The Mystery of Capital

The Mystery of Capital
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A decade ago the celebrated Peruvian economist Hernando de Soto produced his classic work, The Mystery of Capital: Why Capitalism Triumphs in the West and Fails Everywhere Else (New York:  Basic Books, c. 2000). It explains some of the most elusive and daunting barriers to economic prosperity that keep third world nations from moving into first world status. DeSoto finds the developing world today where the United States was early in the 19th century. He recommends that third world countries replicate some of the legal and cultural innovations that allowed people with no capital to move here, prosper, and contribute to America’s exceptionalism.

Prosperity obviously accompanies capitalistic economic systems, but these systems have only thrived in the West. Capitalism, despite well-intentioned efforts, doesn’t easily transplant.  Since people work hard and save money everywhere, one wonders why this is so. “In this book,” he says, to answer the question, “I intend to demonstrate that the major stumbling block that keeps the rest of the world from benefiting from capitalism is its inability to produce capital” (p. 5).  Capital is produced only when property rights are legally secured.  Impoverished peoples have lots of “things, but they lack the process to represent their property and create capital.  They have houses but not titles; crops but not deeds; businesses but not statutes of incorporation” (pp. 6-7).  They have lots of personal assets but not the representational system—formal property—necessary to exploit them.  “Formal property,” de Soto says, “is more than a system for titling, recording and mapping assets—it is an instrument of thought, representing assets in such a way that people’s minds can work on them to generate surplus value.  That is why formal property must be universally accessible:  to bring everyone into one social contract where they can cooperate to raise society’s productivity” (p. 218).

To explain this situation de Soto explores the five “mysteries” of capital that structure his book.  First there is “the mystery of missing information.”  Allegedly impoverished people in Third World and formerly Communist countries are not, he insists, materially impoverished!  “The poor have already taken control of vast quantities of real estate and production” (p. 30).  They may live in shacks in dismal slums, but they have cell phones and TVs and state-of-the-art tools.  This fact never appears in international agencies’ (or humanitarian and religious organizations’) reports (which continually stress distress) because it is not reported.  It cannot be reported because these possessions have no legal standing, and the poor are forced to rely on informal ownership pacts and operate outside the law.  “They have trillions of dollars in dead capital, but it is as if these were isolated ponds whose waters disappear into a sterile strip of sand, instead of forming a mighty mass of water that can be captured in one unified property system and given the form required to produce capital” (p. 210).

Secondly, there is “the mystery of capital.”  Just as Ludwig Wittgenstein recognized that “the sense of the world must lie outside the world,” so too the meaning of capital is found outside the physical world in an immaterial, symbolic realm wherein people can “grasp with the mind values that human eyes could never see and to manipulate things that hands could never touch” (p. 63).  Capital must be differentiated from money, which merely facilitates commerce.  Capital comes when property, legally secured with written contracts, deeds etc., is used to creatively envision and develop resources.  “The moment you focus your attention on the title of a house, for example, and not on the house itself, you have automatically stepped from the material world into the conceptual universe where capital lives” (p. 50).

Thirdly, de Soto deals with “the mystery of political awareness.”  Around the world people are flocking from rural to urban areas, determined to prosper (whether illegally or legally) by entering the world marketplace.  Unfortunately the legal structures in many countries hamper their entrepreneurial endeavors.  Consequently, “people are spontaneously organizing themselves into separate, extralegal groups until government can provide them with one legal property system” (p. 73).  Without the security of legal protection they are limited to a relatively small circle of trusted trading partners.  Any significant division of labor and its resultant prosperity is denied them.

Fourthly, we should study “the missing lessons of U.S. history,” because 150 years ago the U.S. was a “Third World” country that rapidly developed and prospered.  In the New World, particularly on the western frontier, many European systems (notably England’s common law) dissolved as squatters and settlers and miners and claims associations simply took and held desirable lands.  “Squatters began inventing their own species of extralegal property titles known as ‘tomahawk rights,’ ‘cabin rights,’ and ‘corn rights’” (p. 116).   In time these frontiersmen petitioned and pressured politicians to grant them suitable legal titles.  Soon there developed a “legal innovation” known as “‘preemption’—a principle that would be the key to the integration of extralegal property arrangements in American law over the next two hundred years” (p. 120).  During the 19th century, especially, laws were adapted to the peoples’ needs and the modern American system, strongly defending property rights, emerged.  In de Soto’s judgment, “the American experience is very much like what is going on today in Third World and former communist countries:  The official law has not been able to keep up with popular initiative, and government has lost control” (p. 149).  When and if (and only when and if) property rights are secure, we can expect dynamic developments around the world.

So basically the poverty problem is a legal problem.  Infinite amounts of “aid” (whether governmental or private) will hardly heal the endemic abscesses of poverty.  “Without an integrated formal property system, a modern market economy is inconceivable” (p. 164).  Equally important is the elimination of ponderous bureaucratic procedures and self-serving lawyers defending the status quo that severely limit the abilities of industrious individuals to build their own homes and launch small businesses.  For example, in Lima, Peru it takes “728 bureaucratic steps” to “acquire legal title to a home” (p. 191)!  To provide entree to the modern economy what’s needed is leaders such as Thomas Jefferson, who “increased the fungibility of property by abolishing, among other things, the practice of entail (not being able to transfer property outside the family)” (p. 188).  Such leaders, de Soto emphasizes, must “do at least three specific things:  take the perspective of the poor, co-opt the elite, and deal with the legal and technical bureaucracies that are the bell jar’s current custodians” (p. 190).

To Margaret Thatcher, “The Mystery of Capital has the potential to create a new, enormously beneficial revolution, for it addresses the single greatest source of failure in the Third World and the ex-communist countries—the lack of a rule of law that upholds private property and provides a framework for enterprise. It should be compulsory reading for all in charge of the ‘wealth of nations.’”  She knew whereof she spoke, and little more needs saying to endorse this book.

Gerard Reed is a retired professor of history and philosophy, most recently Point Loma Nazarene University in San Diego. He is the author of three books--The Liberating Law; C.S. Lewis and the Bright Shadow of Holiness; C.S. Lewis Explores Vice & Virtue--as well as a variety of articles and book reviews.