Rule of Law

Regime uncertainty

I would like to expand on one of the features of the real estate market in the Ivory Coast: Weak Rule of Law.

In general weak rule of law means that there is regime uncertainty, ie one cannot be certain what rules, permits, regulations or laws apply.  As a business owner one risks being greatly affected by the whims of the people in charge and what mood they are in on any particular day. And it’s difficult to do business when one cannot predict whether the government will issue a permit, confiscate capital investments, ask for bribes, tax according to the law or not, or arbitrarily stall operations.

When the rule of law is respected, it provides business with some measure of predictability so they can plan and operate smoothly. When it is not respected, there are just too many variables, too much risk of loss or waste

So that’s why there is more business and consequently more wealth creation in places with stronger rule of law.  However, the risk premium for doing business in a weak rule of law environment is high, as there is less competition and more opportunities. Niches in weak-rule-of-law environments which are somewhat shielded or countries which are trending towards stronger rule of law seem to be good places to be.

2005 map of Worldwide Governance Indicators, which attempts to measure the extent to which agents have confidence in and abide by the rules of society. Colors range from dark green (90th-100th percentile) to light green (75th-90th percentile), yellow (50th-75th percentile), orange (25th-50th percentile), pink (10th-25th percentile) and red (0th-10th percentile)
2008 World Map of the Control of Corruption Index, which measures the degree to which corruption is perceived to exist among businesses, public officials and politicians. Source: World Bank, http://en.wikipedia.org/wiki/Worldwide_Governance_Indicators

I’m not sure if the Ivory Coast is trending towards stronger rule of law – neighboring Ghana seem to have been doing so over the last years – but residential real estate could be a somewhat shielded niche.

Positives for residential real estate:

  • There is so much of it. The state bureaucracy doesn’t seem to have the resources or organisation to check every single owner occupied or rented dwelling. And if the tax on real estate was to be implemented according to the law or arbitrarily, all over the country, people would protest which would likely make such implementation difficult if not impossible.
  • It’s a business that blends in with ordinary people living in their homes. The government has a hard time targeting those making a business out of real estate without targeting single home owners or tenants.  Commercial real estate, per day renting or hotels on the other hand, are much more visible and more at risk to arbitrary and unpredictable government actions.
  • There is no need to transfer goods in our out of the country, (with the possible exception of importing building material but that isn’t at the core of the business.)  Customs at land borders, ports and airports are among the government entities where the regime uncertainty problem is at its greatest.
  • Property rights for real estate are certainly not as strong as in the developed world, but they are not disastrously weak, at least when there is some sort of building and not just empty land.   And then it’s debatable whether respect for property and other individual rights can be included in the concept of Rule of Law, but either way they are very important.

Negatives:

  • The buying of land, building, selling and enforcing rental contracts processes with their associated paperwork are vulnerable to regime uncertainty.
  • The business can’t be moved elsewhere.
  • There is a largely unapplied tax on all residential real estate, opening up for arbitrary enforcement. On paper the tax is 4% of the gross annual market rent for owner occupied properties, and 15% of the gross annual rent for lettings. What if you get three different tax collectors a year, each not acknowledging the other two, putting most of the tax in their own pockets and trying to negotiate the tax amount using a starting bid at a much too high level?

Political connections

Another survival strategy for businesses to dealing with an unpredictable government is “if you can’t fight them join them”. Ie, that businesses become so involved in government and regulatory bodies that they effectively gain control over the very entities that are supposed to keep them in line.

My guess is that practically all large companies active in the Ivory Coast have employed this strategy to some extent. With weak rule of law, politicians and government administrators get so much power that it is difficult to conduct large scale business operations without having them on your side.

In this environment a discussion on right or wrong in for instance the interpretation of a contract (not necessarily involving any large company), can – and I have seen this happen multiple times in West Africa – turn into a discussion of who knows the highest placed politician.

The fact that businesses can control law-making and regulations, achieve so call regulatory capture, is problematic. A business that achieves regulatory capture is also able to write and implement laws and regulations that it can deal with, but its competitors cannot. The eventual outcome is that companies use regulation to drive everyone else out of business until a monopoly is achieved, putting consumers at its mercy.

Guess this is a problem affecting the developed world as well, strong corporate lobby groups in the US spring to mind.


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One thought on “Rule of Law

  1. Pingback: A Bull on Africa « Hotel Ivory

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