The Mystery of Capital

by Hernando De Soto

  Those countries that adapted quickly, however, made a relatively peaceful transition to a market economy. As soon as the state realized that a working extralegal sector was socially, politically, and economically preferable to a growing number of unemployed migrants, authorities began withdrawing support from the guilds. The result in England was that fewer and fewer people applied for admission to the guilds, thereby setting the stage for the state to alter drastically the way in which business was conducted.

  The power of the state also declined. Any legal system as rigid as the one that preceded the Industrial Revolution was bound to be rife with corruption. A 1692 ordinance in England stated that tax inspectors in many areas visited workshops and factories merely to collect agreed-upon tax payments without ever examining the goods to see how much the producers really owed. Most production supervisors, whether they belonged to the guilds or were appointed by the state, were continually accused of corruption and neglect of duties, a situation that was attributed to lack of civic respect for the law.

  Even members of Parliament, which by the end of the seventeenth century had the power to authorize the establishment of businesses, were known to receive bribes for special favors. Local authorities were worse. In 1601, a speaker in the House of Commons defined a justice of the peace as “a living Creature that for half a Dozen of Chickens will Dispense with a whole Dozen of Penal Statutes.” Public officials sought to blame legislative failures not on bad laws but on inadequate enforcement. “I conclude better laws in these points cannot be made, only there wants execution,” declared one pamphlet in 1577. Joseph Reid argues that the old order broke down because widespread corruption permeated all its institutions and divided the population into those who could outwit the system and those who could not. He also notes that a legal system that encouraged some people to break the law and made others suffer from it would inevitably lose prestige among both constituencies.33 Suburban justices of the peace had little incentive to enforce laws that had been drafted in the cities and were unacceptable to suburban residents. By the end of the eighteenth century, the entire legal apparatus had been weakened and in some countries was completely corrupt.

  At a time when government controlled everything, people placed all their economic expectations in the state. This gave rise to a pattern typical of precapitalism: When wages went up faster than food prices, merchants called for wage ceilings; when food prices went up faster than wages, workers demanded a minimum wage and a price ceiling on foodstuffs. Prices, incomes, and wages were fixed by political pressure and action, a situation that discouraged industrial and agricultural production and hiring. Neither minimum nor maximum prices, therefore, could solve the problems of scarcity, food shortages, and unemployment. “The age,” writes Charles Wilson, “was one of violence, when the pursuit of economic ends constantly demanded the backing of force.”34 It was a time ripe for ideological and partisan battle, in parliaments and in the streets.

  As early as 1680, a kind of fatalism had emerged in the face of the apparent impossibility of substantial economic progress: “The generality of poor manufacturers believe they shall never be worth ten pounds…; and if it so be they can provide for themselves sufficient to maintain their manner of living by working only three days in the week, they will never work four days.”35

  Amid such economic crises and social unrest, the strongest and most self-confident people chose to emigrate or join revolutionary movements. Between the seventeen and nineteenth centuries, hundreds of thousands of Italians, Spaniards, French, and other Europeans emigrated to other lands in search of a better future. In France, the persecution of the Huguenots and the extralegals in the textile sector prompted many entrepreneurs and skilled workmen to leave, mainly for England and Holland, where they and their hosts managed to prosper.

  Finally—After Three Hundred Years

  As badly structured regulations stifled formal businesses and as extralegals openly defied the law and voiced their dissatisfaction at being pushed to the margins, the stage was set for politicians to adapt to the facts on the ground. The law had ossified at about the same rate as the migrant settlements encircled the cities. And as peddlers, beggars, and thieves invaded the streets, as extralegally manufactured or smuggled goods glutted the markets, official corruption became rampant, and violence disrupted civil society.

  Law began adapting to the needs of common people, including their expectations about property rights, in most West European countries during the nineteenth and early twentieth centuries. By that time, the Europeans had concluded that it was impossible to govern the Industrial Revolution and the presence of massive extralegality through minor ad hoc adjustments. Politicians finally understood that the problem was not people but the law, which was discouraging and preventing people from being more productive.

  Although the picture of precapitalist society and the circumstances of its decline are quite similar in most European countries, the outcome was not always the same. Countries that made legal efforts to integrate extralegal enterprise prospered more quickly than the countries that resisted change. By easing access to formal property, reducing the obstacles engendered by obsolete regulations, and allowing existing local arrangements to influence law-making, European politicians eliminated the contradictions in their legal and economic systems and allowed their nations to carry the Industrial Revolution to new heights.

  The past of Europe strongly resembles the present of developing and former communist countries. The fundamental problem that the latter face is not that people are invading and clogging the cities, that public services are inadequate, that garbage is piling up, that ragged children beg in the streets, or even that the benefits of macroeconomic reform programs are not reaching the majority. Many of these difficulties existed in Europe (and also the United States) and were eventually overcome. The real problem is that we have still not recognized that all these difficulties constitute a sea change in expectations: As the poor flow into cities and create extralegal social contracts, they are forcing a major redistribution of power. Once the governments of developing and former communist countries accept that, they can begin to catch the wave instead of being engulfed by it.

  CHAPTER FIVE

  The Missing Lessons of U.S. History

  This land is blessed in having to surmount only one tyranny: that of the status quo.

  —Milton and Rose Friedman

  AS I BECAME increasingly interested in the role of formal property systems in economic development, I made numerous trips to advanced nations to find out how their property rights experts would go about integrating a nation’s extralegal assets into one legal property system. After thirteen years, thousands of miles, and a little more gray hair, I had visited just about every property-related organization in the advanced world—from my friends in Her Majesty’s Land Registry and the Alaska Land Authority to the Japanese Toki Bo. No one had an answer. All the experts I queried, all the professionals associated with the myriad property-related institutions and agencies I visited admitted they had never thought about the question.

  People who operate property systems in advanced nations have fundamentally different concerns. They are largely preoccupied with matters relating to property rights. My primary concern, however, was not property rights per se but “meta-rights”—access or rights to property rights. Although we had many subjects of mutual interest, such as how to reengineer a record-keeping organization so as to integrate information gathered in the field into one database, or how to develop procedures to digitize boundaries on base maps, the property experts could not tell me how to bring people who hold their assets by extralegal arrangements into the legal property system. How do you give people rights to legal property rights?

  It was obvious, from what little Western history I had read, that at some point in their past all Western nations had made the transition from dispersed, informal arrangements to an integrated legal property system. So why didn’t I just go there—into the history of
the West to see how their property systems had evolved? My hosts agreed wholeheartedly, and the history buffs at Her Majesty’s Land Registry and the German Association of Licensed Surveyors pointed me to their favorite books.

  My reading, thousands of pages later, led me to the fundamental conclusion that the transition to integrated legal property systems had little to do with technology (although technology plays a very important supporting role, as we shall see in Chapter 6). The crucial change had to do with adapting the law to the social and economic needs of the majority of the population. Gradually, Western nations became able to acknowledge that social contracts born outside the official law were a legitimate source of law and to find ways of absorbing these contracts. Law was thus made to serve popular capital formation and economic growth. This is what gives the present property institutions of the West their vitality. Moreover, this property revolution was always a political victory. In every country, it was a result of a few enlightened men deciding that official law made no sense if a sizeable part of the population lived outside it.

  The various histories of property in Western Europe, Japan, and the United States all have something useful to say about the present concerns of developing and former communist countries. In each country, apparent lawlessness was not really about crime but a collision between rule making at the grassroots level and rule making at the top. The revolution in each case involved the gradual merging of both systems.

  However, detailed histories of all these countries would be too much for this book. I have decided, therefore, to focus on the United States because, more than 150 years ago, it too was a Third World country. The governments and judiciary of the young states, not yet so legally united, were trying to cope with the law and disorder of migrants, squatters, gold diggers, armed gangs, illegal entrepreneurs, and the rest of the colorful characters who made the settling of the American West so wild and, if only in hindsight, so romantic. To a Third Worlder like me, this picture of the gringo past is astonishingly familiar. Although my colleagues and I have trouble relating to 11,000 on the Dow Jones, we feel quite at home among the squatters in Thomas Jefferson’s Virginia or the log cabin settlements of Daniel Boone’s Kentucky.

  Like Third World authorities today, American governments tried to stem the exponential increase of squatters and extralegal arrangements; but unlike Third World authorities, they eventually conceded that, in the words of one U.S. congressman, “the land system is virtually broken down…and instead of legislating for them, we are to legislate after them in full pursuit to the Rocky Mountains or the Pacific Ocean.” What U.S. politicians eventually learned, as Francis Philbrick put it, was that the “forces that change the law in other than trivial ways lie outside it.”1 Even the celebrated Homestead Act of 1862, which entitled settlers to 160 acres of free land simply for agreeing to live on it and develop it, was less an act of official generosity than the recognition of a fait accompli: Americans had been settling—and improving—the land extralegally for decades. Their politicians gradually modified the law to integrate this reality into the official legal system and won some political points in the bargain. Having thus changed their laws to accommodate existing extralegal arrangements, U.S. officials left the assets of the American settlers and miners primed to be converted into capital. As in the United States in the nineteenth century, the challenge of capitalizing the poor in the Third World and former communist countries is at bottom a political challenge that has to be reformed with legal tools.

  In describing the evolution of property in the United States, as I will do in this chapter, I do not presume to rewrite the history of America; like my legendary namesake, I am simply exploring it. In the process, as you will see, I found many examples that reminded me of developing and former communist countries today: massive migrations, explosions of extralegal activity, political unrest, and general discontent with an antiquated legal system that refused to acknowledge that its doctrines and formulas had little relevance to the real world. I also found how U.S. law gradually integrated extralegal arrangements to bring about a peaceful order—thereby confirming Justice Holmes’s opinion that it is “experience” that gives life to the law demonstrating, as we shall see in the next chapter, that the law must be compatible with how people actually arrange their lives. The way law stays alive is by keeping in touch with social contracts pieced together among real people on the ground.

  The Parallel with U.S. History

  It is hard to grasp just how important extralegal pressure and political responsiveness were in the United States by reading indiscriminately through the U.S. history section of a library. Nor will it be easy for most reform-minded politicians and technocrats to discover the American history they should most care about, namely, the connection between the legalization of property and the creation of capital. To be socially and politically useful, history has to be assembled to illuminate the problem at hand. And by and large, property specialists have not written about the transition from extralegal rights to an integrated legal property system. There may be several reasons for this.

  First, the historical process is not yet complete. Contrary to popular belief, property systems open to all citizens are a relatively recent phenomenon—no more than two hundred years old—and the full implications of the transition have yet to emerge. In most nations of the West, the major task of widespread property reform was completed only about a century ago; in Japan it has been in place for less than fifty years. Since the whole process that created integrated property systems was more the result of unconscious evolution than conscious planning, it is not surprising that it will require time for all the useful lessons of property creation in advanced nations to become apparent to people in the developing world.

  Second, property has traditionally been considered from the point of view of the advanced nations. Most of today’s burgeoning literature on property takes its genesis in the West for granted.

  The third reason why the process of formal property creation is difficult to grasp is that it is hard to follow the thread of the story. The slow absorption of the practices, customs, and norms of extralegals into formal law has been obscured by other historical events. The granting of formal property rights to settlers and squatters in the United States, which eventually created the basis for capital generation and transactions in an expanded market, is typically treated as a political strategy to aid American imperial ambitions, help pioneers exploit the country’s vast resources, and ease sectional tensions. That these same steps may have also permitted the United States to transcend the conflict between the legal system and the extralegal arrangements of squatters and other pioneers has not been the primary focus of property specialists.

  What I intend in this chapter, let me emphasize again, is not to rewrite the history of the United States, but to rearrange the familiar narrative in a way that will help us understand that the apparent chaos in developing and former communist nations is actually a search for a new legal order. Let us look, then, at the transition of extralegal “law” from the woods and fields of the infant United States into its law books.

  Leaving Behind Antiquated British Law

  The sixteenth century saw the beginning of an unprecedented migration of Western Europeans to the shores of North and South America—what the historian Bernard Bailyn has called “one of the greatest events in recorded history.”2 In British North America, according to Hoffer, a “cold, tired, apprehensive assemblage of men and women…gathered on the western shore of the Atlantic, peering into a densely wooded wilderness. Clutching blunderbusses and Bibles, some must have summoned memories of the world they had left behind.”3

  Among those memories were notions of how to build and maintain communities, settle disputes, acquire land, and construct government institutions. The legal system played a prominent role in resolving the conflicts these actions invariably created. Indeed, the law “went everywhere” in early America as “the first colonial governments were based on legal docum
ents—‘charters.’…Colonial economies functioned under laws regulating prices, wages, and the quality of articles. Law gave the means for people to sell or will their land to others, provided a forum for settling arguments about broken fences and straying livestock, and even told people how to worship, marry, rear their children, and treat their servants and neighbors.”4

  Initially, colonists attempted to apply the doctrines of English property law to bring order. But English common law had not envisioned a society that was rapidly generating new forms of property access without an established and generally accepted titling system. English common law, for example, did not provide guidance for how courts should handle cases involving people who had bought or inherited land of dubious title. As a result, “open trials of title in the county courts became absolutely necessary. All interested parties were able to testify, and the court’s decision stood as a relatively effective and public guarantee where none other existed.”5

  Most of these colonists, however, had little comprehension of the technicalities of English law. Many did not know or care to know the differences between legal writs, law and equity, and other subtleties. More importantly, the English common law of property was often ill suited to deal with the problems that confronted the colonists. A superabundance of land in British North America presented the first settlers with opportunities unimaginable in the Europe they had left. Arriving “on a continent where much land was naturally clear or had been cleared by Indians, Englishmen [and other Europeans] rushed to apportion their new source of wealth…. As a result, scrupulous regard to detail was easily overlooked. Inexactness in allotment and recording was tolerated, and little attention was given to the orderly plans which, it had been expected [by colonial authorities,] were to be followed.”6 Not all of the land was fertile, well drained, or within easy reach of meadows to supply hay for the settlers’ cattle and horses.7 In their search for suitable land, American colonists often moved at whim, laying out boundaries, cultivating fields, building houses—and then abandoning it all to move on to more fertile territory.