The Hidden Architecture of Capital

First Published: 2007-12-28

Reprinted with the kind permission of the Institute for Liberty and Democracy

Read Mr. de Soto’s bio here…

Imagine a country where the law that governs property rights is so deficient that nobody can easily identify who owns what, addresses cannot be systematically verified, and people cannot be made to pay their debts. Consider not being able to use your own house or business to guarantee credit. Imagine a property system where you can’t divide your ownership in a business into shares that investors can buy, or where descriptions of assets are not standardized.

Welcome to life in the developing world, home to five-sixths of the world’s population. Their plight underlines a paradoxical reality: capitalism is seen by the West as the answer to global underdevelopment, but it hasn’t even been tried because in a capitalist economy, all business deals are based on the rules of property and transactions which do not even exist in the Third World. Their property systems exclude the assets and transactions of 80% of the population, cutting off the poor from the global capitalist economy as markedly as apartheid once separated black and white South Africans.

Conventional macroeconomic reform programs have ignored the poor, assuming they have no wealth to build on. The ILD’s studies of the underground economy in the Third World prove that the poor are, in fact, not so poor. In Peru, the poor’s assets are worth an estimated $90 billion—11 times the value of equities on the Lima Stock Exchange and 40 times the sum of all foreign assistance to the country since World War II. In Mexico, the estimate is $ 315 billion—7 times the worth of PEMEX, the national oil company. In Egypt, the assets of the poor total $ 240 billion—55 times greater than the value of direct foreign investment over the past 200 years, including the cost of the Suez Canal and the Aswan Dam.

For poor countries to develop, the poor and lower middle classes must be allowed to use their assets in the same way that wealthier citizens do and the political challenges is to bring those assets from the “extralegal” sector into a more inclusive legal property system. There they can become more productive and generate capital for their owners, growth for the nation, and markets for industry.

Third World governments have already proven that they can reform bad property arrangements, at least for the rich. In 1990, for example, the Compañía Peruana de Teléfonos (CPT) was valued on the Lima Stock Exchange at $53 million. The government, however, could not sell the CPT to foreign investors because of problems with the company’s title to many of its assets. The Peruvians put together a top international legal team to create a legal title that would meet the standardized property norms required by the global economy. The result was the property was easily converted into shares. Documents were rewritten to secure the interests of third parties and create confidence that would allow for credit and investment. The legal team also created enforceable rules for settling property disputes that bypassed the dilatory and corruption-prone Peruvian courts. Three years later, the CPT entered the world of liquid capital and was sold for $ 2 billion—37 times its previous market valuation. That’s what a good property system can do.

The poor’s assets can also be legally titled and the potential capital trapped inside can be released. Nine years ago, ILD president, Hernando de Soto, was invited by the Indonesian Cabinet to offer advice on identifying the assets of the 90% of Indonesians living in the extralegal sector. He knew he was no expert on Indonesia, but as he strolled though the rice fields of Bali, a different dog would bark as he entered a different property. The dogs did not have to graduate from law school to know which assets their masters controlled. To determine who owned what in Indonesia, he advised the Cabinet to begin by “listening to the barking dogs.” One of the Ministers responded, “Ah, jukum adat—the people’s law.”

The history of capitalism in the West is a story of how governments adapted the “people’s law” into uniform rules and codes that all could understand and respect. Ownership once represented by dogs, fences, and armed guards is now represented by records, titles and shares. The moment Westerners were able to focus on the title of a house and not just the house itself, they achieved a huge advantage over the rest of humanity. With titles, shares and property laws, people could suddenly go beyond looking at their assets as they are (houses used for shelter) to thinking about what they could be (security for credit to start or expand a business). Through widespread, integrated property systems, Western nations inadvertently created a staircase that allowed their citizens to climb out of the grubby basement of the material world into the realm where capital is created.

The poor are not the problem we think they are, but the solution to their own plight. The time is ripe to take the definition of property away from conservative legal establishments, which see the law as an unmovable edifice, and put it in the hands of politicians who realize that the law is a social consensus.

* A modified version of this article was published as “The Secret of Non-Success” in Time magazine and on AOLA on 16 April 2001.

Copyright © 2001 Institute for Liberty and Democracy. All rights reserved.

The views expressed are those of the author, and not necessarily those of the Nassau Institute (which has no corporate view), or its Advisers or Directors.

Help support The Nassau Institute