The Mystery of Capital, by Hernando de Soto

Hernando de Soto is a name that crops up regularly in my reading about development. He caught my eye partly because he is a world-renowned economist who isn’t from the English-speaking world, but also because his work is recognised by both sides of the political spectrum. He is the originator of what is, quite simply, one the best ideas of the last decade, and it is explained in The Mystery of Capital: Why capitalism triumphs in the West and fails everywhere else.

In a nutshell, De Soto argues that even if countries liberalise and open their economies to foreign investment, they will not succeed in bringing prosperity to ordinary people until they have established a formal system of property rights.

The poor are not without assets – they have homes and farms, small businesses and even quite large enterprises. The big difference between developing countries and Western countries is that the latter have legal structures and established property rights, while the former have informal and often local ownership structures. These ‘extra-legal’ structures work in the local area, but are not transferable or dependable.

“Imagine a country,” writes De Soto, “where nobody can identify who owns what, addresses cannot be verified, people cannot be made to pay their debts, resources cannot be conveniently turned into money, ownership cannot be divided into shares, descriptions of assets are not standardised and cannot be easily compared, and the rules that govern property vary from neighbourhood to neighbourhood or even from street to street.” This is easy for me to imagine. Despite being in the capital city, our house in Madagascar never had a proper address. You either knew where it was or you didn’t.

It’s not that legal structures are non-existent. They’re often there, but they’re obsolete, overwhelmed by rapid urbanisation, and inaccessible to ordinary people. De Soto’s team demonstrate this by boldly following through a series of legal procedures in developing countries.

  • Applying for permission to build a house in Peru: 207 administrative steps involving 52 government departments, taking six years and eleven months. Ownership of the land requires an additional 728 steps.
  • Legalizing an informal property development in the Philippines: 168 steps, 53 public agencies, 13-25 years.
  • Buying land in Haiti: 111 bureaucratic steps, taking 19 years.

It’s little wonder that people don’t bother, and fall back on extra-legal structures instead. What this means however is that although people have wealth, “what they possess is not represented in such a way as to produce additional value.” Informal property rights do not allow people to monetise their assets. In a Western country, you have property deeds, and this allows you to use your assets to raise capital.

The ability to raise capital is the essence of capitalism, and in a Western country anyone can do it. You can take out a loan against your house and use it to start a business, but that’s just the start of it. The address serves as a point of contact for civic purposes such as jury duty, voter registration or taxation, for commercial purposes such as buying things and having them delivered. It means you can be found, if you default on debts or break the law. It’s a point for services, such as energy, water, or telephone lines. “Westerner’s houses no longer merely keep the rain and the cold out. Endowed with representational existence, these houses can now lead a double life, doing economic things they could not have done before.”

The ‘parallel life’ of property is so taken for granted in developed countries that it has been almost totally overlooked in the development debate, De Soto argues. Because the system was pulled together slowly, sometimes over centuries, the history of it is practically unknown. It is implicit.

Remembering that history is important, because it shows how it legal structures could be drawn up for countries without them. Crucially, the history shows that the answer is not to criminalise the millions of people who have built houses without permission, or who run small businesses outside the tax system. The key is to create a system that brings them in, respecting the existing informal ownership structures and granting them official sanction.

This is what the US experienced as the country expanded westwards. Pioneers moved and settled informally on land, and built houses and planted crops long before the legal system caught up with them. In some cases establishing ownership over an un-owned piece of land basically consisted of turning up and carving your initials on a tree. If you raised a crop on a piece of farmland, you could claim it. Known as ‘Tomahawk rights’ or ‘corn rights’ respectively, these had no legal status, but were sufficiently respected by the local communities that you could even sell the land to someone else later on.

As the US government began to bring law to the West, there were efforts to confiscate and redistribute land claimed in this way. Having occupied the land for years and investing so much in it, this didn’t go down well, and sheriffs and lawmen were run out of town. In some case the violence was against the settlers and fields were burned to move people along. Over the course of decades, the government came to see that bringing people into the legal system worked best, rather than applying land ownership structures from scratch. The famous Homestead Act of 1862 was “less an act of official generosity than the recognition of a fait accompli.”

Those sorts of struggles are being played out today in developing countries. I remember whole areas of little market stalls being bulldozed in the night to make way for buildings. The traders returned in the morning to find their wooden shacks gone and their goods being looted, but they had no rights, and had no grounds to demand compensation.

De Soto and his team have had the opportunity to put his theory into practice in Peru, and have drawn up a ‘capitalization process’ for other governments. The campaign to extend these processes is ongoing, through the Institute for Liberation and Democracy. It’s not a silver bullet, but De Soto’s idea is immensely powerful. It provides rights and the rule of law in an inclusive way, creating opportunities for the poor. By opening up and activating what the disenfranchised already own, there’s no redistribution for the rich to fear and oppose. Extending property to the poor bridges the gap between political left and right. It would bring billions of people into the global economy, and release (De Soto’s late 90s estimate) $1,392 billion of dead capital in developing countries.

Reading the book today, it strikes me that there’s another side to the debate. Creating capital requires balance, and the West has actually gone too far in the abstract representation of assets. After all, it is the ‘parallel life’ of our houses that caused the financial crisis, those irresponsible mortgages sliced and bundled and speculated against until nobody understood who owned what or what was worth. But that’s the opposite end of the spectrum, and in-between the derivatives market and Tomahawk rights there’s a middle ground where capitalism works for the poor.

All of which makes The Mystery of Capital a hugely important book, all the more so for being so clear and readable. It is one of those few books I’ve read, I can count them on the fingers of one hand, that could genuinely change the world.

10 Comments on “The Mystery of Capital, by Hernando de Soto”

  1. keerthikasingaravel February 4, 2011 at 6:46 pm #

    Thank you for the write up.I have not read Hernando de Soto in the original.I was introduced to his hypothesis via newspaper editorials.Does this book detail a capitalization process for India?

    • Jeremy February 4, 2011 at 10:35 pm #

      No, there are no detailed capitalization processes outlined for any country, just a rough sketch of how it can be done. De Soto’s book ‘Realizing property rights’ is the more detailed one, I believe, or you could look up the http://www.ild.org.pe/ website.

  2. Sam Norton February 5, 2011 at 2:50 pm #

    Delighted you’ve discovered de Soto, I agree that he makes a very important and compelling argument. I wrote about him here.

  3. winabilliondollarslex Loeb November 27, 2011 at 1:11 pm #

    It is a good book but it may be missing a little something called “liberty” Liberty to develop private property in America goes a little bit beyond rule of law and security of law. De Soto is correct that those factors of property rights are of utmost importance but liberty to make one’s own decisions on use of property owned leads to sometimes very sucessful experimentation. We talk about “lost opportunity costs” when government over-regulates private property or incorrectly zones it. Zoning is an American reversion to European fudalism because it seems sometimes to offer protections against the forces of growth and change. New York City is not a planned city like Vienna or Napoleon III’s Paris It grew from one end of Manhattan to the other and then hit the edge and started growing back over itself in the opposite direction not without blight. Blight was never as bad as after central planning low income housing projects began and quickly became an utter failure (not all of it but too much of it) The vitality of New York is now in a class all its own with private property rights not nearly as certain as they once were. Government is very complicated to change anything or even to rent an appartment out with rent control. Growth in NYC is an anomaly for the US. The real opportunity moved out of town years ago and took a part of the population with it and that is where the opportunity went. People who do well in NYC do well in spite of big government and sky high prices mortals can’t easly live with. New York’s loss was the gain of other places. Property rights and free will (liberty) together are the explosive combination for economic growth . That is no mystery in the new urban china. The mystery there is that they still call themselves communists. In the USA the founding fathers called the explosive capital formation of having both property rights and liberty “happiness.” The right to be happy and not dependent on some empire , royal family, court , manner house or marxist communue. Happiness is the right to own property and control it with what ever might be its highest and best use without too many limits. After that you read commentary about lack of balance because of that attitude of less than social behavior of ownership–the history of the US says something else. It worked amazingly well and often better than any planning agency or central planned government could do it.

    • Jeremy November 27, 2011 at 1:58 pm #

      Have you read De Soto’s book? Because you seem to be arguing against central planning and for liberty – and so is De Soto. That’s kind of the point, to give people the rights to their own properties.

      • Jack Kelly February 1, 2015 at 6:50 pm #

        Underlying deSoto’s compelling argument is that freedom to control and use property requires a consistent, comprehensive,and fair set of laws and regulations. Libertarian decrying such law is just naive and often dangerous in leaving basic rights subject to those with power and pelf to use law to their advantage. I would like to see the argument extended to nations where the rich and powerful use the property law development process to gain even more power and wealth at the expense of the poor.

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