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. As a result, most of them are undercapitalized, in the same way that a firm is undercapitalized when it issues fewer securities than its income and assets would justify. The enterprises of the poor are very much like corporations that cannot issue shares or bonds to obtain new investment and finance. Without representations, their assets are dead capital.
The poor inhabitants of these nations—five-sixths of humanity—do have things, but they lack the process to represent their property and create capital. They have houses but not titles; crops but not deeds; businesses but not statutes of incorporation. It is the unavailability of these essential representations that explains why people who have adapted every other Western invention, from the paper clip to the nuclear reactor, have not been able to produce sufficient capital to make their domestic capitalism work.
This is the mystery of capital. Solving it requires an understanding of why Westerners, by representing assets with titles, are able to see and draw out capital from them. One of the greatest challenges to the human mind is to comprehend and to gain access to those things we know exist but cannot see. Not everything that is real and useful is tangible and visible. Time, for example, is real, but it can only be efficiently managed when it is represented by a clock or a calendar. Throughout history, human beings have invented representational systems—writing, musical notation, double-entry bookkeeping—to grasp with the mind what human hands could never touch. In the same way, the great practitioners of capitalism, from the creators of integrated title systems and corporate stock to Michael Milken, were able to reveal and extract capital where others saw only junk by devising new ways to represent the invisible potential that is locked up in the assets we accumulate.
At this very moment you are surrounded by waves of Ukrainian, Chinese, and Brazilian television that you cannot see. So, too, are you surrounded by assets that invisibly harbor capital. Just as the waves of Ukrainian television are far too weak for you to sense them directly but can, with the help of a television set, be decoded to be seen and heard, so can capital be extracted and processed from assets. But only the West has the conversion process required to transform the invisible to the visible. It is this disparity that explains why Western nations can create capital and the Third World and former communist nations cannot.
The absence of this process in the poorer regions of the world–where two-thirds of humanity lives—is not the consequence of some Western monopolistic conspiracy. It is rather that Westerners take this mechanism so completely for granted that they have lost all awareness of its existence. Although it is huge, nobody sees it, including the Americans, Europeans, and Japanese who owe all their wealth to their ability to use it. It is an implicit legal infrastructure hidden deep within their property systems—of which ownership is but the tip of the iceberg. The rest of the iceberg is an intricate man-made process that can transform assets and labor into capital. This process was not created from a blueprint and is not described in a glossy brochure. Its origins are obscure and its significance buried in the economic subconscious of Western capitalist nations.
How could something so important have slipped our minds? It is not uncommon for us to know how to use things without understanding why they work. Sailors used magnetic compasses long before there was a satisfactory theory of magnetism. Animal breeders had a working knowledge of genetics long before Gregor Mendel explained genetic principles. Even as the West prospers from abundant capital, do people really understand the origin of capital? If they don’t, there always remains the possibility that the West might damage the source of its own strength. Being clear about the source of capital will also prepare the West to protect itself and the rest of the world as soon as the prosperity of the moment yields to the crisis that is sure to come. Then the question that always arises in international crises will be heard again: Whose money will be used to solve the problem?
So far, Western countries have been happy to take their system for producing capital entirely for granted and to leave its history undocumented. That history must be recovered. This book is an effort to reopen the exploration of the source of capital and thus explain how to correct the economic failures of poor countries. These failures have nothing to do with deficiencies in cultural or genetic heritage. Would anyone suggest “cultural” commonalities between Latin Americans and Russians? Yet in the last decade, ever since both regions began to build capitalism without capital, they have shared the same political, social, and economic problems: glaring inequality, underground economies, pervasive mafias, political instability, capital flight, flagrant disregard for the law. These troubles did not originate in the monasteries of the Orthodox Church or along the pathways of the Incas.
But it is not only former communist and Third World countries that have suffered all of these problems. The same was true of the United States in 1783, when President George Washington complained about “banditti…skimming and disposing of the cream of the country at the expense of the many.” These “banditti” were squatters and small illegal entrepreneurs occupying lands they did not own. For the next one hundred years, such squatters battled for legal rights to their land and miners warred over their claims because ownership laws differed from town to town and camp to camp. Enforcing property rights created such a quagmire of social unrest and antagonism throughout the young United States that the Chief Justice of the Supreme Court, Joseph Story, wondered in 1820 whether lawyers would ever be able to settle them.
Do squatters, bandits, and flagrant disregard of the law sound familiar? Americans and Europeans have been telling the other countries of the world, “You have to be more like us.” In fact, they are very much like the United States of a century ago when it too was an undeveloped country. Western politicians once faced the same dramatic challenges that leaders of the developing and former communist countries are facing today. But their successors have lost contact with the days when the pioneers who opened the American West were undercapitalized because they seldom possessed title to the lands they settled and the goods they owned, when Adam Smith did his shopping in black markets and English street urchins plucked pennies cast by laughing tourists into the mud banks of the Thames, when Jean-Baptiste Colbert’s technocrats executed 16,000 small entrepreneurs whose only crime was manufacturing and importing cotton cloth in violation of France’s industrial codes.
That past is many nations’ present. The Western nations have so successfully integrated their poor into their economies that they have lost even the memory of how it was done, how the creation of
capital began back when, as the American historian Gordon Wood has written, “something momentous was happening in the society and culture that released the aspirations and energies of common people as never before in American history.”1 The “something momentous” was that Americans and Europeans were on the verge of establishing widespread formal property law and inventing the conversion process in that law that allowed them to create capital. This was the moment when the West crossed the demarcation line that led to successful capitalism—when it ceased being a private club and became a popular culture, when George Washington’s dreaded “banditti” were transformed into the beloved pioneers that American culture now venerates.
The paradox is as clear as it is unsettling: Capital, the most essential component of Western economic advance, is the one that has received the least attention. Neglect has shrouded it in mystery—in fact, in a series of five mysteries.
The Mystery of the Missing Information
Charitable organizations have so emphasized the miseries and helplessness of the world’s poor that no one has properly documented their capacity for accumulating assets. Over the past five years, I and a hundred colleagues from six different nations have closed our books and opened our eyes—and gone out into the streets and countrysides of four continents to count how much the poorest sectors of society have saved. The quantity is enormous. But most of it is dead capital.
The Mystery of Capital
This is the key mystery and the centerpiece of this book. Capital is a subject that has fascinated thinkers for the past three centuries. Marx said that you needed to go beyond physics to touch “the hen that lays the golden eggs”; Adam Smith felt you had to create “a sort of waggon-way through the air” to reach that same hen. But no one has told us where the hen hides. What is capital, how is it produced, and how is it related to money?
The Mystery of Political Awareness
If there is so much dead capital in the world, and in the hands of so many poor people, why haven’t governments tried to tap into this potential wealth? Simply because the evidence they needed has only become available in the past forty years as billions of people throughout the world have moved from life organized on a small scale to life on a large scale. This migration to the cities has rapidly divided labor and spawned in poorer countries a huge industrial-commercial revolution—one that, incredibly, has been virtually ignored.
The Missing Lessons of U.S. History
What is going on in the Third World and the former communist countries has happened before, in Europe and North America. Unfortunately, we have been so mesmerized by the failure of so many nations to make the transition to capitalism that we have forgotten how the successful capitalist nations actually did it. For years I visited technocrats and politicians in advanced nations, from Alaska to Tokyo, but they had no answers. It was a mystery. I finally found the answer in their history books, the most pertinent example being that of U.S. history.
The Mystery of Legal Failure: Why Property Law Does Not Work Outside the West
Since the nineteenth century, nations have been copying the laws of the West to give their citizens the institutional framework to produce wealth. They continue to copy such laws today, and obviously it doesn’t work. Most citizens still cannot use the law to convert their savings into capital. Why this is so and what is needed to make the law work remains a mystery.
The solution to each of these mysteries is the subject of a chapter in this book.
The moment is ripe to solve the problem of why capitalism is triumphant in the West and stalling practically everywhere else. As all plausible alternatives to capitalism have now evaporated, we are finally in a position to study capital dispassionately and carefully.
CHAPTER TWO
The Mystery of Missing Information
Economics, over the years, has become more and more abstract and divorced from events in the real world. Economists, by and large, do not study the workings of the actual economic system. They theorize about it. As Ely Devons, an English economist, once said at a meeting, “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, The Task of the Society
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.
This 80 percent majority is not, as Westerners often imagine, desperately impoverished. In spite of their obvious poverty, even those who live under the most grossly unequal regimes possess far more than anybody has ever understood. What they possess, however, is not represented in such a way as to produce additional value. When you step out the door of the Nile Hilton, what you are leaving behind is not the high-technology world of fax machines and ice makers, television and antibiotics. The people of Cairo have access to all those things.
What you are really leaving behind is the world of legally enforceable transactions on property rights. Mortgages and accountable addresses to generate additional wealth are unavailable even to those people in Cairo who would probably strike you as quite rich. Outside Cairo, some of the poorest of the poor live in a district of old tombs called “the city of the dead.” But almost all of Cairo is a city of the dead—of dead capital, of assets that cannot be used to their fullest. The institutions that give life to capital—that allow one to secure the interests of third parties with work and assets—do not exist here.
To understand how this is possible, one must look to the nineteenth century, when the United States was carving a society out of its own wilderness. The United States had inherited from Britain not only its fantastically complex land law but also a vast system of overlapping land grants. The same acre might belong to one man who had received it as part of a vast land grant from the British Crown, to another who claimed to have bought it from an Indian tribe, and to a third who had accepted it in place of salary from a state legislature—and none of the three might ever have actually laid eyes on it. Meanwhile, the country was filling up with immigrants, who settled boundaries, ploughed fields, built homes, transferred land, and established credit long before governments conferred on them any right to engage in these acts. Those were the days of the pioneers and the “Wild West.” One of the reasons it was so wild was that those pioneers, most of them nothing but squatters, “insisted that their labor, not formal paper titles or arbitrary boundary lines, gave land value and established ownership.”1 They believed that if they occupied the land and improved it with houses and farms, it was theirs. State and federal governments believed otherwise. Officials sent in troops to burn farms and destroy buildings. Settlers fought back. When the soldiers left, the settlers rebuilt and returned to scratching out a living. That past is the Third World’s present.
A Surprise Revolution
Before 1950, most Third World countries were agricultural societies organized in ways that would have made an eighteenth-century European feel right at home. Most people worked on the land, which was owned by a very few big landlords, some of them indigenous oligarchs, others colonial planters. Cities were small and functioned as markets and ports rather than industrial centers; they were dominated by tiny mercantile elites who protected their interests with thick wrappings of rules and regulations.
After 1950, there began in the Third World an economic revolution similar to the social and economic disruptions in Europe in 1800. New machines were reducing the de
mand for rural labor just as new medicines and public-health methods were cutting the rate of infant mortality and extending life spans. Soon hundreds of thousands of people were trundling down the newly built highways to the cities so alluringly described in the new radio programs.
The population of the cities began to rise rapidly. In China alone, more than 100 million people have moved from the countryside to the cities since 1979. Between 1950 and 1988, the population of metropolitan Port-au-Prince rose from 140,000 to 1,550,000. By 1998, it was approaching 2 million. Almost two-thirds of these people live in shantytowns. Experts were already in despair over this surge of new city dwellers as early as 1973, long before the largest influx had taken place. “Everything happens as if the city were falling apart,” wrote one urbanist. “Uncontrolled construction, anywhere anyhow. The sewage system is incapable of helping drain rainwater and stuffs up every day. The population concentrates in defined areas where no sanitation infrastructure is provided…. The sidewalks of the Avenue Dessalines are literally occupied by small vendors…. This town has become unlivable.”2
Few had anticipated this enormous transformation in the way people lived and worked. The fashionable theories of the day about “development” sought to bring modernity to the countryside. Peasants were not supposed to come to the cities looking for the twentieth century. But tens of millions came anyway, despite a backlash of mounting hostility. They faced an impenetrable wall of rules that barred them from legally established social and economic activities. It was tremendously difficult for these new city people to acquire legal housing, enter formal business, or find a legal job.
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