The Mystery of Capital

by Hernando de Soto
276 pages,
ISBN: 0465016146

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Formal Title is Key to Global Economic Wealth
by Avner Mandelman

Hernando De Soto

Every now and then a book appears which presents an idea so novel, so simple, so compelling, that the reader is surprised the idea has not been presented before, nor tried by a politician somewhere, whose job it is to think of such things.

Yet De Soto's book does precisely this. It presents a coherent plan to lift most of the developing and post-communist world out of their poverty, without outside capital. At the same time, and almost as an afterthought, De Soto proves handily why Marx's cock-eyed economic theory is not only wrong but is also the root-cause of much of the Third World's developmental woes.

De Soto's basic tenet is that Capital is not comprised of physical assets, but rather their legal title. It is this formal title, recognized by an entire nation, from which all Capital flows¨as the owner can borrow against it, give shares in it to others, and be held accountable by the society in which he lives via his ownership. Without formal legal title, there is no Capital.

In the West, we seem to take our centralized, unified title registry system for granted: every hill, every ravine, every house, every lot is centrally registered in someone's name. Because of this ubiquitous Western principle, we entirely miss the fact that in much of the Third World uniform property title is the exception, not the norm. In much of that world, land and home ownership is "secured" not by legal title but by a consensus of neighbors, friends, or tribe, even as the property may be formally registered in some absentee owner's name¨or the State's. Because of this narrow scope of "extra-legal" ownership, the property cannot of course be sold to anyone out of district, and¨here's the rub¨ cannot be used as security, and therefore cannot generate Capital. Such "extra-legal" assets, in De Soto's terminology, are "Dead Capital." His bold claim is that if these assets were made legal, the capital they would generate would enable many of the world's poor to better themselves without any outside help.

Just how much "Dead Capital" is there, really, in the developing world? To answer this crucial question, De Soto and his colleagues traveled to several developing countries and physically estimated the value of all illegally constructed "extra-legal" dwellings. The figures they came up with were astonishing. In the Philippines alone, they found, 57% of all urban dwellings are owned by "extra legals." In the rural Philippines, the figure is 67%. All in all, in the Philippines, De Soto found US $133 billion of Dead Capital in title-less houses, land and farms. This is 4 times the value of all public companies on the Manilla Stock Exchange; 5 times the country's total mining production; 7 times the total saving deposits in all Philippines banks; and 14 times the total value of total foreign investment in the Philippines of the last 20 years.

And the Philippines is not an isolated case: In Peru, 53% of all urban property is owned by the extra-legal sector, and 81% of the rural property, together accounting for $US 74 billion of Dead Capital¨which is double the value of all public Peruvian companies, Eight times of total Peruvian bank deposits, and 14 times the direct foreign investment in Peru over the last 20 years.

These are vast sums. But in countries more populous than the above two, the sums are more staggering still: In Egypt, for example, De Soto found a mind-boggling $US 241 billion of Dead Capital. Even in Haiti, that island of Voodoo and poverty, Dead Capital amounted to at least $US 5 billion.

The remedy, according De Soto, is obvious: The largest potential for development in the Third World and Post Communist nations lies not in external provision of capital, but in providing the poor with clear title to the assets in which they reside, thus freeing their Capital potential.

And just how is this to be done? It is here that the book truly displays its mettle: Instead of veering off on some tangent of strong opinion, supported by mere logic, a la Marx, De Soto delves into the actual history of the property registry system of the West, and shows that it, too, is anchored in a past replete with squatters, "extra legals," and fractured property registries. The U.S. itself, De Soto shows¨as well as Germany, France, Switzerland, and Japan¨less than two centuries ago was in a state similar to that of today's Developing World and post-communist countries: plenty of extra-legality, and a formal legal system at odds with the needs of much of the population.

How did the West change from its past of legally-checkered-titles to the legally-solid titled present? This, De Soto demonstrates, came through as a consequence of the incorporation of the extra-legal customs of squatters into the formal legal system. Without this accommodation, the groundwork for Western capital creation could not have been laid. Here De Soto provides perhaps too much detail with respect to local mining customs that pre-dated the U.S Federal mining regulations, and the local title registry customs of most U.S. pioneers, who were also squatters on Federal Land. Fortunately the over-abundant detail does manage to prove that giving squatters first-refusal purchase ("Preemption") rights to the land on which they squatted was a smart political move. This Western precedent, De Soto claims, can very well be the template for today's movement from extra-legal ownership to full legality: Give squatters first refusal rights to purchasing the land on which they sit¨or at least, the right to compensation for the value of their improvements.

Such ideas sound like instigation to flout the law. Certainly this would be the interpretation in the West, with our centralized, integrated Property registry system, where extra-legals are a fraction of the economically active population. However, in the developing and post-communist world, where more than half the population (often more than two thirds) exists without property titles¨the problem, says De Soto, is with the law, and not with the extra-legals. It is the law in such countries which is out of touch, not those who are forced to skirt it. Consequently, if one desires to advance the dual causes of democracy and prosperity¨and who could object to either?¨ one must find ways to marry the informal property systems of the extra-legals with the formal property title registry.

Can this be done? De Soto argues that it can. One of his most interesting findings is the prevalence of legal-seeming frameworks that extra-legals give their property customs. Squatters form arbitration boards and elect registry officers, determine fair use and define easements, issue official-looking certificates and take testimonies regarding precedence and disputes. Enforcement of extra-legal property rules is done either via local community disapproval, or by so-called local mafias¨or even by bought police. This, historically, has been part of the American West¨and this, De Soto demonstrates, is how it is in much of the developing world. Hence the solution¨which, De Soto suggests, must be a political, not a legal one, since the mainline commercial lawyers, serving the absentee rentier classes, are bound to poke spanners in the wheels of any change in the property laws. Yet such changes must be made, if developing economies are to succeed in boosting their capital creation, while providing, in addition, a stabilizing element to the social fabric by endowing their citizens with instant personal property.

De Soto's ideas, with their underlying attack on ownership's status quo, would seem to be prima-facie anathema to any conservative thinker. Yet the ideas are so well presented, the field research so well-documented, and so persuasive are the arguments attesting to the benefits of change, that in spite of the book's veiled attack on existing legal systems, a whole raft of conservative thinkers and politicians have been persuaded to add their paeans to it. Thus the book's back-leaf is graced with an astonishing array of blurbs, written by the likes of William F. Buckley Jr., Walter Wriston, Margaret Thatcher, Jeanne Kirkpatrick, Milton Friedman, and others of a similar distinction. With the support of such illustrious persons, it is almost a forgone conclusion that sooner or later De Soto's recommendations will be tested in some Developing or post-communist country.

Would such a test be a good thing? Far worse economic ideas have been put into practice, with disastrous results. Giving the poor legal titles to their dwellings seems like a worthwhile goal in itself. And if the economic impact were to fall a bit shy of what De Soto envisions as the outcome of his plan, so what? A developing world full of homeowners is bound to be a better place. And what if the impact is as great as suggested? I have a strong suspicion that De Soto is right on the mark. So if you know a government minister at a developing or a post-communist nation, buy a few copies of this book and ship them over. You may bring far more benefit to that country's economy than if you were to invest in it several million dollars, and create a few dozen jobs in the process. ˛


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