Future Capital Kenya

As part of the second instalment of the Future Capital Series, I see it fit to discuss what capital is. Once the discussion is made, we can go on to understanding how according to Hernando de Soto, Undercapitalisation or "Dead Capital" is the main encumbrance to our development not only as a continent but as the third world. Through this understanding, I take it that the real causes of our problems will be clearer. It is human nature and condition to look for the easiest excuse or the least demanding excuse and run away from seeking the real truth. The issue of Capital falls under that bracket of human beings intellectual convenience.

Capital is defined by classical economists as "that part of a country's assets that initiates surplus production and increases productivity". Furthermore, The Economist defines capital as "money or assets put to economic use, the life blood of capitalism... one of the four essential ingredients of economic activity, the factors of production along with land, labour and enterprise. Adam Smith goes further and distinguishes between circulating capital now known as "working capital" and fixed capital. The former including money, commodities and raw materials while the latter includes land, buildings and mines.

Capital is very important in a market economy... Adam Smith in his book "Wealth of Nations" gives three clues as to why this is so. The first clue is when he says that " the quantity of industry, therefore not only increases in every country with the increase of the stock (capital) which employs it, but, in consequence of that increase, the same quantity of industry produces a much greater quantity of work". Here he links increasing capital to increasing work and industry. Further he adds that "all the accumulation of stock must, in the nature of things be previous to the division of labour, so labour can be more and more subdivided in proportion only as stock(capital) is previously more and more accumulated". We see now that capital is not only important for increased industry and employment but also for productivity and division of labour. All these factors are important for growth.

The last clue takes on a more personalised note when in reference to an individual "he endeavours, therefore, both to make amongst his workmen the most proper distribution of employment, but to furnish them with the best machines which he can either invent or afford to purchase. His abilities, in both these respects are generally in the proportion to the extent of his stock(capital)". Clearly then we see that capital is important for both the development of society but also for personal economic development.

If this is the case then one wonders, does that mean now that Africa or Kenya lacks capital? If the relationship between capital and growth has been so well articulated, is it then that we lack capital?. A reasonable mind will clearly then see that this is not the case. Africa is one of the most well endowed continents in the world, with arable land, diamonds, gold, rivers, lakes and a healthy population we clearly have bucket loads of capital. Why then cant this capital as Adam Smith put it "increase the quantity of industry and in consequence (increase) a much greater quantity of work"?

Here is where Hernando de Soto comes in. His argument is both simple and elegant. Africa and in general the third world has what he calls "Dead Capital". De Soto adds one element of Smith's argument that I have deliberately left out. This is that "for accumulated assets to become active capital and put additional production in motion, they must be fixed and realised in some particular subject... which lasts for some time at least after the labour is past". Here he brings in the concept of formalised property rules. These rules are the ones that fix the accumulated assets in some particular subject which in this case is law. In the West, the difference is that assets are able to live a parallel life both as assets and as capital. Here in Africa we just have assets.

The notion here is that capital is abstract, like a ghost if you will. An abstraction that lives in people's collective minds, collective in that they are gathered in the law. Simonde de Sismondi, a swiss economist as cited in the Mystery of Capital says that capital is a "permanent value, that multiplies and does not perish... Now this value detaches itself from the product that creates it, it becomes a metaphysical and insubstantial quantity always in the possession of whoever produced it, for whom this value could be fixed in different forms". Capital then to me is like molten iron, it can be moulded and shaped by the blacksmith into whatever form he wants so as to derive extra value from his labour.

The issue is that as a people we have come to think of capital as money. It has become the colloquial definition of capital. For business, we have to "raise capital" so as to start the business. The argument put forward by these great economists is that capital is whatever the owner wants it to be so long as there are standardised rules that allow for these different interpretations.

From this perspective it is clear then that a lack of understanding of what capital is has been part of the problem. African governments have confused capital with money and over inflated their economies by pumping money into the economy. Not realising that money is just one of the many forms of capital. To drive this point home. Imagine a matatu tout who has a brilliant mind, a person who comes up with business ideas at a whim. He gets a salary from the owner of the matatu but cannot formally lay claim to his assets (the salary), he therefore lacks capital as in a formalised system, the collective minds of the country would interpret this salary as a formal regular cash flow towards him. He therefore cannot get a loan from the bank as they cannot formally and in a standardised manner lay claim to his capital as collateral. His business ideas which are his intellectual and human capital remain locked in his brain and therefore do not add value and generate wealth. This is what is called dead capital.

Furthermore, imagine two parties, a maasai herdsman who owns cattle and a rancher who owns lush fields. They both have assets, what if the herdsman could reach an agreement with the rancher that allows him to herd his cows on the ranchers fields in exchange for first options on the proceeds from the sale of the herdsman's cows. They would both have great incentives to cooperate because fatter cows would mean higher prices for the cows, whatever stake the rancher would be getting would be proportionate to the health of the cows. He would even fertilise his grass so as to reach this end. However, this would all be impossible if the property laws of the country are not formal, standard and flexible so as to allow the interpretation from these entrepreneurial minds of their parameters.

Dead capital then is the main issue in the third world. The assets and wealth are there but there are no rights that allow these assets and wealth to live their parallel life. There is no furnace to melt the iron ore so that the blacksmith can create value through his labour.

Next week, the discussion will be taken further. The article will be about the economic and financial implications of dead capital. For a more nuanced explanation, I recommend that you read "The Mystery of Capital" by Hernando de Soto. For me it is the most important book that any third world economist or thinker can read.

As part of a five part series covering the steps that Kenya needs to take to achieve lasting sustainable growth and development. I have decided to undertake a small analysis of the noughties (2000-2009) as they have come to be affectionately named. Following from this analysis will be my ideas albeit shaped significantly by the legendary third world economist Hernando De Soto.

The last decade was a very dynamic one for Kenya. Globally it was welcomed with huge aplomb as it was the beginning of a new millennium. We witnessed the most fancy fireworks displays some live and others on TV as they began in Sidney and ended in Los Angeles. We as a world had great aspirations for this new era especially after the massive economic gains that the developing world had made in the 90's. In Kenya we were slowly preparing to bring an end to the Nyayo era (error) which had ravaged and bankrupted our beloved country. There was great hope and excitement as the new decade began. It felt strange when the calenders showed a year that began with 2 and was followed by three 0's.

For Kenya the decade began in significant fashion as mobile telephony which before was a novelty for the rich  began to take root with Kencell and later on Safaricom. I remember my mother had an Ericsson 1018 which was the toast of the household. It was so cool to have a mother who had a mobile phone, almost even a sign of gender empowerment the more I think about it. As things would turn out to be, this was just the beginning of even greater things.

The KANU government led by Moi was swept by the Rainbow tide that was led by Mwai Kibaki with his dynamic team that comprised of Raila Odinga, Charity Ngilu, Michael Wamalwa amongst others. For the first time in Kenya's democratic history, the opposition had united against their greatest foe. Kenyans attended the president's inauguration in droves and the historic event was watched the world over as this tiny African country set the standard for free and fair elections. Euphoria engulfed the country as the collective hopes and aspirations of the country were raised by the new president's speech. I remember attending the ceremony at Uhuru Park with my mother and brother. We found  ourselves some good seats and slowly watched the events of the day. From the embarrassing scenes of foreign diplomats lacking chairs at the dais, the constant mud slinging by eager spectators keen not to have their view blocked and the dismay as the foreign journalists tried in vain with some even fainting to get that million dollar shot of Kibaki's first moments as president. In retrospect this should have been a sign that the change was only ceremonial, a change of guard but not a change of circumstance for the approximately 35 million or so Kenyans.

However nine years later and nothing much seems to have changed. The post-election violence of early 2008 made us wonder whether we were the same people at Uhuru Park, the same people who had showed great unity and togetherness to topple Moi. We watched in shock as fellow Kenyan's brutally and I reiterate brutally murdered each other. This was followed by a nose dive in the economy with it's main indicators such as capital inflows, GDP and the stock market index taking a nose dive. What went wrong? The NARC administration offered so much promise?

The decade ended with the NSE going nowhere, the random walk that was expected ended up being a random stop. As of end 09 figures, the stock market index has gone nowhere. An annualised nominal growth rate of 2% is hardly anything to write about. When one factors in inflation which over the years has grown at an annual rate of 10%, the real growth rate of the stock market was -8%. GDP per capita saw only a slight increase of less than 3%. Added to this we saw a worsening of our cash position as Kenya witnessed huge capital outflows in the last two years of the noughties that reversed all the gains of the previous 7 years.

It wasn't however all doom and gloom. Mobile telephony has greatly eased and improved people's lives as they can now communicate with greater efficiency and ease. In fact mobile cellular subscriptions increased from 0 subscriptions per 100 people in 2000 to 42 subscriptions per 100 people in 2008. Added to this the introduction of Mpesa and Zap have made money transfers easier to average Kenyans and have assisted the numerous unbanked Kenyans. Internet users also rose from 0.3 per 100 to 8.7 per 100. Free primary education has somewhat improved the prospects of many Kenyans as it facilitated easier access education. Primary school enrolment was at a peak of 8.3 million in 2007. However this is in jeopardy as the recent FPE scandal lead to a withdrawal of it's main financial backers. On matters of health, Kenya witnessed a slight improvement in life expectancy from 52 years to 54 years mainly due to increased HIV/AIDS awareness programs. The robust albeit shaky property market has also created wealth for many Kenyans.

However, in spite of all this, Kenya still has disturbing poverty levels, high rates of income inequality and significant tribal issues that make for a very shaky nation. What needs to be done to sort out this mess. The government seems to be incapable of solving it in it's current state.

Next week, I continue off from this quagmire. Part 2 will be about further delving into the nitty gritty of the decay in Kenya and analysing it.

So, I was reading the Daily Nation online last night and I came across an article on the recovery that Kenya's robust economy is expected to have this year. At first, the points the author made were very reasonable and made great sense. However at this point, I hadn't put on my thinking cap on. The more I read on, the less sense it made. Let me just give some of the few points the author makes in his op-ed and give my two cents.

 The first one is that an improved global economy will lead to a somewhat trickle effect that will see Kenya's economy improving. That through increased commodity prices we are likely to see better incomes for our farmers. However this goes against what the data tells us. You see, Kenya has always been a net importer of goods i.e. we import more that we export. Therefore we will continue buying high and passing the high costs to "Wanjiku" so much for global recovery. Already cement prices are likely to see upward pressure due to higher global oil prices. The opinion that a better world economy leads to a better Kenyan economy should be put under a spotlight and thoroughly scrutinised.

Another point he makes is that due to low inflation, we are likely to see lower real interest rates and thus easier access to credit leading to a more robust economy. In my perspective this argument does not hold it's fair share of water. Historical data in Kenya from 1963 does not support any significant relationship between inflation and interest rates. Banks take their operating costs and the costs of handling loans into consideration when deciding on their interest rates and not so much inflation. Classical monetary economic theory does not apply in Kenya and thus don't be misguided to think so. People should understand the reality of Kenya's economy before quoting theory, this is the height of intellectual dishonesty. Therefore in my humble view, we are not likely to see much change in the interest rates unless banks reduce their operating costs and credit information sharing (credit scores) is implemented.

The last point I would make is that he argues that the stock market has bottomed out, i,e reached it's trough and now it can only go up. It could be that the NSE All Share Index (NASI) as well as the NSE-20 Share index will see an improvement, but reasoning that just cause it's been down it will be up is like saying "just caused I tossed heads in my first throw, I will toss tails in my second", it doesn't make sense.

In conclusion, when I read that the author of this op-ed was the former chairman of the Nairobi Stock Exchange, it all made sense. The "conflict of interest" alarm bells were as loud as they could get. It took me back to an advertising feature that I read on the plane to Johannesburg early last year proudly proclaiming an impending market boom on the basis of a two day rise of the index, can someone say "DISHONESTY". When people are serving their own self-interest lies can be told. The aforementioned people want to drive business into their firms because brokerage and asset management have really suffered the last couple of years. They will therefore write very "convincing" articles targeted to the naive reader about the better prospects for the economy laced with the "now is the time to invest talk. Ignore such and if you are to get opinion of where the economy is going, go to KIPPRA or the IMF not a stock broker.

Happy new year people. I hope you are all working on your resolutions and if you do not have any, well join the club. A new year brings with it new things, new aspirations, new realities and new possibilities. This applies to anyone be it a little child, a teenage girl or a man in the throes of his mid-life. It also extends to non-human entities such as companies, schools, universities and countries. With this in mind, I hope to share some of the things that I would like to see happening as well as some of the things that may happen in our financial world.

To start with, I would really like both the Capital Markets Authority (C.M.A) and the Nairobi Stock Exchange (N.S.E) go ahead with the demutualisation of the bourse. It has been a long time coming and could even be longer before this takes place. With demutualisation, the NSE splits ownership and management with the NSE being offered to the public through an I.P.O. Both aforementioned parties have been waxing lyrical over the past couple of years about demutualisation but we are yet to see it happening. Demutualisation would lead to greater transparency that would hopefully lead to increased investor confidence in the market. The confidence reached a nadir with the 2007 post election violence coupled with the Nyaga and Thuo crises. The index subsequently took a nosedive. Confidence is key if the market is to recover. Another benefit that demutualisation may bring is that the NSE may license more stock brokers and hopefully this would bring about a reduction in brokerage fees. Kenyan stock brokers charge excessive fees of about 2-4% per trade. This may sound like pocket change to the layman, but in South Africa typical brokerage fees range from 0.02% to 0.1%. The high brokerage fees make foreign investors and members of the diaspora to shy away from the bourse.

Secondly, I would like to see the powers at be starting from the Attorney General, enforce the Proceeds of Crime and Money Laundering bill 2009. It was a big step for this country when the bill was passed, but if it is not enforced and taken seriously it will be a huge disappointment. I as well as other commentators have speculated in the past that the lack of proper money laundering legislation has been a boon for terrorists and other criminals to "invest" in the country, pushing out locals of the property market. These days house prices are over the moon and sell at extraordinary multiples of our incomes. I dare speculate that if the bill is taken seriously, we could see a reversal in this trend.

Kenya will witness a momentous change this year as the East African Common Market is established. The free movement of people, goods and services should offer Kenyan entrepreneurs bigger markets and more opportunities to thrive. Kenya is well placed to take advantage of this as liquidity right now is very high and we have for a long time had flexible capital mobility regulations vis a vis our neighbours, especially Tanzania. I urge young Kenyan businessmen to strategise for the unification of the East African Market

Finally, and I know it is a long shot, I would like the draft bill to get the right amendments so that Kenya can finally have the constitution that its people deserves. We have suffered for too long and our economy has suffered for too long due to a lack of a proper and well enforced legal framework. I put it to you that the law is the cornerstone of a good working economy. All the maxims of Capitalism are based on a system of property protection that unfortunately Kenya has lacked. The case of the Mau is a perfect example

Hopefully things will go well in regards to the aforementioned aspirations. Feel free to share with me your aspirations for Kenya for 2010.

Happy new year everyone!!! I would like to wish the readers and guests of this blog a very happy new year and warm wishes for the year ahead. From my side, I want to thank everyone who has visited and commented on this blog and I hope that we can continue with our fruitful relationship.

As you can see, I have embarked on revamping the blog and making it a more interactive place. The year ahead promises more good things for Future Capital Kenya. The blog will have guest authors share their views on a range of topics from business, finance, politics and even sports and their effect on shaping the future of Kenya's economy. There will be news reviews about the latest topics in the world of business and finance with  independent analysis encompassing a different nuance to the issues. The blog will also have periodic book reviews and recommendations. This I hope will be a super interactive section where future business leaders and opinion makers will have the opportunity to share their favourite books and even write reviews about them.

From your end, I hope that you as the reader and follower can share the blog with as many people as possible and help make a community of keen minds who want to see a different Kenya.

Thanks a bunch guys and happy new year once more. Please leave comments about the new look, I would greatly appreciate that.

Samora