by Hernando de Soto
(Bantam Press – 243 pages)
Reviewer – Luke Brown
The hour of capitalism’s greatest triumph is its hour of crisis. So begins the Peruvian economist Hernando de Soto’s intriguing work on his view why Capitalism has triumphed in the West, but seemingly failed so many in the developing and former communist countries. Whilst it was published in the year 2000 and follows on from his previous work, The Other Path, the ideas contained within are important and still relevant.
One does not have had to travelled too far and wide amongst the poor nations and regions of the world to draw similar conclusions to that of de Soto. The slums, poverty, poor sanitary conditions, lack of available education and similar inadequacies speak for themselves. But is it Capitalism itself that is to blame, or rather an inadequate implementation of it?
Anti-Capitalists are quick to nod their heads solemnly, sigh and proclaim that all they have been saying about the so-called free market has been confirmed. For a group of critics that place so much emphasis on an analysis of history, they appear irrevocably blind to it. Marxist and socialist ideologies have been disastrous and invariably been brought about through brutal methods to conform society to their aims. But, they cry, it was never really carried through properly. Thank goodness. But look at Capitalism and the way it plunders, exploits for the benefit of the elite West. Like Hong Kong, Singapore and South Korea? But it causes racism, Imperialism and war. That existed before Capitalism, did it not? And war and the like harms trade and the creation of wealth. But so-called free trade merely serves the elite? So call for the end of Protectionism. But what about unemployment; it proves that the free market doesn’t work? It cannot work without free labour markets. But Multinationals exploit the poor. They of course conveniently ignore the wealth-destructive statist practices of certain governments and their own state-run industries in which these corporations invest; plus, only through capital investment can wages be increased and eventually move an economy away from labour-intensive industries towards capital-intensive ones. But the elite runs the world, they call themselves Capitalists and the world is a mess; therefore… So what, I call myself a nice guy who should naturally be a babe magnet; it doesn’t mean its true. Irritatingly, not a but is voiced at this point.
Of course there are those, supposedly on the other side of the fence, who will also snidely nod their heads, safe in the knowledge that History Proved Them Right and that it is a fait accompli that things will eventually just work themselves out. Not so fast. While Capitalism pulled some parts of the world out of immense poverty and despair over a century ago, it has clearly not repeated itself in other parts. If the anti-Capitalists can be categorised as the “But” school of thought, our own set of Capitalists-when-it-pleases-them can best be described as generally belonging to the “Yes, but” school. The usual suspects can be found (or found out) when their own interests (or those of their practically interchangeable entity, the State) are being threatened. Whether it be for the idea that free trade is beneficial… Yes, but at times we need a little bit of subsidies and tariffs, for the good of our own people and our industries. Surely you recognise, though, that paying more for goods is not really good at all? Yes, but they have subsidies for their goods and dump them on us. I thought subsidies were good? Yes, but for, um… besides they started it. Two wrongs evidently make a right. Or the State that can use force to get what it wants because it gives certain people who give it what it wants, what they want; the same entity that can bomb others, far and wide who will not fall down before it. Yes, but you mean other tyrants. Indeed.
One could go on to the subject of destructive Keynesian boom and bust policies and the like, but most people’s eyes unfortunately glaze over when discussion turns to Economics. I believe that Hernando de Soto’s book can prove to be an antidote.
He begins with the premise that the market-based Capitalism is now the only viable game in town. Next he sweeps aside a commonly held notion of some Westerners that citizens of developing and former communist countries have failed to transform themselves into successful capitalist nations because they lack the necessary entrepreneurial spirit, or cannot handle a market-oriented world. Having seen myself the activities of the local businessmen, taxi entrepreneurs and vendors, in such countries as Albania, the Philippines, Burma, Yugoslavia and South Africa, is enough to dispel this myth. And markets and trade have been with us for thousands of years.
So if it is not a cultural phenomenon then, what is it? Over a number of years and, with the assistance of a research team, de Soto travelled to Asia, Africa, the Middle East and Latin America in order to attempt to discover why these countries had failed in their attempts to transform themselves into successful Capitalist nations.
What he found was that, while the poor in these countries had an immense amount of savings and assets capable of being transformed into capital, what was missing was the procedures to turn this “dead” capital into “liquid” capital; this being the representation of assets in the form of adequate property documents.
He describes the size of these savings:
“Even in the poorest countries the poor save. The value of savings
among the poor is, in fact, immense: forty times all the foreign aid
received through the world since 1945. In Egypt, for instance, the
wealth that the poor have accumulated is worth fifty-five times as
much as the sum of all direct foreign investment ever recorded
there, including the Suez Canal and the Aswan Dam.”
But there is a problem:
“But they hold these resources in defective forms: houses built on
land whose ownership rights are not adequately recorded,
unincorporated businesses with undefined liability, industries
located where financiers and investors cannot see them. Because
the rights to these possessions are not adequately documented, these
assets cannot readily be turned into capital, cannot be traded outside of
narrow local circles where people know and trust each other, cannot
be used as collateral for a loan and cannot be used as a share against
The difference between this situation and of that in the West is that practically every piece of asset in the West is represented in a property document that connects each one together. Out of this there are many possibilities: collateral for credit, a credit history, an accountable address for the collection of debts and taxes, supply of utilities, and so on. What this means is for those in the developing world and the former communist nations, they are effectively undercapitalised, “in the same way that a firm is undercapitalised when it issues fewer securities than its income and assets would justify.”
This may all appear rather obvious, but it is quite easy to take it for granted. It must not be forgotten that the West faced a similar situation well before the twentieth century, which the developing and former communist nations currently face. Within the last fifty years there has been a mass movement of populations in these former communist and developing nations from rural areas to the promises of a better life in the cities. In fact, cities have exploded in size and are, in many places, a large mess, unable to adapt in a timely manner. Now more than ever, the need for a system in place to account for the property rights of individuals is paramount. Instead, huge and seemingly insurmountable obstacles seem to be in place, denying ordinary individuals the opportunity to exploit the value of their assets, as de Soto puts it, to extract “surplus value”.
An example will suffice:
“To get an idea of just how difficult the migrant’s life was, my
research team and I opened a small garment workshop on the
outskirts of Lima. Our goal was to create a new and perfectly
legal business. The team then began filling out the forms,
standing in the queues and making the bus trips into central
Lima to get all the certifications required to operate, according
to the letter of the law, a small business in Peru. They spent six
hours a day at it and finally registered the business – 289 days
later. Although the garment workshop was geared to operating
with only one worker, the cost of legal registration was $1,231
– thirty-one times the monthly minimum wage. To obtain legal
authorization to build a house on state-owned land took six
years and eleven months – requiring 207 administrative steps in
52 governments offices. To obtain a legal title for that piece of
land it took 728 steps. We also found that a private bus, jitney or
taxi driver who wanted to obtain official recognition of his route
faced twenty-six months of red tape.”
With these obstacles in place it is no wonder that a large amount of the poor live and operate in the “extra-legal” sector. Operating outside of the legal system means that their houses and tools are effectively rendered “dead’ capital. The scale of this is enormous. For example, in Haiti, according to his surveys, 68 percent of city-dwellers and 97 percent of countryside dwellers live in housing with no clear legal title. The estimated worth for these dwellings is US$5.2 billion (four times the total of all assets of all the legally operating companies in Haiti, nine times the value of all assets owned by the government and 158 times the value of all foreign direct investment in Haiti’s recorded history to 1995). In the Philippines it is US$133 billion (four times the capitalisation of the 216 domestic companies listed on their stock exchange, seven times the total deposits in the country’s commercial banks, nine times the total capital of state-owned enterprises, and fourteen times the value of all foreign direct investment).
But what does this all really mean? To answer this, it is essential to understand the nature of capital. It is not money. Rather, it is the means to produce other things. It must not be seen simply as a physical phenomenon, but rather as a concept. The economist Jean Baptise Say is quoted as saying that “capital is always immaterial by nature since it is not matter which makes capital but the value of that matter, value has nothing corporeal about it.” By conceptual, I mean that it is all in the eye of its owner. He can combine and link various capital items, in roundabout ways, in order to produce what a consumer wants. Houses by themselves cannot produce anything as such. What it is all about is creating a process “that allows him to convert and fix this potential into a form that can be used to do additional work.” De Soto has identified six effects of Property:
1) Fixing the economic potential of assets – this is done through allowing assets to be represented in writing; not a mere description of what the asset is but rather supplying details that will be “economically and socially useful,” in order for them to have a life of their own.
2) Integrating dispersed information into one system – so that those who exist outside the close vicinities that usually are present when it comes to extra-legal communities, can gain access to this information.
3) Making people accountable – for example, taxes, debts and to gain credit.
4) Making assets fungible – which means that through representations in the forms of titles and deeds, assets can be divided up, enabling amongst other things, multiple investors to exploit the assets.
5) Networking people.
6) Protecting transactions – and ownership.
Once such a system is in place for representing property and assets, they can fulfil a parallel life, “doing economic things they could not have done before.” The procurement of credit is made easier; mortgages and collateral can back up investment, and property can be widely represented making the pursuit of economic goals more efficient. There is basically a system in place upon which production and transactions can be built. This in turn provides a platform whereby savings can be more effectively turned into more capital, and so on.
At this point in the book the theory has now been expressed. The next step is the all-important how. De Soto takes the United States as an example. Of course, the first point that will pop into mind is that obviously the United States is a different case and was undertaken in another time. While it is true that the way the system was developed there cannot be exactly transplanted to the current developing and former communist countries, it is important to note that over 150 years ago the United States was also essentially a third world country. What de Soto discovered is that once the United States recognised and integrated extra-legal property rights, its fortunes changed dramatically. What basically happened is that a system of property rights developed according to the needs of those concerned and the norms at the time. They were not simply imposed, but rather were developed. In order for the affected parties to agree to join up to a standard system, they had to be persuaded that it was in their interests to do so. In other words, giving up the life in an extra-legal system would mean that whilst its negative aspects would diminish quite substantially or even totally (for example, there would be no need to hide from the authorities, they could now obtain credit, investment and limited liability protection, and be relatively more free from criminal extortion) these added benefits would have to compensate for the taxes and costs they now would have to incur.
De Soto recognises that, alongside the theoretical legal challenges inherent in setting up a system of property rights, there is the matter of the political challenges. The book is inherently limited at this point, not because he has not covered the potential legal and political challenges fairly adequately, but because theory is no substitute for actual and widespread practice in specific countries and situations in the here and now. As with most things, politics will either make or break it. The elites who cosy up to the politicians may fear that their privileged circles are under threat and that they may be subjected to, god forbid, competition.
While the establishment of an effective system of property rights is essential, it will always be tempered by other important economic and political conditions. Unstable currencies and excessively expanding money supplies, the flouting of the rule of law, elite global economic organisations, authoritarian regimes, terrorist groups, corruption, meddling and expansionary foreign powers, and Protectionism, are all also impediments to prosperity and peace. While they are really beyond the scope of this book, they must always be kept at hand.
Last and by no means least, there will be the resistance of those poor in the developing and third world countries that have much to gain from this property revolution. They have been continually told that free-market reforms are the best thing for them. Support is in fact dropping, which is a pity, because what has been implemented cannot be honestly called free-market initiatives. The mostly deliberate confusion that has been sown by those on the different sides of the economic “expert” fence is truly disturbing. The elites of globalisation say one thing but do another. The opponents snidely write off this so-called free-market as not actually being free. They are to a certain extent correct, but make no mistake about it they do not actually want it free, despite being unable to make an effective argument against true free market ideals. Whether they truly believe that somehow their socialistic policies have some hope of defying economic reason or experience, they do not like the ideas of individual liberty or do not want to give up their distorted high moral position in their intellectual circles, one cannot be entirely sure. No doubt Hernando de Soto’s previous ties with the disgraced former President Fujimori as an economic adviser in the early nineties or his economic work with GATT is proof enough for them that this important work is a mere tool of Western Imperialism. That position sure beats actually showing why the ideas described are wrong.
Hernando de Soto closes with the following:
“I am not a diehard capitalist. I do not view capitalism as a credo.
Much more important to me are freedom, compassion for the poor,
respect for the social contract and equal opportunity. But for the
moment, to achieve those goals, capitalism is the only game in
town. It is the only system we know that provides us with the tools
required to create massive surplus value.
I love being from the Third World because it represents such a
marvellous challenge – that of making a transition to a market-based
capitalist system that respects people’s desires and beliefs. When
capital is a success story not only in the West but elsewhere, we can move beyond the limits of the physical world and use our minds to soar into the future.”