The Mystery of Capital

by Hernando De Soto

  Yet only the Western nations and small enclaves of wealthy people in developing and former communist nations have the capacity to represent assets and potential and, therefore, the ability to produce and use capital efficiently. Capitalism is viewed outside the West with increasing hostility, as an apartheid regime most cannot enter. There is a growing sense, even among some elites, that if they have to depend solely and forever on the kindness of outside capital, they will never be productive players in the global capitalist game. They are increasingly frustrated at not being masters of their own fate. Since they have embarked on globalization without providing their own people with the means to produce capital, they are beginning to look less like the United States than like mercantilist Latin America with its disarray of extralegal activity.2 Ten years ago, few would have compared the former Soviet bloc nations to Latin America. But today they look astonishingly similar: strong underground economies, glaring inequality, pervasive mafias, political instability, capital flight, and flagrant disregard for law.

  That is why outside the West advocates of capitalism are intellectually on the retreat. Ascendant just a decade ago, they are now increasingly viewed as apologists for the miseries and injustices that still affect the majority of people. For example, in 1999 Egypt’s consultative upper house warned the government “not to be deceived any longer by calls for capitalism and globalization.”3 Having forgotten the crucial issue of property, capitalism’s advocates have let themselves become identified as the defenders of the status quo, blindly trying to enforce existing written law whether it discriminates or not.

  And the law in those countries does discriminate. As I illustrated in Chapter 2, at least 80 percent of the population in these countries cannot inject life into their assets and make them generate capital because the law keeps them out of the formal property system. They have trillions of dollars in dead capital, but it is as if these were isolated ponds whose waters disappear into a sterile strip of sand, instead of forming a mighty mass of water that can be captured in one unified property system and given the form required to produce capital. People hold and use their assets on the basis of myriad disconnected informal agreements where accountability is managed locally. Without the common standards that legal property brings, they lack the language necessary for their assets to talk to each other. There is no use urging them to be patient until the benefits of capitalism trickle down their way. That will never happen until the firm foundations of formal property are in place.

  Meanwhile, the promoters of capitalism, still arrogant on their victory over communism, have yet to understand that their macroeconomic reforms are not enough. We must not forget that globalization is occurring because developing and former communist nations are opening up their once protected economies, stabilizing their currencies, and drafting regulatory frameworks to enhance international trade and private investment. All of this is good. What is not so good is that these reforms assume that these countries’ populations are already integrated into the legal system and have the same ability to use their resources in the open market. They do not.

  As I have argued in Chapter 3, most people cannot participate in an expanded market because they do not have access to a legal property rights system that represents their assets in a manner that makes them widely transferable and fungible, that allows them to be encumbered and permits their owners to be held accountable. So long as the assets of the majority are not properly documented and tracked by a property bureaucracy, they are invisible and sterile in the marketplace.

  By stabilizing and adjusting by “the book,” the globalizers’ macroeconomic programs have dramatically rationalized the economic management of developing countries. But because their book does not address the fact that most people do not have property rights, they have done only a fraction of the work required to create a comprehensive capitalist system and market economy. Their tools are designed to work in countries where systematized law has been “globalized” internally, when inclusive property rights systems that link up to efficient monetary and investment instruments are in place—something these countries have yet to achieve.

  Too many policymakers have taken an Olympian view of the globalization process. Once they stabilized and adjusted at the macro level, allowing legal business and foreign investors to prosper and orthodox economists to control the treasury, they felt they had fulfilled their duty. Because they concentrated only on policies dealing with the aggregates, they did not inquire whether people had the means to participate in an expanded market system. They forgot that people are the fundamental agents of change. They forgot to focus on the poor. And they made that enormous omission because they do not operate with the concept of class in mind. In the words of one of their most outstanding pundits, they do not have “the ability to comprehend, however dimly, how other people live.”4

  Economic reformers have left the issue of property for the poor in the hands of conservative legal establishments uninterested in changing the status quo. As a result, the assets of the majority of their citizens have remained dead capital stuck in the extralegal sector. This is why the advocates of globalization and free market reforms are beginning to be perceived as the self-satisfied defenders of the interests of those who dominate the bell jar.

  Facing Up to Marx’s Ghost

  Most economic reform programs in poor economies may be falling into the trap that Karl Marx foresaw: The great contradiction of the capitalist system is that it creates its own demise because it cannot avoid concentrating capital in a few hands. By not giving the majority access to expanded markets, these reforms are leaving a fertile field for class confrontation—a capitalist and free market economy for the privileged few who can concretize their property rights, and relative poverty for a large undercapitalized sector incapable of leveraging its own assets.

  Class confrontations, in this day and age? Didn’t that concept come down with the Berlin Wall? Unfortunately, it did not. This may be hard for a citizen in an advanced nation to understand because in the West those discontented with the system live in “pockets of poverty.” Misery in developing and former communist nations, however, is not contained in pockets; it is spread throughout society. What few pockets exist in those countries are pockets of wealth. What the West calls “the underclass” is here the majority. And in the past, when their rising expectations were not met, that mass of angry poor brought apparently solid elites to their knees (as in Iran, Venezuela, and Indonesia). In most countries outside the West, governments depend on strong intelligence services, and their elites live behind fortress-like walls for good reason.

  Today, to a great extent, the difference between advanced nations and the rest of the world is that between countries where formal property is widespread and countries where classes are divided into those who can fix property rights and produce capital and those who cannot. If extralegal property rights are not accommodated, these societies may muddle along with their dual economies—with the so-called law-abiding sector on one side and the impoverished extralegal sector on the other. But as information and communications continue to improve and the poor become better informed of what they do not have, the bitterness over legal apartheid is bound to grow. At some point, those outside the bell jar will be mobilized against the status quo by people with political agendas that thrive on discontent. “If we do not invent ways to make globalization more inclusive,” says Klaus Schwab of the World Economic Forum, “we have to face the prospect of a resurgence of the acute social confrontations of the past, magnified at the international level.”5

  The Cold War may have ended, but the old class arguments have not disappeared. Subversive activities and an upsurge of ethnic and cultural conflicts around the world prove that when people are extremely dissatisfied they continue to constitute themselves into classes based on shared injuries. Newsweek notes that in the Americas since the 1980s, “each of these struggles has its own unique history, but the fighters all vilify the same enemy: the new face
of Latin American capitalism.”6 In such situations, the Marxist tool kit is better geared to explain class conflict than capitalist thinking, which has no comparable analysis or even a serious strategy for reaching the poor in the extralegal sector. Capitalists generally have no systemic explanation of how the people in the underclass got where they are and how the system could be changed to raise them up.

  We must not underestimate the latent power of Marxist integrated theory at a time when masses of people with little hope are looking for a cohesive worldview to improve their desperate economic prospects. In a period of economic boom, there tends to be little time for deep thinking. Crisis, however, has a way of sharpening the mind’s need for order and explanations into obsession. Marxist thinking, in whatever form it reappears—and it will—supplies a much mightier array of concepts for grappling with the political problems of capitalism outside the West than capitalist thinking does.

  Marx’s insights into capital, as George Soros recently observed, are often more sophisticated than those of Adam Smith.7 Marx understood clearly that “in themselves, money and commodities are no more capital than are the means of productions and of subsistence. That they want transforming into capital.”8 He also understood that if assets could be converted into commodities and made to interact in markets, they could express values that are imperceptible to the senses but can be captured to produce rents. For Marx, property was an important issue because it was clear to him that those who appropriated the assets obtained much more than just their physical attributes. As a result, the Marxist intellectual tool kit has left anticapitalists powerful ways to explain why private property will necessarily put assets in the hands of the rich at the expense of the poor.

  For those who have not noticed, the arsenal of anticapitalism and antiglobalization is building up. Today, there are serious statistics that provide the anticapitalists with just the ammunition they need to argue that capitalism is a transfer of property from poorer to richer countries and that Western private investment in developing nations is nothing short of a massive takeover of their resources by multinationals. The number of flashy cars, luxurious homes, and California-style shopping malls may have increased in most developing and former communist nations over the past decade, but so have the poor. Nancy Birdsall and Juan Luis Londoño’s research shows that poverty has grown faster and income distribution has worsened over the last decade.9 According to a 1999 United Nations “Human Development Report,” gross domestic product in the Russian Federation fell by 41 percent from 1990 to 1997, driving millions into the extralegal sector. The life expectancy of the Russian male has dropped four full years—to fifty-eight. The report blames the transition to capitalism and the effects of globalization.

  These research efforts provide us with healthy warning signals, but they are also putting in place the intellectual missiles needed to discourage privatization programs and global capitalism. It is crucial, therefore, to recognize the latent Marxist paradigms and then add what we have learned in the century since Marx died. We can now demonstrate that although Marx clearly saw that a parallel economic life can be generated alongside physical assets themselves—that “the productions of the human brain appeared as independent beings endowed with life”10—he did not quite grasp that formal property was not simply an instrument for appropriation but also the means to motivate people to create real additional usable value. Moreover, he did not see that it is the mechanisms contained in the property system itself that give assets and the labor invested in them the form required to create capital. Although Marx’s analysis of how assets become transcendent and serve greater social uses when they become exchangeable is fundamental to understanding wealth, he was not able to foresee to what degree legal property systems would become crucial vehicles for the enhancement of exchange value.

  Marx understood better than anyone else in his time that in economics there is no greater blindness than seeing resources exclusively in terms of their physical properties. He was well aware that capital was “an independent substance…in which money and commodities are mere forms which it assumes and casts off in turn.”11 But he lived in a time when it was probably still too soon to see how formal property could, through representation, make those same resources serve additional functions and produce surplus value. Consequently, Marx could not see how it would be in everyone’s interest to increase the range of the beneficiaries of property. Property titles were only the visible tip of a growing formal property iceberg. The rest of the iceberg is now an enormous man-made facility for drawing out the economic potential of assets. That is why Marx did not fully understand that legal property is the indispensable process that fixes and deploys capital, that without property mankind cannot convert the fruits of its labor into fungible, liquid forms that can be differentiated, combined, divided, and invested to produce surplus value. He did not realize that a good legal property system, like a Swiss army knife, has many more mechanisms than just the elementary “ownership” blade.

  Much of Marx’s thought is outdated because the situation today is not the same as in Marx’s Europe. Potential capital is no longer the privilege of the few. After Marx’s death, the West finally managed to set up a legal framework that gave most people access to property and the tools of production. Marx would probably be shocked to find how in developing countries much of the teeming mass does not consist of oppressed legal proletarians but of oppressed extralegal small entrepreneurs with a sizeable amount of assets.

  Admiration for good property systems should not blind us to the fact that, as Marx noted, these systems can also be used for theft. The world will always be full of sharks expert at using property paper to skim off wealth from unsuspecting people. Yet one cannot oppose formal property systems for this reason, any more than one should abolish computers or automobiles because people use them to commit crimes. If Marx were alive today and saw the misappropriation of resources that has occurred on both sides of the former Iron Curtain, he would probably agree that looting can happen with or without property and that controlling thievery depends more on the exercise of power than on property. In addition, though Marx gave “surplus value” a very specific definition, its meaning is not chained to his pen. People have always produced surplus value: pyramids, cathedrals, expensive armies, to name a few examples. Clearly much of today’s surplus value in the West has originated not in scandalously expropriated labor time but in the way that property has given minds the mechanisms with which to extract additional work from commodities.

  Like all of us, Marx was influenced by the social conditions and technologies of his time. The expropriation of small proprietors from their means of subsistence, the access to private property rights stemming from feudal title, the robbery of common lands, the enslavement of aboriginal populations, the looting of the conquered, and the “commercial hunting of black skins” by the colonial system may all have been essential preconditions for what Marx called the “primitive accumulation of capital.” These conditions are difficult to repeat today. Attitudes have changed—to no little extent because of Marx’s own writings. Looting, slavery, and colonialism now have no government’s imprimatur. Most countries today are parties to treaties such as the Universal Declaration of Human Rights and have constitutions that provide equal access to property rights as one of the fundamental rights of humankind.

  Moreover, as we saw in Chapter 6, authorities in developing countries have not been reticent in giving the poor access to assets. The bulk of spontaneous extralegal buildings and businesses in cities throughout the Second and Third Worlds may not have been formally titled, but governments have accepted (if only tacitly) their existence and ownership arrangements. In many developing countries during this century, large tracts of land have been given to poor farmers as part of agrarian reform programs (though without the property representations necessary to create capital). Nor have authorities in those countries been reluctant to earmark budgets for property issues. Billions of dollars have been sp
ent on activities related to registering ownership.

  Property Makes Capital “Mind Friendly”

  Throughout this book I have been trying to demonstrate that we now have enough evidence to make substantial progress in development. With it in hand we can move beyond the stagnant “left versus right” debate on property and avoid having to fight the same old battles all over again. Formal property is more than just ownership. As we saw in Chapter 3, it has to be viewed as the indispensable process that provides people with the tools to focus their thinking on those aspects of their resources from which they can extract capital. Formal property is more than a system for titling, recording, and mapping assets—it is an instrument of thought, representing assets in such a way that people’s minds can work on them to generate surplus value. That is why formal property must be universally accessible: to bring everyone into one social contract where they can cooperate to raise society’s productivity.

  What distinguishes a good legal property system is that it is “mind friendly.” It obtains and organizes knowledge about recorded assets in forms we can control. It collects, integrates, and coordinates not only data on assets and their potential but also our thoughts about them. In brief, capital results from the ability of the West to use property systems to represent their resources in a virtual context. Only there can minds meet to identify and realize the meaning of assets for humankind.

  The revolutionary contribution of an integrated property system is that it solves a basic problem of cognition. Our five senses are not sufficient for us to process the complex reality of an expanded market, much less a globalized one. We need to have the economic facts about ourselves and our resources boiled down to essentials that our minds can easily grasp. A good property system does that—it puts assets into a form that lets us distinguish their similarities, differences, and connecting points with other assets. It fixes them in representations that the system tracks as they travel through time and space. In addition, it allows assets to become fungible by representing them to our minds so that we can easily combine, divide, and mobilize them to produce higher-valued mixtures. This capacity of property to represent aspects of assets in forms that allow us to recombine them so as to make them even more useful is the mainspring of economic growth, since growth is all about obtaining high-valued outputs from low-valued inputs.