Hernando De Soto -- unlocking the mysteries of capital
The Peruvian economist explains that capitalism works in the West but not in developing countries because we have strong property rights laws that protect our wealth and allow it to be leveraged.
In 2003 I interviewed Hernando De Soto about his book ‘The Mystery of Capital,’ which explains why undeveloped countries needed to do what the United States did in the 1800s — create a modern system of property law so that their tangible assets can be identified, protected and transformed into the liquid capital needed to fuel a prosperous, capitalistic economy.
In 2009 Free to Choose did an hour documentary on how De Soto and “a dedicated army of lawyers and activists, defeated the guns and bombs of Peru's Shining Path.” And in 2002 he co-wrote this article for FEE.org that explained why capitalism triumphs in the West and fails everywhere else.
DeSoto Speaks
Hernando De Soto of Peru is one of the world's greatest champions of using market economics and sound property rights law to empower and enrich the poor of Third World countries.
In his 1990 book "The Other Path," De Soto investigated the informal nature of Lima, Peru's, vast street/vending economy and argued that this "informal" or underground economy is a viable market economy that creates enormous wealth.
His latest book, "The Mystery of Capital," declares that the poor of Third World countries actually have enormous wealth, but that it is mainly locked away.
De Soto founded the Institute for Liberty and Democracy in Lima, a think tank devoted to promoting economic development in developing countries. I talked to him by telephone from New York City.
Q: I know it's not fair, but can you give us a 120-second soundbite that describes "The Mystery of Capital"?
A: What the book says is that there is more value to the assets that we possess and the work we develop than meets the eye. This hidden value, according to the classics, would be called capital. It is as Marx concretely would have said, "surplus value." Or today, in modern Wall Street, it would be the capacity to leverage existing assets.
What the book analyzes is the fact the systems that man has created that allow him to create the value, store it and transport it, are basically representations or documents contained in the legal system.
For example, titles to land, shares of stock, debentures, etc. And without the rules and the representative systems or symbols, if you want to call them that, the value does not get captured.
The book then indicates that, as a matter of fact, probably 80 to 90 percent of the inhabitants of the developing and former Soviet nations — five-sixths of the world's population, that is to say, 5 billion people -- do not have the instruments with which to store and transport this value.
As a result of which, they miss out on the crucial ingredient needed for growth in the industrial world — which is capital. That is what the book is about.
Q: What is the definition of capital, as you use it?
A: Capital is the additional value that anything can fetch once it gets inserted into a trading or market economy. And that becomes larger, the larger that market economy is. If the economy is at a national level, it has a certain size. If it’s at a global economic level, it has a larger size. So capital is that hidden value that things have to be able to initiate additional enterprise.
Q: A second mortgage on a house?
A: A first mortgage would be one. That’s what is great about a mortgage system. The thing is, you’re accustomed to having a mortgage system. But to create a mortgage system, you first of all need a legal system that allows you the sufficient means to create trust and enforce it.
And what I’m saying is that for 98 to 99 percent of the real estate in developing and former communist nations, there are no mortgages because the legal means are insufficient.
Q: And you say Third World countries like Egypt and Peru are not really as poor as we think they are.
A: That’s right, because if the idea is that once you have an asset, and that asset can be located, you can then leverage it. It turns out, to use the example of the Egyptians, the poor in that country actually have more assets than the wealthy -- on a global basis.
Concretely, those who do not have an adequate title to their home, own about $241 billion in real estate, which is 55 times bigger than all foreign direct investment in Egypt over the last 150 years, or 30 times the size of the Cairo stock exchange, or 70 times the size of all foreign aid.
In other words, the largest basis on which to create wealth in Egypt are not the rich, are not foreign investment, and it’s not foreign aid. It’s what the poor have already created.
What happens is, it only has the value it can fetch within neighborhoods. These values cannot circulate because they don’t have title, they can’t engage mortgages. If these items could be tradable, and could be leveraged, the very value of those assets would increase many fold and the country would be much richer.
Q: And you say America 150 years ago would have looked a lot like a Third World country.
A: It would not have looked a lot like a Third World country, America was a Third World country. First of all, you had as much violence if not more violence than we do today in third world countries. You also had as much lawlessness. You don’t have to read your history books, you can go out and watch a Clint Eastwood film.
It took you time to become a developed country. But essentially that was due to a great extent to the development of a law that was created to accommodate the large majorities, instead of the exclusive few, which is what occurs today in developing countries.
Q: I just spent a five days in the developing country of Peru. In Lima I saw the insanely busy sidewalks, the street vendors, the informal sector – the crazy taxis, the buses. That’s a scene that would scare most Americans to death. They’d think their cities had just gone out of control. Is what I saw typical of a Third World city? Or is that what a city should really look like if you didn’t over-regulate it the way American cities do?
A: Absolutely. Most Third World cities have an enormous amount of street vendors. You can see them in Middle Eastern markets and Asian markets and in Latin America. It is the way goods used to be sold in the past in the West. If you look at lithographs of a couple of centuries ago, you’ll see that street vendors were everywhere. And not only street vendors, it’s smugglers.
For example, Colbert, the minister of finance of Louis XIV, decided to get rid of smugglers in textiles, who were also selling their wares on the streets. And between hangings on the gallows and summary executions on the beaches, according to police records, he killed over 16,000 people. Smugglers and street vendors were a day-to-day thing in Europe less than 200 years ago.
In fact, Marx, 150 years ago, described Europe – with the exception of large cities such as Paris and London – as one large rural slum. So what you see today in developing countries is what you (America) used to be in the past.
Q: I always use the example of the ‘Godfather’ movies, with those scenes of the ghettos in New York. Those were people making their living.
A: That’s what happens until you become wealthy. When you become wealthy, you don’t need to take over public property on which to sell your wares. You can then gradually organize through urban planning and enforcement, to put the shops in the buildings, which is their ideal place.
Why? Because they’re out of bad weather. Why? Because they’ve got running water, and therefore you have less infections. Why? Because you can stock merchandise. All of these three things you can’t do on the street, but while you’re poor, the street is the usual place where they are.
That doesn’t mean that most of them can’t get off the streets now. The problem is that since they can’t leverage their assets or even leverage their reputation, they can’t get into the buildings.
But let me give you an idea: In Lima, there are 331 markets that are built with running water, refrigeration chambers, etc. Of those, 87 percent have been built by former street vendors; in our calculation, no street vendor stays on the streets more than 13 years. He generally saves so as to be able to buy some kind of a plot within a building to sell.
If you could leverage assets, you could afford to get credit, and then you wouldn’t have them in the street in the first place. But since we can’t get things leveraged, because the laws don’t permit you to, and don’t allow you to secure property for banking or credit, the result is that there are more people on the streets than need be.
Q: How does a country go from where Peru is today to where the U.S. or even Korea is today?
A: The same way you did. First of all, you create good, market-economy law, which is based essentially on property law. If you really think about it, property law is economic law, because there is no other law except the one related to property.
You can’t make an economic transaction without affecting property. What you trade, whether it be liquid value – debentures, bonds, whatever – or solid value, they’re all guaranteed by some form of a property title. Everything from a bicycle up in the United States and Europe is titled.
So the first thing you have to do is create property law. There was none that affected the majorities in Korea, in Japan and in Taiwan, up until the Second World War. The first things you Americans induced when you occupied these three territories after the Second World War was the creation of property law. The results are that those are three of your five ‘Asian Tigers.’
Q: Can this be done from the bottom-up – the streets, sidewalks, squatter towns, etc. – or does it have to be done from the top down by a government?
A: What happens is, enforceable law is a government monopoly. But the important question is not who enforces the law – it’s usually government – but a question of whether the law is built from the bottom up.
In other words, in the cases of Japan for example, it was very clear that what the Japanese did from 1945 to 1950 was basically codify and professionalize the law that they found among common peasants and urban dwellers at the bottom on a customary basis and they codified it. Which is also what you did throughout the 19h century.
Q: With British Common Law?
A: No. Not the British law. That’s an American illusion. You think you’re the sons of the Brits because of law. You’re not.
In fact, Common Law collapsed. That’s the reason why in 32 instances the U.S. Congress had to completely revise the Common Law and bring out statutes to incorporate all the guys who had squatted in California in the Gold Rush – the guys who had squatted practically the whole West – and bring it in through statutes.
And once you got a professionalized law, that was coordinated like your Unified Commercial Codes, you actually created a harmonious and peaceful and prosperous market economy.
Q: Your knowledge is awesome.
A: No. It’s not my knowledge. What happens is this. I have people that I actually contract to explain to me after I’ve done something what it is that I did. I do it because instinctively I feel it’s the right thing to do. Then afterwards, to rationalize and find out what it is that made it work and what it is that may not work, I hire specialists.
What happens is, once you are successful, and once your system is humming, you Americans don’t need to find out what it is that made you successful. It’s much easier to read a book on culture and deem that your Anglo-Saxon pinkishness was what made you successful.
In fact, you worked very hard at it. So we, who are interested in knowing what you did that was right and what you did that was wrong, have to study you more carefully than you study yourself. Otherwise, we’re never going to learn.
Q: What impact has your book had on the real world? Have any countries begun to correct their failures—with or without your book?
A: Well, with the book, we are now working for the heads of state of six countries. We have contracts from Mexico to Haiti to Egypt. These are various million-dollar contracts. I have a team of 50 professionals that work with me -- Peruvians – aside from the locals we contract. We are still in the phases of constructing the reform program and we should be close to implementation soon.
Regarding governments that are on their own, I have quotes from over 20 governments that refer to our work and say that that is what they are doing.
Q: What will it take for Peru to pull this off—to move forward and become a healthy, wealthy First World country.
A: Unfortunately, history indicates – and so does our experience – that these kind of things at the stage of development that we are at require enlightened leadership. In countries that are advanced such as yours, sometimes it doesn’t really matter who you elect as president or who the leaders are, because basically the bureaucracy and the customs and the courts and the legislature run things smoothly on the basis of systems that are well tried.
But before that happened, you did need Jeffersons and you did need Bismarcks and you did need Charles DeGaulles and you did need Napoleons. Someone started off with leadership, right, and changed things. So what Peru basically needs at this time is inspired leadership, which unfortunately in my judgment it does not yet have. Maybe it will soon.