Download Mystery of Capital, Henando De Soto (Summary)

Mystery of Capital, Henando De Soto (Summary)
Hernando De Soto was born on 3rd June 1941 in Peru. His field of study was in economics of
informal sectors, and his research based on property right theory. He is the president of institute
of liberty and democracy, located in Lima, Peru. After the 1948 military coup in Peru, his father
chose exile in Europe, taking his wife and two young sons with him. De Soto was educated in
Switzerland, where he attended the International School of Geneva and subsequently did
postgraduate work at the Graduate Institute of International Studies in Geneva. He retired from the
U.N. in 2007 with the title rank of Assistant Under-Secretary-General. His last position was as the
UN Special Coordinator for the Middle East Peace Process. He later worked as an economist,
corporate executive, and consultant. Hernando De Soto returned to his native Peru at the age of
38, and is now hailed as an international adviser.
Introduction
In the mystery of Capital, De Soto engages himself with why capitalism has constantly
failed in developing and ex-communist nations although he reckons it the best way of organizing
an economy, given its success in the West. He discovers that this failure is due to the inability of
the poor in these societies to access legal representation for their assets, which hinders them from
realizing their full potential as capital. This renders the assets in developing nations as dead, while
their counterparts in western nations live active parallel lives in formal property systems. From
example, while a house in a third world country nation solely provides shelter, houses in developed
nation can be used to secure credit to expand the businesses of the owners of the house. In
demystifying this phenomenon, De Soto uncovers five mysteries which he discusses in the book.
These mysteries are;
Mystery of Capital, Henando De Soto (Summary)
1.
The mystery of missing information:
2.
The mystery of capital:
3.
The mystery of political awareness:
4.
The missing lessons of U.S history:
5.
The mystery of legal failure:
The Mystery of Missing Information
“If economists wished to study the horse, they wouldn't go and look at horses. They'd sit
in their studies and say to themselves, ‘what would I do if I were a horse?’ ” (Ronald H. Coase).
De Soto believes that the above approach employed by many economists fails to study the actual
economic systems but merely theorizes about them. Hence, he conducted a more practical,
observational survey of the economies of five Third World cities – Cairo (Egypt), Lima (Peru),
Manila (Philippines) , Mexico City (Mexico ) and Port-au-Prince (Haiti) . In an attempt to value
the possessions of these people, he discovered that most people in those developing countries are
not desperately impoverished as they are portrayed as. These people own assets. However, their
possessions are not represented in a way that allow them to produce surplus value. This De Soto
termed ‘Dead Capital’.
To De Soto, the lack of functioning institutions that give life to capital: that is, departments
that give capital owners the ability to secure additional value from third parties for their
contribution is the main contributor to the huge dead capital in developing countries. Third World
countries have accumulated lot of capital in the form of real estate (buildings) but fail to secure
additional value on these properties.
Mystery of Capital, Henando De Soto (Summary)
In the developing world, the most dangerous feature he recognizes is the impenetrable wall
of rules that deter people from establishing social and economic activities. These rules require
people to pass through long bureaucratic procedures to register or license their properties. Taking
Egypt for instance, De Soto claims that for a citizen to build a legal dwelling on a land that was
previously used for farming, it will require of him about 6 to 11 years of complex bureaucratic
squabbling. He associates this bureaucratic complexities to the massive illegal dwellings in Third
World cities. In De Soto’s own words, “In every country we investigated we found that it is very
nearly as difficult to stay legal as it to become legal.
De Soto ends the chapter by approximating the value of dead capital in four (4) Third
World Countries. The value of dead capital in untitled Real Estate in Haiti is about $5.2 billion.
That of Peru amounted to about $74 billion, about $133 billion for the Philippines, and some $240
billion in Egypt. He adds that “By our calculations, the total value of the real estate held but not
legally owned by the poor of the Third World and former communist nations is a least $9.3
trillion”.
The Mystery of Capital
In chapter 3, De Soto dives into the heart of his inquiry as to why third world and former
communist nations create less capital than western countries. Key to the prolific nature of capital
in western countries, De Soto says, is the formal property system that westerners have. This system
allows the economically significant aspects of property, representing their potential and values, to
be detached from the physical property in the form of representations e.g. securities, titles, etc. By
these representations, physical assets are able to lead parallel lives as capital in a formal property
system, creating surplus value. How it is that formal property systems achieve this result he
describes in the following effects produced from their existence:
Mystery of Capital, Henando De Soto (Summary)
Property Effect No. 1: Fixing the Economic Potential of Assets
This is how “capital is born [,] by representing in writing – in a title, a security, a contract and
other such records – the most economically and socially useful aspects of the asset. Subsequently,
the parallel life of the property is lived through this representation.
Property Effect No. 2: Integrating Dispersed Information into One System
In developing countries, all documents describing the useful economic and social features of
property can be traced to one authority, or agency for authenticity, accuracy, and enforcement.
This makes traceability and lawful exchange cheap and efficient.
Property Effect No. 3: Making people accountable:
In the formal property systems of the west, it is not possible for property to exist without a direct
trace to an owner. Subsequently, each person with property interest retains a profile in the system.
Therefore, any breach of trust and compromise of trustworthiness is recorded into the system,
warning other participants in the network in subsequent transactions.
Property Effect No. 4: Making assets fungible
Because representations are abstractions, many more interesting things can be done with them than
with physical assets to produce surplus value. For example, through shares, an asset can be taken
up and divided it into pieces and shared amongst investors for money. Something which cannot be
done with the physical form of the asset.
Property Effect No. 5: Networking People
In formal property systems, assets are linked explicitly to owners, and assets to addresses, and
owners to enforcement in such a chain such that transactions between people are the creation of
Mystery of Capital, Henando De Soto (Summary)
new chains between themselves, the addition of new chains, and the intertwining of chains in a
multi-complex network of people, now made into business agents. These traces are what allow for
vital services as credit, utilities delivery, and investments.
Property Effect No. 6: Protecting Transactions
In developing countries the focus of property systems is on protecting transactions so that people
can easily make their assets lead parallel lives as capital. This is made possible by public agencies
that keep accurate, updated records on the economic usefulness of property, helping parties
interested in certain properties know their defects and merits. Also, private services aiding the
property system are even able to insure against specified risks, like unmarketability of titles,
unenforceability, etc.
The Mystery of Political Awareness
As one of the mysteries why capitalism only triumphs in the west and fails everywhere
else, De Soto discovers the mystery of political awareness. He talks about the fact that most dead
capital possessed by the deprived in society has not been tapped into because government is
unaware of the growth of the extralegal sector. The extralegal sector may be defined as any
business venture undertaken that is not known to the law. We can attribute this to the great
migration from rural to urban areas.
Over the years, due to population growth and industrialization, most inhabitants of rural
areas have moved to the cities and urban centers in such of jobs that will earn them higher incomes
to improve their living standards. When they migrate, they are unable to match up to the standard
of most jobs. They have no other option than to find extra-legal jobs in the society. This extralegal sector has accounted for at least 50% of GDP of some advanced countries like Russia and
Mystery of Capital, Henando De Soto (Summary)
Latin America. In view of this, more new jobs were created under the extralegal sector of the
economy of these developed nations. The government of these countries took the opportunity to
solve each of these problems individually by for instance, providing micro financial support for
the extra-legal sections of the economy which has transformed those countries into the
industrialized nations we see today.
He emphasizes that the main problem of non-western nations is not the rural-urban
migration, but rather missing links which he terms as blind spots. This political blindness has issues
such as failure of legal orders forcing the poor to set up their own extra-legal regulations to replace
the established laws. He describes two different blind spots which are Blind Spot I: Life outside
the Bell Jar Today and Blind Spot II: Life outside yesterday’s Bell Jar.
Blind Spot I talks about how governments fails to recognize the flow of extra-legal activity
that has created a new class of entrepreneurs with their own legal laws. Blind Spot II talks about
how most developing nations do not identify that the difficulties they are facing now, such as extralegalities, are not new to the world. Governments do not recognize that the methods that have been
adopted to alleviate poverty are not enough. What they need is to reform laws and the property
rights system to facilitate the division of labor in order to increase productivity.
The Missing Lessons of US History
In this chapter, the author views the US from a different angle and strives to show what the
people don’t see, which is the missing lesson. He states that, "Unfortunately, we have been so
mesmerized 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." This
Mystery of Capital, Henando De Soto (Summary)
statement is key and forms the basis of his main idea in this chapter. The author had to embark on
a research for years, to find out how developed countries integrated legal assets. In conducting
this research, he interviewed people to find out how the systems can be changed to give people the
right to property. However, the interviews were worthless. Hence, he relied on history books to
carry out his research. On this, he discovered tracing back down the line, that western countries
had disseminated informal property arrangements until they transitioned to a legal framework in
which laws were modified by politicians to integrate extralegal assets into the legal framework.
Squatters were very common in America in the 17th century. Squatting was an illegal
process of inhabiting land that does not belong to you. During that era, there were many
immigrants from Europe, especially England, and the laws that were set were not respected as
laws. Hence people did what they felt like doing. The only conventions that were treated as laws
were the ones regarding property. Due to the habit of squatting and because there were a lot of
free space for people to settle, people started to move from place to place frequently and this made
lawmakers instill rules that prohibited this. When these restrictions were passed, the squatters
mobilized themselves and requested for the right to land, which later created complex conversation
between the lawmakers and the squatters because the current system which required the squatters
to buy the land at market price was not favorable for them.
America was able to be placed back on track of the legal system because of “pre-emption”.
This allowed the squatters to regain the value of the improvements that they brought to the land
while they were settled on it. If the owners of the land refused to recompense them, the preemption law provided the squatter the right to buy the land at market price. The owners then gained
Mystery of Capital, Henando De Soto (Summary)
their extra-legal property rights after the state adopted a law that gave squatters the right to their
improvements if they had been settled at a particular place for more than 7 years.
The integration of extra legal rights is worth learning about for the other developing
countries. Since America had to go through all these experiences to reach the current level, the
developing countries should also learn from these and fix their frameworks of property. This will
increase the economic growth of these countries enabling them to reach to the level of the US and
others.
The Mystery of Legal Failure: Why Property Law Does Not Work Outside the West
Every developing and ex-communist nation has a formal property system. The problem
these nations face is that, most of their citizens cannot gain access to this facility. Their only
alternative is to retreat with their assets into the extralegal sector where they can live and do
business. Nonetheless, they cannot convert their assets into capital. Governments of developing
countries have tried to reverse this trend for years without success. The concern then is: why this
failure? De Soto believes that governments have failed in this pursuit because they have operated
under five basic misconceptions, and they are that:
1. All people who take cover in the extralegal or underground sectors do so to avoid paying
taxes.
i. Contrary to popular wisdom, operating in the underground is hardly cost
free. Therefore, if the cost of operating legally are made to be below that of
Mystery of Capital, Henando De Soto (Summary)
surviving in extra-legal sectors, more people will be lured into the legal
framework
2. Real estate assets cannot be legally registered unless they have been properly surveyed,
mapped, and recorded with state-of-the art geomatic information technology.
i. This conception is invalid, since Europeans and Americans managed to
record all their real estate assets decades before computers and geographical
information systems were invented. While these technologies will
3. Enacting mandatory laws on property is sufficient, and government can ignore the cost of
compliance with that law.
4. Existing extra-legal arrangement or social contracts can be ignored
i. De Soto deliberated that creating one national social contract on property
involves understanding the psychological and social processes which
involves the belief, desires, intentions, customs and rules. Hence, extralegal arrangements or social contracts cannot be ignored.
5. 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:
i. Of this De Soto writes: “opening up capitalism to the poor will not be as
simple as running a bulldozer through garbage. It is more like rearranging
the thousands of branches and twigs of a huge eagle’s nest – without
irritating the eagle”. This is to say that this process of bringing capitalism
Mystery of Capital, Henando De Soto (Summary)
to the poor will be a delicate process requisite of the most tactful political
advances driven by strong will.
Conclusion
De Soto concludes that for capitalism to succeed in creating prosperity for developing and excommunist nations as it has for developed countries, the governments of those nations must accept
that:
1. The potential ingrained in the assets 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
And finally,
4. Civil disobedience and the mafias of today are not a marginal phenomenon but the result of
people marching by the billions from life organized on a small scale to life on a big scale