There is no denying that achieving legality is expensive—and often too expensive—in many of these nations. De Soto and his colleagues, for example, opened a clothing factory in Peru with one worker. It took 289 days, working six hours a day, to go through all the processes to acquire the per-mits necessary to make it legal. De Soto’s group also found that to buy a piece of urban property in the Philippines required 168 different steps, including contact with 53 separate agencies, taking thirteen to twenty-five years. Similarly, to register a lot on state-owned desert land in Egypt required going through 77 bureaucratic procedures at 31 public and private agencies.
Eliminating regulations would surely energize commerce, but we are eager to know which of these regulations actually have some value and which do not. De Soto assumes that almost all the obstacles in the way of legalizing business are the unnecessary handiwork of entrenched, usually corrupt, and elitist bureaucracies, whether they are administered by right-wing dictatorships or well-meaning democracies. Such reforms would matter, but we need some demonstration of just how much.
One of de Soto’s central claims is particularly difficult to accept. Are most of the informal businesses he writes about now willing, as he suggests, to pay taxes in order to enjoy the potential benefits of expansion that legality may, or may not, bring? It seems likely that many people will prefer to take a dollar of tax savings today, and remain underground, rather than wait for two dollars of possible but uncertain gains in the future. The basic issue here is not whether legality makes sense or whether everyone would be better off at some future date by legalizing the informal economy, but how people can be persuaded to bring about the changes that de Soto recommends.
Mostly, though, de Soto resorts to history to convince us of his argument. Many early American settlers also had dubious claims to the land they occupied; a large proportion were outright squatters. Like some of the migrants in Peru, they made their illegally owned land into productive farms and they built houses and stores, and eventually entire villages and towns. Along the way, they worked out informal procedures about how to decide who owned what and how property was to be valued. But because state or federal authorities often did not recognize these boundaries, there were continuous battles over who owned property.
What intrigues de Soto is that in early US history the state and federal governments often favored the informal landholders. In the early 1800s, the debt of those who could not meet their payments was often forgiven and the price of land was repeatedly reduced; interest rates were lowered, and squatters were often given legal rights to their property. De Soto could have presented a detailed account of how this happened, but again his purpose is to demonstrate a principle, not provide a comprehensive argument, and he skims the surface of a fascinating aspect of history that is not well understood. For example, as early as 1815 a land rush in Alabama sent prices from one dollar an acre up to $70. With the panic of 1819, many small landowners there could no longer pay their debt. State officials, however, reduced their obligations so that many if not most could ultimately retain the rights to their land.4
Time and again in America, state and local governments redistributed the ownership of land by reducing or canceling debts. During the early nineteenth century, government increasingly sided with the small landowner in other ways. As president in the late 1820s and early 1830s, Andrew Jackson in particular was determined to liberalize property laws in America, and ensure squatters’ legal rights to land. And well after Jackson there was much turmoil over land rights, especially in California during the Gold Rush of 1849. “There were,” de Soto writes, “some eight hundred separate property jurisdictions” in California, “each with its own records and individual regulations established by local consensus.” Eventually, America established one set of property laws, and this no doubt aided its economic development.
But the availability of property rights did not largely account for America’s growth, as de Soto argues. In truth, early Americans brought a strong sense of the right to private property with them from the Old World. What probably made America’s relatively radical policies tolerable to powerful interests was that there was so much land to go around. Moreover, even if early-nineteenth-century economic arrangements were informal compared to later standards, they were highly productive, and far from “dead.” Farms and small businesses were generating income and could be used to secure loans; and those small businesses contributed to the growing market economy of the early nineteenth century. Property rights gave such capital additional life; but before formal property rights were established, this capital was already productive. De Soto fails to see that legalizing informal property rights in the US coincided with the rise of democracy in the Age of Jackson and the establishment of universal white male suffrage. It also coincided with the granting of corporate charters to larger numbers of applicants, legalizing limited liability for corporations, and the spread of publicly financed primary education.
If de Soto were to make explicit the consequences of his own argument in The Mystery of Capital, he would call for broad-based land redistribution policies that are decidedly democratic and even radical in nature. But he fails to discuss who owns the land he would like to distribute to members of the informal economy. Some of the land is owned by the government, but probably most of it is owned by rich, well-entrenched gentry and investors. De Soto proposes the abrogation of contracts and the forgiveness of debt, as was the case in early America. These amount to violations of what economists generally now think of as property rights. De Soto’s book has strong endorsements from Milton Friedman, Margaret Thatcher, and Walter Wriston, the former head of Citigroup. Do these people endorse ignoring legal contracts and widespread forgiveness of debt? It seems more likely that they have been beguiled by de Soto’s faith in entrepreneurship and unfettered markets and haven’t quite realized that he is also arguing for the cancelation of certain property rights that they hold sacred.
What probably gives de Soto confidence in his claims is that it is consistent with growing attention to property rights among economic scholars. Economists usually mean something broader than the rights to land when they discuss property rights. They are essentially talking about the enforcement of all contracts, and the development of such institutions as the stock market and credit cards that depend on the protection of investments and private savings and on honest accounting. A well-known theoretical case for the central importance of property rights was made by the Nobel Prize– winning economist Ronald Coase (who has also endorsed de Soto’s book).
Academic research is also being undertaken in support of property rights. A widely cited study, for example, concludes that the primary factors in determining how rapidly nations will develop are the security of their property rights and the amount they trade with other nations.5 But critics of these findings point out that while a correlation may exist between measures that would establish property rights and economic growth, the advance of property rights also typically coincides with many other factors that promote growth, including improvement in education, wider markets, technological progress, and the commercial tendencies of an acquisitive culture. China’s remarkable economic growth during the past few decades has occurred without conventional property rights.
Academic claims that property rights matter more than anything else have apparently encouraged de Soto to treat government only as an obstacle in his book. He does not discuss education, health care, or the relative benefits of democracy or authoritarianism. He has nothing to say about government programs to build low-cost housing or about the importance of education for women, which is now seen by many economists as a crucial condition of growth in developing nations.
Even de Soto’s contention that capital itself is the main ingredient of growth is a disturbing oversimplification. Referring to Adam Smith, he writes, “Capital is the force that raises the productivity of labor and creates the wealth of nations.” But Smith himself did not go this far. Capital is essential to growth, no doubt, but it is not a sufficient condition for it. Smith’s views are often misinterpreted. A pin factory, Smith wrote, could manufacture one hundred times as many pins in a day by dividing the process of pin-making into nineteen separate tasks. But the factory owners did not create this division of labor simply because they had the capital to buy the needed machines; rather, they believed they could sell many more pins in a large and rapidly growing marketplace. To Smith, a large and expanding market for goods was critical to the increased specialization of labor. De Soto’s informal economies also need markets.6
The debate over the true sources of economic growth has long suffered from a misguided emphasis on finding a single cause, and de Soto suffers badly from the same single-mindedness. When we consider the sources of US economic growth apart from property rights, we have to recognize that there were countless technological advances, from water mills to the steam engine to electricity. Capital could be imported from Europe; Americans were highly literate and had free early education; natural resources were available and, despite de Soto’s skepticism about culture, many settlers brought with them from England highly commercial habits; new religious tendencies reinforced incentives to make money. Most important, in my view, was the existence of an enormous, continent-wide market that, especially as the railroads were built, provided growing demand for the goods and services that business could produce, as well as incentives for continuing technological advance.
The actions of governments, moreover, made a huge difference. The federal government built the roads and canals of the early United States, not to mention the highway system constructed after World War II. State and local governments provided free education throughout the nineteenth and twentieth centuries, from primary school to high school, and they subsidized loans for college. And US governments not only frequently favored the small landholder over the large and powerful, but also reinforced competition by refusing to allow elitist monopolistic control over markets. By 1913 the federal government created a stable financial system with the creation of the Federal Reserve. More than in the developing coun-tries today, the government protected workers from abuse and consumers from fraud. Finally, the US was a democracy whose spirit by the Age of Jackson was openly sympathetic with “the little guy.” Because there was so much to go around, democracy in those years typically meant more for most people—except for African-Americans.
De Soto has something important in common with these Jacksonian principles, as much as he hides it by using language congenial to Milton Friedman and Margaret Thatcher. There is common ground between de Soto’s ideas and the recently formed consensus among some international agencies that poor people have talents and often know better what they need than outside consultants do. De Soto, the World Bank, and the United Nations all say they want to give more power to the poor. They also say they now believe that local citizens themselves must have a part in devising new policies. In the current idiom of the World Bank, the people must “own” the recommended policies.
I suspect, moreover, that de Soto’s ideas are especially appropriate in some developing nations—possibly, for example, Egypt and Peru—where informal economies may now be large and well-established enough to take substantial advantage of insurance, limited liability, sophisticated marketing, and equity markets. De Soto’s proposals for giving more people more property rights could help many of these communities mature still further. They seem to have affinities with early informal economies in the US: they are already economically vital; their capital is far from “dead”; and they have a good chance to compete in the legal economy.
Still, what de Soto fails to recognize in his advocacy of property rights is the ways that unfettered markets can solve some problems but by no means all. In my view, fast economic growth still remains the best social welfare policy. The most progress against poverty in the past two decades has been made in the fastest growing nations of the world—notably in East Asia, including China. As rates of growth in South Asia have improved, nations such as India, which has increasingly opened its borders to trade and international capital, have also made progress toward reducing poverty.
Moreover, fast growth provides tax revenues from which to develop useful social programs, if governments have the will to do so. Botswana, for example, grew swiftly from 1970 to the mid-1990s and was able to raise its social expenditures significantly, resulting in a rapid reduction in infant mortality. The Sudan grew slowly over this period and was unable to raise its social expenditures to the same level or enjoy the same results.7
But rapid economic growth can be misleading, and may be inadequate to help many poor people. In the developed nations of the West, income inequality has worsened in recent decades, especially in the US. Economic growth in Latin America in the 1990s did not reduce the widening inequality that occurred during the troubled 1980s. Even in China, recent economic growth in the sophisticated cities on the coast has not reduced inequality substantially. It was rural development in the 1980s that cut the poverty rates.8
Similarly, countries with only moderate rates of growth have been able to raise life expectancy and reduce infant mortality significantly by allocating social resources to these tasks. Several poor countries, including Jamaica and Cuba, rank high in health care and education, thanks to government expenditures. That health has improved in Cuba is only one aspect of life in a despotic country; but genuine accomplishments there should not be ignored.
One need not renounce the benefits of fast growth, then, to recognize that social programs, higher education levels, and the participation of women in the labor market are important sources of social well-being and that they need government funding and direction. Moreover, public investment, far from being economically inefficient, can promote future economic growth by building human capital and providing transportation and improved communications. In particular, the reduction of poverty enables people to invest in themselves, and promotes that most intangible if important of benefits, a sense of optimism about the future. Thus the poor may not merely start and sustain businesses but also send their children, male and female, to school rather than to work.
Hernando de Soto has done useful work in alerting the world to the energies of informal economies that are too often ignored or dismissed as disreputable. It would be unfortunate if his single-minded advocacy of property rights obscured the genuine perceptions of daily economic life on which his work is based. As he probably knows better than most other experts, just insisting on one general principle or another is not enough.
For a thorough account, see Thomas Perkins Abernethy, The Formative Period in Alabama, 1815–1828 (University of Alabama Press, 1965).↩
See Robert Hall and Charles Jones, "Why Do Some Countries Produce So Much More Output per Worker than Others?," Quarterly Journal of Economics (February 1999). ↩
See an interesting paper on growth in the Middle Ages by Meir Kohn, "The Expansion of Trade and the Transformation of Agriculture in Pre-Industrial Europe," draft chapter from The Origins of Western Economic Success: Commerce, Finance and Government in Pre-Industrial Europe. ↩
On these matters, see a particularly useful article by Gustav Ranis and Frances Stewart, "Strategies for Success in Human Development," Journal of Human Development, Vol. 1, No. 1 (February 2000), pp. 71–82. ↩
Overcoming Human Poverty, p. 39. ↩
For a thorough account, see Thomas Perkins Abernethy, The Formative Period in Alabama, 1815–1828 (University of Alabama Press, 1965).↩
See Robert Hall and Charles Jones, “Why Do Some Countries Produce So Much More Output per Worker than Others?,” Quarterly Journal of Economics (February 1999). ↩
See an interesting paper on growth in the Middle Ages by Meir Kohn, “The Expansion of Trade and the Transformation of Agriculture in Pre-Industrial Europe,” draft chapter from The Origins of Western Economic Success: Commerce, Finance and Government in Pre-Industrial Europe. ↩
On these matters, see a particularly useful article by Gustav Ranis and Frances Stewart, “Strategies for Success in Human Development,” Journal of Human Development, Vol. 1, No. 1 (February 2000), pp. 71–82. ↩
Overcoming Human Poverty, p. 39. ↩