Saturday, May 24, 2008

A Hero of Capitalism

Just a quick post. This is a letter-to-the-editor published 5-8-08 in The Intellectual Activist Daily, a subscription daily news and analysis publication. I wrote it in response to a reference to by the editor, Robert Trasinksi, to The Other Path, a book by Peruvian economist, Hernando deSoto.

Letters to the Editor

In yesterday's TIA Daily ("Latin America's 'Other Path'"), you wrote:

"A lot of the credit for Peru's free-market reforms goes to a man not mentioned
in this article but referred to in its title. 'Peru Takes the Other Path' is a reference to Peruvian economist Hernando De Soto, whose 1987 book El Otro Sendero, 'The Other Path,' made the case for free markets, property rights, and the rule of law as the path to prosperity. (De Soto's title, in turn, was his answer to the Sendero Luminoso, or 'Shining Path,' a Marxist terrorist group.)"

If you haven't read De Soto's other book, The Mystery of Capital, it is very worth reading. De Soto asks the question, why hasn't capitalism brought wealth to Latin America? His answer is fascinating: the inability to produce capital. He points out that capital has two separate meanings: the actual physical assets and the potential of that physical asset to generate surplus value. It is the latter meaning of capital which is missing in Latin America, many former communist countries, and much of the Third World.

The key wealth-creating aspect of capital lies in the existence of formal property systems. Property is an abstraction, a relationship of a person to an asset. In order to be traded, used as credit, shared, and held securely (both against legal and illegal assaults), property must be converted into something concrete. This concrete form of property is generated through the multitude of precise legal rules governing title. Until formalized, property cannot become capital, cannot be securely used as collateral for a loan or equity exchanged for investment, as an address for collection of debts and taxes, or a place to identify individuals for judicial, commercial, or civic purposes. It is access to this aspect of ownership which the poor of the world are lacking.

DeSoto tallied up the value of assets "owned" by the world's poor and found them to be in excess $9.3 trillion dollars. But these assets exist as what De Soto calls "dead capital." The ownership is "informal" or "extralegal." They lack the legal representations of ownership which create enforceable property rights. Although property rights may exist on paper (in the laws), the actual barriers to formalizing ownership are cumbersome and expensive. The time and money required to legally register property or to legally start a business exceed the resources of the poor, so their businesses remain outside the law.

Without access to legally enforceable property rights, businesses must remain small and hidden from the authorities. Transactions can only occur between people directly known and trusted. Assets cannot be used as collateral for loans or credit. There is no way to create securities for trade in the capital market, or to spread risk among multiple investors. Forced to exist outside the law, the law becomes a threat. Disrespect for the law breeds opportunity for mafias and political instability.

In his book, De Soto analyzes in detail the requirements for turning an asset into functioning capital. Through his Institute for Liberty and Democracy, he has put these ideas into practice, helping Peruvians turn their dead capital into true capital. He is a true hero of capitalism.

Here are some links to learn more about his work:

—May 8, 2008

TIA Editor's Note: I have been aware of De Soto since I was a student at the University of Chicago and saw him give a talk on El Otro Sendero in 1987, and I agree with the assessment of him as a "hero of capitalism." I also intend to add him as a prominent example in the forthcoming print-issue version of my "What Went Right?" series.—RWT

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