TCS Daily

Peruvian Prophet

By Nick Schulz - March 22, 2002 12:00 AM

Editor's note: Tech Central Station editor Nick Schulz recently interviewed the Peruvian economist Hernando de Soto, author of the influential book, "The Mystery of Capital." De Soto is no stranger to terrorism having been targeted by Peru's violent Shining Path. We think you'll find his remarks timely and relevant.

Nick Schulz: Let's start off with your book, "The Mystery of Capital." In your book, the sub-title is "Why Capitalism Triumphs in the West and Fails Everywhere Else." For those readers who might be unfamiliar with your work, describe why that's the case.

Hernando de Soto: Understood in the classical sense, capital is value and if you think about how you hold values in the West, you will reach for a property title, you will reach for a share that represents stock in some kind of a company, you will reach for a Treasury bill, you will reach for a document that is governed by rules. It is in this document and those rules that something as abstract as capital actually becomes valuable.

Now, if you look at the developing world and the former Soviet nations, you will see that most of the value they have, whether it's real estate or whether it's business or even ideas, are not captured on paper and representations that are governed by rules. And if you don't have the rule of law and the representative mechanisms that allow you to store and to transfer value, like you do in the United States and Western Europe, you can't have capitalism as it's generally understood.

That is the principle reason why capitalism triumphs in the West and doesn't work elsewhere. There's a lack of the rule of law that sustains a system in the countries where five billion of the citizens of the world live as opposed to the West.

Nick Schulz: You describe in your book a lot of what you call "dead capital" available in the world. I think it would be useful if you can describe for us what it is, how much there is and to put the figure that you've arrived at in some perspective.

Hernando de Soto: Sure. This is, of course, empirical stuff. We have visited different countries in different cultural parts of the world. For example, we visited Egypt and together -- as required by the government of Egypt -- with our Egyptian counterparts, we did an inventory of all the buildings and plots of land that were not represented on paper.

Now, to do that inventory took over 40 people and over one year and it meant counting the plots of land -- once you had your categories, and the buildings, and at the same time evaluating these buildings. We found that the value of buildings that could not be transformed into capital were roughly 244 billion dollars and that these were owned and were lived in by roughly 90 percent of the Egyptian population.

Now 244 billion dollars is 55 times greater than all foreign investment in Egypt over the last 150 years or so, including the Suez Canal and the Aswan Dam. It is equivalent to 30 times the value of capital traded on the Cairo Stock Exchange. It is 100 times greater than all privatizations that have taken place in Egypt.

We've done the same exercise in Mexico for President Fox with whom we have been working now for a few years and we expect to continue working a few more years. We have found out that the value of the assets of Mexicans that is dead capital is about 315 billion dollars.

Three hundred and fifteen billion dollars is the value of all the assets of the oil monopoly of Mexico. Now, if on the basis of the studies that we've done in different parts of the country you then make a projection and ask yourself how much dead capital there is among the poor of the developing and foreign Soviet nations, it comes out to an excess of ten trillion, which is, of course, about something like 50 to 60 times greater than all the foreign aid you've been giving since the Second World War.

In other words, the poor are not that poor, and there are resources. The problem is that none of these resources can become liquid and none of these resources can be constituted to finance or can be converted into investments.

Nick Schulz: Now you, in your book, you liken the power of capital to the potential energy, say, that you would find at the sub-atomic level. It's an energy that needs the right conditions to be unleashed. Describe that metaphor a little bit.

Hernando de Soto: It is an old philosophical tradition since even before Plato that the world is more than what it seems. That when you look at things, there are more things behind those things that you can imagine. For example, by looking at bricks, Einstein found out that you could, from splitting the atom, make one brick of material actually create enormous amounts of energy.

Other people, by looking at lagoons, have found out that if you are able to drop the water and make it turn turbines and then make it light up a generator that can transmit the final energy through wires, you will have converted potential energy into kinetic energy and then into electricity. In other words, a lagoon that only served for fishing and canoeing can easily light up a city. In order words, there's enormous potential in things that is practically infinite. What we humans have learned to do is bring energy out of apparently innocuous material.

Similarly, capital was considered by the classical economists as being the ultimate form of energy and they explained that capital -- which we today call money -- was, in fact, not money. Capital was the force that assets contained that could be used to produce what Marx called surplus value, and they described it in philosophical terms because there was no other way to capture it. They understood that the economy was driven by some kind of additional value that was in things and that could set things in motion.

The way the Economist magazine defines capital, as a matter of fact, is stuff that begets stuff. In other words, in savings you not only hoard value; in savings you are able to use that value to generate further production.

And so the question is, just like hydro-electric plants to extract the value from water and to make it light up a city, you need a human contraption. And the human contraption that does that, in relation to capital, happens to be the property system. The reason that Adam Smith and Marx didn't go that far is simply because the elements weren't in place to be able to come to that conclusion.

We think that our contribution to the economic debate is understanding that the contraption that takes the energy out of savings is the property system because it is able to capture the value and it defines it in descriptive terms, which the market acknowledges and uses for further investment. That is why in the United States, if you own a forest in Oregon, and it's adequately paperized, you can use it to translate it to money or just simply to transfer the shares to buy, say, a sausage factory in Chicago. The reason you can do that is because what captures the value of the forest is the property title to it, which can be valued in the market according to precise rules.

Nick Schulz: On the cover the book, there's a picture of the World Trade Center. Where were you when you heard about the 9/11 attack on the World Trade Center and what went through your mind when that happened?

Hernando de Soto: On September 11th I was in London in a friend's apartment and it just so happened, this friend of mine had the television on and we saw the towers break out into smoke and it was obvious when the second plane hit that this was an act of terrorism. I was just as surprised as anybody else because I didn't expect existing terrorists to be able to put up such a sophisticated show. And of course at the same time you could imagine the screams and, of course, it was a very sad and shocking moment.

Nick Schulz: On your book cover, the picture of lower Manhattan and the Twin Towers, which in some respects is the symbol of Western capitalism. The picture of the Twin Towers is contained within a glass bell jar. That represents a theme in your book and I'm wondering if you could talk about that a little bit and what exactly that representation is suppose to mean.

Hernando de Soto: Yes, of course, the representation. I borrowed the representation or metaphor from an illustrious French historian called Fernand Braudel, who wrote possibly the most important work until today of the history of capitalism in three volumes.

In one of the volumes called the Wheels of Commerce, he identifies capitalism as already existing over 500 years ago and mentions both Venice and Florence, which obviously had been able to create an incredible infrastructure with enormous artistic value. So he could see that accumulation was already taking place and commerce was functioning. But at the same time, he pointed out that that all of that wealth probably only benefited a few families. So he said, why is it that all of this wealth that exists and all this capacity to create wealth hasn't been able to reach the majority of the Italian population? Why is it concentrated on only a few places? And then he goes on to say it is as if a bell jar was concentrating the capacity to organize value in only certain parts of the land.

So I found that as a very interesting metaphor because among certain merchants and sophisticated classes in Italy, it was obvious that they had a legal system at work. There was the rule of law. There was paper that guaranteed investment that permitted them to trade with trust.

And to me it's quite clear that this was not available throughout Italy. So from then I thought, well, what happens is that since nobody is aware that it's essentially the rule of law that allows you to stock and transfer value, over 400 years Europe, beginning with Italy, gradually began handing over those same privileges to be able to represent value on rule-governed paper to the rest of the population. And our challenge in developing a former Soviet nation now is how are we able to do that -- but not in 500 years and having to go through major wars and having to send hoards of our poor people abroad to look for wealth. And having gone through two world wars, how can we do it quicker now that we know that it's the rule of law that allows capitalism to help people prosper?

Nick Schulz: How hopeful are you that this can happen quickly?

Hernando de Soto: Oh, I'm pretty hopeful because I think that our arguments are very solid.
My feeling is that in about the next ten years or so, maybe five years, this will be an ongoing activity, maybe sooner if we're lucky. But if I look at history, it'll take that much time and that isn't bad.

Nick Schulz: That's not bad at all. I'd like to keep talking a little bit about terrorism for two reasons, one, it's on the minds of a lot of people certainly in the United States and elsewhere, but I do think that your ideas are particularly relevant right now. Is it in your view a coincidence that some of the areas that are sort of, for lack of a better word, the swamps that breed terrorists are areas that are without the formal property systems that you discuss at such length in your book?

Hernando de Soto: No, no, I don't think it's a coincidence at all. As a matter of fact, the way we got started in Peru and the reason that we got so much support in Peru to do our work was because in Peru we had a terrorist movement that had begun in the 1980's, a terrible movement that killed over 24,000 people. And we could see the direct relationship of property to terrorism.

To begin with, in the case of Peru the reason terrorists were accepted in certain localities, all of which were poor, is because they basically protected the assets of poor people since they weren't protected by title or by law. One of the things that we did was we made a proposal to the government and the government gave us the go-ahead and we got ourselves financed and went out and wherever we titled those assets of the poor, the people immediately were able to get into the legal system immediately got rid of the Shining Path terrorists because they ceased to have a function.

This is one of the things by the way, which Ho Chi Min also did in Vietnam. As he went along, he recognized the assets of the people as they were instead of trying to introduce fancy redistribution programs. First of all they titled them as they were understood by local customs or local law.

So I am not at all surprised. I'm not at all surprised that people who want to go against the system -- for whatever reason: religious, economic, ideological, or political -- should attract those, principally those who have lost hope. That's where soldiers come from, essentially from poor people.

Nick Schulz: Right, many in the Western world don't even seem to understand the hatred for the West in other parts of the world or how lots of people in the West are incredulous how the ideas of someone like Osama bin Laden can even begin to gain a foothold, but you don't seem surprised by any of this in the sense that you can understand that there's sort of vacuum there that's being filled by this.

Hernando de Soto: I'm not too sure I buy into this idea of hating the West and the United States. You know, it goes both ways. If you go and look at a crowd of poor kids running around the West Bank in the Palestinian area, you will, they've got t-shirts on and they've got jeans and they are very much dressed like Westerners. If you go and talk to the poor in Cairo, they talk about enterprise and they're trying in many cases to imitate the United States.

What I think is behind this is a distortion of these feelings. What is quite clear is that what the Osama bin Ladens are trying to do is invert this desire to be like the United States. And the way to do it was, of course, to bomb you and to expect retaliation.

I don't think that the objective of bin Laden is basically to harm you. The objective of bin Laden, like all other terrorists that are now involved with him or working parallel to him, is essentially to do something that Marx called polarization, which is that, if you hit a foreign enemy effectively, or somebody you wish to be a foreign enemy, and you get him to reply to you, the tendency will be to polarize, just like you Americans have all of a sudden polarized around George Bush and make him rise in the popularity polls to about 90 percent. What you're getting is a similar effect in the Middle East and that's exactly what they want to do.

The whole idea behind Marxism and Leninism was to exacerbate among the poorest of the Europeans their sense of differences with the most prosperous bourgeois classes, produce acts of terror that, in turn, produce retaliation, and with that polarize the classes and get the war of classes going on. That's what they are doing in the Middle East today. So, the final product, if we're not careful, might be a growing hate for the West.

Nick Schulz: That's an important distinction that you're making.

Hernando de Soto: Go anywhere, go to the Philippines and ask most Filipinos where, if they had a choice, where they'd rather migrate to and they'll probably say the United States. Go to Peru at the time when we had the war with the Shining Path, 80 percent of Peruvians were willing to migrate to the United States. Where are most Mexicans going if not the United States? Where are most people in North Africa going if it's not to Western capitalist countries? So obviously, like in every love affair, there's a little hatred that goes along with the love. What these other guys are doing is exacerbating the hate and what those of us who love peace have to do is exacerbate the love.

Nick Schulz: Right. Now in all the discussions and debates going on about how to combat terrorism, is there anything that you think is missing from the debate?

Hernando de Soto: Yes, precisely what we're talking about, which is the rule of law. Interestingly enough, we're now finding out that a lot of the recipes for growth and development, especially those that refer to macro-economic reform, balancing the budgets, opening up for investment, and privatizing, are not enough. When you start doing all of those things, all the things to increase entrepreneurship, it's like in Egypt where 90 percent of the people still cannot enter the system because they don't have the rule of law. And they will remain in poverty too long in a world with rising expectations, with a lot of communications and a lot of images that tell you how it is that Americans and the rich people live.

So, the question is, what capacity does the West have to bring to all of these countries the tools with which they can then create the property and legal systems that are accessible to the poor?

Now, there are times when you did deliver those things or you helped incentivize them, when you occupied Japan, when you helped Taiwan, when you helped South Korea, there you did it. And it didn't really take many resources. So what's missing from the debate is how can you help make those things available.

Nick Schulz: A lot of our readers are interested in technology. You mention in your book the role that technology can play in your view of how governments can transition to formal property systems. Can you discuss that just a little bit?

Hernando de Soto: Of course, information technology is extremely helpful because what information technology does is essentially facilitate the transfer of information.

Now what happens, of course, is that when you don't have a system of property titles, whether it be of loans or stock that means that the things people own, whether its businesses or homes, are not described in a standardized form that can fit on the Internet. So I think that the Internet revolution and the information technology revolution can enormously help developing countries, provided we do one revolution, which we still haven't done, which the United States did in the course of the 19th century, which is put all our values in descriptive form in the law so that the contraptions like the Internet could transport it.

Nick Schulz: You describe what you call the "enemies of representation," and I thought that was interesting. In part there's a technological aspect to it. If we think of technology as anchored by a series of representations, be that there alternating ones and zeros or just a basic computer code or that kind of thing, but describe what you mean by the enemies of representation and how that fits into your whole picture here.

Hernando de Soto: I refer, among other things, to Marx as an enemy of representations. Marx, who was a pretty sophisticated fellow and probably understood capitalism like nobody else before, also understood that it was a very sophisticated system and that only a few minds would be able to understand it very well. So he thought that representations of value were essentially means that allowed the few who knew the ropes how to steal from the rest. As a matter of fact, I think he called it robbery.

Now, what happened over time of course is that more and more people learned how you can use representations. Now today in the United States half of your population plays the stock market and probably 80 percent or more have credit cards and so, as time has passed and people have gotten more educated, people have learned to use representations in a more or less democratic way.

But I think today Marx would agree with us that you can't beat the system of representation because it allows you to capture hidden aspects, hidden energy, of things with such efficiency that the challenge is not in the trying to break it down, but the challenge is in trying to make sure that it's universally acceptable and that enough people are educated to be able to use it.

You know, every time you take, every time you make a technological leap, there are a few people who know how to use it before the others but you can't stop the technology. What you have to do is learn to control it so that it makes sure to favor everybody and you stop the stealing. And the people that don't realize this I call the enemies of representations.

Nick Schulz: Terrific. Thank you very much. I appreciate you taking the time to talk to us.

Hernando de Soto: All the best, Nick.

Nick Schulz: Bye.


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