With the collapse of communism, capitalism became the only game in town but failed to deliver on its promise to millions. Several countries in Latin America, Africa and the former communist nations implemented policies to make them modern economies, but those measures only brought pain to their populations, and the benefits of capitalism went only to a select few. It was in this context that Hernando de Soto wrote the Mystery of Capital. The Peruvian economist sought out to solve the riddle of why capitalism failed everywhere else except the West.
In order to do this, he had to drop his books, abandon his theories, and walk the streets of Lima, Cairo, Port-au-Prince amongst others, and what he found was that poor people were not poor because of culture, or lack of hard work. They were poor because they could not use their assets to generate capital. It turns out that the informal economy globally is massive. According to his estimates, it was worth $9.3 trillion. The only problem is, it is dead capital.
De Soto makes the argument that the foundation of capitalism is formal property rights, and outlines six ways in which it helps generate capital:
- Fixing the economic potential of assets
- Integrating dispersed information into one system
- Making people accountable by removing anonymity
- Making assets fungible
- Networking people
- Protecting transactions
The obstacle to this, he discovered, are regulations which keep the majority of people in Third World countries out. When the cost of being legal is higher than the cost of being informal, people inevitably opt out of the system.
Being out of the system puts limits on the ability of hundreds of millions of people to give themselves a better life. De Soto also discovers that Western nations once had the same challenges encountered by the Third World now, but the foundation of their success – formal property rights – was largely forgotten. In chapter 5, he goes on to give a detailed account of the emergence of formal property rights in the United States, and comes to the conclusion that:
‘The recognition and integration of extralegal property rights was a key element in the United States becoming the most important market economy and producer of capital in the world.’
Creating a formal property rights system is not easy. Any large informal economy already has it’s own ways of operating, and to bring them in means that the legal framework must be adapted to the existing social contracts in order to give them legitimacy. It requires political leadership to institute the legal reforms necessary, communicate the advantages of formalisation, and enlist the co-operation of the elite.
People do not want to get inside the formal property system because they are eager to be mapped, recorded or taxed; they will join when the economic benefits are obvious to them and when they are certain their rights will continue to be protected.
It makes me think about Nigeria. Our informal economy is very large, which means that much of our economic activity is not recorded. How can more people be formalised? How can more people be part of the economy? The advantages are many, the most obvious of which is that it will help to grow the tax base of individual states and the federal government.
Even though this book was published in 2000, it is still relevant today. As the pace of globalisation quickens, many are being left behind even though a lot of people have been lifted from poverty, and de Soto makes a solid case why this is so. It is imperative that as many people as possible benefit from this new economic order, lest social unrest become the norm.
Together with ‘Why Nations Fail’, I view ‘The mystery of capital’ as must have for anyone who is interested in bringing his country to prosperity, because formal property rights are an important part of inclusive economic institutions.