The Mystery of Capital with Hernando de Soto

October 17, 2000 at 12:00 AM EDT

RAY SUAREZ: Finally tonight, another of our conversations about new books, and to Elizabeth Farnsworth.

ELIZABETH FARNSWORTH: Peruvian economist Hernando DeSoto takes on a tough question in his new book, “The Mystery of Capital: Why Capitalism Triumphs in the West and Fails Everywhere Else.” Desoto is president of the Institute for Liberty and Democracy in Lima, Peru. He works with governments from Egypt to the Philippines on problems of economic development. Time Magazine named him one of five leading Latin American innovators of the century in its May 1999 issue.

Mr. DeSoto, you write in the opening line of your book, “the hour of capitalism’s greatest triumph is its hour of crisis.” Explain.

HERNANDO DE SOTO: Well, what’s happened is that the Berlin wall fell some 11 years ago — six billion people in the world. One billion people are in western Europe, north America, the United States, Canada, Japan, and two former colonies, and they’re triumphing. The rest of us, in the former communist nations and developing nations, which are five million people, are all having trouble with capitalism and making it work for the majority of the people.

ELIZABETH FARNSWORTH: You actually use the term “capitalist apartheid.” That’s a pretty strong term.

HERNANDO DE SOTO: Well, it is a strong term, because what it refers to is something you can see when you visit any third-world country or many former communist nations, which is that some of the population, maybe 10%, maybe 15%, have entered into the global economy, and the rest are left outside.

ELIZABETH FARNSWORTH: And yet you’re not in any way anti-capitalist. I noticed that on the back cover of your book, your book is praised by the likes of Milton Friedman and Margaret Thatcher. You’re not exactly coming at this from the left in any way. How would you describe yourself?

HERNANDO DE SOTO: Well, I would describe myself as a person who sees, whether he likes it or not, that it’s the only game in town. There’s nothing else left but capitalism for the moment. And what we have to do is make sure that it works for the majority, which it’s not. What we see in the West, which is the reason why it works, is that capitalism is essentially all about property rights, rights that can be transacted in a market to further the distribution of work, the division of labor. And what occurs in at least 80% to 85% of a population of the third world and former communist nations is that that part of the population has assets. They do have assets, as a matter of fact, trillions of dollars, but they’re not paper rights in a property rights system, so their value cannot travel and actually insert itself into a diversified market.

ELIZABETH FARNSWORTH: Let’s go into some detail here. You see the poor as actually rich. You don’t see the poor as victims in this. You see them as potentially having assets that could they be realized would make them, if not wealthy, at least not terribly poor, right? Explain that first.

HERNANDO DE SOTO: Absolutely. Some of the poor are very poor indeed, but many of the poor are much richer than we think and have done an awful lot since the Second World War in the last 50 years. Take one case: Egypt. In the case of Egypt, in the measurements we did with the Egyptian government, we found out that those that call themselves poor or the lower middle classes actually own, in real estate alone, about $240 billion worth of assets, $240 billion.

ELIZABETH FARNSWORTH: And these are maybe houses on land that they squatted on and they build houses, but they have no title to them, they can’t use it to borrow money. Is that the deal?

HERNANDO DE SOTO: Absolutely. That’s the deal. However, they have accumulated those assets, which is the definition of capital by Adam Smith or Marx. Now, what’s interesting is that $240 billion is equivalent to all foreign investment in Egypt over the last 200 years, includes the Suez Canal and the Aswan Dam. Or it’s 30 times the size of the Cairo Stock Exchange. What it means is that the poor in fact in countries like Egypt and countries like Peru and the Philippines, in countries like Mexico, in effect have got more assets than their local stock exchanges, but as opposed to those who are members of the stock exchanges, they’re not paperized in a way, that is to say they don’t have titles on their assets in a way that they can be leveraged, used for mortgages, used to obtain credit, used to guarantee investments, and as a result of which they are what Adam Smith used to call “dead capital.” They only serve in their physical value if they’re houses or shelters, but not in the financial or investment market.

ELIZABETH FARNSWORTH: Why — you use the term “paperized.” Why do that they not have title? Why can’t they make use of the capital that they do have to borrow money or to start… I think you said that in the United States, somebody’s home is the main source of capital for a small business investment, right?

HERNANDO DE SOTO: That’s right.

ELIZABETH FARNSWORTH: Why can’t they do that?

HERNANDO DE SOTO: In the United States, a home serves as a physical shelter, but also in its representation in the form of a title, it can be burdened to obtain finance, to obtain credit, or to further investment or to become an address where one becomes accountable. But that requires that around the assets you build a legal system which people can access. It just so happens that in most developing countries, to enter the law is a huge problem. For example, in Peru, it used to take 22 years to title a home in the outskirts of lima. In Egypt, to title a sand dune and obtain a home takes you 17 years working eight hours a day, and in the Philippines, it can take up to 52 years.

ELIZABETH FARNSWORTH: Farnsworth: Because of bureaucracies, difficult paperwork?

HERNANDO DE SOTO: Because of laws that are not friendly to poor people. In other words, what we’ve done over the last 11 years, and there’s a lot of good work that’s been done, supported by the world bank and the IMF, is try to create friendly atmospheres for foreign investors. But since we weren’t aware that the poor had accumulated even more assets ready to be invested in developing countries than the rich and foreign investors, we forgot to create a legal system that is also friendly to them. The result is these enormous obstacles to come inside the legal system, and these enormous obstacles to be able to foreclose credit, foreclose markets, and actually do transactions legally for the majority of the population of the citizens of those countries.

ELIZABETH FARNSWORTH: I was struck by that part of your book. You see this informal market or underground market or however one wants to term it as really dynamic. You see it as innovative, dynamic, a potential source of tremendous wealth, don’t you? If only this process that the West went through over several centuries in developing this law could be realized, have I got that right?

HERNANDO DE SOTO: You’ve got it absolutely right. It depends how you look at things. People tend to think of black markets only in negative terms. But if you even think of the United States 150 years ago, California was divided into 800 illegal or extralegal jurisdictions that were created not according to Mexican law, not according to U.S. law, but according to contracts made by informal, extralegal, or black market miners who staked out the land. And on the basis of that, you built the wealth of the United States. In other words, you didn’t inherit the common law, you actually built up your own system. What’s happening in developing countries, it’s their time. Now with the industrial revolution, the population of Port-au-Prince has grown 16 times — the population of Waiaki 11 times in the last 40 or 50 years, and that of Lima and Cairo about six times. Most of these poor people have come into the market now, but what they lack are the legal mechanisms so as to create a modern market economy.

ELIZABETH FARNSWORTH: Don’t they also lack the power to get the legal mechanisms?

HERNANDO DE SOTO: They lack the power, but what was missing so far were the figures. I think one of the strong points of “The Mystery of Capital” is that it’s a result of an empirical investigation where we go city by city to indicate that the poor– even though there are people who are in terrible situations– in the biggest amount of cases have actually got the assets that are required to succeed at capitalism. But what’s happened is we’ve always looked at the poor as really a task for the first lady of a country instead of being the main task for development. And what we are now seeing, as a result of these empirical investigations, is that the poor have done much more for themselves than what we can actually do for them. For example, what the poor in Egypt have is about 100 times more than all the foreign aid that they received in the last 50 years.

ELIZABETH FARNSWORTH: So what do you want to happen next? How would this process that took hundreds of years in the West take place in someplace like Egypt or Russia for that matter or Peru?

HERNANDO DE SOTO: It’s to realize that the problem is the law; second, that you can’t import laws. You can import techniques. But that essentially when you go on the ground, whether you are in Russia, in China, or in Cairo, you will see that poor people already have agreements among themselves, social contracts, and what you have to do is technify, professionally standardized these social contracts so as to create one legal system that everybody recognizes and obeys. That’s how you created it in the United States. That’s how it was created in Switzerland, in Germany. The law is not something that you invent in a university. The law is something that you discover and then you systematize to make it standard so that everybody can participate in a larger market. And a division of labor, which is what creates prosperity, is then possible.

ELIZABETH FARNSWORTH: And finally, is this happening anywhere?

HERNANDO DE SOTO: Well, it’s happening everywhere. The problem is that it’s happening slowly. We’re trying to get them micro credit. We’re trying to be more flexible with our laws. Everywhere, all developing and former communist nations are trying to create space for the black market economy. The question is: Are we going to take 200 or 300 years, like the west did, or now that we know what this is all about, take the short cut and start listening to the poor, and on the basis of what they’re doing in black markets, build a solid white economy.

ELIZABETH FARNSWORTH: Well, Hernando Desoto, thank you very much.