Sunday, December 5, 2010

A Summary and Analysis of Hernando De Soto’s Mysteries of Capital

“The Mystery of Capital: Why Capitalism Triumphs in the West and Fails Everywhere Else” by Hernando De Soto, is a book about the transformation of dead capital into live capital through the institution of formal property rights. De Soto believes by integrating the extralegal agreements into a unified formal property rights system, the world’s poor will be enabled through the creation of ‘fictitious commodities’. Being a Peruvian himself, the majority of De Soto’s examples are specific to his Peru and various other Latin American countries. Written in 2000, Hernando’s book is from the context of Latin America during the 1990s where the world was recovering from the oil shocks, and debt crisis of the 1980’s and resulting in prescriptions of neo-liberal politics encouraged by the IMF. Peru particularly, had over 50% of it’s population under the poverty line. As the president of the Peruvian Institution of Liberty and Democracy he is primarily focused on capital formation for developing nations, and has been a major influence in economic and legal reform of Peru. Currently, less than half of peru live below the poverty line, and so it seems positive economic change has been made.

In De Soto’s book he claims there are five ‘mysteries of capital’: The mystery of missing information, the mystery of capital, the mystery of political awareness, the missing lessons of US history, and the mystery of legal failure. His obvious focus is on the Mystery of Capital, however the others are the basis for his argument, his evidentiary support. This essay will discuss each of De Soto’s ‘mysteries’, and it’s strengths and weaknesses, then conclude with my opinion on De Soto’s theory of development and prescription for social change.

In ‘The Mystery of Missing Information’, De Soto demonstrates his different, more practical and observational, approach to economics. He quotes Ely Devons saying, “if economists wished to study the horse, they wouldn't go and look at the horses, They’d sit in their studies and say to themselves, ‘what would I do if I were a horse?’” (De Soto, 15). De Soto would not do his research this way, and instead did years of field research around the globe; “Over the past five years, I and a hundred colleagues from six different nations have closed our books and opened our eyes- gone out into the streets and countryside's of four continents to count how much the poorest sectors of society have saved. The quantity is enormous. But most of it is dead capital”. This is what De Soto claim’s to be the missing information, dead capital. If the world’s poor could realize this dead capital into live capital they would have opportunity similar to what many micro-loan institutions do today for hopeful, yet poor entrepreneurs, with no initial capital to realize their goals. This, however, raises questions about the quality of De Soto’s research. Even among 100 colleagues, research on six different nations in 5 years seems barely touched.

De Soto, recognizes the stereotype placed on third-world nations by Westerners. Eighty percent of the world is considered poor, however “80 percent majority is not, as westerners often imagine, desperately impoverished” (De Soto, 15). De Soto is saying that while dichotomies of wealth do exist, the ‘poor’ do have possessions but lack the ability to produce additional value from those possessions. The eighty percent is still surviving, however, De Soto wishes to enable that part of the population to realize their assets, in order to properly join the capital game.

How much will it enable the individual? While the capital, altogether might add up to quite a hefty sum, it does not mean split between all the owning individuals that it is enough to truly enable entrepreneurship from the slums. Furthermore, it has yet to be proven that encouraging the poor into capitalism will help alleviate poverty. In fact, the development theory of Post-Development would argue that this method is the wrong, neo-colonial approach to development. As such, this calls into question the appropriateness of his theory.

At current there are political roadblocks that stand in the way of your average person gaining legal property rights. De Soto tried an experiment, trying to register a business to sell T-Shirts. His researchers “spent 6 hours a day at it and finally registered the business-289 days later” (De Soto, 18). Not only does it take too much time to properly register a business, but the cost alone in this case was thirty-one times the minimum wage of that country, and to top it off, the owner also risks losing the property (as they are now surprisingly more susceptible to government laws). These hurdles to formal property registration are why there so many extralegal sectors exist in these slum dwellings. However it is these “extralegal social contracts have created a vibrant but undercapitalized sector, the center of the world poor… these new entrepreneurs are filling the gaps in the legal economy as well” (De Soto, 28). This is why De Soto has hope for the poor of the world. He believes that “in the midst of their own poorest neighborhoods and shantytowns, there are - if not acres of diamonds- trillions of dollars, all ready to be put to used if only the mystery of how assets are transformed into live capital can be unraveled” (De Soto, 37).
Although this hopeful attitude towards poverty is positive, and while altogether the sum of slum property is enormous, has De Soto, a capitalist forgotten what capitalism is all about? Capitalism is for the individual actor, acting in their own self-interest. He never answers how the individual living in the slum can accomplish this. I’m weary to accept their property value will amount to enough.

The Mystery of Capital is the most important part of De Soto’s book, where he explores how to revive this dead capital; his solution is formal property rights. De Soto, explains what he means by active capital drawing on Smith references saying “for accumulated assets to become active capital and put additional production in motion, they must be fixed and realized in some particular subject ‘which lasts for some time after that labour is past. It is, as it were, a certain quantity of labour stocked and stored up to be employed if necessary upon some other occasion’ ” (De Soto, 42).
There is so much potential for the poor, but they will only realize this potential when they are able to gain Property Rights; “what the poor lack is easy access to the property mechanisms that could legally fix the economic potential of their assets so they could be used to produce, secure or guarantee greater value in the extended market” (De Soto, 48). Specifically De Soto has six effects of formal property rights has brought to West and have allowed for generations of generation of capital; fixing the economic potential of assets, integrating dispersed information into one system, making people accountable, making assets fungible, networking people and protecting transactions.

Fixing the economic potential of assets allows for a standard interpretation of the human- attributed economic and social value of such asset; “it represents the invisible qualities that have the potential for producing value” (De Soto, 50). With such potential realized, the property can now be an investment, or be even be realized as collateral. De Soto thinks this to be important because without the ability to leverage assets, one is unable to produce surplus value. “Legal property thus gave the West the tools to produce surplus value over and above its physical assets”(De Soto, 51). This is important because as De Soto said, “money does not earn money. You need a property right before you can make money” (De Soto, 64).

Integrating dispersed information into one system is a difficult but integral part of property rights. It took about one hundred years for the West to have fully integrated property rights. “The reason capitalism has triumphed in the West and sputtered in the rest of the world is because most of the assets in Western nations have been integrated into one formal representational system”, and most of the world’s nations have yet to integrate extralegal property agreements into one formal legal system” (De Soto, 53)

Making people accountable will create individuals from the masses. (De Soto, 54). Formal property rights allow one to realize previous impossibilities De Soto admits that after instating formal property rights, rights and laws are more impersonal and one forfeits “the ability to lose themselves in the masses” (De Soto, 55); you are now legally linked to your property. Formal property rights have allows assets to be fungible, setting a global and national standard for trade, and allows for the easy flow of assets between individuals. In doing so it has enabled the networking of people, improving “the flow of communication about assets and their potential” (De Soto, 59).

Lastly, formal property rights have brought the protection of transactions to the West, which ensures all sales and purchase information is transferred and records of transaction are kept. Yet, De Soto also stated, “a great part of the potential value of legal property is derived from the possibility of forfeiture”, (De Soto, 55). It is also possible that while this could alleviate others, it could cause huge loses for the rest. It brings up the question, which is the lesser evil?: a greater dichotomy with less but more extreme poverty, or or greater amounts of poverty with a lessened dichotomy? I am unsure if this is truly a working solution.

Our third mystery is, consequently, why there a lack of political awareness surrounding this issue: Why have the governments not tapped into the potential of the poor? This is because the recent mass urbanization that has been occurring around the globe. De Soto states “for better or for worse, people outside the West are fleeing self-sufficient and isolated societies in an effort to raise their standards of living by becoming interdependent in much larger markets” (De Soto, 70). As such, this is a problem we must accept as inevitable and address. Particularly urbanization must be addressed as these countries lack the institutions to deal with the mass migration to their urban centers and they are resulting in “the fragmentation of their property arrangements and the unavailability of standard norms that allow assets and economic agents to interact and governments to rule by law” (De Soto, 76). Marx would say that this is the bourgeoisie keeping the proletariate from utilizing the tools of the bourgeoisie, politically alienating them.

Despite the lawless stereotype of the slums, it is clear to De Soto that the poor want to be integrated into the system. This is shown through their actions: “people are spontaneously organizing themselves into separate, extralegal groups until government can provide them with one legal property system” (De Soto, 73). However, there are so many other issues and poorly run institutions that property rights has been left behind and remains outdated and extralegal agreements flourish, (De Soto, 74). “In Brazil, for example, the construction industry reported mere 0.2 percent growth in 1995; yet cement sales during the first six months of 1996 soared by nearly 20 percent. The reason for the apparent anomaly, according to a Deutsche Morgan Grenfell analysis is that 60 to 70 percent of the regions construction never makes it into the records”

Lastly, De Soto focuses on the US as his western example of the transition from developing to developed, as it was just “more than 150 years ago, it (the U.S.) too was a third World country”. Just like developing nations now, the United States experienced massive migration, explosions of extralegal activity, political unrest and general discontent. De Soto does not want the third world to slavishly imitate the US transition to formal property rights but rather take the “primary lesson is that pretending extralegal arrangements do not exist of trying to stamp them out, without a strategy to channel them into the legal sector, is a fools errand”(De Soto, 150).

De Soto believes that we, of the West, are too focused on the disparity of other nations that ‘we’ forget how ‘we’ made the transition from a extralegal to formal legal system. In 13 years, De Soto claims he has visited every property-related institution in the advanced world; to his shock, non of them ad thought about formal property rights and their role in economic development; “my primary concern, however, was not property rights per se but “meta-rights” - access or rights to property rights. Although we had many subjects of mutual interest, such as how to reengineer a record-keeping organization so as to integrate information gathered in the field into one database, or how to develop procedures to digitize boundaries on base maps, the property experts could not tell me how to bring people who hold their assets by extralegal arrangements into the legal property system”, (De Soto, 106). However, he still does praise the history of the west saying, “In every country, it was the result of a few enlightened men deciding that official law made no sense if a sizable part of the population lived outside it.”

De Soto discussed the final mystery, the myth behind why the extralegal cannot be integrated into a formal legal system: and that is due to the corruption within the extralegal system. Trying to avoid being getting caught is taxing enough in itself (De Soto, 155). People want the security of a well-run and integrated political and legal system. In conclusion, there are so many particulars to the legal property system in the West that it is important that the developing nations come to realize their own property system by integrating their extralegal sector into a legal and over the years the intricacies of a more-developed property system will emerge and integrate into all sectors of society.

Overall, Hernando De Soto’s theory about formal property rights for the world’s poor lacked convictions. Riddled with metaphors and flowery language, for example “most of us are like the six blind men in the presence of an elephant: one grasps the animal’s searching trunk and thunk the elephant is a snake; another finds tail and thinks the elephant is a rope; a third is fascinated by the large, snail-like ears; another embraces its leg and concludes that the elephant is a tree. No one views the elephant in its totality and thus they cannot come up with a strategy for dealing with the very large problem at hand” (De Soto, 74). While language to appeal to the average reader is important it diminishes from his argument dragging out topics reliant on the reason and logic of old wives tales.

De Soto made it seem as though extralegal systems did not exist in the western nations when in fact they are plentiful. For example in Canada, the largest agricultural production is of an illegal plant marijuana. Said to trade more than seven-billion annually, it’s sales are three times as large as wheat (, countries in the west have ‘third-world’-like living situations in their own countries, just not to the same magnitude. Maybe the problem is trying to model development after an imperfect and constantly changing model. This is why I found De Soto’s constant reference to US history to hinder his argument, as he does not fully explain why the US and other Western nations have been so successful in their development. The solution thus, seems over-simplified, and like other theories he criticizes, he is negating the importance in other institution reform for the specific western-like, industrial development he is aiming for.

While, I do agree with De Soto that the ‘west’ unfairly stereotypes and homogenizes the ‘the rest’ of the world, especially the poor, and that the poor could benefit from having more readily attainable formal property rights, I do not believe that this is the sole solution.Being educated and raised in the west, like De Soto, it was easy for me abroad to notice the differences or even similarities between ‘their’ and ‘my’ milieu. However, I believe that there is a difference between recognizing that things are different and glorifying one over the other. As I have mentioned previously, De Soto glorifies the direction that the United States and its citizens have taken. While he may encourage each country to make change in their own manner specific to their population, De Soto still has an overall sense of a meta-narrative leading to US-like development. And it begs me to ask the question if De Soto, being Peruvian but educated in Europe, if he understands his fortune and milieu makes it impossible for him to truly understand the needs of the majority of his country, because he cannot separate his bias adoration for western-style life. Especially, during our current recession it seems pertinent to ask if formal property rights, especially those that lead to live capital through credit, loans etc., lead to more entrepreneurs or more Willie Loman’s?

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