Book Review: The Mystery of Capital

It was probably a couple of years ago--word, how time flies!--that a particularly well-known radio talk-show host recommended Hernando de Soto's The Mystery of Capital on his show. I don't recall where, but I heard of the book from at least one other source in the same general time frame, and eventually, I got 'round to borrowing it from the library. I have since purchased a copy for my personal library and I am confident that I will refer to it with some frequency in the coming years.

The book is subtitled "Why Capitalism Triumphs in the West and Fails Everywhere Else"--which may seem a rather dismal assessment at first glance, but when you think about it, where, except in the West, and those countries in the East, such as Japan, that have made a deliberate effort to mimic certain aspects of the West, has capitalism been a roaring success? De Soto notes that capitalism's failure to thrive outside the West is often put down to flaws in non-Western peoples. As a matter of fact, it was De Soto's discussion of this in the first chapter that served as the first of several "light-bulb" moments. Emphasis, where present, is mine:

When these remedies fail, Westerners all too often respond not by questioning the adequacy of the remedies but by blamingThird World peoples for their lack of entrepreneurial spirit or market orientation. 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 IQ's 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 diverse places as China, Estonia, and Baja California, is worse than inhumane; it is unconvincing. The disparity of 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 Kruschev's son, are flocking to Western nations.

...But if people in countries making the transition to capitalism are not pitiful beggars, are not helplessly trapped in obsolete ways, and are not the uncritical prisoners of dysfunctional cultures, what is it that prevents capitalism from delivering to them the same wealth it has delivered to the West? Why does capitalism thrive only in the West, as if enclosed in a bell jar?

Nor is capitalism's failure in non-Western countries due to lack of assets and resources. De Soto notes, still in the first chapter:

...I will also show...that most 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--forty 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 one hundred fifty 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 percent 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.

It is important to note that De Soto is not pulling these figures out of thin air; he and his team spent several years researching them, and traveling much of the world to verify them. Indeed, due to the poor property documentation discussed extensively in the book, extensive travel and personal, on-the-ground investigation were essential to gaining the knowledge they sought.

Read De Soto's last paragraph again. It was fascinating to me. All that money--yet the people in those countries have not a fraction of the material comforts and provision we have in this country. Why? De Soto answers:

...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 the 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 makes them generate capital.

Third World and former communist nations do not have this representational process.

In chapter two, De Soto continues:

Imagine a country where nobody can identify who owns what, addresses cannot be easily verified, people cannot be made to pay their debts, resources cannot conveniently be turned into money, ownership cannot be divided into shares, descriptions of assets are not standardized and cannot be easily compared, and the rules that govern property vary from neighborhood to neighborhood 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 percent of its population, which is marked off as sharply from its Westernized elite as black and white South Africans were once separated by apartheid.

I had never considered the problem in quite this way before. Maybe you haven't, either. As De Soto explains, the "representational process" that so greatly enhances Western concepts of property grew up around us gradually. We tend not to notice its importance to us and how the lack of it in other countries inhibits their success because it is part of our environment. It simply tends not to occur to us. But as soon as De Soto started outlining the problem, I thought, Of course. It only makes sense. These people have money--at least some--but no capital! How on earth could we expect capitalism to work for them?

Of particular interest is chapter five, The Missing Lessons of U.S. History. De Soto "camps out" in the United States for a while, describing how at various points the United States resembled Third World and former communist countries in the way it dealt with formal property concepts.

Also very interesting are chapters four and six, which deal with how to change the situation in Third World and former communist countries so that capitalism--which is, really, pretty much the only game in town, the only economic system capable of generating wealth for a great many people--can succeed there. De Soto is not drawing upon abstractions at this point: he is a significant advisor to the Peruvian government and his ideas are already bearing much fruit there.

While I can't totally dismiss the role that culture plays in economics--I can't help but think that culture has to underly respect for the "representational process"--there is no denying that De Soto has hit on something. Capitalism will not thrive around the world until the "representational process", until "formal property", is available to rich and poor alike everywhere, and I do not think truly effective foreign policy can be made without taking De Soto's concepts into account.

I recommend this book highly; it will greatly enhance your understanding of the problems the world's poor face, and how we can effectively help.

Also, I couldn't help but note how foundational formal property concepts are to successful capitalism, and how we damage those concepts--as in the infamous Kelo decision--at great risk to our continued prosperity and ability to help others.