New Approaches to Progressive Housing in Latin America

Habitat International 27 (2003) 309–323

New approaches to progressive housing in Latin America: A key to habitat programs and policy Bruce Ferguson*, Jesus Navarrete Inter-American Development Bank, 1300 New York Avenue, N.W., Washington, DC 20577, USA Received 3 November 2002; received in revised form 14 December 2002; accepted 30 December 2002

Abstract In advanced industrialized countries, ‘housing’ has become a product delivered complete to families by a sophisticated network of lenders, developers, title companies, and other organizations. In developing countries, 70% of housing investment occurs progressively—that is, households acquire land through purchase or invasion, and gradually improve the structure and legal tenure, and lobby for basic services. A useful approach for housing in this context: (a) offers a wider range of low-cost solutions, rather than just complete new units; (b) joins small loans at market rates (rather than long-term traditional mortgages), with family savings, and—sometimes—a small subsidy; and (c) has Government set the rules of the game and the private-sector directly produce and finance housing. The paper compares the ‘‘product’’ approach of industrialized countries with the progressive housing of developing countries, and profiles three types of program interventions that form an emerging housing practice in Latin America relevant to other developing regions: (a) housing microfinance; (b) low/moderate-income land development; and (c) direct demand subsidies. r 2003 Elsevier Science Ltd. All rights reserved. Keywords: Housing; Progressive development; Housing microfinance; Land development; Latin America

1. Overview In advanced industrialized countries, homeownership performs a critical economic function as well as a social one. Equity in homes represents the largest single asset of the middle-class and most of a nation’s wealth. Mortgages—mostly for residences—constitute a large part of the financial system (about one-third of all financial assets in the US), greatly increasing its depth and solidity. The housing industry (building materials, construction, real estate, financial industries) *Corresponding author. Tel.: +1-202-623-1653; fax: +1-202-623-3173. E-mail addresses: [email protected] (B. Ferguson), [email protected] (J. Navarrete). 0197-3975/03/$ - see front matter r 2003 Elsevier Science Ltd. All rights reserved. doi:10.1016/S0197-3975(03)00013-4

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also generates a significant share of employment—typically around 9% worldwide—and often helps lead national economies out of recession as it did in the United States in 2001 and 2002. In contrast, homeownership in developing countries has tremendous social value-arguably more than in advanced countries, but largely fails to perform these economic functions. The great bulk of families in developing countries cannot build wealth through increasing and leveraging the equity in their homes, mortgage markets are typically small to non-existent, and housing is a minor industry. Thus, ‘housing’ is quite different in advanced and developing countries. A sophisticated network of public and private institutions including primary and secondary mortgage market institutions, the construction industry, title and land registries, real estate agencies join to develop a finished product in advanced industrialized countries. In developing countries, the great bulk of families build their own homes progressively over 5–15 years largely unassisted by formal-sector institutions. At bottom, this is because most households in developing countries cannot afford to purchase the least expensive commercially built new unit (Ferguson, 1999), and have no other good alternative for shelter (i.e. rental markets usually function poorly or not at all). In effect, low household incomes joined with the high costs resulting from distortions in key markets that affect housing (land, financial, building materials, etc.) results in most families building their own homes. Ironically, housing programs and policy in developing countries often try to replicate the dominant mode of developed countries—by producing complete new units to be sold through mortgages. This ‘‘product’’ approach requires large subsidies per unit, results in the formal-sector (developers and financial institutions) satisfying only a fraction of household demand, and fails to generate the market mechanisms necessary to convert homeownership into an economic as well as a social good. The product approach to housing has failed throughout the developing world. Nevertheless, most developing country governments perversely continue to build and finance relatively few high-subsidy, high-cost complete commercially developed units as their main approach to housing. The characteristics of sustainable housing programs suited to the low/moderate-income majority of developing countries (households earning up to US $400 per month, typically) are quite different. Instead of producing a complete new unit for purchase, a sustainable approach offers a wide range of low-cost housing solutions that form part of the progressive housing process. Instead of relying mainly on a large long-term mortgage, sustainable housing finance joins small loans at market rates with the savings of the family and-sometimes-a small subsidy. Instead of directly producing and financing housing, government sets the rules of the game (most importantly, for finance and land development), provides gap funding (subsidies) for the lowestincome households, and relies on the private-sector—both non-profit and for-profit—to build and finance housing. In essence, this paradigm builds and strengthens the mechanisms that the low/moderate-income majority now use to build their homes progressively (‘formalizing informal housing’ as it has been called (see Ward, 1982; Mathey, 1992). A primary goal is to strengthen the economic function of housing, so that households can generate wealth through homeownership as well as secure appropriate shelter. This article explains why and how the product paradigm has failed in developing countries, ventures some ideas on its continuing perverse appeal to governments, and details components of

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a sustainable approach to low/moderate-income housing focused on progressive housing. Although scholars and others have long recognized the function and potential of progressive housing in developing countries starting in the late 1960s (notably, John Turner), this concept failed to develop into a solid basis for programs and policy at that time partly1 because the tools and institutions were then unavailable. This article profiles new tools that are realizing the potential of progressive housing in new types of public and private-sector enterprises. Geographically, we focus largely on Latin America, although the conclusions broadly hold for developing regions in general, and we cite cases worldwide.

2. The role of homeownership in developing vs. advanced countries In developing countries, homeownership has tremendous use value and is a haven for the radical uncertainty of sickness, job loss, and other emergencies with which low/moderate-income families must frequently cope (UNCHS, 1996). Partly for this reason, owner-occupancy rates are typically as high or higher in developing countries as in high-income industrialized countries, particularly in high-cost areas. For example, they are 85% in Mexico and Bangladesh, compared to 66.2% in the US overall (2002) and 61.5% for the 10 largest US metropolitan areas.2 The average homeownership rate of fifteen Western European countries3 is 59% compared to over 70% for Latin America. Although most housing in developing countries has tremendous use value, it has little economic value for a number of reasons. Most importantly, no credit finance is usually available to purchase, rehabilitate, or re-finance existing housing (UNCHS, 2001). Second, partly as a result of the lack of credit finance, families hold onto their house for generations once they finally finish building it, resulting in a very thin housing market (UNCHS, 2001). Third, government regulations often make renting difficult and unprofitable (Gilbert, Olinto, Coulomb, & Necochea, 1993). As a result, the equity households hold in their homes is dead capital (De Soto, 2000). Families have great difficulty building wealth through using this home equity. Even the most prosperous, dynamic developing countries suffer from this problem. Mexico serves as a particularly important example (World Bank, 2001). Because of the North American Free Trade Agreement (NAFTA) and a thriving national economy, more households than ever have formal-sector jobs. But the great bulk of families lack adequate housing, and the ability to build wealth through property ownership. A relatively high share of Mexican families—above 80%—own the property in which they live (owner-occupants). However, 60% of these owners lack full legal tenure to their lot, although most of this group have para-legal rights that secure their occupancy. Less than half (300,000 per year) of newly formed Mexican households (750,000 per year) received a mortgage in 2000. Of these 300,000 mortgages, more than 95% received a large subsidy from government, with less than 5% extended at what could be considered market terms. The remaining households must build their own homes without formal-sector support. 1 No comprehensive assessment of the successes and failures of the housing programs of the 1970s and 1980s based on progressive housing-such as the World Bank sites and services projects of the time—exists. Informed observations, however, strongly suggest that the lack of tools at the time such as those detailed latter in this article played a large role. 2 Source: US National Association of Realtors. 3 Source: Finnish Ministry of Housing.

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Credit for home improvement, to refinance homes, and for purchase of existing homes is virtually unavailable. Consequently, households also cannot easily fix up their homes or sell their homes to move to areas of greater economic opportunity. Less than one home in every ten in the housing stock has a mortgage. Taking equity out to start an enterprise or for any other reason is virtually unknown. Largely as a result of this lack of home finance and poor savings instruments, 70% of Mexican families have no relationship with a financial institution, not even an account. Once families succeed in occupying property or buying a home, households tend to stay there for life and pass it on to succeeding generations. The housing paradigm of high-income industrialized countries is radically different. The US illustrates this other reality. As opposed to building their homes progressively over a long period, US households buy a complete new or existing home supported by a highly sophisticated network of mortgage lenders, secondary market institutions, title companies, infrastructure providers, developers, and others. Many of these functions are rapidly being automated. Despite the stock market rise of the 1990s, US households still hold the largest share of their wealth as equity in their home, which represents a much of their ‘nest egg’ for retirement as well as a residence. US households with $100,000–250,000 in net worth hold 43% of their wealth as equity in their primary residence, compared to 17% in the stock market. Many means exist for leveraging this equity to build wealth. Small entrepreneurs typically capitalize their start-up ventures by taking out equity in their home through re-finance loans. US households sell their homes on average every 7 years. In summary, housing has become a product in high-income industrialized countries delivered mainly by a sophisticated network of private firms and public institutions. The housing of the small upper-middle and upper class in developing countries functions somewhat similarly, although at a much reduced scale and sophistication. Thus, fluid markets for land and housing play a crucial role in economic development, particularly in building household wealth and a middle class. Homeownership along with a reasonable education and household income are the defining characteristics of the middle class in advanced, industrialized countries. In The Mystery of Capital, Hernando de Soto (2000) argues that the critical difference between successful and unsuccessful capitalist societies is the ability to build wealth through property ownership, mainly that of land and housing. De Soto’s focus on land tenure is useful, partly because it reminds us of this underpinning of capitalism largely forgotten in advanced, industrialized countries. However, land tenure is only one piece in galvanizing housing and property markets. This paper fills out this picture. In essence, it defines a new approach to housing initiatives suited to the low/moderate-income majority of developing countries largely based on the quintessentially progressive nature of the housing process for their low/moderate-income majority.

3. Strengthening and formalizing progressive housing Progressive housing accounts for over 70% of housing investment in virtually all developing countries (Hamdi, 1991). Strengthening and formalizing the progressive housing process holds the key to making homeownership into an economic asset in the developing world. The progressive housing process (see for instance, Ferguson, 1996b; Navarrete, 1990) starts with the acquisition of land through one of a variety of means including squatting or the purchase

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of a lot in an informal-sub-division. In some countries—such as Venezuela—squatting serves as the main mode of low/moderate income land development (Ferguson, 1994). In others, such as Colombia, informal land developers are a large industry and account for most new urbanization (Hamer, 1985). Occasionally, organized squatter invasions or informal land developers carefully lay out the occupied area, leaving space for roads and community facilities as well as individual home sites. However, squatting and informal settlement more frequently occur in a less orderly fashion, particularly in hilly terrain such as that of Rio de Janeiro, Caracas and Montego Bay. Once they occupy land, households then build a small, makeshift, temporary dwelling to secure the property, and gradually replace this makeshift dwelling and enlarge their home. They finance home improvement through windfalls, self-help agreements with friends and relatives, small loans (typically at extremely high interest rates), household savings (often invested in building materials in order to hold its real value in an inflationary environment), and other means over many years. In dense urban areas, families typically expand upwards by putting a second story on a flat cement roof. Areas of lower density expand horizontally. As the community becomes established, residents band together in community associations to pressure government for basic services and other investment. In the meantime, households usually obtain some of these services through clandestine connections to electricity and water lines. Areas that receive infrastructure and other forms of official recognition enjoy greater housing investment, appreciate in value, and eventually become part of the texture of the city. These areas then become indistinguishable from other neighborhoods and no one thinks of them as shantytowns or as informal. Scholars starting with John Turner with his work in Peru in the 1970s have recognized that housing in developing countries is quintessentially progressive (Turner, 1976; Turner & Fichter, 1972; Hardoy & Satterthwaite, 1989). The progressive housing process has one central virtue. It offers the low/moderate-income majority a means for affording homeownership unavailable otherwise. From a broader perspective, these families also build much of the physical plant of the city with minimal assistance or funding from government and from formal-sector institutions. For this reason, low-income housing advocates and others who identify with the poor usually consider such ‘self-help’ as the solution to shelter problems (Mangin, 1967). However, if unsupported and unguided—as is typically the case—progressive housing suffers from severe drawbacks (Mathey, 1992; Navarrete, 1990). In particular, fixing these neighborhoods creates much greater public and private costs than if these areas were developed formally in advance. Governments that regularize these areas usually must re-plat them to create space for infrastructure, community facilities, and to rationalize the shape and size of individual sites. Hence, this process usually involves re-locating 5–20% of residents—a highly costly process. Putting in basic infrastructure—roads, drainage, sanitation, and water—costs 2–4 times the amount of these services in new development. For example, Bogota’s public land developerMetrovivienda-calculates that repairing the infrastructure of informal settlement costs, on average, three times as much as providing new infrastructure in formal settlement (AMB, 2002). Infrastructure upgrading, however, forms only one part of the regularization of informal settlements. In addition, regularizing land title—the focus of De Soto’s work—costs much more after generations of residents have sold and re-sold various proofs of ownership, and the resulting title claims become more and more complex. If these communities are on hazardous land, mitigation measures or massive relocation becomes necessary.

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Finally, the progressive housing process condemns families to live much of their lives in unsanitary and disrupted environments lacking some or all of the basic amenities of modern life (Navarrete, 1990). The process of building their homes is painstaking, burdensome, and long. Although families aggressively pursue it as the means necessary to own their own home, this ‘second best’ solution—as Leland Burns and Leo Grebler (1977) call it—exacts a large toll. This inferior environment results in much higher rates of serious diseases—particularly waterborne and sanitation-related health problems—than in other areas, and social stigmas often attach to the area’s residents, making it difficult to marry (India) or find jobs (Jamaica). In summary, progressive housing offers a solution for the shelter problems of most households otherwise unavailable in developing countries, but at enormous public and private costs if unguided and unsupported. For these reasons, elites and formal-sector institutions—including banks and developers— usually view informal settlement and self-built progressive housing as the problem (Mangin, 1967). From this perspective, new slums are inundating their cities, causing immense social and environmental problems far into the future. This fundamental contrast in perspective causes conflict, confusion, and often contributes to poor programs and policies. Typically, governments take the perspective of the elite and act as if the process of low/moderate-income housing were the same as in high-income countries and the same as for the small upper-middle class of their own countries (Turner, 1976, 1986, 1988). In effect, governments think of housing as complete units built by developers that households must purchase with a long-term loan rather than as a progressive process. Because of the many distortions in land and housing markets that stop the private sector from producing and financing much housing, however, government often intervenes in an attempt to finance and/or develop most new housing itself funded by large subsidy systems (Turner, 1976, 1986, 1988). The great bulk of Latin American countries, for example, have at one time or another established a forced contribution of from 2% to 5% of salaries to fund below-market loans for complete units supposedly for low/moderate-income families (see for instance, Ferguson & Haider, 2000). This ‘contribution’ often pays back very little to the household and, hence, is largely a tax. Extant examples of such schemes include the National Housing Trust in Jamaica, INFONAVIT in Mexico, the Ley de Politica Habitacional (LPH) in Venezuela, and the Fundo de Tempo de Garantia de Servicos in Brazil. A brief description of the LPH in Venezuela illustrates the perverse affects of these socialsecurity-cum-housing-finance schemes (Ferguson, 1994). Venezuela’s LPH receives funding in two forms: 3% of salaries (mainly of formal sector workers) and 5% of the national budget (net of certain items). The 3% of salaries is considered the savings of individual workers, on which interest should be paid. The amount of money generated by the LPH has varied substantially. During the mid-1990s, the LPH generated around US $350 million per year. The LPH channels these funds through financial institutions, which originate loans far below market rates to developers to build projects and to eligible households to buy the units in these projects. Subsidy levels range from two-thirds to three-quarters the price of the house. Partly because of these high subsidies, only about one in every 50 contributors to the LPH has received a benefit in the form of a housing loan. Units and, thus, subsidies go heavily to the middle class, and the program essentially excludes the bottom 60% of the income distribution almost entirely, mainly because these households cannot afford the required down payment or mortgage payment for a complete

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unit even on highly subsidized terms. Venezuela, which has experienced high inflation incompatible with such long-term lending, has only a token market-rate mortgage sector limited to upper income households, and no unsubsidized mortgage lending outside of the LPH. Thus, the LPH accounts for virtually all residential mortgage loans in the country. Even if inflation were to decline to levels that allowed mortgage finance to expand, the highly subsidized LPH loans would undermine the development of market-rate home lending—as subsidized loans of similar agencies in Jamaica (National Housing Trust), Mexico (INFONAVIT), and Brazil (Caixa Economica Federal, under the Fundo de Tempo de Garantia de Servico). These schemes represent a traditional way of forcing savings into housing investment. This approach has two big pluses. First, it succeeds in raising substantial sums for housing investment. Second, it often (although not always) uses private-sector institutions to develop and finance housing. However, these schemes have huge drawbacks as illustrated above. Typically, they distort financial markets, crowd out private non-subsidized home lending, produce high-cost high-subsidy units, assign these units more to middle-income families than to low/ moderate-income households, deliver a substantial portion of the subsidy to participating developers and financial institutions rather than the family, result in low population coverage, reach a small share even of the contributors to the scheme, and represent a substantial drag on the national economy. Governments, however, hold onto these and similar schemes for a number of important reasons. In the absence of market mechanisms that work for most of the population, the new housing resulting from these schemes often represents much of the production of the formalsector production. Strong vested interest in the form of social housing developers and participating financial institutions also depend on and lobby strongly for their continuance. Government housing policy makers achieve housing themselves by buying a complete unit with a mortgage—i.e. the product mode—and often do not understand the importance of progressive housing for the low/moderate-income majority. Finally, Governments often lack analysis of the high cost and poor performance of these schemes, and can think of no better alternative. In this context, the immediate political pain of ending these schemes usually outweighs the longer-term potential benefits of moving to more market-oriented and better income-targeted approaches until some combination of two things happens. First, as with all large housing subsidy programs, Government sooner or later runs out of money to fund the subvention. The vested interests in these schemes then diminish and the country’s decision-makers become more open to alternatives. Second, the housing crisis of low/moderate-income households becomes so severe and, thus, the drawbacks of the dominant approach so apparent that it forces Government to take action. The characteristics of sustainable housing programs suited to the low/moderate-income majority are quite different. They are: A wide range of low-cost housing solutions that form part of the progressive housing process, including serviced sites, land tenure regularization, improvement, expansion, and construction of a sanitary core or starter home on a lot owned by the family. Finance joins some combination of: (a) small loans at market rates; (b) the savings and effort of the family; which should be both required and rewarded; and (c) sometimes, a small portable subsidy, preferably delivered to the lowest income families or for the most critical purposes such as land tenure regularization or water/sanitation.

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A dominant role for the private-sector—both for-profit and non-profit—in finance, construction, and development. Government appropriately sets norms, facilitates, provides gap funding (subsidies) for the lowest-income households, and only intervenes directly in clear cases of market failure (such as the first step of the urbanization process in many countries). The next section gives examples of initiatives that meet these criteria.

4. New housing initiatives for developing countries This section profiles initiatives in three critical areas that form part of the housing paradigm necessary to serve the low/moderate-income majority: credit, land tenure and development, and subsidies. 4.1. Credit: microfinance of housing The term ‘microfinance of housing’ refers to small loans to low- and moderate-income households typically for self-help home improvement and expansion, but also for new construction of basic core units (Ferguson, 1999; Ferguson & Haider, 2000). Best practice in housing microfinance involves loans at unsubsidized interest rates and short terms, relative to traditional mortgage finance (Ferguson, 1999; Ferguson & Haider, 2000). Various studies (Serageldin & Driscoll, 2000; Mitlin, 1997) have profiled over 40 such programs in Asia, Africa, the Middle East, and Latin America and the Caribbean. NGOs operate many of these programs. The Habitat International Coalition, the main umbrella group for NGOs working on housing issues, has several hundred members, many of which operate some sort of microlending program. In addition, many for-profit, private-sector entities including financial institutions, informal land developers, and building materials suppliers, make such loans to their clients as part of their business. Indeed, if given the chance low/moderate-income households tend to invent some form of housing microfinance—such as savings clubs—in order to fund their shelter needs (UNCHS, 2001). Over the last 2 years, many of the largest microfinance institutions and their donors have diversified into housing and the practice is now growing rapidly. Housing microfinance lies at the intersection of microenterprise finance and mortgage finance (Ferguson, 1999; Ferguson & Haider, 2000, see also UNCHS, 1996, 2001; Mitlin, 1997). It shares characteristics with both, but also demonstrates some important differences. For example, the amount (US $300–$5000) and the length (2–10 years) of housing microfinance loans are typically much less than that of mortgage finance, but greater than that of microenterprise credits. As microenterprise finance, many housing microfinance programs work with para-legal title and income from self-employment—the typical security that low/moderate-income households can offer. In contrast, mortgage finance typically requires a mortgage lien and formal-sector employment. Most microlending occurs for home improvement and expansion—in effect, for the major phases of the incremental building process. The small amount of these loans makes their debt service affordable to low/moderate-income households. The short term of microfinance also well suits these households’ situation. Low/moderate-income families resist incurring financial obligations for the long periods typical of traditional mortgage finance (15–30 years) because

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of the instability of their income. Many low/moderate-income households do not want the burden of long-term payments even if they can qualify for a loan. Microfinance helps solve basic difficulties encountered by traditional mortgage finance in developing countries. First, the large amounts typical of traditional mortgage lending poorly suit the needs of low/moderate-income borrowers—which are mainly for small amounts for the next step in their progressive housing—and greatly limit the effective demand for these loans, usually to the top third of the income distribution. In contrast, housing microfinance allows lenders to reach down as far as the 20th–30th income percentiles in many countries. Second, deeply rooted characteristics of the economies of many emerging countries such as macroeconomic instability, fluctuating inflation, and, as a result, foreign exchange risk, combine to raise real interest rates and shrink the terms of the liabilities available to financial institutions to a maximum of 1–3 years. Hence, lenders engage in serious term mismatch when they make traditional mortgage loans of 15–30 years. In contrast, housing microcredit—whether for self-help home improvement and expansion, or for new construction of basic core units—often has much shorter terms. These short-term assets better fit the short-term liabilities available in developing countries and substantially reduce, although do not eliminate, the risks of term mismatch. Third, financial institutions in emerging countries often hold substantial portions of their assets in risky if temporarily profitable investments. The collapse of many banks that contributed to the Asian economic crisis of 1997–1998 came mainly from problems with large commercial and corporate loans. In contrast, microfinance institutions in Asian countries—such as BRI (Bank Rakyat Indonesia)—had relatively few problems with its portfolio while other financial institutions failed (Ferguson & Elinor, 2000). As a result, microcredit—whether for housing or microenterprise—can help form a solid foundation for financial institutions and the financial sector, in general, in developing countries (Harper, 1998). In addition, bank superintendencies often require that a smaller fraction of loan amounts be provisioned for mortgage lending. This provides institutions with additional liquidity and profitability. From a policy perspective, microfinance is the missing line in social housing programs. Traditionally, governments in developing countries have relied on subsidies to substitute for market reforms in the housing sector (World Bank, 1993). The forced savings/social housing production schemes profiled earlier in this article serve as an example. Many governments have opted to deliver these housing subsidies in the form of below-market interest rates. This traditional mode of social housing finance has proved extraordinarily pernicious. Housing microfinance can reduce and/or replace subsidies in social housing programs, including slum upgrading, low/moderate-income subdivision development, and core expandable units (see Ferguson, 2003, forthcoming, for details). As the hundreds of housing microfinance initiatives attest, this practice has functioned on a pilot-project and informal basis for many years (see for instance, Harper, 1998; UNCHS, 1996, 2001). In fact, microenterprise finance institutions—such as Mibanco in Peru and those of Bolivia—typically find that about 20% of credits that they have extended ostensibly for microbusiness go for housing (see for instance, Brown & Garcia, 2001). The expansion of this housing microfinance to scale, however, has become critical and timely for two reasons. First, many years of attempting to push mortgage finance down market has resulted in little success in most developing countries. In fact, a substantial part of the developing world has gone backwards in this respect. Most Latin American countries had a viable Savings and Loan system

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in the 1960s and early 1970s. This system succeeded in reaching the middle class in some countries, although not the low/moderate-income majority. However, the high inflation during the late 1970s and part of the 1980s destroyed this system in most Latin American countries and, with it, home finance even for much of the middle class. As recently as 1997–1998, macroeconomic shock (high inflation and recession) decimated one of the strongest housing finance systems that had resisted such pressures the longest—that of Colombia. Thus, traditional mortgage finance has proved a fragile and vulnerable transplant to emerging countries with limited use—that is, credit finance of a relatively small middle and upper class. Second, over the last 15 years, a dynamic industry of financial institutions that serve low/ moderate-income groups has emerged in many developing countries, but for microenterprise. Donors, governments, and—now—the private sector have established successful and profitable microenterprise finance institutions on a substantial scale. Compelling forces are now driving the microenterprise industry to diversify into housing. Most fundamental, housing microcredit potentially represents a huge new market for microenterprise finance institutions that can help them expand and make them financially sustainable. For example, a market study (MBIA, 1998) of microfinance in three Mexican cities (Tijuana, Juarez, and Matamoros) along the US–Mexican border found that 14% of households both wanted and could qualify for such a credit (at interest rates of 35% per annum!), resulting in an effective market demand of US $122 million. The effective demand for housing microfinance was over five times that for microenterprise loans in these three cities! In countries where the microcredit business has become crowded—such as Bolivia, Guatemala, El Salvador, India, and Bangladesh—MFIs have already diversified into housing loans on a substantial scale. Experienced and competent MFIs can diversify into housing relatively quickly and profitably. After one year of introducing a new housing microfinance product, Mibanco in Peru was not only recovering its operational costs, but also its capital costs—achieving full financial sustainability (Brown & Garcia, 2001). 4.2. Low-income land development In addition to credit, land is critical to low/moderate-income homeownership. Securing a lot starts the progressive housing process. The remainder of the process depends critically on success in accessing land. As cities have become larger and denser, developable urban land has become far less available in developing countries in the 1980s and 1990s. High standards and slow, cumbersome development approval process have reduced land supply and contributed to raising land costs. Unfortunately, this idea—which underlies a large literature in advanced industrialized countries (see Lowry & Ferguson, 1992)—is still new and unfamiliar in many developing countries. El Salvador, however, is a striking exception to this rule that demonstrates the enormous positive impact of reducing land-development standards and streamlining its regulation (Souza, 2000). The Government of El Salvador (GOS) undertook wholesale reform of the legal and institutional structure of land development, cadasters, and the property registry. Before these reforms, government required full basic infrastructure (electricity, individual water connection, individual sanitation, drainage, paved roads) prior to sub-dividing. These requirements made the resulting development unaffordable to the majority.

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Now, developers essentially must lay out the sub-division (pegging out individual lots, common facilities, and roads), provide basic water (standpipes) and sanitation (a latrine), and legal title. These changes greatly lower upfront costs, allow incremental upgrading of this infrastructure, and have stimulated a low-income development industry that now accounts for over one-third of all new lots and housing solutions in the country per year. Over 200 low-income development firms have produced lots at a rate far above new household formation since 1996 and rapidly expanded the developed areas of El Salvador’s medium and large cities. As a result, lot prices in El Salvador have gone down in real terms by 20% since the mid-1990s rather than rising fast as they do in most developing countries. The monthly payment for purchase of a 100 m2 lot—averaging US $15–$25—is affordable to low/moderate-income families that earn US $1500–$3500 per year. Residential land development on the urban fringe is critical to the expansion of cities, but often creates particularly thorny problems in developing countries. Frequently, land ownership is highly fragmented among many different individuals, with varying degrees of rights to property and tangled title histories (McAuslan, 1985). The resulting urban expansion consists of a chaotic patchwork invaded land and housing development and unplanned roads that cost government great sums to rationalize (Payne, 1999). The opposite problem (concentration of land ownership) also plagues many cities. One or a small group of landowners sometimes concentrate ownership of much of the developable land on the urban fringe in huge parcels (Payne, 1999). As developing countries cities usually have very low property taxes and poor enforcement, these landowners face few carrying charges and hold this land off the market without cost for long periods, encouraging speculation, creating land shortages, and raising prices. In addition, many developing countries (Indonesia, Mexico, India) retain some form of communal property that also impedes urban development. The case of Mexico is particularly serious (Jones, 1998). Ejidos—a form of communal property dating from the Mexican revolutionnow form 65% of the developable land around Mexican cities. Although ejidal land can be privatized since 1992, this process is often convoluted and difficult. The problems with privatizing ejidos have contributed greatly to the chaos, high costs, and difficulty of residential land development in Mexico. Finally, construction finance for subdividing is customarily unavailable or tightly restricted in developing country markets. Local and state governments often attempt to deal with the land problem by buying and banking parcels (UNCHS, 1996). Government agencies, however, often lack the incentives and technical capacity to use such land reserves well. Another, more useful approach is for local and state governments to undertake the first steps in the land development process to facilitate private build out of subdivisions (Payne, 1999). The city of Bogota, Colombia-for example-has targeted the urban fringe land development problem through the creation of Metrovivienda (AMB, 2002). Metrovivienda buys large tracts of land zoned as rural or semi-rural. The organization typically pays substantially less than if this land were zoned urban. Payment can consist of cash or of an interest (joint venture) of the landowner in the subsequent development. If the landowner is intransigent, Metrovivienda uses its condemnation powers to expropriate the parcel and pays the owner a fair market price set by legal fiat. In conjunction with land acquisition, Metrovivienda applies to and obtains permits from other government entities for development. The organization then puts in place trunk infrastructure, and establishes parks and other common areas in conjunction with other authorities. With infrastructure in place, Metrovivienda sells parcels to for-profit and non-profit

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builders, which commit to construct and sell housing at a maximum price. The subsequent competition among these builders for clients helps control prices and ensure quality. Thus, builders pass on a substantial share of the great cost advantages created by Metrovivienda resulting from lower land purchase costs, larger scale, and quicker development times to homebuyers. Metrovivienda delivers no subsidies itself, although the organization sometimes organizes families to access direct demand subsidies funded by central government to reach lowerincome households. After its first two years of operation in 2000, Metrovivienda had bought 320 ha, and had 1800 units in construction in three projects under development. The build out of these parcels was to result in 31,000 units (100 per hectare). With a staff of 38, the organization was lean relative to most government housing agencies. 4.3. Direct demand subsidies Direct demand subsidy programs first arose in Chile in 1977 in reaction to this country’s salarytax funded housing program, which shared all the vices of traditional housing programs (Ferguson, 1996a; Conway, Mikelsons, Varela, & Jimenez, 1996). In essence, direct demand subsidy programs deliver an up-front grant to households rather than a below-market interest rate mortgage (Ferguson, 1996a; Conway, Mikelsons, Varela, & Jimenez, 1996). Households complement this subsidy with their own equity contribution and—in the Chilean model—a market-rate mortgage to finance their housing solution (Pardo, 2001). Households (i.e. demand)—rather than financial institutions or developers (supply)—receive the subsidy and can choose among different types of units in different locations (Conway et al., 1996). When subsidies are delivered to supply—as they still are in many countries—these providers of units or finance have a captive audience. In effect, households must choose their product in order to receive the subsidy. In such cases, developers and financial institutions invariably absorb a large part of the subsidy (and tend to produce shoddy units in poor locations), rather than pass it on to households. Hence, the ability of households to shop among many different housing solutions with the subsidy (portability) is key to many of the benefits of direct demand programs. Direct demand subsidies have spread from Chile to many countries in Latin America, including Costa Rica, Venezuela, Paraguay, Uruguay, Colombia, El Salvador, Ecuador, Guatemala, Nicaragua, and Panama (see for instance, Held, 2000). Independently, other developing countries including South Africa and Indonesia have adopted similar mechanisms. Direct demand programs have achieved a substantial advance in many countries over traditional programs. Largely because of its direct-demand program, Chile and Costa Rica have produced more units of formal-sector housing than the number of new households formed in the last decade (Pardo, 2001; see also Held, 2000). New informal settlement with its tremendous public and private costs—which still plagues virtually all other developing countries—no longer occurs on significant scale in Chile and Costa Rica. Housing—which used to be one of the most severe socio-economic problems of both countries—is now a strength. In particular, the direct demand subsidy program has contributed to and benefited from Chile’s transformation from a developing country to a developed country over the past 25 years. Nevertheless, direct demand subsidies have required substantial modification to function well in most other environments. The first direct demand subsidy programs—such as those of Chile and

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Costa Rica—delivered relatively large subsidies to finance the purchase of new complete units. These programs represented a great advance over the supply side, pension fund cum social housing programs of the past. However, this first generation has suffered from a number of important drawbacks. Foremost, many of these programs were designed as permanent large subsidy infusions without tackling the reforms necessary for a transition to more market mechanisms (in particular, to credit) and gradual reduction in the subsidy levels. Chile has been able to maintain relatively high subsidy levels (in total amount and per unit) for 25 years because of this country’s rapid economic growth over a long period of time (averaging around 7% from 1976 to 2000). Countries that have grown at less rapid rates have experienced increasing difficulty in funding their direct demand programs. Typically, central governments simply stop transferring this as well as other forms of subsidy when the national treasury runs into fiscal problems, disrupting the program’s pipeline and continuity. Second, most direct-demand programs have ended up delivering the subsidy exclusively for purchase-new construction of commercially built units—the highest cost type of housing solutions and the least appropriate for the low/moderate-income majority. In effect, governments have used the wrong paradigm - that ‘housing’ means a complete, commercially built unit rather than a range of low-cost solutions reflecting the phases in the progressive construction process. Direct demand subsidy programs, too, have had difficulty reaching the low-moderate-income majority. A second generation of direct demand programs is now delivering smaller subsidies to a much wider range of housing solutions suited to the low/moderate-income majority, including serviced sites and land tenure, home improvement, and home expansion. Direct demand subsidy programs in Suriname and in Nicaragua supported by the Inter-American Development Bank now provide small subsidies ($500–$2000) for low-cost housing solutions, including improvement and expansion of an existing home (including land tenancy and infrastructure connection) and construction of a starter unit on a lot already owned by the family (IADB, 2001, 2002). This new generation of direct demand programs also seeks to use subsidies as a mechanism for a transition to market mechanisms—such as housing microcredit—rather than institutionalizing large-scale subvention long term.

5. Conclusion In conclusion, widespread home and property ownership hold key importance to building household wealth and a middle class. However, developing countries suffer from a tangled knot of problems in this sector that makes achieving these economic benefits impossible for most people. Although a high proportion of households occupy property to which they have rights, a minority has full legal title. Home credit is typically available only to the middle class and above (the top 20–30% of the population, at most) to purchase a complete, commercially built unit. Governments accept this upper middle-class model as the correct method of ‘housing’ and create programs that spread this model to a somewhat larger share of the population at great cost. Typically, neither government nor the formal private-sector supports the progressive housing process, which the low/moderate-income majority uses to afford their highly sought goal of homeownership.

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In contrast, housing initiatives appropriate to the low/moderate income majority: (a) work with a wide range of low-cost housing solutions that strengthen the progressive housing process; (b) join small loans at market rates with households savings and a small subsidy, if available to finance this solution; and (c) are operated mainly by the private-sector, while government sets the rules and provides gap funding (only intervening directly in clear cases of market failure). The examples profiled in this paper—housing microfinance, low-cost (progressive) subdivisions, macroblock development on the urban fringe, and direct-demand subsidy programs—have these characteristics. Such initiatives hold the key to satisfying the mass effective demand for housing of the low/ moderate-income majority, and can impact urban development broadly. Hence, this approach also increases the efficiency of cities—the main generators of GDP in modern economies. More broadly, the progressive housing approach and the package of initiatives profiled in this paper embody an approach to housing the low/moderate-income majority in developing countries that can be joined with traditional housing finance interventions—such as secondary mortgage market and mortgage finance reform. Honing these mechanisms to make them operational, joining them into a coherent whole, and disseminating them is a work in progress.

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