How can poor countries escape poverty? They need more than foreign aid. They need a legal system that lets them represent their assets, exchange stuff, and make each other rich.
- The Mystery of Capital: Why Capitalism Triumphs in the West and Fails Everywhere Else (book): Economist Hernando de Soto argues that the legal structure of property rights determines why capitalism succeeds in some places and fails in others.
- Stealing from the Poor to Give to the Rich: An Anti-Robin Hood Story (video): Professor Dan Russell explains why secure property rights are crucial for creating wealth.
- Breathing life into dead capital (article): The Economist compares systems property rights of different countries in Africa.
Daniel Russell: Owning assets versus owning capital. If you and I are neighbors, we can know where my property ends and yours begins without much trouble. We could put a marker at the property line or draw a map and everyone would agree that this is mine and that’s yours, but what if you want to use your house as security for a loan or bundle it with other assets or divide your property into sellable shares? As long as there is no legal system that makes your ownership clear to everyone, all the transactions that would let you turn your property into capital will be simply too costly. Your house can still be used as a place to lay your head, but it can’t live a parallel life as a piece of wealth creating capital.
Hernando de Soto’s research has uncovered that it is precisely this lack of legal means of representing ownership that accounts for much of the long-term, widespread poverty in many developing and former Communist countries and that is really surprising. It may seem obvious that people are so poor in places like Haiti or the Philippines or Peru simply because they don’t own land or houses or they don’t own workshops or businesses, but it’s not as simple as that.
In fact, in 2000, de Soto estimated that if the United States were to send aid to Haiti at the rate recommended by the UN, it would still take more than 150 years for that aid to equal the value of the property that Haiti’s poor people already had. The problem according to de Soto’s research is not a lack of stuff. It’s a lack of representing stuff as capital.
Those systems of representing assets are so familiar in our daily lives that we really don’t notice them anymore, but stop and think about all the things they make possible. Systems for representing assets tell other people what kinds of deals can be made with the owner. People then know that that person has collateral for a loan, that there’s a place to send a bill and there’s a place to deliver services.
Those systems tell other people where there are owners to make deals with. Those other people then know what assets are out there that somebody owns and are available to be put to financial use. Those systems tell other people how secure the deals they make might be. Those people then know how much the owners stand to lose if their word is untrustworthy and in that case, they can find it a lot easier to trust them.
Those systems of representing assets let markets and prices emerge so that the value of the asset can be quantified. That means that people can know how to compare one asset with another, how to combine assets, how assets might be divided into shares and so on.
Those systems tell other people that networks can be built. Those people then know that grid services like utilities can be provided. They know that there are assets over there that can be used to secure a deal over here. They know that insurance groups can be formed and so on. And those systems tell other people what buying an asset would get them into. Those people then know how to adjust the value of an asset to reflect any obstacles like liens that might be attached to the asset.
One lesson here is how important background institutions are for creating wealth such as the legal institutions for representing the ownership of assets. Another lesson is that the absence of institutions like these are among the major causes of poverty in the world. Stable social institutions, even those we never give a second thought are crucial to the human ability to create wealth. That is why it’s so important to give them a second thought after all.