In the acknowledgments for his new book, The Mystery of Capital: Why Capitalism Triumphs in the West and Fails Everywhere Else (Basic), Hernando de Soto thanks the Smith Richardson Foundation for its support, which included providing a bullet-proof vehicle when de Soto’s Peru-based Institute for Liberty and Deomcracy “was being bombed and shot at during the early 1990′s.” The distinctive mix of practicality and wit in that thank you is characteristic of de Soto, whose book The Other Path was read by policymakers throughout Latin America and around the world. He tackles subjects that have produced mountains of unreadable prose and inconclusive statistics, and emerges with a fresh point of view that is at once utterly practical and conceptually dazzling. Michael Cromartie spoke with de Soto during a recent visit to Washington, D.C.
In the first paragraph of your book you say, “The hour of capitalism’s greatest triumph is its hour of crisis. The fall of the Berlin Wall ended more than a century of political competition between capitalism and communism. Capitalism stands alone as the only feasible way to rationally organize a modern economy. At this moment in history, no responsible nation has a choice. As a result, with varying degrees of enthusiasm, Third World and former communist nations have balanced their budgets, cut subsidies, welcomed foreign investment, and dropped their tariff barriers. Their efforts have been repaid with bitter disappointment. From Russia to Venezuela, the past half decade has been a time of economic suffering, tumbling economies, anxiety, and resentment.” Why has there been such bitter disappointment?
I think a useful way of looking at this is thinking first of all about the numbers. There are about six billion people living in the world. One billion of these people live in what is generally known as the “West”: Western Europe, the United States and Canada, Japan, her two former colonies Taiwan and Korea, and also Singapore and Hong Kong. The rest of the world—former communist nations, developing nations—makes up the remaining five billion. Only 10 to 20 percent of those five billion have access to capitalist tools, like mortgages, credit cards, bonds, the kind of paper on which you accumulate value (which is what we call capital) and which therefore can help specialization take place within a broad market. So what we know is that at least four billion people, two-thirds of the world’s population, have not been inserted into the system. They don’t have the paper to be inserted into the system; they don’t have the property titles over their real estate assets; they don’t have the licenses over their businesses; they don’t have the instruments needed to carry value nor the means and the legal vehicles to enforce decisions and transfer value. Paper, of course, doesn’t simply help you to prove ownership; it is like a Swiss Army knife, a knife with many blades, of which ownership is one. You should be able to get credit with it; you should be able to use it as an investment tool.
Why isn’t capitalism working for the majority of people in the world? Not because they tried it and weren’t able to pull it off. No: it’s never even reached them. Capitalism isn’t essentially about trading the little cows and little pigs in the market. It’s about papers, which represent the little pigs. When we talk about capitalism we’re talking about the kind of markets that you have in the Chicago Commodity Exchange; somebody has got a piece of paper that represents 30,000 head of cattle. You don’t have to look at each cow. You’ve got a piece of paper that tells you everything that you cannot see by looking at the cows. The paper tells you how many there are, who they belong to, in what condition they’re being delivered.
With such a piece of paper, you can buy 30,000 head of cattle in one fell swoop. You can trade large quantities with great specificity; you can even take a factory and sell it in ten or a hundred different pieces by dividing it into ten or a hundred different packages of shares. In other words, you can combine and re-combine and add assets to produce additional wealth.
This is precisely what Adam Smith had in mind when he talked about “the division of labor in a wider market.” But to do that you need this legal paper, which assures you that the assets you’re getting are as they have been represented, and that your transaction will be conducted according to specific rules which can be imposed by courts and police systems. Well, how many people in the world among those five billion people who are not in the so-called “West” have got some kind of documentation of their assets? How many are surrounded by the framework of rules that provide the necessary security to make such transactions? Only 500 million or at most one billion of those five billion have the vehicles needed to accumulate capital and engage in transactions in the larger market. That’s why capitalism is failing outside the West. And we had not realized until now that the possibility of getting represented on paper and being guided by rules was a fundamental instrument of capitalism.
In other words, what we have missed about capitalism is nothing more or less than the rules of the game. It’s like a soccer match. You can put up goals if you want to and you can put some white lines on the turf, but if there are no rules, you can kick your opponent, you can make a goal with your fist, one team can have 24 members and the other one only eight members. If there are no rules, there is no game. The game of capitalism collapses without the rules.
You argue that a majority of the population of the Third World possesses considerable assets—”dead capital”—which they are not able to use. Explain what you mean by that.
Even the poor have assets. 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. And most people in developing countries are not starving. I’m not saying that 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. It’s got a parallel life. You can bring it out in paper and guarantee an investment against it, so it actually produces investment.
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 to 90 percent 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, which is what Marx called capital. And those who cannot produce capital therefore have, using Adam Smith’s term, “dead capital.”
As a matter of fact, 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 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—twice as much money as the total circulating in the U.S. money supply.
The poor possess these assets the way Europeans or North Americans possessed their assets hundreds of years ago—that is to say, without proper title. Their property rights are protected only by local social contract—tribal agreements, neighborhood agreements, unwritten laws—and therefore their goods can only be traded and exchanged within small boundaries. So the number-one requisite for development—the division of labor in larger and larger markets, which is what globalization is all about—doesn’t even take place at a national level in developing countries. It takes place at neighborhood levels. In other words, among certain neighbors in Lima and certain neighbors in Cairo and certain neighbors in Beijing, you can trade and exchange goods and buy and sell them with relative security because your peers and your neighbors are your judges, your courts, and therefore you can trust them. But you can’t trade at a national level, so they haven’t even globalized internally at a national level.
They lack property rights?
They lack property rights. In other words, they need to have their rights documented in a standard form, on paper and in records, enforceable by at least national laws, in such a way that the piece of paper can be traded around.
Tell me, when you own part of General Motors or when you own part of Microsoft, what do you carry it in? In a little suitcase? In a pillbox? Or on a piece of paper that documents your ownership? And part of that property right can be your debt to me, so it’s a bond, it’s an IOU, and I can trade it in a secondary market and get myself financed. That’s capitalism. And that’s what most of the people in the world today can’t do.
And when people in the developing world do try to assert their property rights, they are routinely frustrated. If you try and register a concession over a sand dune in Egypt outside Cairo, it takes you 17 years of wading through red tape eight hours a day. In Manila, our findings show it’s about 54 years.
The bureaucracies are really that bad?
It is not so much the bureaucracies; that’s the way politicians like to pass the responsibility off to technocrats. It is simply bad laws. In Peru we started doing very simple stuff like counting how many laws the government of a developing poor country of some 25 million in habitants produced in a year. They produced 28,000 laws a year!
In well-functioning democracies, the cost of these rules and laws seeps back into the decision-making system and there is self-correction. But because of the deficient political and administrative systems in developing countries, you don’t get comparable feedback. As a result, you accumulate huge walls of paper, which have actually sectioned society in two. One set of laws applies to the elite; another to the vast majority.
Until about 40 years ago the majority of poor people in developing countries lived in the hinterland. But over the last 40 years cities like Port-au-Prince in Haiti have grown to 16 to 17 times their former size. Most cities in the developing world have grown by at least 7 to 8 times. This is all very well known, and much has been written about the problems of these burgeoning cities. But what we are just discovering is the impact of the law on these rapidly growing populations, which takes the form of property apartheid.
I use the term property apartheid because 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 percent of the population, live in a jungle of rules which are in applicable and unaffordable, and which keep them in misery.
In developing countries we’ve been trying to make regulations and laws that are friendly to foreign investors. How can we do things in such a way that foreign investors can come and set up independent power producers and supply water through private means or buy the telephone companies? So we’ve created a friendly legal atmosphere for foreign investors. That’s well and good. But what we forgot to do is to see whether the law was also hospitable to the little investors in the country, the poor people—who, as we have seen, actually have more value in assets than foreign investors!
What we have to do is create the kind of contractual mechanisms and the representative documentation and records which will allow the poor to mobilize all that stored value, all that stored labor, to be able to fund, in forms of investment or finance, additional production, which is what wealth is all about.
You oppose the popular view that success or failure with capitalism is determined by cultural differences. Why is that?
I don’t see any reason why your cultural background should make you more entrepreneurial than I am. I disagree with Max Weber that capitalism is possible because of Calvinist influences. We’ve all been entrepreneurs for a long time. We’re all living from the product of our work.
To put a good legal system in place you don’t need a particular cultural pedigree. Look at the United States. You inherited the British tradition. Yet in the nineteenth century, when you decided to squat all across the continent without even surveying it, when you divided California into 800 jurisdictions through miner claim clubs—you did the same thing in Texas—you weren’t following British law. You were adapting to the local circumstances: people needed land and were fleeing oppression. And you actually created a new system, which you then incorporated through a series of well-structured legal devices—not common law but statutory law, like your Homestead Act—into your principal law.
I think that cultural explanations for the widespread failure of capitalism outside the West have thrived in part because no one had a better explanation. “You have to be like those Anglo-Saxons.” Now we are beginning to find a more useful answer. In the United States, to convert an asset into capital, to put it into the market, to produce a piece of paper on the basis of which you can make a solid, enforceable contract: all this is a matter of hours or days. In countries like mine, it’s a matter of decades. And we’ve been able to identify that fundamental difference. Law is something we can change, because we can pinpoint the places where the problems exist, the places where the bridges are missing.
You studied for two years under Father Gustavo Gutierrez, one of the founders of liberation theology. Tell us something about your agreements and disagreements with him. What would he think of this line of argument?
Gustavo Gutierrez is a very brilliant man, admired and revered by many people (myself included) because he says that to be a good Christian, it isn’t enough to accept certain gospel truths; it’s essential as well to have compassion for the poor. And there, of course, we agree. The trouble is that Gustavo did write with some sympathy toward Marxism. Now you can use Marxism to help the poor, but you can also use capitalism to help the poor. And in that sense, one would say that we disagree. As the years have passed, I think both Gustavo and I have come to the conclusion (though I’ll let Gustavo speak for himself) that bad human beings can distort any economic system. But the system that that Gustavo admired so much—Marxist, socialist—just doesn’t exist anymore as a viable alternative.
Gustavo is my friend; he is also the priest who married me to my wife. I would say that today I have many more similarities with him than differences. I think we both agree that generally speaking the world has been unkind to the poor, and he would probably agree with me that the law has got a lot to do with it.
What would happen if everybody started doing what your book recommends?
We would have a lot more countries that would look like the United States, where people are not undercapitalized. We would have a lot more countries that would look like Western Europe, where assets are not undercapitalized. We would have introduced liquidity into the system. We would have introduced enormous amounts of information as to who owns what and what rights are for sale or not for sale, and we would know what assets could be combined with other assets so as to create wealth.
It would be revolutionary.
Of course! It’s what the United States has been doing for the past 200 years.