Hernando deSoto, property rights, and Egypt

Lynne Kiesling

Yesterday the Wall Street Journal featured an essay from Peruvian economist Hernando De Soto, focusing on the socio-economic roots of the current protests against the authoritarian Mubarak government. De Soto’s work on the debilitating consequences of the lack of property rights for individual prosperity and economic growth is outstanding, and he has been working in Egypt for some time. He summarizes a study he published in 2004:

• Egypt’s underground economy was the nation’s biggest employer. The legal private sector employed 6.8 million people and the public sector employed 5.9 million, while 9.6 million people worked in the extralegal sector.

• As far as real estate is concerned, 92% of Egyptians hold their property without normal legal title.

• We estimated the value of all these extralegal businesses and property, rural as well as urban, to be $248 billion—30 times greater than the market value of the companies registered on the Cairo Stock Exchange and 55 times greater than the value of foreign direct investment in Egypt since Napoleon invaded—including the financing of the Suez Canal and the Aswan Dam. (Those same extralegal assets would be worth more than $400 billion in today’s dollars.)

The entrepreneurs who operate outside the legal system are held back. They do not have access to the business organizational forms (partnerships, joint stock companies, corporations, etc.) that would enable them to grow the way legal enterprises do. Because such enterprises are not tied to standard contractual and enforcement rules, outsiders cannot trust that their owners can be held to their promises or contracts. This makes it difficult or impossible to employ the best technicians and professional managers—and the owners of these businesses cannot issue bonds or IOUs to obtain credit.

I strongly recommend reading his whole essay; this excerpt cannot convey the eloquence of his argument for formal, transparent protection of private property rights for all individuals at all income levels, and the effects of such institutions on their prosperity and on economic growth.

I first wrote about his 2004 Egypt report back in 2004, and will reprint that original post here to complement De Soto’s outstanding essay.

[February 23, 2004] Friday at the Mercatus Chief of Staff Retreat, Hernando De Soto spoke on the work that they are doing in Egypt. Hernando De Soto founded the Institute for Liberty and Democracy in Peru, successfully fighting the Maoist Shining Path guerillas in Peru. De Soto laid out the economic and philosophical argument for why law, liberty and democracy are fundamental foundations of development in The Other Path. His most recent book, The Mystery of Capital, delves into the consequences of the lack of legal ownership and property rights in poor societies.

De Soto and ILD have been working in Egypt for 4 years, mapping out how much of the asset base in Egypt is actually “owned” and operates beyond the confines of existing law, and how much economic activity takes place in an underground economy. They have found that 92 percent of Egypt’s asset base is in the hands of Egypt’s working poor, and that ownership of these assets is not supported or enforced by Egypt’s legal system. DeSoto and the ILD have been working to persuade the Egyptian government that bringing law and property rights to the Egyptian people will not only create an environment in which they can be economically productive, it will also be a good political move to be the government that empowers such a large percentage of the voting population.

This was the first time I have heard De Soto speak, and he truly is inspiring. He is able to move from the specific features of Peru or Egypt to the general benefits that accumulate when societies have the legal institutions that support the move from personal to impersonal exchange. Trust is an important precursor to exchange, and institutions that enable trust among strangers and thus facilitate exchange are important precursors to economic growth. Another aspect of trust is the longevity of the business. To paraphrase from De Soto’s remarks, in poor societies you worry more about whether the businessman is going to have a heart attack, because the legal institutions do not exist that support the longevity of his business beyond his life. This lack of longevity shortens timeframes, meaning few or no long-term contracts and diminished investment.

Another interesting point that he made is that in economically vibrant countries like the US, most small business is initially funded by mortgages and second mortgages on homes. The ability to borrow against your home is not available in many poor countries because of the lack of legal ownership. As he put it, in the US your home can do many things for you simultaneously. In poor countries, it does one thing: provides a roof over your head.

And as De Soto said, these legal and economic institutions are more important than roads or ports, so if we really want to help the poor in developing countries, we should focus on institutions that create business longevity, facilitate impersonal exchange across larger markets, and enable people to borrow against their assets.

Texas Observer: Some Companies Made Millions Off the Texas Blackouts

Michael Giberson

In other commentary on ERCOT’s rolling blackouts: “Some Companies Made Millions Off the Texas Blackouts.”

While Texans suffered rolling blackouts yesterday, some power generators were enjoying windfall profits. Starting around 5 a.m., prices in the wholesale market surged to the market cap, $3,000 per megawatt-hour, and stayed there, off and on, until around noon. Prices are typically below $100/megawatt-hour, acknowledged ERCOT CEO H.P. “Trip” Doggett today in a press conference.

There are still more questions than answers but this much is clear: At best, some power generators around the state raked in oodles of money thanks to the way ERCOT has structured the energy market. At worst, some may have manipulated the market to drive up prices.

… ERCOT may have allowed prices to reach the cap in order to maximize the amount of power during the crisis yesterday. In other words, ERCOT was willing to pay whatever it took to secure the system. [Public Citizen-Texas's David] Power compares it to flinging hundred dollar bills at a taxi driver who’s already got the pedal to the floor.

“You just keep throwing money at the front seat,” he said. “You’re not going to get any more out of him; you’re just going to have a really happy driver.”

(First it should be clarified that most power produced during the emergency was likely paid under a long-term contract, so didn’t get paid $3,000 per. Only to the extent that a generator had the capability to increase output over existing contractual commitments would it be able to earn that price on the increase.)

The $3000 price is part of ERCOT’s “scarcity pricing” mechanism. It is a rule that plays about three or four roles all at once. First off, during emergency shortages you want to motivate every generator out there to take every reasonable step to maximize production. At the same time, you want to motivate large-scale customers that see something like a real-time price to cut back on consumption to the degree possible.  In addition, the price is supposed to help motivate longer term investments – generators investing in a little more spare capacity, consumers investing in a little more conservation or the capability to curtail during emergencies.  These later effects won’t help during the current emergency, but the hope is to be a little better prepared for the next emergency.

So it isn’t just a matter of making the current taxi drivers happy.  We want customers who don’t need cabs so badly to find some other way around, and we want to have more taxi drivers in the city for the next emergency. No doubt, though, with the political attention the event is receiving, the possibility of market manipulation will be and should be examined.

ASIDE: By the way, if you assume 1 MWh of energy would keep 250 homes from being blacked out, at $3000/MWh the cost is about $12 each.* Much, much higher than the typical cost of electricity, but I’m sure many (not all) consumers that lost power yesterday would rather have their monthly bill $12-48 higher and kept their power through the cold. With a fully developed smart grid we wouldn’t have to guess whether or not consumers would want to pay these kinds of prices. Consumers could decide for themselves what their limits were, and set their devices to manage instant responses to system emergencies.

My preliminary assessment of the rolling blackouts was posted earlier today: Cold snap brings rolling power outages to Texas; is ERCOT policy of isolation at fault?
*A very rough ‘back of the envelope’ calculation, not based on consumption data from Wednesday. Feel free to improve upon it in the comments.

Speed as a for-profit service

Michael Giberson

Wednesday’s Wall Street Journal included a story on HOT lanes and other ways commuters can buy through congestion, “American Idle: On the Road.” One excerpt:

In the early years of the nation, entrepreneurs built toll roads, offering travelers a faster carriage ride in return for money.

Now, the concept of the toll road is making a comeback. In Virginia, a key element of a $4 billion transportation package proposed by Gov. Bob McDonnell includes expanding the use of “HOT” lanes, an acronym for high-occupancy toll lanes. These fast lanes will be operated by a private company within the existing freeway system. Toll rates could fluctuate according to demand, or be set based on time of day as they are on Route 91 in Los Angeles. Such pay-to-roll roads are in operation or on the drawing board around the U.S.

Cold snap brings rolling power outages to Texas; is ERCOT policy of isolation at fault?

Michael Giberson

[Note: This item was originally posted at MasterResource as: "Texas Power Outages: A Preliminary Analysis (Cold snap brings failure--isolated ERCOT an issue)"]

Wednesday morning, ERCOT, the power grid operator for much of Texas, called upon local distribution companies to cut power to blocks of consumers on a rotating basis. The rolling outages were a great hardship the people throughout the region, and have consumers and policymakers wondering what went wrong and what should be done about it. The following is a preliminary analysis based on public data and news reports. A subsequent post will present more details once more complete information becomes available.

In brief, extreme cold weather pushed power demand to very high levels for the winter.  At the same time, 50 of the state’s power plants were offline due to the effects of the cold and several more were undergoing planned maintenance. The combination of very high demand and reduced supply left the ERCOT grid perilously short of reserves.  Some wondered whether wind power was at fault, but wind power contributed about 7 percent of ERCOT’s power during the emergency – about the same as this time last year. Rolling consumer outages were employed to protect the system from failing completely.

No power system is immune to hazards. But policy decisions that increase the likelihood of hazards or multiply the resulting damages ought to be given careful reconsideration. In this case, the choice by Texas policymakers to keep ERCOT isolated from surrounding power systems prevented power companies within ERCOT from accessing excess power capacity elsewhere in the state and in neighboring states.  Other policy issues also are raised by the emergency, but few solutions are likely to be as cost-effective and technically simple to implement as linking ERCOT to its neighbors.

ERCOT Map

A more detailed examination of the topic follows.

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