“Third-World” Economics Lessons for the “First-World”
(c) 2006 - FVHayek & Co. LLC

The PBS video production of “Commanding Heights,” adapted from the book by the same name (Yergin, 2002) is fascinating in its breadth and scope. It follows the thread of economic thought throughout the twentieth and early twenty-first centuries in a way that provides an invaluable foundation of understanding. It is modern history punctuated with the meaning of economic events. This book and video provide context and meaning for the contributions of towering figures like Friedrich Hayek, and John Maynard Keynes, and for many lesser known, yet significant figures. With all of this, it was Hernando DeSoto’s “The Mystery of Capital,” introduced to me through this video, which has been most striking to me. (DeSoto, 2000) This book led me full circle back to the conservative economics of “The Road to Serfdom,” (Hayek, 1944) “Free to Choose,” (Friedman, 1980) and “Basic Economics.” (Sowell, 2004)

DeSoto’s research seeks to understand why the desperately poor of third-world and formerly communist countries often struggle to reap the benefits of capitalism. His basic thesis was so fascinating that I was compelled to rewind the segment and replay it numerous times, hanging on each word. What was compelling to me about DeSoto’s work was that he may have found the key to empowering the poor, not in yet another aid program, but in streamlining the legal property mechanisms by which the wealth and power they already possess could be made real. As one who believes in entrepreneurial capitalism, and its ability to free the divine spirit of the individual, this was a revelation for me. As I came to understand his argument for turning the dead-capital in the extra-legal property systems of the third-world into the productive capital of a functioning legal property representation system, the second epiphany for me was the implication that this research has for the “poor and disenfranchised,” the so-called “have-nots” of the first-world. But before looking at that, it is necessary to understand what DeSoto’s team has discovered.

The foundation of Hernando DeSoto’s work is the distinction between the concept of “capital,” and the systems of “money” and “property” by which we represent and exchange capital. He points out that these systems have evolved in the “first-world,” first in Europe and then in the United States, over centuries, in a not altogether deliberate, nor easily decipherable process. He and his team have scoured historic archives to trace the evolution of “extra-legal” property systems into the familiar systems we know today. These extra-legal systems are the means by which property was controlled, transferred, and protected before properly functioning legal systems of property and money were developed. He has researched the functioning, and dysfunctions, of the legal and extra-legal property systems of the newly formed United States, of its westward expansion, of the California “gold-rush,” and of their parallels with the current state of emerging market economies around the world. These systems have become so much a part of our daily existence that we no longer appreciate the implications of operating without these systems, as many newly capitalist economies today still must. The significance of DeSoto’s work cannot be fully appreciated until he explains that even the “poor” of developing economies have vast resources of potential capital which is rendered “dead-capital” by their extra-legal status.

“Even in the poorest countries, the poor save. The value of savings among the poor is, in fact, immense – forty times all the foreign aid received throughout the world since 1945. In Egypt, for instance, the wealth that the poor have accumulated is worth fifty-five times as much as the sum of all direct foreign investment ever recorded there, including the Suez Canal and the Aswan Dam. In Haiti, the poorest nation in Latin America, the total assets of the poor are more than one hundred fifty times greater than all the foreign investment received since Haiti’s independence from France in 1804. If the United States were to hike its foreign-aid budget to the level recommended by the United Nations – 0.7 percent of national income – it would take the richest country on earth more than 150 years to transfer to the world’s poor resources equal to those they already possess.” (DeSoto, 2004, p. 5)

This is a good place to make an important relevant point about charitable giving. The United States – in fact – donates a good deal more aid to other countries, as a function of GDP, than any other country in the world; between government and private aid, totaling about 0.5 percent. It seems noteworthy, and relevant to this discussion, that the U. N., other countries – and even DeSoto it would seem – routinely overlook the fact that the U.S. is indeed more charitable than any other country, because they routinely ignore private giving, an oversight which is understandable when you realize that Europe and indeed most other developed countries by comparison give almost nothing to private charities. Their focus is totally on the flow of capital from government to individuals, rather than the creation of capital by individuals. (Brooks, 2006, pp.115-121) The other very interesting thing is that in the U.S., the individualist “right-wing conservatives,” the so-called “neo-cons” are far more charitable than the collectivist “left.” Arthur C. Brooks’ research data shows that the two traits most correlated with charitable giving are regular church attendance, and a distaste for government wealth re-distribution. Those who are associated with these traits are twice as likely to be charitable as those who are not, and will donate 100 times more money to charity, and 50 times more money to explicitly non-religious charitable causes. (Brooks, 2006, pp. 10-12) In short, those who say they care about the poor and who favor government control and wealth re-distribution (the political left), do very little individually to help the poor, and those who are opposed to government wealth re-distributions, give far more individually to charity. The point is that perhaps the “left” should listen to “conservatives” when they say that the way to help the poor is to remove obstacles from the market wealth creation systems, it is apparently not true that conservatives say these things just because they are greedy and selfish, as those on the “left” routinely charge. Now DeSoto has confirmed very much the same thing, the way to help the poor is to get the government out of the way, and implement simple, functional, legal property systems. Hayek may have best described the virtue of the individualist’s values in his seminal work “The Road to Serfdom” (which in the interest of brevity I do not insert here, but have included as an appendix). (Hayek, 1944, pp. 65-67)

Returning to DeSoto’s research of the poor, one is tempted to ask: “If the poor have so much capital, why are they ‘poor’?” DeSoto goes on:

“But they hold these resources in defective forms: houses built on land whose ownership rights are not adequately recorded, unincorporated businesses with undefined liability, industries located where financiers and investors cannot see them. Because the rights to these possessions are not adequately documented, these assets cannot readily be turned into capital, cannot be traded outside of narrow local circles where people know and trust each other, cannot be used as collateral for a loan, and cannot be used as a share against an investment.” (DeSoto, 2000, pp. 5-6)

It turns out that this is just the beginning of the story. It is the legal system of representation that turns property into capital, but in the process this capital accomplishes many other things. Utility providers that supply electricity, natural gas, heating oil, water and sewer service, telephone service, trash collection and other things are willing to connect their services to a particular piece of property and trust that the owner will pay the bill, precisely because there is a formal legal system of record through which they have recourse if the owner fails to pay for these services; indeed, because there is – legally – an owner. The ready availability of these services, in turn, increases the useful value of the property they connect to. Owners of property which is properly represented in legal systems are compelled to abide by the legal agreements they enter into, because they have a stake in the legal system, and because their property is at risk of lien and lawsuit if they do not. These underpinnings are so interwoven in every facet of our society that we can scarcely imagine the far-reaching ramifications absent such a system.

It is not that there are no governments and legal systems in third-world countries, it is rather that the systems there are so excessively bureaucratic, dysfunctional, and corrupt as to be unusable by any but an elite few; those that DeSoto describes as existing inside the “bell jar” of privilege. Hernando DeSoto and his research team set out to understand just how dysfunctional these legal systems are for those outside the bell jar:

“To get an idea of just how difficult the migrant’s life was, my research team and I opened a small garment workshop on the outskirts of Lima, Peru. Our goal was to create a new and perfectly legal business. The team then began filling out the forms, standing in the lines, and making the bus trips into central Lima to get all the certifications required to operate, according to the letter of the law, a small business in Peru. They spent six hours a day at it and finally registered the business – 280 days later. Although the garment workshop was geared to operating with only one worker, the cost of legal registration was $1,231 – thirty-one times the monthly minimum wage. To obtain legal authorization to build a house on state-owned land took six years and eleven months, requiring 207 administrative steps in fifty-two government offices … To obtain a legal title for that piece of land took 728 steps. We also found that a private bus, jitney, or taxi driver who wanted to obtain official recognition of his route faced twenty-six months of red tape.” (DeSoto, 2000, pp. 18-20)

DeSoto documents comparable circumstances in the Philpines, Haiti, Egypt and elsewhere:

“In every country we investigated, we found it is very nearly as difficult to stay legal as it is to get legal. Inevitably migrants do not so much break the law as the law breaks them – and they opt out of the system. In 1976, two-thirds of those who worked in Venezuela were employed in legally established enterprises; today the proportion is less than half. Thirty years ago, more than two-thirds of the new housing erected in Brazil was intended for rent. Today, only about 3 percent of new construction is officially listed as rental housing. To where did that market vanish? To the extra-legal areas of Brazilian cities called favelas, which operate outside the highly regulated formal economy and function according to supply and demand. There are no rent controls in the favelas; rents are paid in U.S. dollars, and renters who do not pay are rapidly evacuated.” (DeSoto, 2000, p. 21)

Niryana Murthy – the founder and CEO of InfoSys in India, confirms DeSoto’s research, and has seen the difference that reforms can make:

“…prior to reform in India [it] required two years and fifty trips from Bangalore to Dehli to get permission to import a computer worth $1500. Things are different now: ‘Ever since 1991, there has not been a single instance when I went to Dehli for any license for any business of InfoSys. Today I can import a computer worth millions of dollars’ without having to see a single bureaucrat or apply for any license. The results have been extraordinary: India’s software exports have been growing at a 50 percent rate. … ‘The lesson to be learned there is the less the regulation, the further the government is away from business, the better it is for business.’” (Yergin, 2002, p. 228)

Murthy, once sympathetic to socialism, also said in the PBS video:

“If you want to eradicate poverty, you don’t do it by re-distributing existing wealth, you have to create new wealth.” (Yergin, 2002, DVD)

What makes DeSoto’s thesis doubly fascinating, is the parallels to be found in the first-world. Conservatives have long complained of the economic drag created in this country from excessive government regulation and bureaucracy. Beginning with Friedrich Hayek, and continuing with Milton Friedman, Thomas Sowell, and others, conservatives have long said that the best way to make everyone better off economically is to remove impediments to free market activity. Even Deng Xiaoping of China, who opened China to market reforms, said that he had

“... two choices: to distribute wealth or distribute poverty.” (Yergin, 2002, p. 410)

The socio-political debate in developed countries now often devolves to the rhetoric of “the widening gap between the rich and poor,” or even the more highly-charged language of the “haves and have-nots.” It should first be said that even the “poor” in the U.S. are dramatically better off than what would be considered “poor” in third-world countries. Nevertheless, if the fact is that there is a widening gap between the rich and poor in the U.S., it is because the middle and upper classes are creating so much new wealth, not because the poor in the U.S. are getting poorer. The economic truth is that the success of those creating new wealth uplifts even those who are not as successful, but DeSoto’s research may show the way to improving the opportunity for the poor to benefit.

I believe the impediments to market activity that exist: excessive government bureaucracy, excessive taxation, and so on, are felt more acutely, and create more real obstacle to upward mobility if you are poor. This is clearly what DeSoto has found in the third-world, and I see no reason why that should not be the case in the first-world. These bureaucratic drags on the economy in the U.S. are often the result of well-intentioned efforts to help the poor which inevitably hurt more than they help. As Hayek, Friedman, and Sowell repeatedly point out, the left typically prefers to transfer wealth from those at the top to those at the bottom through taxation and large bureaucratic entitlement programs, and the right prefers to increase the opportunity for all classes to participate in the wealth creation potential of capitalism by removing these government obstacles. We have long realized that one problem with the plan of the left is that to the degree that you increase transfer payments from wealth creators, it tends to decrease incentives and put the brakes on wealth creation. What is fascinating about the research of Hernando DeSoto, is that if his research shows the way for the poor of the third-world to become successful capitalists and raise themselves out of poverty, surely the much less “poor” of the first-world can be no less empowered. Contrary to this view is that of the socialist “wealth redistributionists,” which strikes me as yet another example of “The soft bigotry of low expectations;” (Bush, 2004) the belief that the poor are incapable of helping themselves, leaving them increasingly dependent on social welfare programs.

While we may not lack the legal property systems to the degree that developing economies do, still there must be lessons here worth learning. As any would-be entrepreneur in the U.S. knows too well, our legal systems are not without impediments. These systems are not such a challenge to a wealthy entrepreneur with a staff of lawyers and accountants, but lowest cost lawyer’s fees might run $250 an hour. A simple product patent costs about $5,000 to $10,000 with legal and filing fees. In my personal experience, the City of Hillsboro, Washington County, Oregon, a small business can be charged $27,000 just to move across the street, ostensibly an assessment for traffic impact fees, even when there is in fact no reasonable impact at all. The U.S. Federal code, the IRS statutes, and the state and local codes, are so complex that no entrepreneur can know the tiniest fraction of the laws he must obey. A would-be entrepreneur of modest means has a tough job just getting started. If we are really serious about benefiting from more surplus value in the economy, a very large portion of the accounting and legal fees paid by all businesses are consumed accommodating a massively bloated tax code, and an entire industry created to serve it; costs which could be almost entirely recovered by replacing the IRS with a greatly simplified tax code.

The genius of DeSoto’s thesis is that our property becomes capital and we are made wealthy by it because we have made ourselves accountable to our legal system, but that this only works for those to whom this legal system is practically accessible. As our legal and government systems become bloated and dysfunctional, the first to be disenfranchised are the poorest among us. If we want to allow the poor to better participate in the vast wealth creating potential of our economy, we should simplify our bureaucracy and legal codes. When conservatives say, as Ronald Reagan, famously, that we need to “get the government off our backs,” or we need to reduce taxes, it is not because conservatives are greedy or stingy and do not want to help the poor, Arthur Brooks has established the truth of who is charitable and who is not. Conservatives and Christians should know that capitalism, unleashed, provides the greatest opportunity for all people to prosper, and embodies the Biblical principles of sowing and reaping.
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Brooks, Arthur C. (2006). Who really cares – America’s charity divide, who gives, who doesn’t, and why it matters. New York, N.Y.: Basic Books.

Bush, George W. (September 2, 2004). President Bush's Acceptance Speech to the Republican National Convention. Retrieved December 12, 2006, from http://www.washingtonpost.com/wp-dyn/articles/A57466-2004Sep2.html

DeSoto, Hernando. (2000). The mystery of capital – Why capitalism triumphs in the west and fails everywhere else. New York, N. Y.: Basic Books.

Friedman, Milton and Friedman, Rose. (1980). Free to choose – A personal statement. New York, N. Y.: Harcourt.

Hayek, F. A. (1944). The road to serfdom. Chicago, Ill.: University of Chicago Press.

Sowell, Thomas. (2004). Basic economics – A citizen’s guide to the economy. New York, N. Y.: Basic Books.

Yergin, Daniel, and Stanislaw, Joseph. (2002). The Commanding Heights – The battle for the world economy. New York, N.Y.: Touchstone.

Yergin, Daniel and Cran, William (Writers). (2002). The Commanding Heights – The battle for the world economy. [Television Series Episode, DVD]. Yergin, Daniel and Thompson, Sue Lena (Executive Producer), Heights Production. Sullivan, Michael (Executive Producer) WGBH. Boston: WGBH.
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Appendix:

“Not only do we not possess … an all-inclusive scale of values: it would be impossible for any mind to comprehend the infinite variety of different needs of different people which compete for the available resources and to attach a definite weight to each. For our problem it is of minor importance whether the ends of which any person cares comprehend only his own individual needs, or whether they include the needs of his closer or even those of his more distant fellows – that is, whether he is egoistic or altruistic in the ordinary senses of these words. The point which is so important is the basic fact that it is impossible for any man to survey more than a limited field, to be aware of the urgency of more than a limited number of needs. Whether his interests center round his own physical needs, or whether he takes a warm interest in the welfare of every human being he knows, the ends about which he can be concerned will always be only an infinitesimal fraction of the needs of all men.

This is the fundamental fact on which the whole philosophy of individualism is based. It does not assume, as is often asserted, that man is eqoistic or selfish or
ought to be. It merely starts from the indisputable fact that the limits of our powers of imagination make it impossible to include in our scale of values more than a sector of the needs of the whole society, and that, since, strictly speaking, scales of value can exist only in individual minds, nothing but partial scales of values exist – scales which are inevitably different and often inconsistent with each other. From this the individualist concludes that the individuals should be allowed, within defined limits, to follow their own values and preferences rather than somebody else’s; that within these spheres the individual’s system of ends should be supreme and not subject to any dictation by others. It is this recognition of the individual as the ultimate judge of his ends, the belief that as far as possible his own views ought to govern his actions, that forms the essence of the individualist position.

This view does not, of course, exclude the recognition of social ends, or rather of a
coincidence of individual ends which makes it advisable for men to combine for their pursuits. But it limits such common action to the instances where individual views coincide; what are called “social ends” are for it merely identical ends of many individuals – or ends to the achievement of which individuals are willing to contribute in return for the assistance they receive in the satisfaction of their own desires.” (Hayek, 1944, pp. 65-67)