Capitalism at its finest .... a win-win for the entire world. 
This is what struck me as most important "That fruit seller is a successful entrepreneur.
"The "Next Big Thing" for Global Business
By Peter F. Schaefer
Source TCSDaily
"Exactly a century ago, Cemex became the first Mexican cement producer. In 2000, Cemex became the largest cement producer in the world beating out France's Lafarge and Switzerland's Holcim. Although the Cemex market profile has changed over the last hundred years, its early success came from their ability to serve micro-markets -- selling a bag at a time to poor folks.
In a micro-market like this, a homeowner who lacks a title to his house and property (an "informal" homeowner) but has a bit of extra cash, might buy a single bag of cement and a dozen cement blocks and use it to add a few square feet to a house wall. Finishing the house often takes years, but in the end he has a real house. And like 55% of all American wealth, this is where he saves -- he lives in his savings "account."
Cemex mastered this part of the market and has prospered. But poor homeowners throughout the developing world remain poor because their savings account is frozen and so they can't leverage their property. Unlike Americans, these informals have no diversity in their savings. Informal shelter, and the cottage industries they often house, are nearly always their total savings. And also unlike Americans, their savings - their capital - can't be used to back up a credit card or get a home improvement loan. An informal homeowner can't even make a contract with a utility company to deliver electricity or water since the utilities have no way to know who owns the house so have no certainty of being paid.
As a result of this capital being "dead" -- that is, their savings are illiquid -- the potential market it represents is rarely considered by multinational businesses. And when they do think about it, they usually conclude that there isn't a viable strategy to open it widely to their products.
But this market could be enormous. It wasn't long after the collapse of the tech stocks that a new conversation started in the business community; "What," they asked, "is the next big thing?" Well today, these informals hold one of the largest discrete pools of capital ever accumulated. But it is not on anyone's radar screen since these frozen savings are held by the world's poor and so they are relegated to the margins of this conversation despite its enormous size.
Nevertheless, this capital is there and eager to enter the global marketplace if only it can be unlocked. So let me propose a "key" for opening the market and then suggest ways for businesses to help facilitate it.
Unlocking Frozen Capital
Several years ago, the World Bank acknowledged that there was a large "informal" (extralegal) business sector in all developing countries. It was not made informal by tax avoidance but by bureaucracy avoidance (see Doing Business 2004). Ongoing research into the structure of these informal economies reveals the legal, regulatory and bureaucratic barriers for small businessmen and homeowners which block their entry into the formal economy. In fact, these barriers impede modernization for the entire society and render futile the various efforts of aid organizations to significantly reduce poverty. This failure compels poor countries to become dependent on outside sources of capital (commercial loans, government debt and foreign aid).
Recently the new US Millennium Challenge Corp. established the criterion for its grant-aid recipients stating that they must remove the barriers to formalization. So far, the MCC's clients have strongly supported this approach, which could signal the start of a quiet revolution. But more needs to be done. If these efforts - and those of many other organizations - are successful, this opening for the poorest people in the world could not only give them a ladder up out of poverty but be "the next big thing" in the global economy benefiting everyone in the equation. But in the end this transformation will be driven by markets and businesses, not changes in public policy which, though necessary, can never be sufficient.
Markets at the Bottom of the Pyramid
Businesses are not philanthropies. So doing business at the so-called "bottom of the pyramid" (BOP) requires new strategies and tactics that are generally not familiar to traditional businessmen. There is a real market at the BOP, and that market could evolve more quickly with the help of the business community. But to capture the interest of multinational corporations, they must see clearly how they can profit from this opportunity.
The first step is being convinced that the market is real, since this capital is essentially invisible. It is the cold, dark matter of global finance. But the informal economies of many countries have been mapped by a number of researchers, and the pattern is consistent throughout all poor countries in every part of the Third World. The force driving the social and economic transformation of these countries in the second half of the 20th Century was urbanization, just as it was in 19th Century in North Atlantic countries. And this trend will continue, even accelerate, for the foreseeable future.
The process is familiar; the rural poor - mainly subsistence farmers or their children - migrate to cities in search of work. But the focus on jobs and employment is misleading. Unlike Mexicans migrating North for jobs, these people, mainly, become entrepreneurs not employees. Some fellow on the sidewalk with his blanket spread out and covered with pieces of fruit is an entrepreneur, not an employee. Even nominal "employees" in informal businesses put their time at risk because they are paid from profits and so are more like partners than employees.
And the system works. There are four to five billion poor, and growing. Look closely. That fruit seller is a successful entrepreneur. He was there yesterday and will be there tomorrow and almost certainly has a house and family.
Another surprise is that these poor entrepreneurs save, although their savings are relatively small and, once made, they become all but illiquid. Moreover, without viable alternatives to savings, this pool of frozen savings is constantly growing, which fuels a process that continuously moves their capital from live to dead, or liquid to illiquid. In so doing it also freezes a large part of national savings.
The economic problem is that frozen savings can't be leveraged or spent without great difficulty and, thus, prohibitive cost. Since any excess earnings must nearly always be invested in shelter, urbanization ends up being a form of forced savings; it's a process of freezing, not a freeing the wealth of the nation. Individually, the size of these invested savings is small, but in aggregate it is huge, correlating with the growth of enormous, third world mega-cities.
The process is almost the same everywhere. It begins when a squatter takes land and starts making a shelter. Any money spent on creating shelter or starting a business becomes frozen in the structure since it is invisible to the law. Every time the squatter expands or improves his home, or invests in his business these illiquid savings continue to grow.
A billion or so poor families and hundreds of millions of informal businesses yield trillions in this "dead capital" (Adam Smith's term). Six years ago, one well-respected researcher published an estimate that this dead capital was worth nearly ten trillion dollars globally. By comparison, the total loss of market capitalization in the 2001 "tech bubble" crash was just over four trillion dollars.
Viable markets in poor countries would provide continuous opportunities for growth and commerce that were not based on speculation but on making and selling real things to buyers with cash. But the cash of these buyers at the BOP is frozen solid so entering this new market is not simply a matter of waiting for the aid agencies to help countries formalize their markets, and then opening up your widget store in the capital city.
The Lost Art of Entering the Formal Market
How can these poor entrepreneurs join the formal market? For years they were carried in official statistics as "unemployed." So how do you even find them? Well, finding them is easy as the poor are living and working everywhere in developing countries just as they were in Scotland when Adam Smith wrote about them 250 years ago. And they live, mostly, in squatter settlements on marginal land and in the fringes of big cities. Their houses are crude by our standards and their businesses are mainly "cottage" industries. But as the numbers of informals grow larger through urbanization, and their settlements become more permanent, so their savings grow.
At the most basic level, their "business" might be to buy a pack of cigarettes in the morning and then sell them one at a time at stoplights for a few pennies profit. But they may also own a small office building, or a truck, or even a fleet of trucks. There is no formula, just the universal condition that they are invisible to the law. They occupy a parallel economic universe, and so are unable to buy products that people with identities, addresses, demonstrable income and credit history take for granted.
The key to unlocking this pool of dead capital begins with legal and regulatory reforms which define and protect private property. This is a political process which America pioneered, intellectually and practically, so we should be experts. But we only did it once and Jefferson is long dead. This means our blueprint is a few centuries old and so now it has become a lost art. Although many developed states run a modern political economy very well, they have forgotten how to build one. The challenge is not to invent a new program. America's Founding Fathers have shown us, and all other developed countries, how to figure out what to do and how to compress this haphazard process of centuries into one of only a few years.
Blueprints, Not Aid; Inputs Not Outcomes
Milton Friedman suggests that what poor countries need today is America's original blueprint. They need those inputs of modernization we established in the 18th Century, not the outcomes we have in the 21st. But it is just these outcomes that we try to export to the developing countries. Western aid agencies and the World Bank work very hard to distribute Western capital to poor countries to little avail. But they have done very little to free up that capital they already have by legalizing these informal homes and businesses. We don't need heavy equipment operators, we need lawyers and political economists who understand the missing pieces.
But there is a moral hazard in expecting the World Bank to do this work because the Bank exists to provide Western capital to poor governments. But the poor countries don't need gifts of outside capital -- they have plenty. They need technical support to create systems that free up the capital already there. Moreover, the World Bank's entire portfolio is around $120 billion and its private sector arm's is around $25 billion. If the existing savings were made liquid, aid funds would be lost with the table scraps.
It is the Western business community, not aid agencies, that needs to become the leaders in fixing this problem. But an effective strategy is much more than a snappy ad campaign. Businesses need to proselytize on behalf of a truly modern economy and then play a part in making it happen. Do well by doing good. They can support the needed reforms in developing countries by a number of means. First, they should have their investment teams quietly suggest to political leaders in poor countries that these reforms are important to their investment decision but will also be useful in encouraging modernity and economic growth for the entire economy, not just the enclave in which these foreign firms operate.
Multinational corporations will benefit in many ways. Most obviously it will expand their markets. If you have a desirable product, there are 4 billion people who might be interested. Also these businesses will gain better property rights for their own investments, products and copyrights. After all, their neighbors, their employees and often their suppliers don't have real property rights themselves so it is somewhat unreasonable to expect them to respect the rights of foreign businesses.
Changing the Climate of Opinion
The business community has a very poor record of supporting free trade think tanks. It is understandable that a company may not wish to fund an NGO advocating significant reforms, no matter how beneficial. They want to sell soap-flakes, not political change. But there is a whole universe of think tanks that very effectively promote a growing global network of free market groups. Organizations such as the Atlas Economic Research Foundation, the Fraser Institute, the Cato Institute, the Heritage Foundation, the Hoover Institution and many others have a real impact on the intellectual climate for change. And university think tanks, such as the Mercatus Center at George Mason University, are becoming more active as advocates not just chroniclers of reform in recent years. These organizations and others like them need significant additional support from the business community.
Here at home, business leaders can support the idea of spreading property rights as a fundamental objective of US foreign policy, something now only a marginal part of foreign aid. Businesses have a vital interest in these reforms and they should press the administration and their Members of Congress to insist on change and also let them know that MCC is on the right track.
And finally, there is considerable profit to be made from engaging in the business of just formalizing the several billion properties and businesses that populate most of the poor countries. Banks, insurance companies, IT firms, law firms, mapping firms and utilities all stand to benefit immediately and directly from the process of formalization. And those businesses already in poor countries will realize immediate opportunities from their newly formal customers.
Changing the Business Model
Because this formalization process is a win-win for everyone - governments, the World Bank/IMF, aid donors, businesses, banks and, most of all, the poor themselves - and because these reforms are enjoying increased visibility (for instance awarding the recent Nobel Peace Prize to a banker to the poor), it is likely that over time these systems will be established in most poor countries just by a slow build-up of momentum. And when this happens these new markets will be opened.
There are two commercial opportunities. The first is to accelerate the process of formalization. Those who will serve this market are the sectors mentioned above. Initially firms that can devise commercial approaches to stimulate and manage these reforms will have the most opportunities. Formalizing a billion properties will require the investment of $300 billion to $500 billion from which businesses will seek to profit.
The second part is selling to the new formals. This is appealing because these billions of poor entrepreneurs have little or no debt secured by their property. And entrepreneurs need capital, so if they were given access to credit secured by their existing property then markets for the entire range of manufactured goods would open up. The challenge here is how do you sell to them, and the answer is right-sizing and credit.
Cemex and Other Examples
Cemex built its early growth largely by serving this mini-market, one which it still serves today. Selling to the market at the BOP cannot follow the Sam's Club bulk model. In fact, in most cases, it can't even follow the Wal-Mart model, though it is intriguing that Wal-Mart is moving into China. Service through training or education, distribution through little neighborhood stores, reformulation and mini-packaging are some of the keys to success at marketing to the BOP.
A new marketing strategy is needed because people who are not exposed to modern manufactured goods may need help in utilizing them effectively. Also, they cannot hop in their car and run over to the store but often have to walk to distribution points. Yes, poor people eking out a living need shampoo, but it need not smell like fresh raspberries. And, finally, they may not be able to buy a pint or a quart at a time. For example, Lever Brothers had considerable success in India by selling single-use packs of shampoo and other products. That's a good model.
But all this only works if the poor can get credit once a house is formalized. This is a significant problem. Banks in poor countries have almost no experience with small loans. They normally make loans to facilitate trade, corporate finance, and to raise sovereign debt. The current Micro-lending model, developed by Nobel laureate Mohammed Younis, is important but mainly to prove poor entrepreneurs are good credit risks, not because it is opening this dead capital. Compared to a securitized loan, social-contract lending is inefficient and relatively costly. Moreover it will never be able to mobilize more than a tiny fraction of the investment needed to fund this transformation. But banks can do it if they employ the power of computers and specialized software programs that allow them to make a profit on a $100 loan. This step is key.
A Rare Win-Win Scenario
Bringing the poor into the modern global economy has benefits across the board, not just for the informals. The governments of poor countries will have a broad tax base so long as the transformation is not used as a pretext for over-taxation or over-regulation, either of which will drive people back into the informal sector and so kill the effort. But there is an enormous incentive to manage such a system sensibly.
If governments can resist using formalization to exploit poor people, they will have security, stability and access to credit. As a result, the overall society will be more stable and so less susceptible to extremism. Foreign aid institutions can stop wasting money on things that don't work. Local businesses will see an increase in their market, so they will buy more from multinational firms thus increasing trade as well as sales. International and domestic banks will acquire a large new pool of secured borrowers. Poor governments can better rationalize their economies and broaden their tax base. And, finally utilities will be able to identify and serve an enormous new customer base.
American firms should go after this business. It's there. Waiting. "
Peter F. Schaefer has worked in the Third World since 1970, in both the public and private sectors. "
http://www.tcsdaily.com/article.aspx?id=111606A
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