Commentary Magazine


The Mystery of Capital by Hernando de Soto

The Mystery of Capital: Why Capitalism Triumphs in the West and Fails Everywhere Else
by Hernando de Soto
Basic. 276 pp. $27.50

Hernando De Soto, a sixty-year-old Peruvian economist, heads the Institute of Liberty and Democracy in Lima. He came to widespread public notice in 1989 with the translation into English of his book on the actual workings of the Peruvian economic system, The Other Path1 In 1990, he became an adviser to Alberto Fujimori, then newly elected as president of Peru.

De Soto is a man of one idea, but it is a powerful and persuasive idea. In contrast to those who argue that third-world poverty is traceable to the inequities of the capitalist system, which can be remedied only by a redistribution of wealth, he contends that its real cause is an insufficiently developed capitalism. Studying the economy of Peru for The Other Path, he and his associates discovered that nearly 40 percent of the country’s gross domestic product was the creation of “informal” assets and enterprises that remained outside the legal system because the entrepreneurs who held them lacked titles of ownership. Without such titles, they could not obtain mortgages or other forms of credit, or buy insurance, or raise capital by going public. As a consequence, a great deal of capital was “dead,” i.e., unproductive. The state suffered financially as well, because these resources were outside the reach of the tax collector.

On de Soto’s advice, Fujimori set up special registry offices to provide easy procedures for transforming informal into legal property. In time, some 276,000 small enterprises availed themselves of this opportunity. The government gained an additional $1.2 billion in taxes.

In the present volume, de Soto applies the same methodology to several other third-world countries, including the Philippines, Egypt, Haiti, and Mexico. Everywhere he finds the same picture: the process of legalizing possession is so expensive and cumbersome as to discourage even the most determined:

In Egypt, the person who wants to acquire and legally register a lot on state-owned desert land must wend his way through at least 77 bureaucratic procedures at 31 public and private agencies. . . . This can take anywhere from five to fourteen years. To build a legal dwelling on former agricultural land would require six to eleven years of bureaucratic wrangling, maybe longer. This explains why 4.7 million Egyptians have chosen to build their dwellings illegally.

In Haiti, the very poorest of the Caribbean islands, the situation is similar. There,

untitled rural and urban real-estate holdings are together worth some $5.2 billion. To put that sum in context, it is four times the total of all the assets of all the legally operating companies in Haiti, nine times the value of all assets owned by the government, and 158 times the total of all foreign direct investment in Haiti’s recorded history to 1995.

In all, de Soto estimates that “the total value of the real estate held but not owned by the poor of the third world and former Communist nations is at least $9.3 trillion.” Releasing this “dead capital,” he is certain, would revolutionize the economies of the third world. But the decision to do so is a political one. Governments have to display the will to simplify radically the procedures for transforming possession (a term which, for some reason, he eschews in favor of “extralegal” or “informal” assets) into true property.

In support of his thesis, de Soto asserts that until approximately two centuries ago, assets in Europe and the United States were just as insecure as they are in the third world today. Economic progress in the West surged once governments realized that it made no sense for so large a proportion of the people to live and work outside “official law.” There is no reason, he concludes, why the same thing cannot happen elsewhere.

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I buy de Soto’s argument, although with qualifications.

First, his statistics. In countries hardly known for the accuracy of their information-gathering services, it is difficult to believe one can arrive at the precise worth of something as shadowy as the informal economy. Do we really know that the total value of informally held assets in Port-au-Prince is $1.8 billion? Or that in the Middle East and North Africa, such assets amount to $0.74 trillion? These numbers, surely little more than rough guesses, cast doubt on de Soto’s figure of $9.3 trillion for the total value of real estate held but not legally owned in the third world and former Communist countries. It would have been enough—and more convincing—to speak of this “dead capital” as running in the trillions of dollars.

Next, history. Legal property in land existed in Europe much earlier than de Soto assumes. There are even indications that it existed in ancient Israel and Athens—that is, in the first millennium B.C.E. Rome had a highly developed legal system built around private property in land. Recent research has shown that as early as the 13th century, land in England was bought and sold in a manner not much different from today’s. In most European countries, moreover, landed possessions were taxed from early modern times.

In brief, property in the West was recognized long before “a couple of hundred years ago,” as de Soto suggests. Indeed, it is this ownership that led throughout the continent to the rise of parliaments, whose primary function it was to grant tax money to the king. This fact also indicates that culture, including political culture, plays a much larger role than de Soto allows in the evolution both of property rights and of capitalism.

Finally, de Soto may underestimate the difficulties of running enterprises even in today’s capitalist West. In the Wall Street Journal Europe, a British businesswoman named Danielle Downing recently spelled out the obstacles she encountered with various regulatory agencies while managing her Bagel Street Company with its 50 employees. British regulations applicable to small hotels and restaurants come to 1,500 pages. To open a bagel bar, one needs at least ten permits, and the cost of securing them amounted in her case to £2,000. Dealing with the various agencies sometimes required her to spend—to waste—40 hours a week of her time.

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These caveats qualify but do not invalidate de Soto’s general thesis: that there exists in much of the world today a kind of “capitalist apartheid” that prevents “the majority from entering the formal capitalist system.” When it is abolished, or at least significantly reduced, the economic benefits are likely to be stunning. As he convincingly demonstrates, the road to worldwide prosperity requires not restraining capitalism but making it universal.

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Footnotes

1 For a discussion of this book, see “The Only Hope for Latin America” by Mark Falcoff (COMMENTARY, April 1989).

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About the Author

Richard Pipes is professor of history emeritus at Harvard and the author most recently of Russian Conservatism and Its Critics (Yale).




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