The Region

Interview with Hernando de Soto

Peruvian economist and president of the Institute for Liberty and Democracy shares his thoughts on the intrinsic wealth in poor countries, 19th century United States as Third World country and more.

David Fettig - Editor

Published June 1, 2001  |  June 2001 issue

Political pressure kept Hernando de Soto's family out of his native Peru when he was a child, but his father insisted that Hernando and his brothers return to their native country each summer to stay connected with their homeland. As the economist and president of the Institute for Liberty and Democracy (ILD) in Lima explains in the following interview, it was this experience that caused him to wonder why his European friends were wealthier than his Peruvian friends.

Photo of Hernando deSoto This question, in part, motivated his economic studies, but economic textbooks did not provide adequate answers, and so the question stayed with him throughout his career until, about a dozen years ago, he began his own quest to answer it. His first book, The Other Path, investigated the informal nature of much of the Peruvian economy and argued that a viable market system—capable of generating wealth—was operating under the nose of the government. His latest book, The Mystery of Capital, based on five years of field research by the ILD in developing countries, argues that five-sixths of the world's population holds the answer to its poverty in its own hands—its property—if only this property were recognized by government and legal authorities.

Solving the mysteries of capital, as this interview attests, involves reflections on U.S. history and of great economic thinkers, as well as references to barking dogs, bell jars and assorted Hollywood legends. All leading back to de Soto's fundamental query: "The question of why these different countries are more prosperous than the others has always been in the back of my mind. I find it one of the most intriguing questions to consider."

De Soto's international experience has allowed him to consider this question from many perspectives. Born in Arequipa, Peru, in 1941, de Soto did his post-graduate work at the Institut Universitaire de Hautes Etudes Internationales in Geneva. He has served as an economist for the General Agreement on Tariffs and Trade, as president of the Executive Committee of the Copper Exporting Countries Organization (CIPEC), as managing director of Universal Engineering Corp., as a principal of the Swiss Bank Corp. Consultant Group and as a governor of Peru's Central Reserve Bank. He was also President Alberto Fujimori's personal representative and principal adviser.

The ILD, the organization that de Soto currently leads, is a private, nonprofit group whose efforts have been recognized worldwide.

What my definition of capital is, for the purposes of this book, are all those values that are hidden in assets and that come forth when property is well defined.

It's much more interesting to talk to dead Americans than to live Americans, because dead Americans two centuries ago were facing the same problems we are now.

Region: You say in your new book, The Mystery of Capital, that the essential meaning of capital has been lost to history. So, let's begin by defining our terms, and one term in particular—capital.

de Soto: What I take from the word capital is a notion of value, very much discussed by classical economists throughout the 18th and 19th centuries, going all the way from Adam Smith to Karl Marx, who said it was the most important part of the economy. And what is interesting, and that's why I got back to the 18th and 19th centuries, is that they insist very much that capital is not money. They define it as not money. They say it can be represented by money and captured by money in certain given circumstances; which is, of course, very familiar to us Latin Americans, who have many times throughout history produced tremendous inflations thinking that wealth was money. What my definition of capital is, for the purposes of this book, are all those values that are hidden in assets and that come forth when property is well defined.

There are certain values in goods that are in the physical assets themselves, or that are in the value ideas themselves, but that gather surplus value when they are correctly defined within a property system. So, what I say is that a lot of the capital value—that additional surplus value that you Americans or Europeans obtain in your market economy—is not available in developing countries because it isn't captured in descriptive form.

It's actually somewhat more complex than that, but the general idea is that there are two types of knowledge: knowledge by acquaintance and knowledge by description. When you're acquainted with a physical object, you get a sense of part of its value. But, when an object is defined in such a way that things about it are captured on paper, and knowledge about it is organized in such a way that it is user friendly for agents in the market, it develops additional value. Typical examples are the Latin American state corporations that, before being privatized, had a value on the stock market—like the Peruvian telephone company, for example, which had a value of about $100 million. But when, after a year, we had created titles for these companies and they were organized within a body of law that made sense—because that body of law allowed them to define the asset better; it defined economic attributes of the assets that were not visible; it defined what markets they could have; it defined clear procedures for settling disputes—the value of the Peruvian telephone company was increased enormously. It was sold at $2 billion—20 times the original price.

So, what we're saying is that when things enter the world, their description within a property system brings out surplus value. And the capacity of something to bring out surplus value, and therefore be used as a productive agent in new enterprise, is our definition of capital. Capital is the surplus value that can be obtained from an asset or from labor for productive purposes by defining it within a property system.

Region: So, we may be getting ahead of ourselves, but if capital is misunderstood, it's also likely misunderstood in the West, where it works. So, is one of the mysteries of capital that it can work despite the ignorance of those who benefit from it?

de Soto: In other words, how can that be?

Region: Yes—how can this be?

de Soto: Well, for example, people were navigating using compasses 500 years before anybody discovered the theory of magnetism. And most people who were involved in animal husbandry knew about genetics before the theory was put into place some 700 years later. As a matter of fact, theory is our capacity to understand many of the things we do and put it into an intellectual context.

A perfect definition of capital would, of course, go beyond what I'm talking about. But a lot of the surplus value that you are able to obtain from the assets you have created, or the transactions that you make, is due to the fact that they can be put together in property documents. To start off with, for example, your markets as opposed to most of our markets, work by paper. When you go to the Chicago Commodities Exchange, what's being traded is paper that is about assets. You go to the New York Stock Exchange, it's the same thing. When you go to a Palestinian market, Egyptian market or Peruvian market, it's one cow at a time and it's one pig at a time, without the papers involved. By putting things on paper through representational devices, you get an enormous amount of additional surplus value—what Marx was always looking for. Where does this surplus value come? Marx was always asking: Where's the hen that lays the golden eggs? And then he said, well, that hen that lays the golden egg is the surplus value that is extracted from labor by capitalists. Terrible thing, huh? Adam Smith said it's a wagon way through the air that is structured by bankers as they made deals.

And what I'm saying is that what they were both referring to is property paper, basically, because when you get this you are capable of adding an enormous amount of additional value. In the West you can trade enormous amounts of goods, physical goods. I mean we can trade a cow at a time in Peru and in Egypt, while in the Chicago Commodities Exchange, you can trade 10,000 head of cattle with just one document. So, it has economies of scale built into it; because of the precise descriptions it cuts transaction costs; because of definitions, it lessens the risk.

So, I don't doubt that capital is many things. I mean, somebody will probably even say the Pyramids of Egypt are capital because they're tourist capital. Sure, there's that broad definition. But, what I'm saying is that what characterizes your kind of capital is the fact that you can document it and you can insert it into a broad legal system. Capital is that value, that additional value, that comes from things that are duly titled.

Region: One more term, and you touched on it in your response, and that is property, which you describe in your book as pure concept. Please describe this understanding of property.

de Soto: Sure, let me try. [At this point, de Soto fishes an apple out of his briefcase and places it on the table.] This is my apple, obviously, because I brought it out and there are three witnesses, including yourself. Now, it's my apple, but nothing on it says Hernando or de Soto or from Peru. Therefore, property is not the physical object itself; it's something about the physical object. Basically, it's a contract between you and me and our witnesses. It's a social contract.

Now, you have a lot of assets in developing countries—we probably have more oil, we probably have more copper, we probably have more uranium than the United States and Western Europe put together—but when I say we don't have property, what I mean is that we don't have social contracts defined well enough so that the title, back to our apple now, that picks up the property concept about the apple does not allow us to increase the value of the apple.

Okay, remember what I said about the telephone company, that it had a value as a physical asset? I mean, we brought in experts who said how many bricks, how much cement was in the Peruvian telephone company before it was privatized. How many towers, how much wire? We never got more than about $100 million. But when we got a title and finally sold out for bids, it was worth $2 billion, because many aspects about the physical objects—which are not apparent by looking at them—got organized in a property system, and allowed them to increase enormously in value. Property, then, is a concept.

For example—energy. You've never touched energy and you've never seen energy, nor has any North American nor has any Peruvian. But it's a concept, and because you have that concept, it allows an engineer who looks at a body of water to understand that, aside from its physical nature, the weight of the body of water, if it can be allowed to drop, to tumble out, can be converted into kinetic energy. And when it makes the paddles of the turbine turn, it converts it into mechanical energy. And as this one goes through transformers and a generator and heats up the wire, it converts it into electrical energy. But nobody's touched energy; nobody's ever seen energy, but it's a very useful concept. It allowed Einstein to look at a brick of plutonium and understand that, aside from the plutonium inside, there were a lot of other potential things that could be released.

This notion of capital, very similar to the one of energy, was one that was used by the classics—from my reading of them—to indicate that there is a potential value in all things, and that this value can be revealed or used provided we organize things adequately in our minds. Notice how capital is like energy—not realizable physically, but realizable as a concept. And what I try to say in the book is that what allows you to obtain much more capital value or extract more additional value from all the assets you have, and allows you to cooperate in this division of labor—which is the market economy—is because you are able to organize concepts about assets in property documents.

Whether you realize it or not, by creating a property system, you end up creating a system that goes beyond defining ownership, and it becomes a system in which you transfer value. And that's why when you see images of a capitalist market it's not about people working with their hands—like these big Soviet paintings of people laboring and moving monkey wrenches around—it's about people moving paper, moving descriptions of assets around, but very secure ones within a body of law that allows you to extract hidden wealth.

But many of the things in the world, like Hayek says, are developed for one purpose and they end up having additional functions attributed to them. And these additional functions create wealth. That's one way of describing capital, getting back to our original term.

Region: Any more on property?

de Soto: Yes, an American philosopher named Daniel Dennett uses a helpful concept. He says human beings are continually creating prosthetic instruments of the mind, like music. I mean, we wouldn't have all of these problems with Napster if somebody hadn't invented musical notes that you can capture. And writing captures other things. Symbols allow you to capture other things that you can float through the Internet, but if you hadn't put in the symbols in the first place, you couldn't pass an apple through the Internet.

The whole capitalist system creates value because, by describing physical things or assets, you end up not only just getting juridical precision, you also end up getting additional aspects of value, which is why you're able to produce much more than we are. That's it.

Region: So, people who equate capital with money are clearly missing something.

de Soto: Well, how did the first bank get started? It started not because there was somebody like Scrooge McDuck—you know, Donald Duck's uncle who had a swimming pool full of money that he could use one way or another. It started with people who had certain assets and had certain contracts that were about assets, and they were able to paperize them adequately with proper backing. And they went to other people and asked: Can you fund me? And these private bankers started creating their own bank notes.

Property led to the creation of credit money, not the other way around. There's a general feeling that first of all you need the money, that we're poor countries so we need your money. But, in fact, we could create our own value of money if we had property, because on the basis of property you create all the discount mechanisms with which you can generate solid money. And we think that's a part of the economy that has not been well studied. That's why I like going back to Marx and to Adam Smith, because at those times the system was just being born, and all of these things were much clearer. Today, they make very little sense to a Westerner who's already within a system that's humming, and you don't know whether money or property is the chicken or the egg. But, from our point of view, it's very important to have a clear understanding of this, because it will tell us how to structure economies in our political system.

You know, my continual problem in life is that for the problems I face in Peru, where I work, and in other parts of the Third World, it's much more interesting to talk to dead Americans than to live Americans, because dead Americans two centuries ago were facing the same problems we are now. I look at many of your jurists, for example, and if I mention the name Reynaldo Noyes, does it make any sense to you? But, you know, this man wrote 150 years ago and what he says is just so relevant to what we're doing.

Region: This is a good point to talk about U.S. history and the comparisons you make between pre-colonial and colonial U.S. experience and present-day Latin America. This strikes me as an eye-opening way for Westerners to think about the problems today.

de Soto: There is something about early American history that's very similar to us, which makes me say in the book that you were once, of course, a Third World country. And, therefore, it's very important for us to find out how you got out of that mess. And the idea behind it is that the very notion of nonfeudal property is born as a result of large migrations, and people deciding—and it's part of the Industrial Revolution—that they're going to appropriate certain assets whether the law agrees with them or not. Whether it's common law or it's statutory law. And they break the law in massive numbers because those who have rights, which are patrimonial rights or feudal rights, are a small minority who are obviously abusing whomever doesn't agree with them. That's why a great part of the story of the United States from the 19th century is basically disorder. In different parts there are different squatting orders, there are different property orders, and what's interesting, of course, is the study of your preemption acts. These are the different acts of Congress during dozens of years before the Homestead Act, accepting—at the end—that the spontaneous creation of property rights by squatters is the source of law from here into the future.

And one of the areas, of course, that's important in this discussion is California. When the Gold Rush miners came around and made their claims, they ignored Mexican law. And you Americans didn't even have very good mining law. So, basically, they took their miners' claims contracts and built them into the kind of property and mining law which today rules the United States. You didn't import it from Switzerland, you didn't import it from France, you grew it from the bottom up. In other words, people—like this apple, where we just created a social contract that says it's mine—in the United States, once they saw and became acquainted with new assets, started creating social contracts around their relationships and the relationships of these assets on which you could build a system which everybody today believes. Because it came from the bottom up.

So, we are exactly in that stage now, from Russia to South Africa, where written law says one thing, but what people are doing on the ground is completely different. And when that happens, like it happened to you—you had a common law imported from the United Kingdom and it wasn't working. There was Clint Eastwood shooting everybody up and Hopalong Cassidy shooting everybody else up and it wasn't working. You had to structure and build a new law, which is what you did throughout the 19th century. And, what we're saying now is that everything we import from Europe is also outdated. It doesn't work. Because when we bring out the figures, we start finding out that 80 percent of the assets in Egypt are not within the legal system, which is pretty much the same number that you've got in Peru and Venezuela and Mexico.

So, the time has come to make the law jibe with reality so that it helps us organize reality and obtain capital value from things. And what I'm saying is that there are strong parallels not only between when you were a Third World country in the United States, but when Europe was also made up of Third World countries. And what we try to do is find out how you jumped and stumbled from one false solution to one good solution over time, and find out how you did it over 200 years so we could shorten that period to two or five years. We know what worked and we know what didn't work. We know that when you started organizing territory on lines of sovereignty and giving away to your Indians, it doesn't work. People eat other people's sovereignty. Property rights, those are more respected.

Region: How tight is the parallel? That is to say, the United States was new—in the sense that the Europeans were relatively recently settled—and so you didn't have generations of squatters or generations of other problems or issues to resolve. May it have been easier for the United States, given its relative newness, to pull that off?

de Soto: We're just as new. I'll tell you why. The property rights problems come to us because of large migrations. In other words, the majority of the citizens of Third World countries were disbursed throughout the hinterland 50 years ago. Since then, 30 years ago even, Port-au-Prince has grown 16 times—that's pretty new. Guayaquil has grown 11 times, that's 10 times more new. Iquitos, in my country, has grown something like 16 times in 30 years. That's something new. So, it's the same old people, but in a new situation.

And that's also what happened in Europe. It was also when Oliver Twist came to town that forced the British to define property rights. They didn't have to do it before because before it was very simple—it was royalty and blue blood that owned everything. But when Oliver Twist and Fagan came to town, they wanted their share of it. They weren't content with the poorhouse so they had to redefine the system. These social pressures and migrations have created that newness that was available to you in the United States. It's a different social consensus in people that have passed from one social order to another.

The important things probably are the notions of the Industrial Revolution. When asked to define the Industrial Revolution, the best historians I've seen have defined it not as industry, but rather as a result of migration toward a new order—a new order in which people are now learning to work in a context of a great division of labor. In other words, in the old days, like in the United States—and the films are there that show John Wayne in his place, and there's a lady milking the cow, the kids are taking care of the crops and his brother-in-law is building log cabins—no specialization, no division of labor. Every family basically builds its own home, takes care of its own house, makes it own cheese, takes care of its own crop, cuts its own wood. The Industrial Revolution is the movement from independence for things on a small scale, to things on a large scale. That's what creates the newness. Not the emptiness.

Region: So, back again to the idea of things bubbling up from the people, if you will, of social contracts begetting law; this suggests, at least to me, that democracy is the key. But we've had democracy, or attempts at it, in Latin America for a long time. Why hasn't that worked? People always wanted this to work, I'm sure, but—

de Soto: Absolutely. It's because our capitalism is a fake capitalism, and our democracies are fake democracies. Let me start by giving you a couple of examples. Your congressmen are elected in district elections, right? There's district number 32 in New Jersey, there's district number, I don't know, 18 in California, some come from John Wayne County; in other words, the way you do your elections, your congresspersons have to be popular back home. In district number 32, they've got to be representative. So, if the district has many Hispanics, they better cater to Hispanics, and if it's mainly Jewish, they'd better cater to them. Whatever it is, they better cater to what the needs of that sector are. If they want to get elected, nobody's going to save them—neither Clinton nor Bush. They've got to go back home and mend their fences.

In Latin America, in our democracies, congressmen don't get elected by district. They get elected by party list. So, Fujimori or Hugo Chavez are candidates who represent their party list, and you vote for it as a whole. Now, it might just look like an expedient way. You know, we've got literacy problems, and so on, but in fact, what it means is that the allegiance of the congressmen is not to the people who voted for them—because it's the nation in general that voted for them—their allegiance is to whoever picked them for the party list. And the result, of course, is that the congressmen end up doing what the president wants and that's it. Otherwise, they have no more political life left and there is no traditional campaign to help.

So, if you start looking at our different institutions, in theory we've got the same thing you do—an executive branch, a legislative branch, the judiciary—but when you start finding out who's accountable to whom and who's accountable to what, it's still the old feudal system. It's still kingship. The president is king. He can do and undo.

Region: The answers are political then, in part?

de Soto: Oh, absolutely. I would say the source is political because at the end, it's the political powers that create the rules of the game. We know that a market economy is about the rules of the game. It's like a football game, you take away the rules and there's no game anymore. It's not enough just to have a couple of posts. As long as you don't have rules, you don't know if each team's going to have 11 or 13 or 14 players. Can you make the goal with your hand? Can you do it with your foot? Can you do it with your head? The rules are the game—that's the market.

And what I'm trying to say is that capital is also law. And since law is basically rated by the political system, yes, at the end it's a very political matter. What you've [in the United States] got is good politics, and it should be of no surprise that all the countries that actually have good politics, and democratic politics, are all the countries that are wealthy.

Region: On that note: Much work has been done lately on the question of why some nations are rich and others poor. How does your work fit within the context of this broader debate?

de Soto: I understand that what we're doing is a contribution, of some sort, to that debate. And why do I understand this? Not because I have read everything else that's been published—I basically work in the field—but simply because of what some friends tell me. Like when Ronald Coase got his Nobel Prize and he was in Tunisia, and they asked him who he thought was doing the most sophisticated work now in institutional economics, and he said these guys from Lima, Peru. So, we know we're doing things that are useful, but not because I read all the books about this other work, but because other people who look at us say so.

So, I don't think that anybody's got the magic bullet to development. I've been criticized for writing the book in the magic bullet sort of sense. I don't believe that, I don't pretend to; it's just my way of putting an argument together and making it more exciting. I don't pretend to have all the answers, but I think I've isolated a very important phenomenon, which is the important role that property law can play—a crucial role that it plays. Does that mean everything? No. It's like when people start saying, aren't there other things like culture? And I'm sure that's going to be one of your questions; if you want I can save this for later.

Region: It's certainly one of the questions that's often asked about your work, and we might as well address it now.

de Soto: Well look, I brought something along and you can describe it. [De Soto retrieves a stack of laminated paper, about six inches high and attached end to end, so that when pulled apart forms one long chain.] One of the things we worked on for President Mubarak was to illustrate, for him, the power of law, in its simplest form. There are a lot of bakeries in Egypt because they've got free flour subsidized by the government. So, we said, we've been working in your country for a year, and we've infiltrated a few bakeries, because it takes time to gain their confidence. How long does it take to incorporate—to get your license to operate a bakery? So, we managed to make a legal history.

It takes lots of months to get the confidence and then incorporate. This is 40 yards long, and it indicates that with a lawyer, it takes you 549 days, working eight hours a day, to get a license to operate a bakery, aside from building the bakery, putting in the ovens, training the people and so on. Without a lawyer, it's about 650 days. And to get a title on a house in a sand dune in Egypt, it's 17 years, and in Peru it's 21 years. And in the Philippines, it's 54 years. So, maybe these guys with all the cultural arguments have got a point.

But let's take this stuff out of the way, and then let's have the discussion to find out whether people are more culturally ready to do certain things in certain parts of the world for ethnic reasons or inheritance reasons or whatever it is, or whether it's just that you were lucky enough to have ancestors that built a good legal system and put the seeds inside for a good legal system. I mean, there was a time in America when you and I would have preferred to be living in Mexico City or Lima, than in Williamsburg, I assure you. So in different parts of different worlds, different cultures have stumbled upon easy solutions.

My feeling is that culture is something that you can't get your hands around. It makes for good writing; you're going to get a lot of readership; it allows a lot of cultured people with lots of anecdotes to put them in. If you're white and Anglo-Saxon, it makes you feel real proud, but I can't get my hands around it. What I do find is very objective—nonsubjective—reasons why people have a hard time having flourishing businesses and trading wealth. Let's get that out of the way, and then we'll just find out which culture is superior to the other one. Now, of course, you can come back to me and say: Ah, but law is part of the culture. Okay, but when you find a useful way to grapple with culture, I'll be very grateful.

Region: If culture were an issue, wouldn't it be the case that those coming to a Western country from one of these other cultures would be unable to deal with their new economy?

de Soto: That's it.

Region: But that's certainly not the case, is it?

de Soto: That's not the case. You found it out with the South Vietnamese, who were an impoverished bunch of Chinese Latinos, sort of, when you were fighting the war in Vietnam, and they are extremely productive today. And all these whiz kids from Asia, and all these Peruvians who wouldn't stop at a red light in Lima, who stop at red lights in Miami. Absolutely. I mean, ask the Europeans—all these Turks coming into Germany, and all these Portuguese and Yugoslavs and Montenegrins coming into Switzerland.

I'm not saying that culture doesn't exist. I mean, I go to Paris because I like to change cultures once in a while, and I like going to a Mexican island because it's a different culture altogether, and that's why I like traveling. But to come down and say that this culture is more prepared for one thing than another, I think, is a tall order. It's a tall order and it's unfair, and it predisposes people to do the wrong things.

Among other things, heads of state can't get their hands around it and they say look, it's cultural, it's wishy-washy; so the president of the Latin American Republic says: The poor? Let my wife take care of them.

I can see two years of debating North Americans on this issue of culture, but it's not going to get us anywhere. What's going to get us somewhere is getting good law and a good order that reflects the culture. That, I agree with. I can capture culture through laws, but when you talk to me outside this context, it's good debate. We'll give each other bloody noses in different American universities but it doesn't help you. It doesn't help you develop.

Region: It hinders development?

de Soto: It hinders development. It's unavoidable that this will be the subject in the United States, because the United States is very gung-ho on culture, very gung-ho, and I can understand it. If you're born on 42nd Street to 45th Street in New York, it's a different culture than down here, and so on. I understand all that. But when you try to raise the issue in Latin America, or when I speak in Egypt, people don't take culture seriously. It's a university subject. They don't take it seriously.

Let me tell you, everybody was saying, oh, it's going to be very difficult for you Peruvians to work on these issues in Egypt because the Muslim mind this and the Muslim that. But when we came over and we said look, the fact is that the poor Egyptians own $241 billion in real estate outside the legal system, and you've got 17 years of red tape blocking them from good property law that gives them credit, no one—I haven't found one Egyptian who came to work for me—who said, you are touching my culture, man, get off it. Nobody. But in the United States, I can see myself going to universities and 101 gringos with freckles on their face saying, ah, culture is the thing. I have a feeling that culture is your culture. That you've given, in your culture, much too much importance to what you can actually do through culture.

Region: Tell us the barking dog story, the metaphor.

de Soto: That's about culture too.

Region: Yes, and it gets to the nub of the point.

de Soto: It's a good metaphor. I'll tell you how that came about. My other book, The Other Path, was written for Peruvians, but I was amazed when it spread beyond Peru to all of Latin America and became a Latin American best seller. And then it started going to other developing countries, and one of the other countries it went to was Indonesia. And I was also thrilled because my publishers in Indonesia were the extreme left-wing press, which I thought was interesting.

So, I went with my wife to the other side of the world. And one of the reasons I went there was not only to see what Indonesia looked like, but specifically to go to an island called Bali. Because every time I talked on the plane with somebody—these people are very well traveled, and travel with a continual sun tan—I would ask them where they liked to visit the most. Everybody always says Bali. So, I went to Bali after having presented my book.

And when I was in Bali, your ambassador to Bali called me and said that Suharto and his Cabinet would like to see me if I'm available, because they know we're doing all this work on property rights in Peru. So, I went to see them. And they said, don't talk to us about the virtues of property; we know the virtues of property—most of them were, as a matter of fact, Ph.D.s from Berkeley and UCLA—we want to know how it gets done, because we figure that 92 percent of our people don't actually have property, they just have possessions. But start off with something concrete. How do you know who owns what? That was the concrete question. In other words, you've got all these masses of people; how do you warrant a property type in a systematic way to 160 million people? You need systems.

And so, if I had to give them a long-winded reply, which means putting out my flow charts, it would have been impossible and I would have lost their attention. With politicians, you lose their attention very quickly. So a metaphor came into my head. And I said look, I've just been in Bali, that beautiful island, and all I've done during these 16 days is walk up and down Bali—because that's all you can do in Bali. It's got these rice fields and these palm trees and these pagodas, and I just kept on walking with my wife. We always knew when we changed properties because a different dog would bark. Therefore, all the information you need is in the hands of Indonesian dogs. So, get the Indonesian dogs organized. And everybody understood it. And then, of course, one of them said, "Jukum Adat," the people's law.

Basically, wherever we go, we find the symbol of the dogs barking; people have agreed on some form of law on how they're going to relate to each other regarding their assets. And what we do is we try to build up a legal system of property that is based on the realities already on the ground. In other words, if at this moment there was a huge earthquake in Washington, D.C., and we find out afterwards we were the only four living survivors and we had to share all of Washington, D.C., among ourselves, we'd make a property rights agreement pretty quick. Either we'd agree to govern the whole thing jointly, or we'd split it up into four.

And that's what happens with people, they make agreements among themselves. And they understand these agreements. They have invested in them over a long period of time. And we saw that this is basically what you did in the 19th century all throughout the western United States, and this is pretty much what occurred also in central Europe, but it occurred many years ago. So, we try to reproduce that process very quickly with computers in the 21st century. So, that's what's behind the barking dogs.

In other words, you don't go out and copy other people's legislation. You can't take other people's rules and bring them in. You can get inspired by the principles, but you basically have to build them from the ground up. And that's why your democracy works so well, because it's built from the ground up. It's adjusted from the ground up. It always takes into account public opinion.

Region: So, to give property value, to create capital or live capital, as you describe it, where it doesn't exist now, you don't write the laws from the top and hand them down; rather, you go out and see what social contracts, if you will, already exist, and write the laws from reality?

de Soto: On the basis of reality, yes. That's what you do. As a matter of fact, I forget who it was, but there were common law judges who described four centuries ago what the law was. And they said law isn't something you build; law is something you discover. You can take a state cooperative, for example, which is what we did in many parts of Peru, where the left-wing military government had actually organized a great part of the countryside in state cooperatives. They had taken indigenous communities and created state cooperatives managed by government bureaucrats. And when we went there to title them, we knew that they had no sense of property in the traditional sense—it was like a salad bar. You had kibbutzim in there, you had indigenous communities, you had private parties, you had hippie associations; every way of organizing property was there. And if you wanted, you could combine or recombine the notions. We said here's the menu, you choose. The important thing is you come within the law. That's all. In other words, you're going to create property rights and once you're in those laws, you can change. But it's a legal process—it doesn't have to be a revolution anymore. We want you inside the law—in systems. And we'd come back six months later and they had then created their own barking dogs, even if they didn't have a tradition.

In other words, you don't have to have customs over many years. If somebody has been given six months to decide how the four of us are going to hold 600 hectares, well, under no pressure we would do it. If we've been given three months, in three months we'll make the decision. And because we'll sweat it out, it'll be a strong one. The important thing is that we agree on it, and that's what gives it legitimacy, and that's what allows it to grow. And everybody knows where the starting point is.

Region: I want to make sure I have a chance to ask you about yourself, so please tell us how it is that you came to decide that you were going to spend your life thinking about these sorts of questions and worrying about these sorts of problems.

de Soto: Well, the opportunity to do this only came about 15 years ago. I spent most of my life in private business. I ran continental Europe's largest engineering company, and I financed projects in hydroelectric plants and nuclear plants worldwide. That's what I did before, and I continued to do some work in the mining business.

For political reasons, I was raised outside Peru, but I visited Peru every year. My father called it the Peruvinization of the boys. You have to go back to Peru so as not to lose your Latin American culture—supposedly, according to my father, who was very stuck on Latin America. He was very proud of being a Latin American.

So, I would go to school with my American friends, my European friends—I picked up some of your accent there—and I'd go back to Peru. And when I was in Peru, I think it was about the age of 17, it all of a sudden dawned on me—after living in both places, nine months in Europe, three months in Peru from the age of say 5 to the age of 17—that I came from a poor country.

We rode a lot of horses and mules in Peru, and in Switzerland we rode bicycles—there were these types of differences—but with the people there was something you could distinguish, one from the other. So I said, well, why do my cousins come from a poor country and my friends in Europe from a wealthy country?

And so, that's what made me curious, and that's why I kept on reading most of these books. I probably studied economics just to find out what the ingredient was. And then I started seeing how the formulas included stable money, fiscal equilibrium, privatization and so forth, and yet the changes remain. So, I thought that most of the differences must, therefore, not be things that are visible. But to analyze things that are not visible requires a lot of time, and it requires a lot of time not locked up in an ivory tower, but actually doing things on the ground and seeing where you fail and seeing where you succeed.

So, when the Shining Path became prevalent in Peru, and there was space and financing to be able to take time off to see how reality did work, and to try to pass legislation in Congress, I found a golden opportunity. And afterwards, it got so exciting, of course, that I even stopped watching Schwartzenegger and suspense films. Life itself was more exciting, and now I'm stuck in it and I can't let it go until the mystery's solved.

It's just very exciting, of course, and it's always been in my head. I have friends in America and Peru and Europe—I mean, I've got Italian friends and they're very different from my Swedish friends—but there's nothing in that difference that indicates why some are more prosperous than others. So, the question of why these different countries are more prosperous than the others has always been in the back of my mind. I find it one of the most intriguing questions to consider. And The Mystery of Capital is taking a stab at it.

Region: Let's talk about another metaphor that you use in your book: the bell jar, wherein the wealthier people of lesser-developed countries live—the "legal" residents—with everyone else outside—the "extra-legal." What is the incentive, if any, for those in the bell jar to support change for those on the outside and, in effect, let them in?

de Soto: What happens is this: If you document it well, in the worst of cases you win over their neutrality. In other words, if you document that 30 percent of the country's been taken over extra-legally, and you tell those within the bell jar that those extra-legals are never going to give it back—you can call for compensation, but it's never going to go back—and if you don't settle this property rights issue, they'll take over 60 percent, then 90 percent. So, let's deal with it now.

If you're able to articulate a clear image of what's happening, and you tell them how this happened in the United States, and this happened in Japan when they destroyed the feudal system, they will understand. And the smart guys are those who settle fast and quick. Because the sooner you get a property rights system, the sooner those poor people will actually be on your side to protect property rights, because otherwise they're going to be squatted upon as well.

It isn't a question of claiming for justice. It's just the same situation the Europeans had 200 years ago and the Americans had 150 years ago. So, that's the political reality. Settle it, then those within the bell jar will do it. They won't do it with enthusiasm, but they won't resist it. But that means that you've got to bring across a strategy. You've got to talk not only to the barking dogs, but also to the elites as well, and settle their issues.

Region: Given your prescription, what is one country that looks promising for the near future?

de Soto: In the Third World?

Region: Third World.

de Soto: Probably Chile. Because, you see, they've got a consensus. They've managed, in spite of everything, to work up some kind of consensus. They've got a social contract going on. I mean, the left and the right have agreed that they want the Washington consensus; they've seen the fruits of entrepreneurship. You know, the three countries of the southern cone of Latin America—Chile, Argentina and Uruguay—are very different from the rest of us. We're more like Mexico—from Mexico down to Bolivia, Brazil, we're Third World. Many people never understood why Argentina didn't look more like Australia. These are basically Western European countries. And among them, the people who have seemed to have gotten their act together much better have been the Chileans.

Then secondly, probably Mexico, and that has a lot to do with the influence of NAFTA [the North American Free Trade Agreement]. You see, I think there's a hidden strategy in Mexico, that tying all their laws—all the modifications they've made to their old patrimonial system—to agreements with the United States and Canada has allowed them to lock in certain institutions securely. And so I think they're probably going to head in the right direction. And with that, they've also beat this cultural thing about Mexico vs. the United States.

Region: That should apply to others then, right? Can you apply that Mexican model—that way of thinking—to other countries?

de Soto: Yes, well, that's how Spain started coming into the West. The Pyrenees were considered really the tip of northern Africa until about the 1950s because Spain was out of the loop. And by then, with old Franco and all the Spanish elites emphasizing their Europeanness rather than their Latinness, they were able to hook up to a model the people could believe in.

So, it's no coincidence that developed countries all come together. All poor countries are lumped together and all rich countries are lumped together; there's this imitation effect. So, if Chile really starts making enormous progress, and maybe Argentina jumps into the loop, then the rest of us will have a tendency to go there. Or, if that happens to Mexico, then all those barriers of resistance to change will break down just the same way they did in Europe. Some countries took off faster than others—Germany took off very fast, but when Germany did, then Austria, Switzerland and all the other eastern European countries had to follow. When one country's very successful, it catches on in the rest of the neighborhood.

Region: Some might read the subhead of your book—Why capitalism triumphs in the West and fails everywhere else—and see cause for hope instead of concern; that is, they might hold capitalism in very low regard, and just as soon see it fail and fail again. Is capitalism the only game in town?

de Soto: Yes, I don't know of any other game in town. I think it's a very sophisticated game. We have to analyze it better and better. It's a very, very sophisticated game, and it's the only success story. There may only be 25 countries that have succeeded out of a total of 190 or so, but it's the only game in town for the moment.

Now, where your question is very pertinent, of course, is: Will it continue to be the only game in town? Yes, that is a good question because, you know, the fact that you don't have a communist system with a Comintern controlling you from the Kremlin doesn't mean that people don't invent systems. I mean, fascism can grow up out of nothing, and other social systems can grow up out of nothing. So, it is the only game in town for the moment. But if it continues to be so, it's going to depend very much on its creativeness and its capacity to reach out to the poor and not consider them simply as a sob story, or a charity story.

Generally speaking, most people who write about capitalism don't have a view on that because they're thinking about the First World; or they apply IMF [International Monetary Fund] and World Bank recipes alone. But then again I don't think it is an IMF or World Bank responsibility. I think it's a local responsibility. If we have that amount of poor imagination—that we're incapable of doing anything else than just simply repeating the recipes given to us from Washington—then we don't deserve to be called good economists or good politicians.

Region: Thank you, Mr. de Soto, and good luck.

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