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Mysterious Capital and the World's Poor

Book Review: Hernando de Soto, The Mystery of Capital: Why Capitalism Triumphs in the West and Fails Everywhere Else (New York: Basic Books, 2000).

Hernando de Soto, named after the Spanish explorer, is a Peruvian economist and President of the Institute for Liberty and Democracy in Lima, Peru. He is a former economist for the GATT and former governor of Peru’s central reserve bank. In this well-researched and clearly written book he seeks to explain why the world’s poor seem to find no traction in the world’s economy despite the fact that they have considerable assets. Yes, that’s right, de Soto’s starting claim is that the world’s poor have tremendous wealth, but virtually no capital. They find themselves in this unfortunate predicament primarily by virtue of the laws of the countries in which they live.

The poor inhabitants of these nations – five-sixths of humanity – do have things, but they lack the process to represent their property and create capital. They have houses, but not titles; crops, but not deeds; businesses but not statutes of incorporation. It is the unavailability of these essential representations that explains why people who have adapted every other Western invention, from the paper clip to the nuclear reactor, have not been able to produce sufficient capital to make their domestic capitalism work (6-7)

Wealthy westerners live in a world where they can convert their money to capital and back again easily. The world’s poor are not so lucky. To gain an idea of how difficult the migrant life of the world’s poor is, de Soto’s research associates decided to run an experiment in Lima, Peru. They would start a legitimate business by legal means. They filled out forms, took bus trips to central Lima to get certifications, filled out forms, &c. The team spent six hours a day and finally succeeded in registering a small garment workshop – 289 days later – having spent $1,231 – thirty-one times the monthly minimum wage! They then decided to obtain legal authorization to build a house on state-owned land. This process took six years and eleven months, requiring 207 administrative steps in fifty-two government offices. To obtain legal title for that piece of land took 728 more steps. To obtain official recognition for a private bus, jitney, or taxi took twenty-six months of red tape (pp. 18-20).

They and their associates repeated the experiments in other poor nations:

  1. In the Philippines, to purchase legally a dwelling that has already been built on state-owned or privately owned urban land necessitated 168 steps, involving fifty-three public and private agencies and took 13-25 years. If the dwelling is in an area considered “agricultural,” the settler would have to clear 45 additional bureaucratic procedures before 13 entities, adding two more years to his request (20).
  2. In Egypt, to acquire and legally register a lot on state owned desert land – 77 procedures must be performed at thirty-one public and private agencies,taking anywhere from five to fourteen years. This explains why 4.7 million Egyptians have chosen to build their dwellings illegally. If, after having done so, he wants to legitimize his property, he risks having it demolished, paying a steep fine, and serving up to ten years in prison (20-21).
  3. In Haiti, one way an ordinary citizen can settle legally on government land is to lease it from the government for five years and then buy it. This process takes 65 steps and a little more than two years just for the privilege of leasing the land for five years. To buy it requires 111 more steps, and twelve more years, 19 years in total (21).

“Yet even this long ordeal will not ensure that the property remains legal. In fact, in every country we investigated, we found that it is very nearly as difficult to stay legal as it is to become legal” (21).

The poor, not being stupid, of course end up building, holding, buying and selling their domains in an “extralegal” market – a domain outside the official law. The result is that their resources are essentially invisible.

A shanty in Port-au-Prince: $500.
A cabin by a polluted waterway in Manila: $2700.
A substantial house in a village outside Cairo: $5000.
A respectable bungalo with a garage and picture window in Lima: $20,000.

Collectively, the value of holdings by the world’s poor outweighs the total wealth of the rich! (33) “By [de Soto’s] calculations, the total value of the real estate held but not legally owned by the poor of the Third World and former communist nations is at least $9.3 trillion” (35). This is twice as much as the total circulating US money supply, nearly as much as the total value of all the companies listed on the main stock exchanges of the world’s twenty most developed nations, more than 20 times the total Foreign Direct Investment into all Third World and Communist nations in the ten years from 1989-1999 (35).

As de Soto repeats again and again: the world’s poor are not the problem, they are the solution.

THE PROBLEM for many of the world’s poor is that they do not have access to capital. They cannot use their wealth. With no address and no legally recognized title, the owner of a plywood shack with a cement floor and a tin roof, worth about $500, cannot secure a fifty dollar loan to buy a bicycle – or whatever. The point is that they are hampered by their lack of access to capital – capital being not money, which they have, however little, but potential to turn that money into a better life.

To unravel the mystery of capital, we have to go back to the seminal meaning of the word. In medieval Latin, “capital” appears to have denoted head of cattle or other livestock, which have always been important sources of wealth beyond the basic meat they provide. Livestock are low-maintenance possessions; they are mobile and can be moved away from danger; they are also easy to count and measure. But most important, from livestock you can obtain additional wealth, or surplus value, by setting in motion other industries, including milk, hides, wool, meat, and fuel. Livestock also have the useful attribute of being able to reproduce themselves. Thus the term “capital” begins to do two jobs simultaneously, capturing the physical dimensions of assets (livestock) as well as their potential to generate surplus value (40-41).

In short, capital comes from inside your head. Capital is a mental phenomenon. For some reason, many poorer nations have imagined that the poor are not a part of the nation’s wealth.

As the flux of extralegal workers continue to gather in the world’s cities (see this TED talk about the world’s shadow cities and its 1.6 billion squatters), politics and the law will have to respond appropriately to the needs of the world’s migrant poor. They face the same choice that the United States faced in the 19C when they had to decide what to do with the thousands of peoples flocking to the American West. Either they must take these “extralegals” and make them part of the dominant legal system or they must fight the common sense of large communities and ultimately undermine the cohesion of society as well as the coherence of the state’s legal system. (In one country, a newspaper inspired by de Soto’s research discovered that the mansion in which the nation’s president lived had no legal title!)

In conclusion, Hernando de Soto believes that the best way to enrich the world’s poor is to take the perspective of the poor to understand their needs and coopt the elites by showing them the economic potential of the poor (189). The argument is much more detailed than I can sketch here, but the most powerful implication is that people are a safe bet, whether rich or poor.

This article was cross-posted at the author’s blog, www.avenhampark.blogspot.com

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True? by Occams

Thanks for that David, very thought provoking. If it is true, and I have it right, it is saying that if poor countries would improve their property laws, get their finance markets working, and streamline their bureaucracies, then they could become much more prosperous.

This seems like a massive oversimplification. Surely if it was that simple it would have been done long ago. As the author says, these people are poor but they are not stupid. If it is really so difficult to start a business the impact of it would be very well known.

Nevertheless, the author’s credentials are impressive, so there must be some truth in it. I have worked in a number of third world countries where experts from developed countries, the UN, World bank and the Asian Development Bank are doing their honest best to get the economies going, and without much success. PNG was the most recent, and it seemed to be sliding backwards fast.

This book sounds really interesting. I might have to pick it up.

If I understand, this whole concept would seem to have some serious implications. First, the view commonly pushed that “95% of the world’s wealth is owned by 1% of the people” (or whatever) isn’t what it seems to be. Sure, it may be technically correct, as these extralegal systems may not consist of proper ownership, but the idea of there being very few living in vast wealth while the rest of the world runs about in abject poverty just isn’t correct.

And, you know, this makes sense with what I’ve seen of the world. I’ve spent enough time in South Korea, Brazil, and various European countries to realize the division of wealth is about what it is in the U.S. (albeit on a slightly different scale): there were some rich and some homeless, but most people just comfortably go about working, raising families, making friend, and otherwise living. (I’m not sure how I accepted the “huge division of wealth” idea so easily without challenge. I suppose I just assumed there were millions and millions of people dressed in rags and digging around in the dirt for grubs in places I hadn’t yet visited, like Africa, China, India, etc.)

Another important implication is the effect these poorly-designed governments have on foreign businesses. Most large, Western, well-established companies have strict policies against bribery, making it very difficult to get along in countries where bribery is an integral part of how government work gets done. This is particularly true for industries where permits and cooperation with government companies/agencies is required (like the oil industry).

What is the incentive for these governments to stick to such problematic (and unprofitable) systems? Well, either that or they go the route of Venezuela, which I don’t think is much better.

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