A review of “The mystery of Capital”

Author: Hernando De Soto

Transworld Publishers, 2000

276 pages

“The hour of capitalism’s greatest triumph is its hour of crisis”. This is Hernando De Soto’s opening statement in what has now become a classic of property rights. He starts with a brief description of the “triumph” of capitalism and the end of the cold war. “Capitalism”, he says, “stands alone as the only feasible way rationally to organise a modern economy. At this moment in history, no responsible nation has a choice”. So then, the “responsible” nations of former communist and third world territories embraced capitalism with considerable enthusiasm, following the fall of Berlin Wall. And wait for it: they came away with bitter disappointment. And how did the leaders and Capitalist America and Europe respond? With the same old “wearisome lectures: stabilize your currencies, hang tough, ignore the food riots, and wait patiently for the foreign investors to return”

Why has capitalism prospered in the West, and generally failed elsewhere? That is the Big Question De Soto sought to address in this book. Of course, 15 years after it was originally published, some of the claims are now dated, but the key ideas continue to gain traction in policy and development research circles.

De Soto empathically rejects the suggestion that “Third World” peoples are lacking in entrepreneurial spirit or market orientation. On the contrary, he says, the inhabitants of poor countries are highly entrepreneurial, and have such a ready grasp of technology that American Businesses, for example, are “struggling to control the unauthorised use of their patents abroad”. So then, again, why has capitalism failed so woefully in these poor countries?

De Soto’s big idea is “Property”, and with it the explanation of the inability of these poor nations to produce capital, which is in turn the “lifeblood of the capitalist system”, the means by which it “raises productivity of labour and creates the wealth of nations”. The curious paradox is that most of the poor already possess the assets to make a success of capitalism. By one estimate, “the value of savings among the poor is… forty times all the foreign aid received throughout the world since 1945”. The poor have things, “but they lack the process to represent their property and create capital. They have houses but no titles; crops but not deeds; businesses but not statues of incorporation.

At this point, De Soto introduces his “five mysteries of capital”, and these will be the titles of the next five chapters: The mystery of missing information; the mystery of capital; the mystery of political awareness; the missing lessons of US History; and The Mystery of Legal Failure.

The author now turns his attention to the phenomenon of “dead capital”, and how this is caused and aggravated by the lack of legal documentation and formal representation of property held by the poor. In Haiti, for example untitled real-estate holdings were, as of 1995, found to be worth 158 times the value of “all foreign direct investment in Haiti’s recorded history”. At the time of writing, De Soto and his team estimated that the total value of real estate held but not legally owned by the poor was $9.3 Trillion, which was “about twice as much as the total circulating US money supply”! The poor face great obstacles to legally register their property and businesses. In Haiti, it takes an estimated 19 years to go through all the bureaucratic obstacles to legally own a land! And what is not formally documented, legally owned, cannot be “taken to the bank”. It is dead capital, and cannot be transformed into usable forms to facilitate or promote economic productivity. The vast assets of the poor, because they are not fixed in a formal property system, are very difficult to move in the market. Formal representation makes assets more fungible.

However, it is instructive that the capitalist nations of the West have in fact been through the process of transition from undocumented and informal arrangements to legally documented property rights, and this formal representation has been instrumental for economic progress.  In Britain and the rest of Europe, the process took about three hundred years of tumult and turbulence, during which the great numbers of informal settlers and unregistered entrepreneurs came in constant conflict with the law. Ultimately, officials and kings came to the final recognition that the problem was actually with law, and not with the people. The extralegal settlers and businesses had come to stay, and the law needed to catch up and integrate them. Nowadays, the idea of fixed, formalised assets is taken for granted in Europe, and this is partly why the economic preachments of the West often fail to address the peculiar circumstances of the developing world, because certain fundamentals, including property rights, cannot be taken for granted in these poor countries. For example, in sub-Saharan Africa, the vast majority of property held by the poor are untitled, not legally owned, and cannot be used as collaterals in banks, or in other legally binding business transactions. Millions of these innovative entrepreneurs are locked out of the mainstream, left to depend on scraps and crumbs in the informal sector.

The United States has, relatively more recently, gone through a similar process. If we set aside, for a moment, the tragic episode of land grab from native Indians, European settlers in North America were squatters who simply occupy tracts of lands, often secured by a few deadened trees at the boundaries. For a long time they were deemed illegal trespassers by the official governments of the colonies. After years of bloody conflicts between the squatters and the government, they ultimately came to formal agreements on legal documentation of the squatters’ holdings.

Paradoxically, a major obstacle to needed reform in poor countries today is the legal system that is not only unfit for purpose, but also resistant to change. De Soto does not like lawyers, obviously. He considers lawyers to be, by default, stubborn defenders of the status quo against the practical realities of human experience. In a sense, De Soto seems to be saying, by way of an old cliché, that the law was made for man, and not man for the law. A legal system that keeps majority of the population out official mainstream is bound to fail, sooner or later. A functional law should reflect the reality of how people live, not hinder or stifle human enterprise and creativity. Lawyers should support, and not stand in the way of, necessary reform.

As compelling as De Soto’s arguments are, it is impossible to shake off the nudging feeling that the challenge is a bit over simplified, and that his prescribed solution is a little over-stated. The challenge of under-development may be more complex than antiquated property laws. There are other institutional and leadership challenges. Even at that, his central thesis is persuasive: get rid of artificial, antiquated barriers and give people the rights and opportunities to make the best of their assets. Then stand by and watch them make great, unprecedented contribution to “the wealth of nations”.