Domestic reforms are crucial for development in African countries. While foreign aid often helps to preserve a non-working system, domestic reforms can, if carried out well, actually make a difference.

In Tanzania, a project started last year to formalise the country’s huge informal sector and spread higher economic growth to a larger part of the population, is showing signs of success. The architect behind the project is the Peruvian economist Hernando de Soto.

Mohamed Abubakar lives in the village of Mapinga, a few kilometres outside Bagamoyo north east Tanzania. On his 10-acre land, he grows mangoes, oranges and coconuts. But his main business is to grow and sell cashew nuts.

He says: “I sell my nuts to local businessmen for five hundred shillings per kilo and they sell them for one thousand shillings per kilo at the market in Dar es Salaam. If I had my own car I could take the nuts to Dar es Salaam and earn more money”.

What Mohamed needs most is a pump for spraying the cashew nut trees. Cashew nuts are often attacked by vermin, and Mohamed knows businessmen pay more for nuts that are sprayed, since they are of high quality. However, the price for that pump is about Tshs300,000, an amount that is almost impossible for Mohamed to raise. He and his family depend on this business, but he cannot afford any big investments.

Mohamed’s cashew nut culture belongs to the informal sector in Tanzania. He is not registered by any authorities, and therefore pays no tax. He has no papers showing that the land belongs to him. “Everybody in the village knows that this is my land,” says Mohamed.

But since there are no title deeds, he cannot use his land, or his house for that matter, as collateral if he wanted to borrow money from a bank. Mohamed has therefore no access to the credit market.

This is not a unique situation for Mohamed and the other peasants in Mapinga. In fact, majority of people in Tanzania do not belong to the formal sector of the economy. The agriculture sector, which to a very large extent is informal, employs almost 80% of the people here, and is estimated to form about half of the country’s GDP.  Many of the small companies in the cities are also informal.

Private enterprises are common in Tanzania these days, a country where socialism and collectivism were the main lodestars a few decades ago. Many households are dependent on business for their living. Most of these companies employ one or two persons, and the company’s capital is usually equivalent to a few dollars. Big investments are not possible, and the business can only grow gradually.

Hamisi sells groceries in his small shop in Msasani, on the outskirts of Dar es Salaam city centre. “I sell twenty thousand a day. But that is before all the outlays,” he says. He says that he got a loan from a female friend, so that he could expand his business. Since his business is not registered, bank loans are not accessible. “That is why small businesses remain small. They cannot afford saving and since they are outside the formal sector they cannot get loans banks,” says Lusugga Kironde, a financial consultant in Dar es Salaam.

Assets are not in short supply as many farmers and owners of small companies within the informal sector do own properties. However, there are no papers showing that these assets really exist and who owns them.

According to a study by the World Bank, 55% of all businessmen in Tanzania say that they their property rights are not fully covered by the law.

The country’s underdeveloped financial sector is impeding the growth for small companies in general, for example, the valuations of assets. “The valuations that are carried out today do not reflect the assets real value,” he said.

According to Mr Kironde, banks regard lending to small companies as a risky business, even in situations where collateral is available. The fact that many investments within the formal and the informal sector are never realized is hampering the overall production and thus creating a shortfall in income.

Even though the past years policy has led to a higher economic growth, many people, especially in the rural areas, are yet to see their standards of living shaping up at the same rate. The higher growth, to a large extent is concentrated in the big companies and the inhabitants of the big cities.

Tanzania’s President Benjamin Mkapa, who has been a strong force behind the new policy, is aware of the problem. It was therefore not by accident that he invited Peruvian economist Hernando de Soto to Tanzania in 2003. The essence of Mr. De Soto’s theory is to explain why countries that abandon socialism to the benefit of market economy don not always get instant and widespread prosperity.

The problem that assets cannot be transformed into cash – defined as dead capital – is a reality in Tanzania and in many other African countries as well.

Hernando de Soto’s institute based in Lima, the Institute for Liberty and Democracy (ILD), had the task to make a report describing how a project formalising the informal sector in Tanzania could look like. The report was completed early 2004, and a plan for the project was formed - ‘Properties & Business Formalization Program’- last year.

“What we are doing in the initial stage is to find out more on what is hindering small scale enterprises from growing,” says Ladislaus Salema, the coordinator of the project. “This will assist us decide what we will do later on.”

The overall objective is to identify assets and guarantee property rights. The procedure to register new companies will be focussed on, which means many rules and regulations will be looked into as well to enable small companies should grow.

 “Even if we are not ready by 2015, the year the Millennium Development Goals are supposed to be attained, we can still be proud,” says Mr Salema. “We must make sure that the people we are set to reach with the reforms gain, if they become part of the formal sector. If we force them it will be hard to succeed.”

The impact of the reforms is estimated to be seen three years after the implementation. According to the report from the Institute of Liberty and Democracy, if the reforms are 60-80% successful, they will enhance Tanzania´s long run growth rate of per capita GDP by between 0.8 and 1.5 percentage points per year. The experiences from other similar projects – in Peru in the 1980s - show that the consequences for the poor people in perspective of prosperity can be substantial.

A key factor that makes this project look good is the increased competition among banks in Tanzania.  More commercial banks in the country and low interest rates on alternative investments have already created an increase in banks lending to other customers than big companies.  Many banks today see a big potential in micro-financing, or lending to smaller companies, and if this can be done with a lower risk it will probably increase further. The banks are waiting for the starting signal to serve smaller business with fresh capital. If so, the current high interest rates will hopefully come down to a more competitive level.

Within government, especially among local leaders, the enthusiasm for new ideas and policy changes has not always been sparkling. But Mr Salema is optimistic. “I cannot see anybody criticising the project saying the present situation is preferable,” he says. “Some people must change their way of thinking.”

If Mohamed is to gain from the project he must know how to use his house or land as collateral and how to apply for a bank loan. Hamisi must be able to see the benefits of registering his business; otherwise he will probably continue to say, “If I see people on the street looking like they are from the tax authority I quickly close my shop.”

But if in the future he can borrow money at a sensible interest rate and expand his business he may change his mind. All small businessmen cannot be as lucky as the street hawker (street salesman) in Dar es Salaam who recently won one million shillings in a lottery. For him it was obvious how to use the money. “I will develop my business”, he told the local media.