance to provide such regulation. The latter was of course not created to fulfill the needs of nascent markets; in the reverse order, trade originally thrived in city states which had a ‘solid internal political and commercial organisation’ beforehand (Greif et al. 1994: 755). According to Douglass North (1990: 14 and 98; cf. North and Thomas 1973), ‘the growth of economies has occurred within the institutional framework of well-developed coercive policies’, i.e. states; and in turn, ‘economic history is overwhelmingly a story of economies that failed to produce a set of economic rules of the game that induce sustained economic growth’. The latter statement is of particular relevance for the proposed project as it will focus on developing countries.
Much of economic theorizing has ignored or challenged Weber’s analysis and emphasized the self-regulating capacity of markets. The fundamental problem is the scope for cheating that exists in almost all real-life transactions, caused by the time-lag between each agent’s performing his/her side of the exchange (Basu 1986: 1894). In what appears like wizardry to the layman, classical Standard Equilibrium theorists solved the problem of fraud and deceit by denying its very existence. Under conditions of perfect competition (which implies perfect information of all parties involved), social order is supposed to arise spontaneously if required at all. New Institutional Economics, on the other hand, starts off by altogether rejecting the neoclassical assumptions about socially atomized agents as ‘undersocialised’: ‘The anonymous market … is virtually nonexistent in economic life and transactions of all kinds are rife with … social connections’ (Granovetter 1985: 495). Opportunism is thus minimized through trust generated in mutually beneficial exchanges and institutionalized in networks and self-governing institutions, with still little scope for state intervention. This argument is further developed by Streeck and Schmitter (1985).
Jean-Philippe Platteau, in a groundbreaking article (1994) upon which this brief discussion heavily builds, criticizes both strands of theorizing for making unrealistic assumptions. Compliance with the rules of the game can only be expected on the basis of ‘generalised morality’ which is deeply rooted (embedded) in the social fabric but needs to be reinforced by the state: ‘Unless the division of labour remains rather limited, an effectively working market cannot be sustained only on the basis of purely decentralised mechanisms of fraud and deceit control. Private and public order institutions are required and recourse to coercive power cannot be escaped’ (1994: 564; emphasis added). In the words of de Soto (1989:183): ‘There can be no denying that the law, and the institutions safeguarding it, are the principal source of … trust.’ Very simply put, regulatory functions require a degree of neutrality that no self-interested individual or group can be expected to possess. The ‘invisible hand’ that coordinates individual greed in order to achieve the common good needs to be complemented by a quite visible hand that sets limits to greed. Thus the state cannot itself become a player in the market and has to raise the necessary revenues by other means, i.e. taxes and fees.
Platteau also warns us that the process of market expansion is highly conditional and some soils are unreceptive to it. Neither the shift from limited-group to generalized morality nor the emergence of a strong and neutral state to ‘supply’ and reinforce moral norms can be taken for granted, but the conjunction of these factors is actually rather extraordinary (1994: 795-802). To effectively act in accordance with such functions the state itself has to be embedded in society, a condition that proved hard to fulfil in many Third World countries. In segmented societies the state apparatus is widely perceived to be a mere instrument of one or few of the segments. De Soto (1989: 201ff.) has diagnosed Peru to be a ‘mercantilist’ rather than a market society, and competition for rents rather than profits to be its main principle. This situation encourages nepotism and corruption on the side of the dominant groups, and there is a high likeliness that regulation is evaded or contested by the excluded, together leading to incomplete and expensive enforcement and high transaction costs. Only if reforms in institutional arrangements are accompanied by (or lead to) changes in actual political and social practice, can vicious circles of underdevelopment be broken (Putnam 1993: 184).
Incomplete market expansion, the persistence of the care economy and the emergence of the informal sector
Mainstream economic literature is conspicuously silent about the fact that market expansion remained incomplete even in the most advanced societies. Economic activities within households (and sometimes communities) do neither follow the logic of the market, nor are they regulated by the state. There is no monetary remuneration, and entitlements are defined and governed by personal relations rather than property rights. Especially feminist research has emphasized the fundamental importance of the economy of subsistence and care, and the inadequacy of output measures which neglect its contributions. The development of the advanced capitalist economies led to a clear divide between this sector on the one hand, and formal production and distribution on the other. The ‘grey zone’ between the two–where activities are for profit but not regulated by the state–is relatively small. It contains on the one side illicit economic ventures and (organized) crime that come quite close to, and are not rarely transferred into, regular enterprises; and on the other moonlighting, paid neighborhood help, housework and childcare which are much rather part of the subsistence economy.
Development in the countries of the South has followed a different pattern. The state’s capacity to control and regulate economic activities remained very limited, and is presently even shrinking in the course of structural adjustment. At the ‘underside’ of the formal economy a large informal sector emerged which absorbs much of the labour force and contributes significantly to the production and distribution of goods and services. The term ‘informal sector’ itself has been criticized for being little selective and encompassing qualitatively different sorts of activities. Building upon Farbman and Lessik (1989) we propose a classification that looks at the interfaces towards both the formal, state-regulated economy and the subsistence/care economy (Figure 1).
Figure 1: Economic sectors and regulation in advanced and developing countries
Advanced countries Developing countries
The question mark in Figure 1 stands for the focus of this paper. We start from the assumption that personal relations are an important means of coordinating/governing relations in the informal sector (as they are in the formal one); yet that they are not sufficient but have to be complemented by informal regulatory institutions. This argument is further developed in the following section.
Informal regulatory mechanisms and actors
In principle three forms of interpersonal relations can and do play a role in economic transactions, namely trust, violence and social sanctions based on collective action.
As abundantly stressed in New Institutional Economics, trust plays an essential role in overcoming information deficiencies. Based on individual acquaintance or collective experience (reputation), it is an extension of personal relations into the market sphere. Individuals will not pursue their interests at the expense of others if and as this jeopardizes future business. So there is an incentive to stick to the rules, all the more if not only the victims of fraud but also members of their network will boycott wrongdoers. The term ‘social capital’ is appropriate as trust can be borrowed from patrons who serve as guarantors. As discussed in the theoretical section, there remains an obvious moral hazard problem: People will cheat if the immediate gain is large enough, and the risk of being caught limited.
Given the (usually) smaller scale of operations in the informal sector and the limited number of people involved, it is plausible to assume that trust does play a more important role. Moreover, extension of trust through the use of patrons and guarantors serves as an essential lubricant of informal business. On the other hand the moral hazard problem is even more difficult to solve than in the corporate world if transactions go beyond direct exchange, take place between genuine strangers, and no means of punishing fraudulent behaviour are available. Mumvuma (2000: 272ff.) demonstrates that in a low-trust environment, entrepreneurs’ attempts to engage in complex contracting tend to lead to the decline and death of their businesses. Eventually, trust in itself offers no solutions to disagreements about the interpretation of rules. In short: If there were no mechanisms of sanction, dispute solution and arbitration, operations in the informal sector would be largely restricted to the narrow space of local communities.2
If over-emphasis on trust leads to a too optimistic picture of the informal sector, concentrating on violence certainly results in an overly pessimistic one. In a Hobbesian line of argument, absence of state control is equated to an absence of any kind of regulation. Without the strong hand of the Leviathan Man would turn into Man’s wolf, and forcible appropriation be the order of the day.
There is clearly no absence of violence in the informal sector, and it is again plausible to assume that violent conflicts over resources are more frequent than in the formal economy. According to de Soto (1989: 5), ‘only part of the ground relinquished by the state has been occupied by … new organizations. The rest appears to be taken over by violence.’ However, violence is a very expensive and insecure mode of governance even for those who employ it. Its prevalence would put a premium on investments in armaments rather than productive assets, a breakdown of exchange relations and eventually production. Nobody will offer goods and services on the market if he/she expects to be robbed. Even in the world of organized crime, gang wars are mere exceptions to the rule of negotiated, institutionalized arrangements.
This paper hypothesizes that such informal (non-state, ‘indigeneous’) institutions are the predominant mode of governance in the informal sector. They possess a relatively stable and accepted authority to impose social sanctions on rule-breakers and decide on conflicts. Their role articulates trust and (potential) violence in an organized manner; it may combine legislative, executive and judicial elements, and include the collection of ‘taxes’ and fees. We expect to identify at least four different sources of such authority, and corresponding actors in regulation:
Traditional leaders (chiefs, councils of elders, religious authorities);
moonlighting state administrators (mayors, police officers etc. acting outside their official authority);
non-traditional organizations (CBOs, informal business organizations, co-operatives).
It should be noted that these modes of ‘governance without state’ are not mutually exclusive. In places where traditional leaders prevail their rulings are increasingly commercialized; corrupt officials are not rarely involved in syndicates; and the boundaries between the latter and ‘genuine’ CBOs are far less distinct than we would like to believe.3 Informal institutions tend to combine several sources of authority, thereby broadening and stabilizing the basis of their power; at the same time the may be at least as repressive and exploitative as their formal counterparts.
The following is not a systematic analysis of the gaps left by the absence of state regulation and ways in which they are filled, but much rather an heuristic raster of questions based on examples. It leaves a lot of space for additional research.
Allocative rights and fees: Informal activities often imply the private use of public property, for instance of sidewalks for hawking and vending. Locational advantages and disadvantages are just as pronounced as in formal business. A vendor of snacks will prefer a place close to a university entrance, a developer prefer idle land along a highway over peri-urban ricefields. A first-come-first-serve system would literally force the entrepreneurs to spend day and night in ‘their’ location and create a lot of space for violent conflicts. How are favourable places for business and housing allocated, and what fees are paid to whom?
Property rights and prices: A substantial part of low-cost housing in the cities of the South is produced through illegal subdivision. A plot of land is serviced with basic infrastructure (water and traffic connection), subdivided and sold to squatters. How do developers protect their initial investment against competitors and freeriders? How can the squatters be assured that the rights they buy are worth more than the piece of paper they may or may not be written on?
Quality control and compensation: Imperfect information can lead to disputes about whether a product or service does have the assured quality or not. If a roof repaired by a carpenter for a price is blown to pieces in the next downpour, does the houseowner have any claim to repair or repayment? If a family falls sick from fish poisoning, can the vendor be held liable?
Conflict solution and arbitration: Transactions in the informal sectors go far beyond simple barter or sale for cash, and often imply fairly complex contractual obligations. A meat producer, for instance, may send piglets to scavenger families for fattening and collect them later in exchange for a fee. If the piglets die after some days, the scavengers may claim that they were ill on delivery while the customer blames poisoning by inappropriate food. In the absence of conclusive evidence, how is the case decided?
Syndicates, patrons and the state in informal housing markets4
As extra-legal housing is one of the most voluminous and profitable segment of the informal sector, we can expect a relatively high degree of institutionalization. The terms ‘spontaneous settlements’ and ‘clandestine subdivision’ suggest that urban land is just there for the taking of enterprising individuals and families. This picture is misleading. Even for the most modest demands, a parcel of land has to fulfil two minimal conditions to be suitable: accessibility (some public transport) and a source of water. To be attractive, it has to be located not too far from the places of employment, i.e. industrial and commercial centres. If idle land of such qualities does exist, it is as a rule hazardous. Places like mountain slopes and riverbanks put their inhabitants at physical risk, especially in the tropics where rains come in seasons. Residents of dumpsites and heavily polluted industrial areas are not much better off. If a suitable site is vacant because it is held back for speculation purposes, the owner will use all means available to evict unwanted occupants.
Less marginal locations in the city usually have a price tag attached to them. Even sidewalk dwellers in India or the Philippines have to pay regular fees to policemen or syndicates. Denis Murphy, one of the most experienced practitioners in the area of housing problems in Asia, comes to the sobering conclusion that ‘there is no free squatting’ (1993: vii; cf. Berner 1997: 69f.). Pal Baross’s (1983) distinction between non-commercial and commercial articulation of illegal land supply becomes, thus, questionable. Where traditional, patronage-based systems of land allocation exist they are often losing significance or becoming commercialized themselves (see for instance Payne 1997: 6ff.; van Lindert and van Westen 1991).
Like in the rest of the informal sector, definition of extra-legal subdivision is basically residual: Transactions in the informal land marked are not controlled and registered by the authorities. This implies that houses are built without permits and their quality as well as the provision of infrastructure may be below regular standards, which is precisely what makes them affordable for low-income groups: ‘It is their ability to cut corners–and costs–which has helped the commercial subdividers to expand their operations and to provide plots which are more appropriate, affordable and easily available than any other housing option’ (Payne 1989: 2). The land subject to extra-legal subdivision is often zoned for other purposes, e.g. agricultural, recreational or natural reserve. It is obvious that most land suitable for this purpose is located at the urban fringe. It cannot be too remote, however, because unlike middle-class suburbanites, the prospective buyers do not have private vehicles and can ill afford high transportation costs in terms of money and time.
Apart from these common characteristics, there are notable differences in the legal status of settlements. Baken and van der Linden observe a ‘continuum of subdivisions, ranging from almost, or partly, legal to completely clandestine’ (1992: 29). Private land owners may themselves act as developers and sell or rent out parcels. This procedure can be seen as semi-legal as property rights are not violated. Moreover, this type of ‘tolerated invasion’ is beneficial for all parties involved. The settlers find shelter and relative security of tenure at an (at least initially) modest rate; they accept in turn that infrastructure is at best minimal, at worst non-existent, and they have to develop the place by their own devices. The owners not only derive a short-term profit from rent or sales; tenants convert barren hillsides, marginal fields or swampy marshes into housing land, thereby increasing their value and creating a fait accompli for future zoning. As the land owners usually keep the formal title, they can later capitalize the value added (Berner 1997: 143ff.).
In the course of commercialization of urban land markets, the conversion business is increasingly being taken over by professional, tightly organized syndicates than combine the roles of entrepreneurs and regulators, and make huge profits out of the housing needs of low-income groups (Amis 1984; Payne 1989). In order to do so they have to be capable of establishing effective control over a suitable piece of land. Like the whole phenomenon of extra-legal subdivision, the strategies of squatter syndicates vary between places and over time. Outright land-grabbing against the expressed will of the legal owner appears to be rare, except in cases where the syndicates have political backing (Baken and van der Linden 1992: 23; Turkstra 1998: 20). Especially in the case of public land, local administrators, police officers and or military personnel almost invariably have a hand in the syndicates–either actively or as recipients of bribes. ‘In the extreme, politicians and officials manipulate the regulations to create artificial shortages and drive people towards the informal sector, which may then be supplied by the public officials acting as private developers but using public land’ (Jones 1996: 250).5 Depending on culture and legal system, local strongmen like chiefs (who in parts of Africa have the traditional right to decide on land use) or party officials (who play the same role in some former socialist countries) may also hold stakes.
Developers’ initial investment in infrastructure is restricted to the most basic needs. As we have indicated above, one such necessity is accessibility as people have to get to and from their place of work. As basic access road will attract suppliers of public transport, e.g. communal taxis, tricycles or trishaws (often unregistered themselves); in some countries people accept to walk long ways so that a pathway is sufficient. The second precondition is a source of water for which some faucets are set up, a deep well is drilled or at least a delivery service organized. Illegal electricity taps are not uncommon. Environmental concerns, e.g. with sanitation and garbage removal, are obviously not high on the list of priorities.
The ‘serviced’ land can then be subdivided and sold–what is actually sold is the ‘right to squat’ on a certain plot, and no one mistakes this for a legal title (Payne 1997: 7). It is not uncommon that part of the land is set aside for speculation purposes (UNCHS 1996: 243). Another pattern is slumlordism, i.e. acquisition of several plots by a single person who rents them out with or without a house. The first wave of occupants is commonly organized in a larger group to reduce the vulnerability of the settlement in the critical initial period; this procedure can easily be mistaken for a non-commercial invasion.6 The going price rates within a city depend on location/centrality, security of tenure and quality of infrastructure. Although empirical evidence is scattered, it can be safely said that the informal land market functions pretty much like its regular counterpart: Comparable plots will yield similar prices. Customers are often renters from other low-cost settlements who have saved enough (or access to sufficient credit) to pay a considerable sum on the spot and save on regular rent payments in future (van der Linden 1990).
Saving on rent is, however, not the only rationale of low income groups’ striving for home-ownership. A house, even if it is just a shanty in an informal settlement, is after all an asset–an asset that is likely to grow in value in the course of urban development. In newer debates about poverty, lack of assets is identified as a major aspect of the poor’s vulnerability (e.g., Chambers 1995; Moser 1998). Incremental improvements of the house, in this view, are a form of savings as labour and capital are invested to make the asset more valuable. Hardoy and Satterthwaite, quoting a Brazilian squatter, underline that not only material input is involved: ‘The value of my house–26 years of struggle’ (1989: 62). Increased security, however, is precarious. First, in case of an eviction the whole property may be lost in an instant (which is just another form of vulnerability); second, even in emergencies people will think twice about selling their house as this may jeopardize their access to their sources of income. Improving security of tenure is thus a major goal for residents of informal settlements.
To sum up, squatting (and renting from squatters; cf. Rakodi 1995) is not a cheap way to live in the city. On top of the price of land ‘rights’ and other illicit payments, costs of water, electricity and other services are normally much higher than what regular customers pay. Taking into consideration the often congested living conditions and the lack of open space, residents of extra-legal subdivisions may pay just as much money per square meter as those in legal ones, or sometimes even more. The major benefit lies in the possibility of incremental development and building improvement which leads to a spreading of the costs: ‘Ultimately, the difference between the two systems is probably not the price limit per se but the way low-income families phase their expenses for housing’ (Baross 1990: 7).
Regulatory deficiencies in the informal sector
The case against the state as regulator is certainly a strong one, and it is supported by both the neoliberal mainstream and protagonists of alternative development in the de Soto tradition. Most developing countries have made little progress in adapting rules and standards to local conditions, streamlining cumbersome bureaucratic procedures, and minimizing graft and corruption. Tremendous transaction costs make these countries unattractive for foreign investments by offsetting low wages, and put local businesses at a disadvantage in global competition. Rightful criticism of the state should however not lead to a romanticizing view of informal institutions. De Soto himself, while maintaining that the ‘system of extralegal norms’ be a spontaneous and bottom-up affair organized by ‘the informals’ themselves, is quite aware of its shortcomings and limitations. According to his detailed analysis, the ‘inefficiencies of extracontractual law’ result in likewise tremendous transaction costs and limits to capital accumulation and growth (1989: 151ff.). Informality may be costly not only for entrepreneurs but also for the employees, customers, and society at large. Again, the following discussion is not comprehensive and systematic but may serve as a starting point for further investigation.
Cost to entrepreneurs: Informal businesses do not operate outside the legal system but are in constant contact with it, normally to their disadvantage. In order to remain inconspicuous entrepreneurs face a disincentive to scale up their operation, and still have to pay regular bribes to avoid penalties. The necessary secrecy, on the other hand, makes it more difficult for potential business partners and customers to identify the enterprise, thus limiting backward and forward linkages, increasing the costs and lowering the quality of information. Lack of access to formal credit, and the immense interest rates in informal systems, have often been cited as an obstacle to growth. Less attention is paid to lack of access to instruments of insurance and risk sharing. This adds to a general situation of insecurity caused by precarious location, exposure to crime, and unforeseeable behaviour of law-enforcing agencies (see below).
The main bottleneck, however, seems to lie in the need to organize institutions for contract enforcement and the inadequacy and limited scope of these. Private judges, be they traditional leaders, syndicate representatives, or moonlighting state officials, are often expensive to turn to, their neutrality is questionable, and opponents’ obedience to their decision not guaranteed. Self-organization in CBOs offers a solution only apparently. First, as we have learned from Mancur Olson (1965) organizing is costly itself; second, the domain of CBOs is usually restricted to small local communities thereby severely limiting the scope of business activities; and third, the mechanism of solidarity itself may impose sharing obligations on successful entrepreneurs and become an obstacle to capital accumulation (Evers and Schrader 1994).
Costs to employees: Contractual insecurity is of course passed on to employees who are fired at will and enjoy no security in case of illness and injury, the latter not rarely caused by hazardous working conditions. Workers’ reverse freedom to desert their job whenever they find something more attractive has detrimental effects for themselves. Employers will not invest in human resources as they have to expect competitors to poach trained staff. This prisoners’ dilemma combined with capital scarcity prevents technological upgrading and contributes to the depression of wages in the informal sector.
Costs to customers: Lack of insurance and, again, the difficulty of contract enforcement make it unlikely for customers to get compensation if their purchase is deficient or they suffer outright damages, for instance by environmental hazards on a housing site that a reckless developer was silent about. Moreover, landlords may step back from their contractual obligations even after decades of collecting rent, and declare their tenants ‘squatters’ in order to get rid of them (Berner 1997: 143ff.).
Costs to the public at large: Tax evasion is of course one of the main incentive to go or remain informal. It leads to a shrinking tax base which increases the burden on consumption and formal businesses, driving even more of the latter underground. Informal factories can easily externalize environmental costs leading to health problems not only for their workers but for the public at large.
To sum up: Much of the informal sector is characterized by inefficient regulatory systems leading to general insecurity, lack of capital and problems of accumulation, underinvestment and limited growth, and a massive waste of economic and human resources. Informal enterprises are locked in in terms of space, scale, and technology, and suffer from tremendous transaction costs. This situation can be called appropriate only relative to an even less efficient state apparatus; involution in the informal sector is thus inseparably linked to the involution of whole national economies.
In the informal housing sector, however, additional deficiencies arise from its inevitable and long-term exposure to legal institutions. While the developer can pocket the profit and launder it if necessary, the customers can hardly hide their newly acquired asset from the eyes of the law.7 Apart from being the basis for the extortion of bribes, this situation leads to a permanent threat of eviction. Insecurity of tenure is not only a main element of the urban poor’s general vulnerability, but a major impediment to further investments and improvements. As squatters are forced to keep their property mobile they are reluctant to put money into productive ventures. Environmental upgrading likewise requires considerable investments and long-term commitment of the residents, e.g. in non-pollutive sanitation and waste disposal management (Lee 1998). Such contributions are unlikely if people are unsure whether they will be able to enjoy the benefits.
Conclusions and a call for further research
There are two main fields in which the results of further research are expected to contribute relevant knowledge:
The informal sector is increasingly a field of intervention in terms of promotion, upgrading and legalization. Additional knowledge on the way relations and transactions in this sector are organized will provide input in order to improve the quality of policies. It may especially help to reduce unintended consequences, e.g. when it comes to providing assets (which may be appropriated by local powerholders) or eliminating middlemen (who may play a crucial role in the economic fabric).
The very existence of a large informal sector indicates deficiencies and inadequacies of the regulatory system itself. Certain elements of informal institutions seem to be better adapted to, and more appropriate for local conditions than regulations which are frequently vintage colonial heritage. Corruption, for instance, may indicate that the official price for certain services is too low while formal requirements are far too cumbersome.
The preliminary evidence presented in this paper supports neither romantic views of the informal sector as self-regulated ‘popular economy’, nor neoliberal calls for comprehensive deregulation. Formal and informal regulatory systems are interlocked and interdependent, the latter closely reflecting the inadequacy and inappropriateness of the former. Relations in the informal sector are ‘un-civil’, inequitable and exploitative, and actors are exposed to insecurity. Informal settlements suffer from underinvestment and are thus nearly invariably of low quality and deficient in terms of services and environmental conditions. Legalization, however, is self-defeating unless the legal system itself is fundamentally changed (Berner 2000). The challenge lies, in the words of Jan van der Linden, in the ‘bridging of the gap between the legal and the illegal systems, starting with the recognition that illegal systems have in the past achieved far more than any official initiative’ (1994: 225; cf. Fekade 2000, Kombe and Kreibich 2000). Hernando de Soto’s (1989: 252) call to ‘adjust the legal system to reality’ should still be high on most developing countries’ agenda.
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