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Review of "The Mystery of Capital: Why Capitalism Triumphs in the West and Fails Everywhere Else" by

This short book is very easy to read and is based upon detailed research in many countries including Peru and Egypt. Most developing countries do not have a reliable and efficient way of registering and transferring title to land. Without this, their residents cannot convert property they actually own into capital to develop businesses by using their property to secure borrowings.

Summary

23 July 2012

I was born in Pakistan which was a poor country in 1950 and remains a relatively poor country today. However I have lived for most of my life in the United Kingdom which is one of the wealthiest countries in the world. Why are some countries rich with high levels of average income, with incomes being well distributed amongst the population, while other countries are poor?

Capitalism has made rich the United Kingdom, Western Europe, North America, and Japan to name some regions where it has succeeded. Unfortunately in some countries capitalism was suppressed by force. This applied to the USSR throughout its history; and to the People's Republic of China until a few decades ago. Such state socialism resulted in widespread poverty. However other parts of the world, such as Latin America, were not explicitly socialist but nevertheless capitalism failed to flourish there. Why is that?

In the 1990s Hernando de Soto and his colleagues went fact-finding. They went into the streets of developing and former communist nations to learn what real people are achieving inside and outside the formal economy. They found that even poor people in such countries have assets and savings which could be used for successful capitalism, but nevertheless these countries are underdeveloped. In this book they summarise their findings.

Summary of the book

I have the hardback edition published in 2000. It is quite short, just over 250 pages, and very easy to read. It is divided into seven chapters with some endnotes and an appendix.

Chapter 1 – The Five Mysteries of Capital

The book begins by summarising the problem:

"The hour of capitalism's greatest triumph is its hour of crisis. The fall of the Berlin Wall ended more than a century of political competition between capitalism and communism. Capitalism stands alone as the only feasible way to rationally organise a modern economy. At this moment in history, no responsible nation has a choice. As a result, with varying degrees of enthusiasm, Third World and former communist nations have balanced their budgets, cut subsidies, welcomed foreign investment, and dropped their tariff barriers.

Their efforts have been repaid with bitter disappointment. From Russia to Venezuela, the past half-decade has been a time of economic suffering, tumbling incomes, anxiety, and resentment; of 'starving, rioting, and looting,' in the stinging words of Malaysian Prime Minister Mahathir Mohamad.… The triumph of capitalism only in the West could be a recipe for economic and political disaster."

The author reminds us that when developing countries fail to develop sufficiently, Westerners usually blame the countries concerned.

"If they have failed to prosper despite all the excellent advice, it is because something is the matter with them: they missed the Protestant Reformation, or they are crippled by the disabling legacy of colonial Europe, or their IQs are too low. But the suggestion that it is culture that explains the success of such diverse places as Japan, Switzerland, and California, and culture again that explains the relative poverty of such equally diverse places as China, Estonia, and Baja California, [part of Mexico] is worse than inhumane; it is unconvincing. The disparity in wealth between the West and the rest of the world is far too great to be explained by culture alone. Most people want the fruits of capital – so much so that many, from the children of Sanchez to Khrushchev's son, are flocking to Western nations.

The cities of the Third World and the former communist countries are teeming with entrepreneurs. You cannot walk through a Middle Eastern market, hike up to a Latin American village, or climb into a taxi cab in Moscow without someone trying to make a deal with you."

The author goes on to explain that it is not entrepreneurial drive that the people in these poor countries lack, it is capital. Furthermore he has documented that they lack capital despite owning assets.

"I will show, with the help of facts and figures that my research team and I have collected, block by block and farm by farm in Asia, Africa, the Middle East, and Latin America, that many of the poor already possess the assets they need to make a success of capitalism. Even in the poorest countries, the poor save. The value of savings among the poor is, in fact, immense – 40 times all the foreign aid received throughout the world since 1945. In Egypt, for instance, the wealth that the poor have accumulated is worth fifty-five times as much as the sum of all direct foreign investment ever recorded there, including the Suez Canal and the Aswan Dam. In Haiti, the poorest nation in Latin America, the total assets of the poor are more than 150 times greater than all the foreign investment received since Haiti’s independence from France in 1804. If the United States were to hike its foreign aid budget to the level recommended by the United Nations – 0.7% of national income – it would take the richest country on Earth more than 150 years to transfer to the world's poor resources equal to those they already possess.

But they hold these resources in defective forms: houses built on land whose ownership rights are not adequately recorded, unincorporated businesses with undefined liability, industries located where financiers and investors cannot see them. Because the rights to these possessions are not adequately documented, these assets cannot readily be turned into capital, cannot be traded outside of narrow local circles where people know and trust each other, cannot be used as collateral for a loan, and cannot be used as a share against an investment.

In the West, by contrast, every parcel of land, every building, every piece of equipment, or store of inventories is represented in a property document that is a visible sign of a vast hidden process that connects all these assets to the rest of the economy. Thanks to this representational process, assets can lead an invisible, parallel life alongside their material existence. They can be used as collateral for credit. The single most important source of funds for new businesses in the United States is a mortgage on the entrepreneur’s house. These assets can also provide a link to the owner's credit history, an accountable address for the collection of debts and taxes, the basis for the creation of reliable and universal public utilities, and a foundation for the creation of securities (like mortgage-backed bonds) that can then be rediscounted and sold in secondary markets. By this process the West injects life into assets and make them generate capital."

In comparison, the author describes the assets of the poor as "dead capital" since they cannot be used as collateral for a loan and cannot be sold in an open market but instead can only be sold to those local people who will recognise informal ownership rights. He explains that the poor "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. It is the unavailability of these essential representations that explains why people who have adapted every other Western invention, from the paperclip to the nuclear reactor, have not been able to produce sufficient capital to make their domestic capitalism work."

The author summarises the problem as a series of five mysteries.

The Mystery of the Missing Information

While charities emphasise the poverty of the poor, the author states that no one has properly documented their capacity for accumulating assets. Over five years the author and 100 colleagues from six nations went into the streets and countryside to count the assets of the poor. The quantity is enormous but most of it is dead capital.

The Mystery of Capital

As explained in the book, the author addresses directly the question of what is capital, how is it produced and how is it related to money.

The Mystery of Political Awareness

Why have governments failed to tap into the potential wealth of the poor?

The Missing Lessons of US History

The author explains "Unfortunately, we have been so mesmerised by the failure of so many nations to make the transition to capital that we have forgotten how the successful capitalist nations actually did it.… It was a mystery. I finally found the answer in their history books, the most pertinent example being that of US history."

The Mystery of Legal Failure: Why Property Law Does Not Work outside the West

Developing nations have copied the laws of the West since the 19th century. It has failed to work. "Most citizens still cannot use the law to convert their savings into capital."

The author devotes a chapter to each of those mysteries.

Chapter 2 – The Mystery of Missing Information

The author introduces the problem.

"Imagine a country where nobody can identify who owns what, addresses cannot easily be verified, people cannot be made to pay their debts, resources cannot immediately be turned into money, ownership cannot be divided into shares, descriptions of assets are not standardised and cannot easily be compared, and the rules that govern property vary from neighbourhood to neighbourhood or even from street to street. You have just put yourself into the life of a developing country or former communist nation; more precisely, you have imagined life for 80% of its population, which is marked off as sharply from its Westernised elite as black and white South Africans were once separated by apartheid.

This 80% majority is not, as Westerners often imagine, desperately impoverished. In spite of their obvious poverty, even those who live under the most grossly unequal regimes possess far more than anybody has ever understood. What they possess, however, is not represented in such a way as to produce additional value. When you step out the door of the Nile Hilton, what you are leaving behind is not a high-technology world of fax machines and ice makers, television and antibiotics. The people of Cairo have access to all those things.

What you are really leaving behind is the world of legally enforceable transactions on property rights. Mortgages and accountable addresses to generate additional wealth are unavailable even to those people in Cairo who would probably strike you as quite rich. Outside Cairo, some of the poorest of the poor live in a district of old tombs called 'the city of the dead.' But almost all of Cairo is a city of the dead – of dead capital, of assets that cannot be used to their fullest. The institutions that give life to capital – that allow one to secure the interests of third parties with work and assets – do not exist here."

The author goes on to explain briefly that the USA had similar problems early in its history but overcame them. He explains that in detail in Chapter 5.

The Obstacles to Legality

The great thing about this book is that it is based upon observation and experiment. The author recounts one of his experiments.

"To get an idea of just how difficult the migrant’s life was, my research team and I opened a small garment workshop on the outskirts of Lima, Peru. Our goal was to create a new and perfectly legal business. The team then began filling out the forms, standing in the lines, and making the bus trips into central Lima to get all the certifications required to operate, according to the letter of the law, a small business in Peru. They spent six hours a day at it and finally registered the business – 289 days later. Although the garment workshop was geared to operating with only one worker, the cost of legal registration was $1,231 – thirty-one times the monthly minimum wage. To obtain legal authorisation to build a house on state-owned land took six years and eleven months requiring 207 administrative steps in 52 government offices. To obtain a legal title for that land took 728 steps. We also found that a private bus, jitney, or taxi driver who wanted to obtain official recognition of his route faced 26 months of red tape."

The author and his team with local associates repeated these experiments in other countries such as the Philippines, Egypt and Haiti. In every country it took years. It was also difficult to remain legal after having become legal. "30 years ago, more than two-thirds of the new housing erected in Brazil was intended for rent. Today, only about 3% of new construction is officially listed as rental housing. To where did that market vanish? To the extralegal areas of Brazilian cities called favelas, which operate outside the highly regulated formal economy and function according to supply and demand. There are no rent controls in the favelas; rents are paid in US dollars, and renters who do not pay are rapidly evacuated."

The Undercapitalised Sector

The author points out that migrants into cities are not idle; they are simply refugees from the law. Cottage industries have sprung up everywhere and the streets are full of hawkers.

That is consistent with my own experience when I visited Jakarta in 2009 when the streets had stalls hogging the pavement selling everything from fruit to building supplies. I did not enquire whether those stalls had permits but I suspect that they did not. More recently the Arab spring was sparked in Tunisia by the suicide of Mohamed Bouazizi, a street vendor who did not have a permit to sell fruit and vegetables and who was regularly harassed and humiliated by the police.

Chapter 3 – The Mystery of Capital

The author states that his team have estimated that the poor own $9.3 trillion of dead capital. In this chapter he discusses the process by which assets are converted into capital. He points out that in the West the formal property system registers information about assets and produces legal titles, and explains why that is so essential.

"Any asset whose economic and social aspects are not fixed in a formal property system is extremely hard to move in the market.… Without such a system, any trade of an asset, say a piece of real estate, requires an enormous effort just to determine the basis of the transaction: does the seller own the real estate and have the right to transfer it? Can he pledge it? Will the new owner be accepted as such by those who enforce property right? What are the effective means to exclude other claimants? In developing and former communist nations, such questions are difficult to answer. For most goods, there is no place where the answers are reliably fixed. That is why the sale or lease of a house may involve lengthy and cumbersome procedures of approval involving all the neighbours. That is often the only way to verify that the owner actually owns the house and there are no other claims on it. It is also why the exchange of most assets outside the West is restricted to local circles of trading partners."

The author points out the many uses of property in the West apart from providing a place in which to live.

"In the West, for example, most formal property can be easily used as collateral for a loan; as equity exchanged for investment; as an address for collecting debts, rates, and taxes; as a locus point for the identification of individuals for commercial, judicial, or civic purposes; and as a liable terminal for receiving public utility services, such as energy, water, sewage, telephone, or cable services. While houses in advanced nations are acting as shelters or workplaces, their representations are leading a parallel life, carrying out a variety of additional functions to secure the interests of other parties."

Chapter 4 – The Mystery of Political Awareness

In this chapter the author explains in detail the fact that governments are aware of the problem of undocumented land titles but have failed to solve the problem of extralegal ownership and extralegal business activities.

Chapter 5 – The Missing Lessons of US History

The author explains that he spent 13 years trying to learn how the Western systems came about. He visited "just about every property related organisation in the advanced world – from my friends in Her Majesty's Land Registry and the Alaska Land Authority to the Japanese Toki Bo [land registry]. No one had an answer. All the experts… admitted they had never thought about the question."

The author found his answers by reading about the history of Western countries. While he looked at several, in this book he focuses upon the United States because "more than 150 years ago, it too was a Third World country. The government and judiciary of the young states, not yet so legally united, were trying to cope with the law and disorder of migrants, squatters, gold diggers, armed gangs, illegal entrepreneurs, and the rest of the colourful characters who made the settling of the American West so wild and, if only in hindsight, so romantic.… Although my colleagues and I have trouble relating to 11,000 on the Dow Jones, we feel quite at home among the squatters in Thomas Jefferson's Virginia or the log cabin settlements of Daniel Boone's Kentucky."

The author goes on to explain how the USA successfully dealt with the problem of land ownership.

Chapter 6 – The Mystery of Legal Failure

The author explains the problem.

"Nearly every developing and former communist nation has a formal property system. The problem is that most citizens cannot gain access to it. They have run into Fernand Braudel’s bell jar, that invisible structure in the past of the West that reserved capitalism for a very small sector of society. Their only alternative, as we saw in chapter 2, is to retreat with their assets into the extralegal sector where they can live and do business – but without ever being able to convert their assets into capital."

The author goes on to point out that governments in developing countries have been trying for 180 years to open their property systems to the poor. He goes on to explain why they have failed.

"The reason is that they usually operate under five basic misconceptions:

  • all people who take cover in the extralegal or underground sectors do so to avoid paying taxes;
  • real estate assets are not held legally because they have not been properly surveyed, mapped and recorded;
  • enacting mandatory law on property is sufficient, and governments can ignore the costs of compliance with the law;
  • existing extralegal arrangements or 'social contracts' can be ignored;
  • you can change something as fundamental as people's conventions on how they can hold their assets, both legal and extralegal, without high-level political leadership."

In comparison to the failure of developing countries, the author and his colleagues have looked at how Western countries such as the USA addressed this problem in the past. They set out a very detailed step plan for how countries in the developing world should go about it today. He stresses the importance of starting with the ownership facts on the ground.

"In Haiti, for instance, no one believed we would find documents fixing representations of property rights. Haiti is one of the world's poorest countries; 55% of the population is illiterate. Nevertheless, after an intensive survey of Haiti's urban areas, we did not find a single extralegal plot of land, shack, or building whose owner did not have at least one document to defend his right – even his 'squatting rights.' [The book includes a page of facsimile reproductions of Haitian informal titles.] Everywhere we have been in the world, most informals have some physical artefact to represent and substantiate their claim to property. And it is on the basis of these extralegal representations, as well as records and interviews, that we are everywhere able to extract the social contracts undergirding property."

The author believes that as well as the economic benefits discussed earlier, proper property registration will solve other problems as well.

"Widespread legal property will even help solve one of their [the government and elites] loudest and most persistent complaints about the expanding urban poor – the need for more 'law and order.' Civil society in market economies is not simply due to greater prosperity. The right to property also engenders respect for law."

The author identifies the legal profession and the property registration technicians and surveyors as obstacles to achieving what is required. He explains this by detailed reference to his work and the way that land titles were successfully established in Western countries.

Chapter 7 –  By Way of Conclusion

The author summarises the failure of capitalism outside the West.

"Capitalism is in crisis outside the West not because international globalisation is failing but because developing and former communist nations have been unable to 'globalise' capital within their own countries. Most people in those nations view capitalism as a private club, a discriminatory system that benefits only the West and the elites who live inside the bell jars of poor countries.

… Even as they consume the goods of the West, they [the poor outside the West] are quite aware that they still linger at the periphery of the capitalist game. They have no stake in it. Globalisation should not be just about interconnecting the bell jars of the privileged few. That kind of globalisation has existed before."

The author goes on to discuss the failure of capitalism in the countries of Latin America since they became independent from Spain. He also challenges the intellectual leftovers from the thinking of Karl Marx. He expressly refutes the idea that capitalism is a cultural feature limited to certain societies.

Is Succeeding at Capitalism a Cultural Thing?

"Think of Bill Gates, the world's most successful and wealthiest entrepreneur. Apart from his personal genius, how much of his success is due to his cultural background and his 'Protestant ethic'? [A sideswipe at Max Weber’s work ‘The Protestant Ethic and the Spirit of Capitalism’] And how much is due to the legal property system of the United States?

How many software innovations could he have made without patents to protect them? How many deals and long-term projects could he have carried out without enforceable contracts? How many risks could he have taken at the beginning without limited liability systems and insurance policies? How much capital could he have accumulated without property records in which to fix and store that capital? How many resources could he have pooled without fungible property representations? How many other people would he have made millionaires without being able to distribute stock options? How many economies of scale could he have benefited from if he had to operate on the basis of dispersed cottage industries that could not be combined? How would he pass on the rights to his empire to his children and colleagues without hereditary succession?"

The author is clear that this success of capitalism in the West relies upon a strong system of legal property rights.

The Only Game in Town

The author believes that capitalism can succeed in developing and former communist nations.

"I hope this book has conveyed my belief that this state of affairs is relatively easy to correct – provided that governments are willing to accept the following:

  1. The situation and potential of the poor need to be better documented.
  2. All people are capable of saving.
  3. What the poor are missing are the legally integrated property systems that can convert their work and savings into capital.
  4. Civil disobedience and the mafias of today are not marginal phenomena but the result of people marching by the billions from life organised on a small scale to life on a big scale.
  5. In this context, the poor are not the problem but the solution.
  6. Implementing a property system that creates capital is a political challenge because it involves getting in touch with people, grasping the social contract, and overhauling the legal system.

… It makes no sense continued to call for open economies without facing the fact that the economic reforms underway open the doors only a small and globalised elites and leave out most of humanity."

Appendix

In the appendix, the author summarises the estimates of "dead capital" prepared by his team for certain countries.

Philippines

They estimate the dead capital of the urban poor at $72 billion and that of the rural poor as $60 billion. They point out that this dead capital is four times the market value of the Philippines stock exchange at the end of 1997 and 14 times the value of all foreign direct investment in the Philippines between 1973 and September 1978.

Peru

The author estimates the dead capital of the urban poor at $36 billion and that of the rural poor at $37 billion. This is eight times the total value of savings and time deposit accounts in commercial banks in Peru in 1995 and 14 times the value of all foreign direct investment in Peru up to 1995.

Haiti

Haiti is a small and poor country but the author estimates that the poor own $5.2 billion of dead capital which is 11 times total savings and time bank deposits in 1995 and 158 times the value of direct foreign investment in Haiti up to 1995.

The appendix also includes photographs of some informal property holdings in Haiti with estimates of the value of the property concerned. One of the buildings shown is estimated to be worth $75,000 but since it is not legally registered, it can play no part in the capitalist system.

Egypt

The author estimates that the poor of Egypt have $241 billion of dead capital which is 55 times the value of direct foreign investment in Egypt up to 1996.

Concluding Comments

This is one of the most inspiring books I have ever read and it transformed my thinking about what is needed in developing countries.

In the West we take strong property rights so much for granted that we rarely think about them. They, and the trust that they give rise to, is fundamentally important for our economies to prosper. They enabled me to send money from the UK to the USA for investment without having to worry whether it would be stolen. The American shares that I bought may fall in value but I have every confidence that if I sell them I can repatriate the sale proceeds back to the UK without them disappearing.

What developing countries need from countries like Britain is not more foreign aid but help in transforming their legal systems so that they function properly and in particular help in registering the assets that are already owned by the poor in those countries. At the same time those countries need help in dismantling the jungle of legal regulations that impede business activity. For example everyone who knows anything about the Indian economy is familiar with the phrase 'the licence Raj' which held India's growth rate to a snail's pace from independence until the Manmohan Singh reforms of the early 1990s. However much more needs to be done in India, let alone the rest of the world. Looking at another country, Egypt, which is covered in this book, there is no reason for Egyptians to be poor other than the legal impediments to conducting lawful business activity and the lamentable failure of land registration and the legal system more widely.

I recommend this book to everyone who cares about the poor of developing countries.

 

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