Academic journal article Independent Review

Mystifying the Concept of Capital: Hernando De Soto's Misdiagnosis of the Hindrance to Economic Development in the Third World

Academic journal article Independent Review

Mystifying the Concept of Capital: Hernando De Soto's Misdiagnosis of the Hindrance to Economic Development in the Third World

Article excerpt

In his well-publicized book The Mystery of Capital (2000), Hernando de Soto claims to have discovered the explanation for poverty in countries of the Third World and the former Soviet Communist bloc. He claims it is the inability of the poor people in these countries to convert their "dead capital" into live, functioning "capital" because of a "legal apartheid" their governments have created. He asserts that the conversion of dead capital into live capital explains the rise of capitalism, which he equates with economic development, in the West. Numerous reviewers of the book have praised de Soto's diagnosis of the cause of underdevelopment and his recommendation of the widespread granting of formal titles to properties owned by the poor as a solution to this problem. In academic journals, the positive reviews include those by Libecap (2001), Buch (2002), Rosenberg (2002), and Pal (2003).

In the process of developing his argument, de Soto refers to the well-known explanation that clearly defined and enforceable property rights reduce transactions costs (Coase 1937) and promote investments, thus earning Ronald Coase's endorsement of the book: "A very great book ... powerful and completely convincing. It will have a most salutary effect on the views held on economic development." Similarly, Milton Friedman endorsed the book, noting: "De Soto has demonstrated in practice that titling hitherto untitled assets is an extremely effective way to promote economic development of society as a whole. He offers politicians a project which can contribute to the welfare of their country and at the same time enhance their own political standing, a wonderful combination" (see the book's back dust cover for both quotations). (1) Comparing de Soto's claims with some of the grand development theories of the 1950s and 1960s, Jagdish Bhagwati (Columbia University) also declares that "de Soto is arguably the most interesting intellectual writing on development today.... [He] is the man with 'big' ideas.... His Mystery of Capital will endure as a work of extraordinary importance" (qtd. in Clift 2003, 10). The Economist hails the book as "the most intelligent ... yet written about the current challenge of establishing capitalism in the developing world" (Clift 2003, 8).

Despite these accolades, de Soto is quite mistaken in his diagnosis of the real hindrance to economic development in the Third World and former Soviet bloc countries. Rather than the lack of titles to property, the problem is the inadequacy of their domestic savings to finance investment. Poor people in these countries hardly own assets, the absence of whose formal titles impairs their ability to borrow funds, or "capital," for investment. Thus, de Soto's suggested solution of a massive titling program by the governments of these countries would be a wasteful diversion from what needs to be done in them to promote their economic prosperity. This point is implicit in Culpepper's criticism of de Soto's property-titling project as "flawed" and "inherently biased against the landless and propertyless tenants," although his book "purports to speak on behalf of, and to empower, the poor and disenfranchised" (2002). Because de Soto's book has received numerous endorsements from high-profile figures, the fundamental errors of its premise need wide publicity in order to spare Third World governments from being misled. (2)

De Soto appears to have arrived at his fundamental misdiagnosis of the hindrance to economic development primarily from his misconception of "capital" and the source from which it derives. He thinks that "an implicit process buried in the intricacies of [the] formal property systems ... creates capital in the West" and that "the formal property system is capital's hydroelectric plant ... the place where capital is born" (2000, 46, 47; hereafter cited by page number only). But this view is incorrect. Rather, it is a community's savings that mainly create the "capital" that may be borrowed by titled or untitled property owners. …

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