Archives for category: Institutions

Uhuru and Ruto wrote in the Jubilee Manifesto that they plan to establish a development Bank to “prop up the private players”. Although nobody is talking about it, and although we have no idea if that will happen anytime soon, this could be a huge deal for the future of Kenya. What is a development bank? And is it a good or a bad idea for Kenya?

A traditional definition of a development bank is one which is a national or regional financial institution designed to provide medium-and long-term capital for productive investment, often accompanied by technical assistance, in less-developed areas. Development banks fill a gap left by undeveloped capital markets and the reluctance of commercial banks to offer long-term financing. [full “primer on development banking” here]

We have to keep in mind is that UhuRuto provided no details about how a development bank fits into their grand scheme for economic development in Kenya. For example, we don’t know if the objective is to promote small businesses (like the informal sector or SMEs), whether they want to finance large infrastructural projects, agriculture or large manufacturing industries.  However, the sure thing is that whenever the plan is to increase the government role in the economy, you attract both huge praise and criticism:  that’s the difference between the “industrial policy view” and the “political view”

According to the industrial policy view, development banks do more than just lending to build large infrastructure projects. They also lend to companies that would not undertake projects if it was not for the availability of long-term, subsidized funding of a development bank. Furthermore, development banks may provide firms with capital conditional on operational improvements and performance targets. In such circumstances, we would expect to see the firms who borrow from development banks increasing capital investments and overall profitability after they get a loan.

According to the political view, on the other hand, lending by development banks leads to misallocation of credit for two reasons. First, development banks tend to bailout companies that would otherwise fail (this is the soft-budget constraint hypothesis, e.g. Kornai, 1979). Second, the rent-seeking hypothesis argues that politicians create and maintain state-owned banks not to channel funds to socially efficient uses, but rather to maximize their personal objectives or engage in patronage deals with politically-connected industrialists.

So, whether a development bank is a good idea or not for Kenya entirely depends on your opinion on the current political class: will they be committed-to-development or good-old rent-seekers? For now I want to keep on the optimist side.


The state of Lagos in Nigeria decided to embrace de Soto’s “Legalist” idea of development and to start a process of mass formalization of the informal sector. I don’t know if Hernando de Soto will go there in person, but his Peru-based think tank – the Institute of Liberty and Democracy- is involved in the project. From an article in This Day Live:

The Lagos State Government has begun a comprehensive reform process, which it designed to formalise about 90 per cent assets currently locked in the state’s informal sector.

the state government had trained more than 100 enumerators in collaboration with the Institute for Liberty and Democracy (ILD), Peru to assist in data collation and information gathering under the state’s informal sector reform initiative.

.. Raji [Ministry of Commerce and Industry] said the state government was interested in having comprehensive information about the sector, and know why most people choose to operate informally, and, then work out modalities that will help in formulation policies that will encourage their migration to the formal sector.

Giving more recognition to informal operators is undoubtedly a good thing, but I wonder how far this can go. The Legalist school argues that formalizing property rights in the informal sector would trigger a virtuous cycle: business formalization turns “dead capital” (i.e. capital without property rights) into real collateral. Real collateral allows access to formal finance and new markets. Increased access to formal finance encourages business investments. Increased investments … I bet you can guess the rest of the story.

I used to like de Soto’s ideas, and to some extent I still do: as simple as they are, they point to the right direction – informal economies have a large development potential. But I turned more critical when I realized that his simple arguments have transformed into an over-simplification of reality. The equation “business registration=formalization” neglects that most activities in the informal economy are sustained by an infrastructure of (non-formal) regulatory, financial and welfare institutions beyond the reach of official governance. The central question raised in Lagos, “to know why most people choose to operate informally, and, then … encourage their migration to the formal sector” misses the point. The question should be reversed: we should try to understand how informal firms and their institutions work in practice, and to determine how formal institutions can “scale-down” and become appropriate for their needs – definitely not the other way around.

Let me point out two errors in the title of this post. First, the plural of chama in Swahili is ‘vyama’, not ‘chamas’ like English speakers say. Second, the term self-help group is a “development-friendly” way of describing a chama, but in fact chama means ‘association’, ‘club’ or ‘party’ which can be involved in all kinds of activities. In the past I enjoyed using exotic terms like ‘indigenous’ (or ‘endogenous’) institutions in my papers but I realized that, whether I like it or not, they tend to indicate some sort of backwardness.  So, I started calling them “social networks”, like sociologists do, but I’m still not convinced.

Vyama are widespread all over Kenya and deeply embedded in the local culture, probably because they allow members to face problems and opportunities as part of a group rather than individually. This is quite a difference from the individualistic environments where I grew up (hint, it’s in Europe), where I may count on my immediate family members and friends in some occasions, but in general people rely on markets and formal institutions for almost everything. Vyama instead seem to work for the exact opposite reason: because they are flexible and informal and because they are built on social ties instead of formal structures. I should point out that vyama do get some sort of government recognition, as they usually register as Community-based Organizations (CBOs) at the Ministry of Gender, Children and Social Development but this doesn’t make them a legal entity. In very rare occasions, vyama are registered at the Attorney General’s office as private enterprises, partnerships or societies, but this happens only if the chama makes profit or large-scale investments.

What do vyama do?

Because of their flexible and informal nature, vyama are extremely difficult to categorize in simple groupings. Though, since this is a blog and I can over-simplify things, I would divide them in four main categories: (i) financial, (ii) investment (iii) welfare (iv) regulation.

Financial vyama are by far the most common. You’ll find them in the literature under the name of ROSCA, ASCA, merry-go-round or saving club. Members meet regularly and put money in a common “pot”. The sum is then given to one of the members on a rotating basis (a la ROSCA) or is given as a loan with interest (a la ASCA). A growing type of chama are the so-called “investment clubs”, which are vehicles for investments usually in land, the stock market, or in new businesses ventures. Welfare clubs are also extremely common in Kenya; they usually operate as informal safety nets and help members in case of emergencies, funerals or other type of financial shocks.  Finally the “regulatory vyama” are associations that operate in specific locations (i.e. a neighborhood, a market, etc.) and set a number of internal rules.

Now, the readings:

Probably one of the most comprehensive accounts of chama groups written in Kenya is the recent book by Mary Njeri Kinyanjui called “Vyama: Institutions of Hope” (disclosure: I work with Mary at the University of Nairobi). The book looks at the role of vyama in learning and education, investment, redistribution, social protection and socio-economic development. She also wrote a paper in 2010 (freely available here) which I strongly recommend.

If you are interested specifically in the financial role of chama groups at the household level, then you should read the papers by Susan Johnson (from 2004 and 2012, both PDFs), which show the complex landscape of formal and informal financial providers in Kenya. The organization called FSD-Kenya has collected a wealth of data on this issue as well. For more info check out the nationally-representative Finaccess surveys conducted in 2006 and 2009. The 2012 survey should come out over the next months (disclosure 2: I am also collaborating with FSD, but on a different project).

Finally, if you want more info on investment chama groups, there is an interesting manual written by the “Kenyan Association of Investment Groups – The Chama People” (KAIG) which gives suggestions about registration of chamas, internal regulations, type of investments and lots of other things. I noticed just now that KAIG recently changed policy and you need to register in order to download the “Chama handbook”. That’s quite annoying, but if you are a University student you can register for free here.

This 2008 paper by GMU’s Peter Boettke, Chris Coyne and Peter Leeson (pdf) is one of my all-time favorite studies on institutions, path dependence and economic development. If you think that the title of the paper is catchy, wait and read the full abstract:

Research examining the importance of path dependence and culture for institutions and development tells us that “history matters,” but not how history matters. To provide this missing “how,” we provide a framework for understanding institutional “stickiness” based on the regression theorem. The regression theorem maintains that the stickiness, and therefore likely success, of any proposed institutional change is a function of that institution’s status in relationship to indigenous agents in the previous time period. This framework for analyzing institutional stickiness creates the core of what we call the New Development Economics. Historical cases of postwar reconstruction and transition efforts provide evidence for our claim.

The authors divide institutions in three types: foreign-introduced exogenous institutions (FEX), indigenously introduced exogenous institutions (IEX) and indigenously introduced endogenous institutions (IEN). The core argument is that institutions tend to “stick” when they are built upon the “mẻtis” of a society.

 A concept passed down from the ancient Greeks, mẻtis is characterized by local knowledge resulting from practical experience. It includes skills, culture, norms, and conventions, which are shaped by the experiences of the individual. This concept applies to both interactions between people (e.g., interpreting the gestures and actions of others) and the physical environment (e.g., learning to ride a bike). The components of mẻtis cannot be written down neatly as a systematic set of instructions. Instead, knowledge regarding mẻtis is gained only through experience and practice. (…) In fact, mẻtis can be thought of as the glue that gives institutions their stickiness.

I often try to think about how this “mẻtis” looks like in real life, especially in the realm of small enterprise finance. If I think about the Kenyan context, my best guess is that the culture of “chamas” (i.e. self-help groups) is part of the mẻtis and that any new financial, welfare or regulatory institution has a much higher chance of “sticking” if it is built upon them. Kenyan banks understood this many years before me, and they introduced new financial products specifically designed for self-help groups (so-called chama accounts). As far as I know, these accounts have been a big success.

The role of chama groups in the Kenyan society and economy is an intriguing topic, which deserves way more attention. I’ve written about it before here and here. New posts are in the pipeline.

Konza Technological City

After Tatu city –a multi-million real-estate project to build a satellite town in the outskirt of Nairobi, the Government of Kenya has planned a new mega-project called Konza Technological City, already dubbed “African’s Silicon Savannah”, which is supposed to become the largest hub for high-tech and ICT firms in Africa.

The government bought a large piece of unused land in Machakos county, about 60 kilometres south of Nairobi, with the plan of investing $200 million in basic infrastructure (sewage, roads, electricity, etc); the rest of the investment should come from the private sector through public-private partnerships. There’s nothing official yet, but it looks like Boeing, Fedex, Huawei, RiM and Samsung are already lining up in the project. The main Kenyan interest is coming from Safaricom, Wananchi Group, the University of Nairobi and Jomo Kenyatta University for Agriculture and Technology among others. According to the promoters of this project, Konza will create 20.000 skilled jobs in the next 3 years, 200.000 by 2030.

Of course there’s great excitement all over Kenya. I was in a restaurant in downtown Nairobi yesterday and I noticed that most tables around me were talking about it. Though, thrill was mixed with a good dose of skepticism  I wondered myself: is this really going to work out?

To some extent, it looks like the government is playing Sim City, a popular video-game where you build cities from scratch. You have a budget, you start building roads, power-plants, water and sewage systems and you assign different areas of your city to industrial plants, commercial activities or residential houses. But the difference is that in Sim City you start with small projects and eventually, if you are successful, you expand them. Konza seems to be the product of a grand-design, a city where everything is pre-planned, and nothing is supposed to evolve through trial-and-error. There will be no space to figure out what works and what doesn’t.  It either goes the way that planners have in mind, or it will just be a great failure.

This reminds of the debate on charter cities. The main difference is that Konza will not be managed by foreign governments, with foreign rules and foreign institutions, so unlike charter cities Konza will not revamp any memories of colonialism. On the other hand, just like charter cities, I’m not sure whether cities with no history can grow out of nothing.

In one of my favorite articles on urban development, Edward Glaeser shows the development of New York since the early 19th century. The city grew thanks to an endless sequence of innovative ideas and entrepreneurialism, none of it happened because of a grand scheme. I recommend reading the whole article, but if you don’t have time, Glaeser basically shows how (1) New York initially developed due to a natural and geographic advantage; (2) it grew when an entrepreneur changed the logistics of trans-Atlantic trade; (3) increased trade helped the development of the sugar refining industry, apparel manufacturing and printing.(4) The economy eventually turned into real estate and the garment industry and  finally, (5) the finance sector boomed.

This is a terrible summary of a great article. But the point is that the development of the city did not follow a straight line. The face of the city and its economy changed completely over a relatively short period of time. Of course Konza is not New York, but I do not think that the dynamics of urban development are so different. Just like New York, Konza will not succeed unless it develops gradually through entrepreneurialism and innovative ideas. A small push from the government will be helpful; having bureaucrats playing a real-life version of Sim City will end up in certain failure.

But let me get back to the restaurant conversations I overheard yesterday. What was the skepticism about?

Criticism of Nairobians did not involve Edward Glaeser, New York or Sim City –It was much more practical. The most common points were rather spot on:

  • Konza city is ultimately a real estate project, not a technology one. The real goal is to increase the value of the land
  • Most businesses interested in the project are not Kenyan, what about the plan to promote local entrepreneurship?
  • Corruption will be all over the project.
  • How do you get thousands of skilled workers and their families to move from Nairobi to Konza? Customers will not move to Konza as well. Logistics will be an issue, especially for smaller businesses.

These are all interesting points, and a lot of food for thought.

Bankelele tells a very irritating story:

I once interacted with someone in a Nairobi bankruptcy court. He was always dressed in a new suit, white or grey, even as his lawyer told the judge he was too poor to pay his bank and other debts. He was said to drive a Mercedes jeep, but there were no assets were listed in his name.

His lawyer always tried to ensure that the court process took as many months as possible to frustrate his creditors. Once his lawyer slipped up by saying his client would not be able to attend the next hearing as he  had to make an overseas business trip, at which point the court official said that the client should have lodged his passport with the court as a pre-condition of the bankruptcy proceedings.

The long delays seemed to work as, one by one, his creditors stopped showing up at the bankruptcy hearings. Either they lost interest in the debt or got frustrated with the long process, but in some cases, they accepted small payments from the man for a fraction of what they had initially demanded.

A few months ago, one of the company’s of the previously bankrupt man won a court judgment, including a large sum of money as compensation, when a judge ruled that the government which had shut down the company, could not prove that it had engaged in fraud.

If you are interested in finance and investments in Kenya, make sure you follow this (award winningblog.

Interesting new paper by Jose de Sousa and Julie Lochard in the Journal of African Economies (ungated version here). From the abstract (emphasis is mine):

Does colonisation explain differences in trade performance across developing countries? In this paper, we analyse the differential impact of British versus French colonial legacies on the current trade of African ex-colonies. We initially find that former British colonies trade more, on average, than do their French counterparts. This difference might be the result of the relative superiority of British institutions. However, a core concern is the non-random selection of colonies by the British. Historians argue that with Britain, trade preceded colonisation. Using an instrument based on colonisation history to control for this endogeneity, we find no evidence of a systematic difference between the British and French colonial legacies with respect to trade. This finding suggests that the apparent better performance of British ex-colonies might be instead explained by pre-colonial conditions.

A couple of years ago I wanted to write a paper on African pre-colonial economies so I read everything I could on the topic. I never wrote that paper (I couldn’t get the data I was looking for) but if you are interested, I have a few “must reads”:

Are there other studies I “must” include in this list?

My supervisor calls them “institutions of hope” but most academics use fancier acronyms like ROSCAs and ASCAs, or terms like merry-go-round, saving clubs, business associations or insurance networks. Kenyans just use the word “chama” to define “groups” or “associations” that people voluntarily create to pull resources, help each other or find common “rules of the game” in areas where there is little legal enforcement.

Yesterday, during one of the awesome Kariobangi lunchtime conversations (that’s when the best observations always come out!), my table companions and I realized that it would be impossible to understand the dynamics of local markets without considering chamas. They are an “infrastructure” of regulation and financial support that shapes the way businesses function. Though, there are huge differences within the local market in Kariobangi/Korogocho: my impression is that the more businesses operate informally, the more they depend on chamas, the more business are formalized, the lower is their reliance on these social networks–we’ll see what the data says.

The best statements that came out during lunch:

  1. The informal economy would not exist without chamas.
  2. If the government effectively outlawed chamas, the informal economy would disappear (let’s hope that no politician is listening to us!).
  3. Chamas are more relevant today than they used to be for our parents.
  4. Everybody uses chamas, also the rich people.

Wealth doesn’t always translate directly into demand for a particular service or product. Malindi’s beach boys who are mostly half educated unemployed dropouts spend most of their time in the cyber making global connections and setting up future business with forthcoming tourists during the low season. Its a boomtime for the local cyber whose revenues can reach as high as Ksh 250,000 a month during this time. In comparison, the cybers in Kajiado [which is supposedly the richest county in Kenya] are lucky to make about Ksh 3000 a month or a little higher when schools have their vacations and the majority of their business is from other services like typesetting, photocopying or scanning et al.

We tend to assume that as population incomes increase their demand for modern technology will increase as well – that prosperity and the world wide web go hand in hand is implicit in so much of the ICT4D frameworks. But every once in a while there comes along an example like Kajiado’s where the exception to the ‘rules’ can be found and it does us good to pause and think for a moment. Maybe not everyone wants exactly the same things we aspire to own, and maybe there is a different path to progress and wellbeing than the one we have taken. And just maybe, the cyber is a pretty cool place to sit and have a cold drink and shoot the breeze with one’s friends on the sofa, and just watch the real world go passing by.

This is Niti Bhan writing on the excellent Semacraft Blog. I discovered it only a few days ago but it is already one of my favorite sources of new ideas.
H/T Africa Unchained

There is an interesting new paper by Johanna D’Hernoncourt and Pierre-Guillaume Méon (ungated older version here) investigating the relation between trust and the size of the shadow economy. From the abstract:

This paper reports a negative relationship between the size of the shadow economy and generalized trust, in a sample of countries, both developed and developing. That relationship is robust to controlling for a large set of economic, policy, and institutional variables, to changing the estimate of the shadow economy and the estimation period, and to controlling for endogeneity. It is independent from trust in institutions and from income inequality, and is mainly present in the sample of developing countries. Those findings suggest that the tax compliance effect of trust dominates its role as a substitute for the formal legal system.

The idea is that countries with a higher level of generalized trust have smaller shadow economies. The measure of trust is taken from the World Values Survey and it measures the number of people in each country who answer “yes” to the question “Generally speaking, would you say that most people can be trusted or that you need to be very careful when dealing with people?”.

Johanna D’Hernoncourta and Pierre-Guillaume Méon

I think that this is a very interesting piece of research, though it overlooks the inner dynamics of the informal economy. As legal systems are weak and property rights are not enforced by formal institutions, informal operators must rely on trust in all their transactions. In social capital theory, this is called a “club good”, meaning that trust is very strong within a group but small towards the general public (read this paper for a much better explanation).

We are seeing this everyday in our research in Kariobangi. One of the most common problems for entrepreneurs is that costumers cannot pay on time. Though, rarely entrepreneurs decide to cut the relationship with the insolvent clients, because this might reduce future business. Trust within groups, be they other entrepreneurs in local markets, informal associations or ethnic networks is very high because there is no alternative.

It would be very interesting to calculate a proxy for “social capital as a club good” in the World Value Survey and regress that against the size of the shadow economy. That would make a very interesting paper.