Informality and Extralegality When international agencies jet their consultants to gleaming glass towers in the most elegant sections of town, they’re dealing with only a fraction of the entrepreneurial world. In the developing world, the emerging economic powers are not just in the high-rise offices, but teeming in the streets below. Garbage collectors, bus operators, shoemakers, appliance repairmen, and even construction companies are working and creating value. But these emerging entrepreneurs are part of the informal, extra-legal economy.

The formal, legal world is one most of us in the West know. It is a world where the majority of people enjoy the rule of law—where property, identity, and businesses all are legally defined and documented. This system is responsible for our staggering prosperity. It is a system in which:

• citizens can prove who they are,
• people and businesses have legal addresses and identities,
• property titles and registries allow everyone to know who owns what,
• articles of incorporation enable investors and customers to know who they are buying and selling from.
• legal contracts are binding and enforceable.

This is the world we move in daily. We never think about the vast invisible architecture that lets us live, work, and prosper as few in human history ever have.

The overwhelming majority of humanity lives in a world without this invisible architecture. Not only are they lacking these beneficial tools, they must often trade and create value in the face of unnecessary bureaucratic obstacles that de Soto refers to as the “paper wall.”

It is a Byzantine world filled with confusing and exclusive laws, procedures, bureaucracy, and corruption. De Soto says:

Four billion of the world’s six billion, many of them with assets – homes and businesses – and eager to improve their life chances in the larger markets are outside the rule of law. Those four billion have little chance of success because discriminatory burdensome, and costly legal systems have kept them from the legal tools they need to cooperate economically on a national basis, never mind a global one.

As a result, the poor exist outside the legal system. They are in an extralegal place, a place in which:

• the poor’s assets cannot be represented in such a way to be economically useful;
• people are not easily held accountable for their commitments;
• assets are not liquid and cannot be used to create credit or capital;
• people are not as interconnected across distances and transactions cannot easily be tracked from one owner to the next;
• the poor do not have the means to divide labor and control risks through limited liability and asset partitioning, or associate freely in forms such as corporations and cooperatives, and
• people cannot be identified, and contracts are unable to reach a market outside the limited confines of acquaintance.

The reach of the legal economy is still too limited. De Soto believes this is the primary reason why globalization has not yet delivered on its promise. The majority of the poor are without the legal tools to take advantage of the legal system and their children have virtually no hope to move up the economic ladder.

Advanced nations take the formation of their successful systems for granted, treating the issue of the rule of law as given. In fact, legality that is rare; extralegality is still the norm for most of the world.

The owners of extralegal businesses cannot get formal bank loans, nor can they enforce contracts or expand beyond a personal network of familiar customers and partners. An estimated 2 billion people are without access to basic financial services. As a result, the poor have no choice but to accept whatever they are able to extract from these informal networks. That very often means a condition of uncertainty.

People in the informal sector want legal tools of development so desperately that they often develop their own rudimentary codes. In other words, they cope by devising their own solutions. Informal ways of documenting things blend customary practice with ingenuity. These, sometimes sophisticated informal structures, guide how the poor live, work, and do business. To obtain essential services such as water, energy and protection in their communities, they have to be resourceful. They enter into informal labor contracts, run unregistered businesses and often occupy land to which they have no legal use-rights.

The poor sometimes choose to operate informally because there are no institutions. Often however, the formal institutions are dysfunctional or the system is corrupt. Reliance on informal institutions can leave the poor vulnerable to exploitation, bureaucratic meddling and criminality. Making a transaction is thus a high-cost affair. Unpredictability and insecurity are rife in these systems and they are certainly not suited to integration into the global economy. The Informal sector is therefore unlikely to be a springboard for development, as it provides few opportunities for economic growth and revenue for public investment in services like infrastructure and justice.

However hard they work, these self-employed workers, casual day laborers and industrial outworkers find it difficult to escape poverty. While some may have basic rights and protections in theory, they don’t in practice. They do not benefit from labor laws and collective-bargaining arrangements, because their employment relationship is unclear. They suffer inferior working conditions and job insecurity. They are typically denied access to state or employer benefits and social security. de Soto believes that recognition and enforcement of the rights of individual workers and of their organizations is critical for breaking the cycle of poverty.