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June 12 , 2006
Basu peers into The Mystery of Capital worldwide

by myra thomas

When The Mystery of Capital: Why Capitalism Triumphs in the West and Fails Everywhere Else hit the shelves in 2000, it marked a turning point in the understanding of economic failures in less developed countries. In this landmark book, Peruvian economist Hernando de Soto contends that the success of the complex financial arrangements in modern economies hinges on the widespread acceptance of legally enforced property rights. Their acceptance allows land and property to be used not only directly, but also as collateral for loans to accomplish other productive activities. De Soto calls this the “energy in assets.”

Today, as economic theorists, leaders in international finance and charity and relief organizations debate how to reduce chronic poverty, the lessons of de Soto’s work become even more salient. In March, the World Bank’s directors approved $52 billion in debt relief for poverty-stricken countries, including many nations in Africa.

But much more is needed than debt forgiveness, said Sudipta Basu, associate professor of accounting in Goizueta Business School. In a recent interview with Knowledge@Emory, Goizueta’s electronic newsletter, Basu discussed the lessons of The Mystery of Capital.

Knowledge@Emory: According to de Soto, the black market and undocumented financial activities that occur in the developing world represent tremendous untapped economic power. What is the difficulty in moving a country from an extralegal system to a formalized, legal one?
Basu: First, you need to get people to develop a consensus on how property can be used and the extent to which rights can be controlled by different people. People have to reach a common understanding of property rights over a large geographical area. It is often difficult to get people to change their old norms and customs. It helps if everyone believes that property rights will be enforced impartially and vigorously, and that private property will be protected from the rich and powerful, especially those in government. De Soto describes how settlers in the American West marked local property claims and how these were eventually formalized into legal claims. Japan made a similar shift during its land reforms in the Meiji era, but the Japanese trusted the government and so the transition was much easier. The biggest problem in less developed countries is that the governments there only seem to care about their allies and supporters. The elites under the current regimes cannot take the psychologically difficult step of letting other people also have a chance to do well and get ahead in life.

De Soto’s research found that in Lima, Peru, for example, it took about six hours a day for 289 days to legally register a business. What do you think is the most important aspect of this research on extralegal economies?
He powerfully illustrated just how difficult it is to do business in an extralegal economy on a day-to-day basis. Putting a spotlight on ineffectual or corrupt governments helps to change laws and local practices. Often, rulers are very shortsighted and tax and rob the productive even though they could benefit more by helping everyone become more productive. De Soto points a finger directly at the problem of how venal governments stifle the innovation and creativity of their subjects. The World Bank now annually ranks countries on the ease of doing business (www.doingbusiness.org) following de Soto’s ideas, and these rankings have created pressure for reform.

Why do so many contend that culture is the real culprit for the lack of economic development in less developed countries, when de Soto thinks that it is rather a lack of an established, uniform and formalized economic structure with clear property rights?
Culture is as much a consequence of deeper social and political structures as a cause of poor economic development. If everyone agrees to bribe and everyone else accepts that, then government officials won’t do what’s needed unless they are bribed. Then, these norms become engrained. Many mistake the symptom of widespread bribery for the root cause of poorly developed property rights. People in these unlucky countries accept the prevailing norms because they have never seen the alternative. It becomes difficult to visualize that such a different society is possible without actually having lived in one or observed one up close.

The author concentrates on the urban poverty problem abroad, and gives less attention to rural poverty. Why?
When poverty is more concentrated, it becomes more entrenched and obvious to the outsider. Also, the difference between rich and poor is much starker in the cities. Cities are engines of innovation, and that’s where increased economic opportunity can do the most good. Contrarily, hampering people in the city imposes much greater costs on them, usually because they have borrowed heavily to finance their stay. The prospect of economic benefit is what takes people to the city in the first place, but then they are more easily exploited, as they are much easier to find.

What do you see as the first step to a better economic system in Eastern Europe, certain parts of Asia, Latin and Central America and Africa?
You have to start small, possibly by getting the rural poor integrated into the economy. The microloan approach appears to be very effective. Basically, you get people together in a group to take a loan, and they then decide who is best equipped to use the loan, and the others serve as collateral. You are essentially monetizing human capital and also getting them to monitor each other. Also, you can market to the poor instead of excluding them from the marketplace. So, micromarketing—selling products on a smaller scale and at a cheaper price point—makes it easier for the poor to buy what they want only when they want it and in the quantities needed for immediate use.

De Soto argues that the poor in less developed countries should not rely on international financial institutions like the World Bank and the International Monetary Fund. What is the biggest problem with this sort of intervention?
A big problem is that the money is often not reaching those it was intended for, as the governments are corrupt. It’s basically giving charity to the rich. Certainly, a push toward justice and the punishment of elites that commit the abuses are needed. Much more importantly, these international institutions’ plans assume that their experts know what the poor need and can design optimal strategies to deliver these needs. This is a fallacy that the communist world also believed in for many decades. It would be much better to free the poor to express their demands in the marketplace and let the private sector fulfill them, as we have seen from the example of the newly industrialized countries in East Asia.

A version of this article first appeared in Knowledge@Emory, and it has been edited and reprinted with permission.

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