The Mystery of Capital: Interview with Hernando de Soto

May 8, 2002

Carnegie Council's Christian Barry follows up with Hernando de Soto on several of the issues he had raised in his Morgenthau Lecture, focusing on questions concerning the fairness, equity, and legitimacy of de Soto's property rights thesis.

Christian Barry: Attempts to reform property rights have failed in the past. How do you convince the affluent of today, who own most of the property, to support legal reforms that might weaken their position?

Hernando de Soto: The first thing to note is that times have changed. Whatever resistance on the part of the elites to sharing power, in many cases it has diminished because the poor have already staked out a large amount of the assets. Take the example of my native Peru. Fifty years ago, private companies handled all of our urban transport needs, but today, about 80% of that transport consists of extralegal buses and taxis. In other words, what the rich haven't given to the poor, the poor have simply taken over.

My institute actually tries to spread awareness among the elites about their loss of control over markets and their limited access to consumers. The most powerful group of consumers in any developing country nowadays is from the extralegal sector—people who do not respect the law. The elites have every interest in establishing a standard legal system because that way they will have the chance to defend themselves in the face of their enormous losses.

Christian Barry : How do you legitimately determine a system of formalized property rights, and how can you ensure that the new system will benefit everyone, including those without any informally-held property to begin with?

Hernando de Soto: The first step is figuring out who owns what, and that is not always clear because record-keeping systems for assets, whether real estate or business, do not necessarily reflect reality. The only way you can get the owners to come out and say "Yes, I own this" is by giving them a property right that is more efficient than the existing system and that allows them to defend their property claims.

When President Aristide of Haiti called my institute, he said that aside from formalizing real estate assets, his government wanted to redistribute the wealth. But how are you going to redistribute wealth unless you know who owns what? One of the problems that he had was that he didn't have records. So the first step was to bring everybody into a record-keeping system. Then, once you've got everybody's assets on record and find that things are inequitable, you can proceed to do whatever reforms you want. You have to distinguish between the creation of a property rights system and the redistribution of property within that system.

That, by the way, was how the Japanese proceeded under MacArthur between 1945 and 1950. First of all, they had a great record-keeping system. After bringing everyone under one property law, they were able to accomplish a redistribution of assets.

Christian Barry: Does property rights reform help developing countries address urgent needs such as providing basic social services?

Hernando de Soto: Regarding other services such as health and education, I don't see how you can provide services adequately—and have a collection system that allows these services to be sustainable over time—without knowing what the property arrangements are behind each plot of land. How are you going to know how much electricity a particular town needs if you don't now how many industries the town has? You wouldn't even know what kind of transformers to put into place. If you don't put in transformers with a high enough voltage, they'll blow up. If you put too much voltage in, you'll be paying much more than you need to. So you need the kind of information that comes with a property rights system.

You also need, by the way, the accountability that comes from the property rights system. I'm not talking about titling but about the social contracts at the bottom of the social ladder, where the majority of the population lives. In other words, a property rights system isn't about how pieces of land are connected but how people are connected. What do they accept as punishable offenses? What kinds of incentives do they respond to? Until you know those things, you won't know what kind of governance is needed.

So I am not saying that other reforms aren't necessary; I'm simply saying that a property rights system is a principle reform, without which other reforms are difficult to manage. It's quite clear that property law alone does not resolve the other problems. But to me, what is also quite clear is that without property law, you will never be able to accomplish other reforms in a sustainable manner.

Christian Barry: But do you perceive any danger in establishing property rights in the absence of accompanying reforms—couldn't this lead to serious abuse and injustice?

Hernando de Soto: By insisting that progress happens from the bottom up, we avoid many of the problems experienced by Russia and the former Soviet republics when, basically, they did property law but got bad results. That was because they gave a large share of the total assets to former Soviet bureaucrats. So we exclude that kind of injustice from the beginning. Anybody we work with agrees to consult the people at the bottom.

Actually, it's possible to work on several areas at once. For example, before my institute went in and started creating a property rights system in Peru, we set up an ombudsman to, among other things, settle problems that led to outbreaks of violence or conflict. We also revamped the marriage licensing system so women would understand the advantages of coming under the law: the new property rights system recognizes the stake of women in land ownership and that of their children.

In other countries, my institute helped to introduce insurance companies and banks to sweeten the package. We do whatever we have to do. We do not do just one thing.

Christian Barry: How do you make your case for prioritizing property rights reform to a minister of finance? Will resources used for this purpose promote development more efficiently and equitably than investing in education and the provision of basic social services?

Hernando de Soto: I will answer with reference to Peru, although I could refer to any of the other countries my institute has worked in, with minor variations. There are three main points:

  • The minister of finance won't be able to identify most of the existing health hazards until Peru has a property system. It provides an identification system that allows a government to reach most of its people.
  • Peru has consistently invested in education for the last fifty years. It has improved "human capital." The only problem is, most Peruvians with a good education are now in the United States. So if you invest in human capital without giving people the opportunities, the jobs, the guarantees, the home address, and the rules, they are just going to migrate. This doesn't mean you don't do education, but you do education as well as property systems.
  • Finally, it should be noted that most Peruvians are willing to pay to get property. It's not an unpopular system. As a matter of fact, we continually receive offers from private companies that are willing to set up the most expensive part of any property system—from intellectual property rights to real estate law—in exchange for the ability to use the information we collect. So if governments were willing to abandon that aspect of sovereignty, a property rights system would be very easy to finance.

But even if a national government decided to finance property reform on its own, the fact is that we're talking about a very small amount of money. The problem isn't money. The problem is recognizing that when we talk about property systems, we are not talking about titling. If the United States decided to title the part of Montana that hasn't yet been titled, it has already got the legal system in place to do so. The titling process would consist of awarding plots of lands, or whatever other assets there are, or recognizing specific squatters. That is the easy part. The hard part—the challenge all developing countries face—is putting a legal system into place that everyone will respect. None of the funds set up by international institutions are earmarked towards accomplishing this kind of reform.

Christian Barry: Some international critics, such as Joseph Stiglitz and George Soros, have argued that international institutions tend to be operated for the benefit of the rich countries that control them, often to the detriment of the poor. What package of macroeconomic and institutional reforms will best help to "unlock" the potential of dead capital? Do you support capital controls along with other elements of the reformists' agenda?

Hernando de Soto: In the first place, I believe that many of the problems that we are now facing on a macroeconomic level would not have occurred if property rights reform had taken place, enabling most citizens to participate in the global economy. When you are talking about property rights reform in developing or former communist nations, you are basically giving people a vehicle to participate in the market. Also, from the point of view of foreign investors, they would obviously prefer to have property rights in a specific country.

So the problem at the international macroeconomic level is that most financial arrangements are made between developed countries and a very small number of elites in the developing world. International organizations simply aren't equipped to cover all the cracks in the wall. They can only deal with specific problems.

George Soros maintains that international institutions need to revise their priorities. I agree that we need some rules of governance for capital flows. The phenomenon whereby capitalists can come into a country and go out in less than a blink can be extremely noxious for very small countries. It rocks their economies. You need clear rules of the game and you need enforceability. So I don't think anything I have said is contrary to what one hears from George Soros.

I am beginning to read more of Joseph Stiglitz, and I think his criticisms of international institutions are extremely welcome; they will help us look much more closely at the Bretton Woods reforms, for example, which were set within the context of a very different reality than we have today.

The insights provided by George Soros, Joseph Stiglitz, and the like deserve consideration as we try to build a new system of world governance.

Christian Barry: One of the key questions the Carnegie Council asks is whether the wider international community can and should play a role in alleviating poverty and promoting development in the developing world. What kind of support should developed countries and international organizations be providing?

Hernando de Soto: Most developing countries must seek solutions to their current problems internally. There are figures indicating that most of the resources that are necessary for developing countries exist within the countries themselves. For example, my institute has produced figures indicating that worldwide, the excluded or the poor in developing countries have over 40 times more assets than all World Bank loans since its inception. And they have 50 to 60 times more assets than all foreign aid given by developed countries since the end of the Second World War. Thus what developed countries can provide in terms of material resources or political resources is truly marginal. There is very little they can do aside from putting in conditionality and incentives into their aid and loans.

That said, I think that developed countries can do more to raise awareness of the problem. There is a tendency for them to think that concrete things like building materials are more important than the law; there is a tendency on their part to forget that it was law that brought them peace and prosperity. For hundreds of years, Europe was a battlefield, and the last two battles that took place—World War I and II—left over 70 million dead. So Europe may have enjoyed prosperity, but it was prosperity with a very high cost. Europeans solved the problem of establishing a peaceful economy only recently, through what is now the European Union. They came up with various conventions and treaties to unite them economically and to create a wide and secure market.

These were all legal changes—just as in the United States, it was law that brought the nation together. Law enabled everybody in the United States to prosper within a governable economy. This is the very stuff of nation building and what needs to take place throughout the developing world.

Developed countries tend to put emphasis on concrete things that make them morally happy—I am transferring hospitals, I am transferring medicine—all of which is very well; but it is nothing compared to the size of the problem developing countries face, and nothing compared to the resources within developing countries themselves.

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