The Mystery of Capital

by Hernando De Soto

  If all this sounds more like an anthropological adventure than the basis for legal reform, it is because knowledge about the poor has been monopolized by academics, journalists, and activists moved by compassion or intellectual curiosity rather than by the nuts and bolts of legal reform. Where have the lawyers been? Why haven’t they taken a hard look at the law and order that their own people produce? The truth is that lawyers in these countries are generally too busy studying Western law and adapting it. They have been taught that local practices are not genuine law but a romantic area of study best left to folklorists. But if lawyers want to play a role in creating good laws, they must step out of their law libraries into the extralegal sector, which is the only source of the information they need to build a truly legitimate formal legal system. By examining this “people’s law” and understanding its logic, reformers can get a sense of what they need to do to create a self-enforcing legal system.

  When they have done this, governments will have literally touched the social contract. They will have the information required to integrate the poor and their possessions into a legal framework, so that they can finally begin to have a stake in the capitalist system. But implementing legal reform will mean tampering with the status quo. That makes it a major political task.

  Part II: The Political Challenge

  Nobody planned the evolution from feudal and patrimonial systems to the modern property systems that exist in the West today. However, on the long evolutionary path to modernity, in those stretches of the journey when reformers embarked on deliberate programs to make property more accessible to a wider range of citizens, these programs were successful because they were supported by well-thought-out political strategies. That is what Thomas Jefferson did in Virginia at the end of the eighteenth century, when he increased the fungibility of property by abolishing, among other things, the practice of entail (not being able to transfer property outside the family). When Stein and Hardenberg set the stage for universal property rights in Germany at the beginning of the nineteenth century, and when Eugen Huber, in Switzerland at the beginning of the twentieth century, began to integrate all the dispersed property systems of his country, they likewise employed carefully planned strategies to storm the barricades of the status quo. They made sure they were armed with astutely aimed legislation that permitted government to create popularly supported, bloodless revolutions that could not be halted.

  Why do you need a political strategy today? Who could possibly be against removing a legal apartheid that is so obviously unjust? Few, in fact, would dispute the need for reform. But a tiny, powerful minority will intuit that reform is bound to perturb their little niches, and they will resist silently and insidiously. There is also a related problem: Many of the statutes that wall off the majority of people from capital may also contain provisions that protect vital interests of powerful groups. Opening up capitalism to the poor will not be as simple as running a bulldozer through garbage. It is more like rearranging the thousands of branches and twigs of a huge eagle’s nest—without irritating the eagle. Although this rearrangement will impose only small inconveniences on this tiny minority, when compared to the nationwide benefits of bringing capital to the poor, those affected will not see this unless reform is driven by a strong political initiative with the message and numbers to back it up.

  Clearly, this is a job for experienced political operatives with the sophistication to rearrange the eagle’s nest without being clawed. They are the only ones in a position to synchronize change for the majority and stability for the wary minorities. A strategy to capitalize the poor has to integrate two apparently contradictory property systems within the same body of law. If it is to succeed, a president or prime minister who is more than a mere technocrat has to take charge and make formalization a pillar of government policy. Only at the highest political level can reform command overwhelming support and wipe out the willful inertia of the status quo. Only the top level of government can prevent bureaucratic infighting and political conflicts from paralyzing the progress of reform. Whenever a nation sets out to make a major change, whether to stabilize money, privatize government agencies, or open up the schools to all races, the head of state steps forward to lead the charge. Emancipating the poor surely falls within the responsibilities of the nation’s leader.

  History and personal experience have taught us that to conduct a property revolution, a leader has to do at least three specific things: take the perspective of the poor, coopt the elite, and deal with the legal and technical bureaucracies that are the bell jar’s current custodians.

  Taking the Perspective of the Poor

  Everyone will benefit from globalizing capitalism within a country, but the most obvious and largest beneficiary will be the poor. With the poor on his side, a leader intent on reform has already won at least half the battle. Any opposition will be hard-pressed to take on the head of state and most of the people. But to win, he or she will have to gather the facts necessary to build a case. This involves carrying out original research: Reformers have to put themselves in the shoes of the poor and walk their streets. Official statistics do not contain the information they need. The facts and figures can be seen only from outside the bell jar.

  When I began studying the possibility of giving the poor access to formal property in Peru in the 1980s, every major law firm I consulted assured me that setting up a formal business to access capital would take only a few days. I knew this was true for me and my lawyers, but I had a hunch it was not true for the majority of Peruvians. So my colleagues and I decided to set up a two-sewing-machine garment factory in a Lima shantytown. To experience the process from the point of view of the poor, we used a stopwatch to measure the amount of time a typical entrepreneur in Lima would have to spend to get through the red tape. We discovered that to become legal took more than three hundred days, working six hours a day. The cost: thirty-two times the monthly minimum wage. We performed a similar experiment to find out what it would take for a person living in an extralegal housing settlement, whose permanence the government had already acknowledged, to acquire legal title to a home. To receive approval from only the municipality of Lima—just one of the eleven government agencies involved—took 728 bureaucratic steps (see Figure 6.3). This confirmed what I suspected from the beginning: Most conventional data reflects the interests of those, like the lawyers I consulted, who are already inside the bell jar. That is why the bell jar can be seen only from the outside looking in—from the perspective of the poor.

  Once government obtains this information, it will be able to explain its intent in a way the poor can understand and relate to. As a result, they will support the agenda of reform enthusiastically. The poor will become the most effective public relations machine for reform, providing the feedback from the streets necessary to keep the program on course.

  This is what happened in Peru. From 1984 to 1994, my colleagues and I directed all our efforts at informing the public about the benefits of lifting the bell jar (at the time we called it “formalization”). Our objective was to prove to the politicians that there was a hidden national consensus for reform and that formalizing the assets of the poor was politically a winning strategy. By the late 1980s, the polls confirmed this: Our proposals to change the formal property system had an approval rating of nearly 90 percent. With numbers like that, it was not surprising that when the first pieces of legislation and regulations that my organization drafted for formalization came before the Peruvian Congress in 1988 and early 1990, they were unanimously approved. During the 1990 presidential campaign, every candidate, including Mario Vargas Llosa, the novelist and candidate of the libertarian-conservative coalition, and Alberto Fujimori, the dark-horse populist and eventual winner, along with the outgoing socialist president Alan Garcia, subscribed to the agenda of formalization. Even today, in spite of implementation efforts that have been erratic and very incomplete, formalization is an uncontested and permanent fixture of the Peruvian political landsc
ape.

  With the facts, figures, and public opinion all on the side of reform, the government will be in a position to move the whole issue of poverty dramatically into its agenda for economic growth. Relieving poverty will no longer be seen as a charitable cause, to be undertaken if and when it ever becomes affordable. On the contrary, the future of the poor can now top the list of the government’s program for growth.

  Coopting the Elites

  Once the economic potential of the poor—the largest constituency in the nation—has been revealed and their support for reform is manifest, reformers will have the attention of the elite. This is the moment to break their illusion that lifting the bell jar benefits only the poor. It is not only that bridging the gap between classes is a general social good. This kind of legal integration can help almost every interest group in the nation. Just as reformers collected facts and numbers to win the support of the poor, they must use other facts and figures to win over vested interests. The elites must support reform not out of patriotism or altruism but because it will also enlarge their pocketbooks.

  For example, bringing the extralegal sector inside the law will open up the opportunity for massive low-cost housing programs that will provide the poor with homes that are not only better built but much cheaper than what they themselves have been building in the extralegal sector. Creating a home in the topsy-turvy world of the extralegal sector is equivalent to getting dressed by putting on your shoes first, then your socks. Consider what it takes for a new migrant from a rural area to create a home for his family in a shantytown outside a large city. First, he not only has to find a spot for his house but also has to occupy the land personally, with his family. The next step is to set up a tent or shelter made from, depending on the country, straw matting, mud bricks, cardboard, plywood, corrugated iron, or tin cans—and thus stake out a physical claim (because a legal one is unavailable). The migrant and his family will then gradually bring in furniture and other household items. Obviously, they need a more livable and durable edifice. But how to build it without access to credit? They do what everyone else does—stock solid building materials and begin to build a better house, stage by stage, according to what kinds of materials they can accumulate.

  Once the inhabitants of one of these new neighborhoods have organized enough to protect their holdings or the local authorities take pity on their deprivation, they can bring in pavement, water, waste disposal, and electricity—typically at the cost of having to destroy parts of their houses in order to hook up to the utilities. Only after years of building and rebuilding, and saving construction materials, are these homeowners finally in a position to live comfortably.

  In the West, creating a home is the equivalent of putting on your socks before your shoes and is thus much less hazardous, expensive, and degrading. A developer typically holds title to the land, which gives him the security to develop the infrastructure (paved roads, utilities, etc.). Then he sells the house, which he proceeds to build according to the buyer’s preferences. The new owners, who have probably borrowed most of the price of the house from a bank, will then move their furniture in and, finally, the kids and the cat.

  As soon as the poor become accountable under formal law, they will be able to afford low-cost housing and thus escape from the topsy-turvy world of the extralegal sector. The elites will then begin to collect their rewards as well: Builders and construction material manufacturers will find their markets expanding, as will banks, mortgage companies, title agencies, and insurance firms. Formalization will also help the suppliers of public utilities to convert home addresses into liable terminals. It will provide governments and businesses with information and addresses for merchandising, securing interests, and collecting debts, fees, and taxes. In addition, a formal property system supplies a database for investment decisions in health care, education, tax assessment, and environmental planning.

  Widespread legal property will even help solve one of their loudest and most persistent complaints about the expanding urban poor—the need for more “law and order.” Civil society in market economies is not simply due to greater prosperity. The right to property also engenders respect for law. As the eminent historian Richard Pipes pointed out in his book about the Russian revolution:

  Private property is arguably the single most important institution of social and political integration. Ownership of property creates a commitment to the political and legal order since the latter guarantees property rights: it makes the citizen into a co-sovereign, as it were. As such, property is the principal vehicle for inculcating in the mass of the population respect for law and an interest in the preservation of the status quo. Historical evidence indicates that societies with a wide distribution of property, notably in land and residential housing, are more conservative and stabler, and for that reason more resilient to upheavals of all sorts. Thus the French peasant, who in the eighteenth century was a source of instability, became in the nineteenth, as a result of the gains of the French Revolution, a pillar of conservatism.18

  When poor people have confidence that their land and businesses are legally theirs, their respect for other people’s property increases.

  Formal, up-to-date property records will also provide the police with the information necessary for civilized restraint. In developing and former communist nations, one of the chief characteristics of outlaws is not having a legal address. When a crime is committed, police do not have the records, leads, or other property-based information necessary to “skip trace” prime suspects. That is why law enforcement authorities cannot be as selective as their Western counterparts when rounding up suspects and are thus more likely to violate innocent people’s civil rights.

  Owning formal property also tends to discourage unruly behavior. When people are forced to divide their property into smaller and smaller parcels, the heirs of their heirs, crowded off the family land, are more likely to squat elsewhere. Also, when a person cannot prove he owns anything, he is more likely to have to bribe his way through the bureaucracy, or with the help of his neighbors, take the law into his own hands. Worse still, without good law to enforce obligations, society in effect invites the gangsters and terrorists to do the job. My colleagues and I have carried out formal titling campaigns that have displaced terrorists by coopting their role as the area’s security force against the real or imagined threat of land expropriation.

  Property also provides a legal alternative to drug trafficking. As long as the farmers remain illegal landowners, short-term cash crops, like coca and opium poppies, remain their only alternative. For small farmers in some areas of the developing world, money advanced by drug traffickers is practically the only credit available, and because their property arrangements appear in no official system, law enforcement cannot even find them, never mind work out an enforceable crop-substitution agreement. This lack of legal protection also means that growers of drug crops have to band together to defend their assets or call on traffickers to defend them. Without a formal property system that includes such landowners, controlling growers of drug crops, chasing drug traffickers, and identifying polluters of the environment becomes virtually impossible. There is no way for authorities to penetrate the tight extralegal arrangements the people create to protect their interests.

  Legalizing property is hardly charity for the poor. Creating an orderly market that makes owners accountable and gives their homes clear titles worthy of financing will generate an expanding market, encourage law and order, and put money into the pockets of the elite.

  Dealing with the Custodians of the Bell Jar

  Once reformers have the poor and at least some of the elite on their side, it will be time to take on the public and private bureaucracy who administer and maintain the status quo—principally, the lawyers and the technicians.

  The Lawyers. In theory, the legal community should favor reform because it will expand the rule of law. But, in fact, most lawyers in developing and former communist countries have been trained no
t to expand the rule of law but to defend it as they found it. Lawyers are the professionals most involved in the day-to-day business of property. They sit in the key government offices where they can suppress major decisions. No group—aside from terrorists—is better positioned to sabotage capitalist expansion. And unlike terrorists, the lawyers know how to do it legally.

  Although entrepreneurs and ordinary people are the builders of capital and capitalism, it is the lawyers who fix property concepts in tangible representative form and define those concepts in statutes. The security of ownership, the accountability of owners, and the enforceability of transactions must ultimately be concretized in procedures and rules drafted by lawyers. In fact, it is the legal profession that perfects all the artifacts of formal property: titles, records, trademarks, copyrights, promissory notes, bills of exchange, patent rights, shares of corporate stock. Whether you like lawyers or not, no genuine change in the property regime and the capital formation process will take place without the cooperation of at least some of them.