Fulbright Economics Teaching Program Economics Executive Education Program The Mystery of Capital

2001-2002

The Mystery of Capital

By Hernando de Soto

Book Summary
By Nguyen Xuan Thanh

They have houses but not titles; crops but not deeds; businesses but not statutes of incorporation.
It is the unavailability of these essential representations that explains why people who have
adopted every other Western invention, from the paper clip to the nuclear reactor, have not been
able to produce sufficient capital to make their domestic market economy work.

In his book Mystery of Capital Hernando de Soto summarizes years of research into the reality of
economic life in places as disparate as Haiti, Egypt, the Philippines, and his native Peru, and
comes to a set of conclusions as to the causes of their failure to make their economies work. He
starts by establishing the idea that Capitalism is in crisis outside the rich nations, and that is
because developing and centrally planned nations have been unable to “globalize” capital within
their own countries.

He also states that the basis of a market economy is capital and the basis of capital as an
economic tool is rational property law. Without a complex system to delineate and protect
rightful ownership, capital is “dead” It cannot be used as collateral for a mortgage; it’s not
attractive as an enticement to investors. Its potential as a wellspring for further production can’t
be tapped, because owners, lenders and investors have no certainty of ownership beyond the
moment. De Soto’s team documented the existence of trillions of dollars in “dead capital” in the
economically blighted areas of the developing world far in excess of every World Bank loan,
foreign aid package and foreign investment portfolio combined. Most of the poor already
possess the assets they need to make a success of their businesses. What they lack is not the asset
base necessary to economic success, but the framework in which those assets can become
capital.

Nguyen Xuan Thanh 1

Fulbright Economics Teaching Program Economics Executive Education Program The Mystery of Capital
2001-2002

The problem is not a lack of government. Many governments have adopted the trappings of
western governance (bureaucracy and the paperwork). But they have attached meaning and
substance only to the trappings rather than building structures that fulfill the needs of a market
economy. As an example it takes 77 bureaucratic procedures, 31 agencies and 5 to 14 years to
acquire a piece of land in Egypt with no guarantee that the deed will not be revoked by the next
ministry to process the paperwork.

In addition, a large part of a country’s commerce is bled off into the underground economy under
such regime. As de Soto predicts one might say that this traffic of the underground economy
does help in one way or another, but it still leaves the fundamental problem, the capital moves,
but not in a manner transparent and secure enough.

In general, only an elite minority has secure title to their homes and businesses. Most people
have neither the connections nor the legal backing to secure their assets, so they are severely
limited in their ability to borrow and invest.

De Soto strongly opposes the popular view that success is determined by cultural differences.
When the preaching of the usual remedies of “stabilize your currency, hang tough and await the
return of foreign investors” doesn’t work, westerners respond not by questioning the adequacy of
the remedies but by blaming Third World people for their lack of entrepreneurial spirit or market
orientation. Meanwhile, de Soto finds that the real problem is actually the inability to produce
capital. The value of savings among the poor is immense “ 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.” However, the issue is that 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. So
because these assets are not adequately documented, they cannot readily be turned into capital,
cannot be traded outside of the 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.

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Fulbright Economics Teaching Program Economics Executive Education Program The Mystery of Capital
2001-2002

The mystery of economic failure in much of the developing world, lies within the following
FIVE MYSTERIES:

The Mystery of the Missing Information

Charitable organizations have emphasized the miseries and helplessness of the world's poor but no one
has properly documented their capacity to accumulate assets. Over five years, de Soto and about a
hundred other researchers from six different nations gone out into the streets and countrysides of four
continents to count how much the poorest sectors of society have saved. The quantity is enormous. But
most of it is dead capital serving only the immediate holder

The Mystery of Capital

This is the key mystery and the centerpiece of the book. Capital is a subject that has fascinated thinkers
for the past three centuries. “Marx said that you needed to go beyond physics to touch "the hen that lays
the golden eggs"; Adam Smith felt you had to create "a sort of waggon-way through the air" to reach that
same hen. But no one has told us where the hen hides. What is capital, how is it produced, and how is it
related to money?” de Soto summarizes the key to this mystery as follow:
• Fixing the economic potential of assets: Capital is born in a contract that allows the holder to
disengage the resource from its material constraint and focus more on its potential.
• Integrating dispersed information into one system: The reason market economies have triumphed in
rich nations and sputtered in much of the rest of the world is because most of the assets in rich nations
have been integrated into one formal representational system.
• Making people accountable: holding people with property interests responsible promotes a sense of
security and assets protection among potential investors.
• Making Assets Fungible: Transforming assets from a less accessible condition to a more accessible
one.
• Networking people: By making assets fungible, enforcing ownership and making information easily
accessible assets will move freely between people.
• Protecting transactions: Through laws, deeds, contracts, etc. By emphasizing on the security of
transactions, rich countries allow their citizens to move large amounts of assets with very few
transactions.

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Fulbright Economics Teaching Program Economics Executive Education Program The Mystery of Capital
2001-2002

The Mystery of Political Awareness

If there is so much dead capital in the world, and in the hands of so many poor people, why haven't
governments tried to tap into this potential wealth? Simply because the evidence they needed has only
become available in the past forty years as billions of people throughout the world have moved from life
organized on a small scale to life on a large scale. This migration to the cities has rapidly divided labor
and spawned in poorer countries a huge industrial-commercial revolution—one that, incredibly, has been
virtually ignored.

The Missing Lessons of U.S. History

What is going on in the Third World and the former centrally planned countries has happened before, in
Europe and North America. Unfortunately, people have been so mesmerized by the failure of so many
nations to make the successful transition to economic growth that they have forgotten how the successful
rich nations actually did it.

The Mystery of Legal Failure:

Why Property Law Does Not Work Outside the West

Since the nineteenth century, nations have been copying the laws of the West to give their citizens the
institutional framework to produce wealth. They continue to copy such laws today, and obviously it doesn't
work. “ Only true leadership can coax the law of property out of its preoccupation with the past and into an
appreciation of the present.”

De Soto also presents evidence of how every nation in the world at one time went through the
transformation from extralegal ownership to a formal unified legal property into wealth he uses
the United States as an example of how the west had forgotten about its own struggle to arrive to
this transformation. He does, however, point out that the absence of this legalization in the
poorer regions of the world, where five sixths of humanity lives, is not the consequence of some
Western monopolistic conspiracy, but rather because Westerners take this mechanism so
completely for granted that they have lost all awareness of its existence “Although it is huge,
nobody sees it, including the Americans, Europeans, and Japanese who owe all their wealth to

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Fulbright Economics Teaching Program Economics Executive Education Program The Mystery of Capital
2001-2002

their ability to use it.” He points out how the past of the rich is the present for many of the poor
and how Western nations have integrated their poor into their economies so well that they have
lost even memory of how it was done.

He cautions that in the rich nations there is a growing concern that the failure of most of the rest
of the world to achieve self-sustaining growth will eventually drive the rich economies into
recession. As millions of investors learned from the evaporation of their emerging market funds,
globalization is a two-way street: If the third world and former centrally planned nations cannot
escape the influence of the rich nations, neither can the rich nations disentangle itself from them.
From Russia to Venezuela, the past half-decade has been a time of “economic suffering,
tumbling incomes, anxiety, and resentment; of starving, rioting and looting”.

And finally, De Soto advises Third World governments to do away with “property apartheid”
and awake the fact that the “dead capital” of the poor is a source of tremendous wealth.

One of the greatest challenges to the human mind is to comprehend and to gain access to those
things we know exist but cannot see. The great creators of wealth were able to reveal and extract
capital where others saw only junk by devising new ways to represent the invisible potential that
is locked up in the assets we accumulate.

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