An interview with "the world’s greatest living economist"

INDIVIDUAL PROPERTY RIGHTS ARE KEY TO DEVELOPING CAPITALISTIC NATIONS

HERNANDO DE SOTO, NEW YORK, FEBRUARY 2, 2008

Termed “the world’s greatest living economist” by Bill Clinton, among Time magazine’s 100 most influential people in the world and Forbes magazine’s “15 innovators who will reinvent your world”, Hernando de Soto (b. 1941) has won 20 prizes worldwide for his contributions to economics, from the Fisher Prize (U.K.) to the Americas Award (U.S.) and Innovation Award (Social and Economic Innovation) by The Economist magazine. Born in Peru to parents who were exiled after the 1948 coup, de Soto lived through his formative years in Switzerland. He returned to Peru when he was 38.

de Soto’s central argument in his two celebrated books, The Mystery of Capital; Why Capitalism Triumphs in the West and Fails Everywhere Else (2000) and The Other Path: The Economic Answer to Terrorism (1989), revolves around the importance of a system to accord and protect individual property rights which, in turn, will raise economic standards of a nation.

de Soto is President of Lima, Peru-based Institute for Liberty and Democracy (ILD), which consults for more than 20 governments on the design and implementation of capital formation programs. He also co-chairs the Commission on Legal Empowerment of the Poor, with former U.S. Secretary of State and UN Madeleine Albright.

de Soto served as an economist for the General Agreement on Tariffs and Trade (GATT), as president of the Executive Committee of the Intergovernmental Council of Copper Exporting Countries, as a principal of the Swiss Bank Corporation Consultant Group, and as a governor of Peru’s Central Reserve Bank. He was Peruvian President Alberto Fujimori’s personal representative and principal advisory until he parted ways with the President before the latter’s self-coup in 1992.

Dr. Amit Mitra formulated the issues for this conversation, and Shashidhar Nanjundaiah raised these and more issues in person in a conversation with de Soto in New York for India and Global Affairs, an international economics journal.
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In your classic, The Mystery of Capital, you have said, “The fall of the Berlin Wall ended more than a century of political competition between capitalism and communism. Capitalism stands alone as the only feasible way to rationally organize a modern economy.” Given that there is much contemporary discourse on a ‘third way’ and ‘social markets’, do you still stand by your conclusion made in the year 2000?

Saying that the war between capitalism and communism ended in capitalism’s favour doesn’t mean that there are no alternatives. It does, through redistribution (as in Europe and Nordic countries), or cooperatives, where competition is not the only interest. But the pricing, as opposed to central planning, is the natural system worldwide, whether capitalism is managed by social democrats, Christian democrats, or conservatives.

So capitalism will change over time?

It might change, but certain elements will have to remain for us to be able to continue using that word. First of all, property rights are an imminent part of capitalism. There has to be a system of property rights where people can decide whether the system can protect their rights to the ownership of property. Second, capitalism can only be accumulated in a form that can be represented, and I don’t see it happening without a property system.

Capital itself is a notional value, captured only on paper—such as property documents. I believe in capitalism as a market and a property system where you find people with business and property rights.

Capitalism can come with more or less freedom, and sometimes it can get out of hand. For example, the sub-prime market in the United States is out of hand. It is obvious that the U.S. property system has ceased to be able to truthfully represent the value of assets for mortgages—so evidently they need to be adjusted.

So, while the United States follows that pattern of individual property holding, the value attached to that property can be unrealistic sometimes?

Yes, of course. The whole fight is to have realistic representation. We manage our world through representations. That is the way human beings control and get our bearings on an enormous world that we cannot see—we can only see a fraction of the world. My thesis is that so far, the world of so-called capitalism and its instruments—property on the one hand and forms of organization—seem to represent the workings of a spontaneous economy better than any other system. I’m not a die-hard capitalist—how can you explain a system that has exploited so many people, used as a pretext for the North invading the South, has protected greed? But if we want to proceed toward prosperity, the elements of the capitalistic system seem to be the only ones [to adopt].

You have made an important point in your writings. You have said, “The absence of this process in poorer regions of the world, where five-sixth of humanity lives, is not the consequence of some Western monopolistic conspiracy.” Do you believe that neo-colonialism by MNCs is not the reason for the poor to remain poor?

I don’t think there is a conspiracy at all. MNCs don’t care about the poor. It has been in their best interests to create wealth. That said, since their objective is making profits, they take advantage of the rules that exist. They found the speculating in currency extremely profitable in South East Asia. Mohamed Mahathir[1] and the others found that the developing countries do not have the size to take free, uncontrolled capital flows. Capitalism continues to be in place, as countries continue to need and depend on foreign investment. And now, those countries who suffered the currency “bubble burst” are using the same capitalistic instruments to invest back in Europe and the United States.

So the rules will continue to change—but what you may call a conspiracy is what I’d call a “non-interest”.

The Western nations did understand a few decades ago that the efficiency of legal institutions in developing the former Soviet nations was important. If you read Williamson’s Washington Consensus[2], it’s in the agenda. But out of the ten points in the Consensus, only eight were adopted. Property rights were left out. My argument is the entrepreneurs in a country need tools to operate.

You were instrumental in getting mining companies to do corporate social responsibility (CSR) activity in property rights in Peru. How do you think we can map your experience onto other regions of the world?

Well, barring poor and indigenous people from geological assets means you are leaving them from the tools of development. When someone is able to get the rights to the geological assets, they depend on secondary negotiating systems for participating. That way, they can obtain their rightful place as partners in the corporation. And that’s what we did in Peru, by persuading corporations to participate.

You are aware that India’s urban slums and shanty towns reflect all the elements of your thesis that capitalism is characterized by state protection of property right where ownership and transactions are clearly recorded. These towns are centres of enterprise and squalor. They are defined by a lack of property rights and incapacity to use assets as collaterals for borrowing and investing. Yet correcting this problem appears to be a Herculean task. Could you give us the methodology to tackle this in a vibrant democracy such as India?

This is where the challenge is. I don’t know India that well, but obviously there is an Indian property rights system. There is a tacit agreement in the villages as to who owns what. You have to work with informal and formal systems and bring them together under the rule of law.

I’d suggest that the government first identify what the informal systems of property rights in the country are, and then make sure all these systems to manage assets are within the rule of law. It also needs to ensure that using the law is cheaper than not using it—otherwise people are not going to agree to it.

The other method is through what I call “normative instruments”—do the property rights actually reach the people? Can you manage the records system? Can the credit cards function in them? To what extent are property owners protected from those with superior knowledge of the transaction side of the business? What are the cost-benefit ratios to property rights?

The problems in the methodology of property rights are a) bringing property rights under the law and convincing people that it is impartial—like a telephone system—and reducing suspicion, b) managing the instruments, c) bureaucratic delays, and d) the inertia of “this is how we are—we’re very different from the rest of the world”.

Would your solution differ from country to country?

Yes and no. It’s always the same problem. It’s bad law, adopted from the British or from the Koran, that is not adapted to local circumstances. Huge extra-legal economies, up to 90%--whether you’re in Egypt, Albania, Africa, same thing. Migration is a problem. Cracking local culture is the easiest part of the job. But the basic problem remains about the same thing.

Let us say, retroviral drugs have diminished the consequence of AIDS in Switzerland, and therefore they should be helpful in South Africa. But you can’t map governance in the same way: the local formula has got to have some kind of indigenous meaning, vocabulary, and roots. It needs to be packaged to be understood locally so that it can mobilize attitudes and allow you to build up the constituency that is necessary to defeat the status quo.

We should get more and more “legal maps” of the world to see the consequences of not being within the law and therefore be able to put the word out that can easily be recognized by all their citizens. When that happens, then the politicians have a very simple task, which is saying to themselves, “If I do the right thing, I will not only do the right thing, but also get the right number of votes.” Otherwise, it’s going to be very difficult.

Would people without rightful property be able to pay for asset creation?

Yes. The fact is if you have got the right property and record systems, people should be able to pay for it. When you don’t have law, that’s when you pay bribes. That’s when people have to pay for what they should consider their right. And when they don’t pay, it means they vote in a certain way, they have to marry off their daughter to the right guy. The cost of protecting property in a lawless land is much higher than through a good legal system.

You once raised a fundamental question: “Why does capitalism thrive only in the West, as if enclosed in a bell jar?” Can you explain what you meant, and whether you think it holds true today?

I think the argument against some privileges prevalent [when I wrote it] and somewhat less prevalent today—which is about culture. The general arguments were that certain cultures are just inimical to development systems with competitive markets. The rise of the West is not because they are racially or religiously any superior. Where they are superior is in the fact that they have much better legal systems.

Would you say that their religion might allow them to have that kind of a legal system?

No, I am not saying that at all. You could take [Max] Weber’s argument and link capitalism to Protestantism[3], but, well, that argument has changed with time. There is Shintoism[4]. People started realizing that before Protestant countries were wealthy, Catholic cities such as Venice were much wealthier. And now we’re starting to find out that India, with different religions, and some of the Communist countries, are also moving ahead.

People need to look at the law as a development issue. That’s why I was adamant at that time, and still am, although more then than now, that capitalism in the West is not a Protestant victory. It’s the victory of superior law. [Western countries] certainly tried in the Philippines--the United States in Philippines, the British in India, and so on. They couldn’t bring in the correct institutions into place. So we need to have a hard look at these, instead of simply saying it’s cultural. I think it has to do with the mechanisms of the law.

And of economics?

It has to do with good economic thinking about the law… because the law has economic consequences.

Do you believe Western nations made sure that the rule of law was the be-all and end-all of a society, and did so by keeping culture alive but not to the extent that it might harm a society—partly by harnessing cultural rules and then standardizing them into law?

I have found some writing from the 19th century France, Britain and the United States that indicated that there was a spirit moving in the direction of empowering people. A man called Coquelin in France who said that given the desegregation of society and the decentralization of power in the revolutionary 19th century, man needs another vehicle to organize himself that is not religion, not family, not kinship, not politics—but a company, a corporation with a hierarchy that is different from the above. Even if it is a family corporation, who the CEO is doesn’t depend on who is the eldest brother.

The problem with this whole concept is that it is so poorly documented that people in Western countries today don’t seem to appreciate it enough. My hope is that developing countries will document it in such a way that people get to see it day in and day out and be conscious of it.

You have said, “The Western nations have so successfully integrated their poor into their economies that they have lost even the memory of how it was done.” Can you give us some graphic examples from that history which are similar to the current situation in the developing world?

One of the first things that characterized Henry VIII’s rule in Britain was the Poor Laws. He was extremely concerned about the poor—the poor constantly revolted, they had problems. During the Industrial Revolution the Labour Party in the U.K. evolved ways of empowering the poor and not have to go through charity. Then they forgot about it because it was a long drawn-out process. Not only were people of capitalist mentality involved, but also people who wanted to do redistribution. The process was so gradual that people forgot about it.

Until about 130 years ago, you could not form a company in the United States to do business without political authorization. People did not think about company law in the US or in Britain. They wouldn’t think of the 1862 joint stock company as a liberating force, but it was. They really democratized the access to doing business. So the West has forgotten where its crucial moments were. That’s the truth.

What is the total real estate value held but not legally owned?

We’ve taken a shot at it by sampling in about 20 countries and expanding it to 160, and have found that value to be in excess of $1 trillion. It’s probably much bigger than that. Among other things, if you were to adequately record the property and give it rights according to rightful enforcement, 1 trillion will probably become 4, 5 or 6 trillion dollars. It’s hard to determine it, but even with the conservative estimate of $1 trillion, he asset base exceeds all foreign aid—World Bank, Asian Development Bank, and all foreign direct investment; in other words, the major resources in developing countries.

You are an optimist. You have said that “this state of affairs (in the developing world) is relatively easy to correct, provided the governments are willing to accept a set of principles and actionables.” You already mentioned local realities as one. Is there any other parameter you’d like to add?

As far as we can see, the process will be highly accelerated by the will of the political party’s culture—especially the head of state. Wherever these developments have taken place, the head of state was involved. William Jefferson questioned why the eldest son should get it all. These were politicians who plowed ahead, pushed the agenda.

Nearly wherever you see the democratization of property rights, there is an intelligent strategy that beats the status quo. That may not be the only way to do it, and things may evolve over time. But if you want a major change, somebody somewhere has to identify the direction to take and create the appropriate institutions for it to work.

Or as it happened in North America, people just landed up from somewhere else and occupied the land?

Well, in that case Jefferson took a stand and decided that was all right, it was legal. It was not a technical decision—it was political. Once that decision is made, the technical part is duck soup. So it’s all about the political will.

Do you think Mohammed Yunus’s micro-credit system has emerged as an alternative method to the property rights technique in improving the economic and social indicators of a nation?

These two techniques manifest great belief in the power of the poor. I think they run parallel to each other. We’re both in the same fight, but mostly different targets—in some cases similar ones. Both our goals are directed at the same people. Most people don’t have that belief. To do what I am doing is to believe that the poor can administrate property with efficiency. To get micro-credit you must believe in the same thing.

Switching gears a bit, your other book, The Other Path, is about the movement of the now-nearly-defunct Shining Path. You implemented a scheme whereby poor citizens living around the Shining Path’s operations were given proper documentation for their land, thereby legalizing that property and deeming the Path’s interference redundant. Do you believe that militancy in other parts of the world has an economic solution—such as in parts of India?

I think it does. Militants are always rebelling in the name of the underdog. An example is religious dogmatism which can be used—as [Karl] Marx would have said—to “channel” economic oppression. “Religion is the opiate of the poor,” because religion can be used as an explanation for much more complex economic problems. If we’re able to explain poverty not in religious terms but in terms of the “underdog” not having the tools for asset creation, then we may see a decline in militancy.

Secondly, how do the militants get the following of the poor? The Shining Path were actually “protecting” the poor—whether their coca fields or their homes. That’s where they got their legitimacy. When the government intervened and awarded property rights to the residents, it wasn’t the machine guns that would protect them, but the rule of law. The whole nation then started depending not on the two goons outside with machine guns, but on the law of the country.

So absolutely—there is an economic solution to militancy. If India could gather the evidence and marshal it together, the example would be tremendous. That evidence would land on world stage.

How did the Institute for Liberty and Democracy (ILD) come about? Was it at the epicentre of your thesis?

It wasn’t exactly that. My father was a part of a left-wing government in Peru—pretty reasonable government, at that. After being exiled, it was always my desire to return to Peru. ILD was a think tank. As a businessman I had to face enormous amount of red tape in Peru. I set out looking for books that dealt with law and marginality at the same time. For all the search, I found one article. That set me thinking. One day I had a “Eureka” moment.

Now ILD is engaged with 21 governments and requests from 35 heads of state. We are making local alliances in many countries, for general partnerships—universities, for example. I am trying to find the model where these partners can influence governments.

Since your arguments are so clear and persuasive, why have governments in the developing world and former communist countries not adopted them immediately? What are the road blocks?

There is a certain “pastism,” reverence for anything that is past, that creates culture. For example, lawyers find bits and pieces to put together, so that whenever you have something extra-legal, they get judicial protection. So they’ve already got a solution, why create standards? Such incorrect mapping makes it all look cultural. Ministries that have always worked in a certain way will not accept something that is coming from an outsider view. And lack of data is also part of the problem.

“Category mistakes” are another problem. In Palestine, the encroachments are clearly over settlements, property rights. What happens when you are defending your own land, which is objective, versus defending your nation, which is sentimental? Property has to do with individuals, sovereignty with nations. Until Israel and Palestine both realize that it is a property problem, not a sovereignty problem, you can’t solve the problem.

But what happens when the categories themselves are so many? Isn’t legalization complicated when there are many kinds of informal cultural rules?

It always happens. But it is all about standardization—reaching out for common denominators and putting them into standards. It’s a painstaking process, but if there were one extra-legal system, it would be running the country since it would be the most powerful. The reason that such systems don’t run countries is because there are so many extra-legal systems in a country. About 140 years ago, California had 800 different property systems. Then, from the gold mining associations arose a single property system. It’s been there for a hundred years now. It’s not that difficult, really.

FOOTNOTES
[1] The Prime Minister of Malaysia (1981-2003) who is credited with modernization and promotion of non-individualistic “Asian values”. It was in his tenure that a financial crisis swept across Asia like a “contagion”.
[2] John Williamson’s (1989) consensus included ten broad sets of recommendations:
· Fiscal policy discipline;
· Redirection of public spending from subsidies toward pro-growth, pro-poor services like primary education, primary health care and infrastructure;
· Tax reform – broadening the tax base and adopting moderate marginal tax rates;
· Interest rates that are market determined;
· Competitive exchange rates;
· Trade liberalization: any trade protection should be by low and uniform tariffs;
· Liberalization of inward foreign direct investment;
· Privatization of state enterprises;
· Deregulation except for those justified on safety, environmental and consumer protection grounds, and prudent oversight of financial institutions;
· Legal security for property rights.

[3] Weber argued that religion was one of the non-exclusive reasons for the different ways the cultures of the Occident and the Orient have developed, and stressed importance of particular characteristics of ascetic Protestantism which led to the development of capitalism, bureaucracy and the rational-legal state in the West.
[4] Successful capitalism in "traditional" Shinto and Buddhist Japan and many other ASEAN countries seem to have disproved Weber's conclusions that capitalism can arise only in Protestant societies.