The Mystery of Capital: Why Capitalism Triumphs in the West and Fails Everywhere Else by Hernando de Soto (New York: Basic Books, 2000, 276 pp, $41.50)
How do you know in Bali where one man’s property ends and another’s begins?
Except for the affluent elite, people in Bali do not have access to a formal system of property rights.
Someone may have occupied a home or done business out of a little shop or farmed a patch of land for decades, and no one else may wish to lay claim to the land or buildings, but legally that person would not own it, since they would have no documented title of ownership.
So, according to Peruvian economist and anti-poverty activist Hernando de Soto, in Bali you only know when you are stepping onto someone else’s property when a different dog starts barking.
Much of humanity still lives in extreme poverty. According to the World Bank, about 1.2 billion people live on less than $1 (U.S.) a day. That is a fifth of the world’s population. And little progress has been made in the struggle against poverty since the international collapse of communism during the 1990s. The share of sub-Saharan Africa’s population living on less than $1 (U.S.) a day remained constant at about 46 per cent from 1987 to 1998. Over the same period of time, in Latin America and the Caribbean the poverty rate by this measure stayed unshakably at about 16 per cent. The only region where the poverty situation improved significantly during those 11 years was East Asia (including China), where the poverty rate dropped from 27 to 15 per cent.
The question that drives de Soto’s research and activism is this: How can the poor be brought within the circle of economic development?
De Soto believes emphatically that the poor are not the problem. In his view, the poor are the solution. The problem is the law.
In an interview with Michael Cromartie of the Ethics and Public Policy Center in Washington, D.C. (Books & Culture, January/February 2001), de Soto claimed that the poor in less developed countries live in a state of property apartheid.
Apartheid indicates that you discriminate through rules. Poor people can’t live in the part of town where the rules are clear. They have to live on the outskirts. The rules that apply to the outskirts, from Manila to Cairo to Mexico City, are different rules. As the French historian Fernand Braudel said, it’s as if you placed a bell jar over one part of the city, the realm of our politicians and our technocrats, which imitates the West. The rest of the people, 80 or 90 per cent of the population, live in a jungle of rules which are inapplicable and unaffordable, and which keep them in misery.
The lack of appropriate property laws is, in de Soto’s considered opinion, the reason for this misery. This lack turns the assets of the poor into dead capital. “Even the poor have assets,” de Soto told Cromartie.
You’ve got a cow, you’ve got a pig, you’ve got a bicycle, you’ve got a motorcycle, a bus, a truck, a small factory, a house. Most of them have something. If they didn’t, they would be starving. I’m not saying there are not some people in terrible situations—the poorest of the poor, who are in terrible misery. But most people are building cities, are carrying out economic activities, and are more or less surviving.
“Dead capital” is all the assets these people possess that cannot be brought to life—or to a parallel life, one might say, where the assets are transformed into financial capital or investment capital. For most Peruvians and Egyptians and Russians and Chinese, a house is a shelter from the cold and the rain. It has a physical value. But to you Americans, a house is many other things. It is, for example, collateral for a mortgage. So while you are living in your house, it is working for you in the financial markets at the same time. . . . And your house is your address. If you know that de Soto lives here, you can collect rates and therefore you can supply him with energy and water. Or you can collect taxes, or you can make him a business partner. Today, 80 or 90 per cent of Egyptians and Peruvians lack legal addresses, so how can they have that parallel life?
We are starting to understand that property law doesn’t merely allow you to claim ownership but also allows you to liberate your assets and to bring out from them surplus value.
“In the West,” writes de Soto in The Mystery of Capital,
every parcel of land, every building, every piece of equipment, or store of inventories is represented in a property document that is the visible sign of a vast hidden process that connects all these assets to the rest of the economy. Thanks to this representational process, assets can lead an invisible, parallel life alongside their material existence. They can be used as collateral for credit. The single most important source of funds for new businesses in the United States is a mortgage on the entrepreneur’s house. These assets can also provide a link to the owner’s credit history, an accountable address for the collection of debts and taxes, the basis for the creation of reliable and universal public utilities, and a foundation for the creation of securities (like mortgage-backed bonds) that can then be rediscounted and sold in secondary markets. By this process the West injects life into assets, and makes them generate capital.
A large part of de Soto’s research effort involves trudging through urban shanty towns and rural farmland around the globe collecting information about the assets of the poor. Together with his team, he spends about a year in each country preparing an exhaustive topology and valuing the informal landholdings. Local leaders are recruited to help chart the intricate and demanding rules that make doing business legally so difficult for the poor. The results of his investigations are astounding.
As de Soto told Cromartie,
in Egypt alone the poor own 240 billion dollars worth of real estate, which is equivalent to all investments in Egypt over the last 200 years, including the Suez Canal and the Aswan Dam. In Peru, they own close to 70 billion dollars, which is equivalent to the value of Peru’s exports for something like the next 20 years and at least six times the value of the stock exchange. In Mexico, they own something like over 320 billion dollars of land and businesses, which is many times more than all the oil or petroleum assets of Mexico, the cement assets, and all the state corporations and privatizations carried out so far. The total value of real estate held but not legally owned by the poor in the developing world is at least $9.3 trillion [U.S.]—twice as much money as the total circulating in the U.S. money supply.
The problem, however, is that “the poor possess these assets . . . without proper title.” Instead, “their property rights are protected only by local social contract—tribal agreements, neighbourhood agreements, unwritten law—and therefore their goods can only be traded and exchanged within small boundaries.” As a result, in countries like Egypt or Peru, the assets of eight out of ten people are excluded from the formal economy.
Nonetheless, de Soto is quite positive about the possibilities for change, because “law is something we can change, because we can pinpoint the places where the problems exist, the places where the bridges are missing.” “The main obstacle to development in the Second and Third World is the law. The first thing we need to do is create a system of representations where value can be fixed and realised.” His optimism is somewhat dampened, however, by his discovery that the process for legalizing possession, almost everywhere in the less developed countries, is prohibitively expensive and cumbersome.
“In Egypt,” he writes, “the person who wants to acquire and legally register a lot of state-owned desert land must wend his way through at least 77 bureaucratic procedures at 31 public and private agencies. . . . This can take anywhere from five to fourteen years. To build a legal dwelling on former agricultural land would require six to eleven years of bureaucratic wangling, maybe longer. This explains why 4.7 million Egyptians have chosen to build their dwellings illegally.”
For this situation, de Soto places the primary blame on lawyers in poor countries, who have been trained to defend the system as they find it, rather than reform it to do justice for the poor. The result is that many poor countries have the appearance of market economies but are actually mercantilist economies, with small elites enriching themselves through government favours, contracts, and privileges while excluding and marginalizing both local and foreign competitors by government means.
To enable poor people like these 4.7 million Egyptians to put their dead capital to work, de Soto proposes a process of formalization, or capitalization, of assets. Such a process would have three phases: a discovery phase for identifying and contextualizing a country’s dead capital, a political and legal phase, and an operational phase. Of these, the middle phase—the political and legal—is the most crucial.
This political and legal phase of the capitalization process requires a strategy of political persuasion that must result in a set of laws. Such a strategy, according to de Soto, must contain at least six elements: (1) the highest political authorities in the country must assume accountability for the capitalization of the assets of the poor; (2) governments must establish agencies that will permit rapid change; (3) governments at all levels, but especially at the local level, must remove administrative and legal bottlenecks in the property title registration process; (4) political leaders must build a consensus in favour of capitalization between the legal and the extra-legal sectors; (5) lawyers and policy experts must draft statutes and procedures that lower the cost of holding assets legally below those of holding them extra-legally; and (6) governments must find ways to reduce the risks associated with non-governmental investment.
The capitalization process will fail, according to de Soto, if the system of property law is conjured up in ignorance of the extra-legal social and economic practices that already exist among the poor to secure possession—however tenuous those processes might be. To succeed, the capitalization process must recognize existing possession and crystalize and standardize the existing extra-legal property arrangements among the poor.
De Soto argues that capitalization will have political consequences in addition to the economic consequence of alleviating poverty. In this regard, de Soto quotes the historian Richard Pipes, who writes, “Private property is arguably the single most important institution of social and political integration. Ownership of property creates a commitment to the political and legal order since the latter guarantees property rights: it makes the citizen into a co-sovereign, as it were.”
Perhaps the most controversial aspect of de Soto’s program is his insistence on the universal validity of the capitalization process, regardless of cultural diversity, as a means to unlocking the potential of the assets of the poor, and alleviating poverty. According to de Soto,
Westerners all too often . . . [blame] Third World peoples for their lack of entrepreneurial spirit or market orientation. If they have failed to prosper despite all the excellent advice, it is because something is the matter with them: they missed the Protestant Reformation, or they are crippled by the disabling legacy of colonial Europe, or their IQs are too low. But the suggestion that it is culture that explains the success of such diverse places as Japan, Switzerland, and California, and culture again that explains the relative poverty of such equally diverse places as China, Estonia, and Baja California, is . . . unconvincing.
The cities of the Third World and the former communist countries are teeming with entrepreneurs. You cannot walk through a Middle Eastern market, hike up to a Latin American village, or climb into a taxicab in Moscow without someone trying to make a deal with you. The inhabitants of these countries possess talent, enthusiasm, and an astonishing ability to wring a profit out of practically nothing.
The poor in less developed countries, insists de Soto, “are not pitiful beggars, are not helplessly trapped in obsolete ways, and are not the uncritical prisoners of dysfunctional cultures.”
“I humbly suggest,” writes de Soto, “that before any Brahmin who lives in a bell jar tries to convince us that succeeding at capitalism requires certain cultural traits, we should first try to see what happens when developing and former communist countries establish property rights systems that can create capital for everyone.”
It is this statement that has reaped de Soto the criticism that his proposal of capitalization as a silver bullet for alleviating poverty is simplistic.
A mild version of this critique comes from Catholic theorist Michael Novak, who writes in The Weekly Standard (January 2001),
Is de Soto correct that institutions unlock the gate into development? Or is it culture? De Soto is surely right that simple changes in law have had a dramatic effect on economic behaviour. On the other hand, at least some changes in culture are needed to propel political support for the institutional reforms de Soto calls for. Culture, not institutions, determines the success of a society. But new institutions can change a culture for the better. These two truths . . . complement each other.
I doubt that de Soto would disagree with this moderate position. As he writes in conclusion to his brief comments on culture,
This is not to say that culture does not count. All people in the world have specific preferences, skills, and patterns of behaviour that can be regarded as cultural. The challenge is fathoming which of these traits are really the ingrained, unchangeable identity of a people and which are determined by economic and legal constraints. . . . Much behaviour that is today attributed to cultural heritage is not the inevitable result of people’s ethnic or idiosyncratic traits but of their rational evaluation of the relative costs and benefits of entering the legal property system.
Unless de Soto, Novak, and the other participants in this debate work with a much narrower definition of culture than those with which I am familiar, culture includes institutions, rather than standing in contrast to them. The debate between de Soto and his critics in this regard seems misdirected. The question is not whether either culture or institutions—in this instance the specific institution of the legal capitalization of assets—serve as the necessary spur to economic development, but rather, how capitalization functions as an element of culture—interacting with other elements—to advance economic development.
Modern economics often suffers from a mechanistic utopianism: if we were only to tweak the institutional structures of society enough, we could solve all the world’s problems. This reduction of reality to a mechanism which can be relatively easily understood and manipulated is equally often further reduced in modern economics in that “all the world’s problems” are reduced to questions of the supply of and demand for material goods. De Soto’s suggestion that the problem of poverty can be reduced simply to the problem of dead capital and simply solved by the capitalization of the assets of the poor has the flavour of such a materialistic and mechanistic reduction.
The Dutch economist Bob Goudzwaard has pointed out that a trilogy of constraints keep the poor from taking care of their responsibilities: opportunity constraints (the absence or denial of access to resources, such as inadequate educational opportunities, the unobtainability of work, or de Soto’s dead capital), external motivational constraints (a set of relationships that inhibit the poor from the pursuit of opportunities, such as a crime-ridden neighbourhood that discourages people from leaving their homes to seek work, or the absence of a father and the need to take care of children in a single mother household), and internal motivational constraints (attitudes that keep the poor locked in poverty, such as an inherited poor work ethic or sheer sloth).
De Soto’s program for the capitalization of the dead capital of the poor might indeed be a silver bullet for development in those situations where poverty is due entirely to opportunity constraints. But where poverty is the result of motivational constraints, or a combination of motivational and opportunity constraints, capitalization cannot be enough. And even where poverty is due largely to opportunity constraints, dead capital is seldom the only issue—the assets of the poor are often extra-legal not because of a mere oversight on the part of their governments but because of a deliberate effort to keep the poor poor, or at least powerless, in the interest of the local political elites. Sadly, even such situations of tyranny are preferable to the situations of anarchy and brigandry under which many of the world’s poor live—such as in the Congo, where the effective absence of law and the destruction even of the fabric of social custom makes the capitalization of extra-legal assets less than a distant dream.
That said, there are a number of countries, several of which de Soto mentions—for example Peru and Egypt—where capitalization could make a quick and significant difference.
“Property [involves] the responsibility of use,” according to the American economist John Tiemstra, “and ownership is a legal definition of that responsibility which puts firm boundaries to the interference of others and creates an economic domain within which people can exercise stewardship.” Capitalization can in many circumstances define ownership, protect the poor from undue interference, help create a fruitful economic domain, and liberate the assets of the poor for responsible usage.
Capitalization may not be a silver bullet, but it is more than a dog’s bark.