CULTURE CLASH: A Talk with Hernando De Soto

Monday, April 22, 2002

In the West, capitalism reigns triumphant. Living standards, wealth, and technological development in the capitalist Western countries surpass anything seen before in human history. But why has capitalism so obviously failed in most developing countries? Why are some saying that capitalism is in a state of crisis today in the Third World? Does the success of capitalism depend on Western cultural values that simply don't translate to the Third World? Or can economic and political reforms, especially reform of property rights, enable developing countries to share the same fruits of capitalism and free enterprise that we enjoy in the West?

Recorded on Monday, April 22, 2002

Peter Robinson: Today on Uncommon Knowledge, the United States is rich. Mexico, Peru, Columbia, Bolivia, Ecuador are not. How come?

Announcer: Funding for this program is provided by the John M. Olin Foundation and the Starr Foundation.


Peter Robinson: Welcome to Uncommon Knowledge, I'm Peter Robinson. Our show today, capitalism and the Third World: a conversation with renowned Peruvian economist Hernando De Soto. In the West, capitalism reigns. Living standards and technological progress surpass anything ever before seen in all of human history. But in the Third World, capitalism seems obviously to have failed. One developing country after another, just isn't developing. Why? Is it because capitalism requires cultural values that exist in the West, but not in the Third World? Or, can economic and political reforms, especially reforms of property rights, finally enable the Third World to enjoy some of the fruits of capitalism? Hernando De Soto is founder and President of the Institute for Liberty and Democracy in Lima, Peru. He is also the author of The Mystery of Capital: Why Capitalism triumphs in the West and Fails Everywhere Else.

Title: The Wealth of Notions

Peter Robinson: Robert Samuelson: "Capitalism is a peculiar creation of Western culture." Does that mean that everywhere outside the West, the Third World, is doomed to fail at becoming capitalists?

Hernando De Soto: If culture is separate from law, he's wrong. I think that capitalism is particular to the West, because of the legal system the West has.

Peter Robinson: Now, in your work there are two concepts that I take it to be absolutely central to your work. The first is capital itself. What do you mean by that term?

Hernando De Soto: I mean by capital, the value that things have that can be transported to start off new ventures. Pretty much what I think the economist defines it as, stuff that begets stuff. That is to say, value. It's value that can be monetized or not. It can be expressed in monetary form or it can be expressed in other forms, but that you can move around. Let me give you an example, the Peruvian Telephone Company, had a value back home in the Lima Stock Exchange in 1990 of fifty-three million dollars. Badly titled, within a bad legal system. We decided, the Peruvians, to privatize it. So basically, over three years, it was re-titled because nobody would buy it. And we titled and represented it on paper. And once it was properly titled, put within the right legal context, it got sold for two billion dollars, thirty-seven times its value; which means, that without painting the telephone company, without mowing the lawn, repairing the windows, or whatever, just by representing it in paper, in a structure and format that the law allowed to travel internationally, we raised its value thirty-seven times. That's capital.

Peter Robinson: Who bought it?

Hernando De Soto: It was bought by Telefonica of Spain. But what I'm trying to say is that…

Peter Robinson: Right.

Hernando De Soto: …when things are represented correctly, then people understand them better, and the system of representation in the West is law.

Peter Robinson: So that brings us to the second concept that is essential to you work and that is property, because capital, as you've described it, inheres in clear title, clear property ownership, so what is property? It's not just a mug, something that I can hold. It's not just a physical object.

Hernando De Soto: Of course not. This, for example, I understand, if you are a generous organization, that this is my mug. This is my tea, right? Now, if we look at this cup, there is nothing in this cup that says this is Hernando's mug. This is Hernando's tea, because essentially, property is an understanding between you and me and anybody else in this room, that this is mine. So property is a concept. It is something that makes this cup meaningful, meaningful to us. Therefore, property is essentially, when it comes to the West, a legal device, a property title that is backed up by statutes, that is backed up by custom, that determines that this is not a stolen mug, but it's my mug. So property depends very much on consensuses and some consensuses are picked up by law, and therefore easy to transfer, and some aren't picked up by law. This mug and everything you've got in this country, is described within a property system. And that allows things to therefore travel in an identity form. In other words, when you come into the United States, there's two realities: there's the reality of the mug, physical things; and there's the reality of what we think about physical things, which are passports and property titles. But what travels in your markets, are not mugs, what travels in your markets are this. When you go to the Chicago Mercantile Exchange, nobody drives in ten thousand head of cattle, they come in with a document that says I own ten thousand head of cattle. And it makes a lot of sense because if you look at that property document, you'll know more about the cattle than you will by looking at each pair of brown eyes.

Peter Robinson: Let me ask Hernando for an example of how inefficient property systems inhibit capital in the developing world.

Title: A Baker's Doozy

Peter Robinson: Suppose I'm a baker. I want to open a business, and I want in some sense to own it. And in Peru in the old days, what did I have to do?

Hernando De Soto: Well in Peru, you'd first of all, have to prove that you own the shop, and you'd have to get an authorization, like any part of the world, to operate any business legally, you need a license…

Peter Robinson: Right, a license.

Hernando De Soto: …about whatever it is. Okay, in the case of Peru, for example, regarding, not bakeries, but sewing machines, we found out, what happens if you have a sewing machine, and you want to have a shop that is recognized by the law, so that you can sell, legally sell, the shirts you make, or whatever it is you sew. And that takes you roughly three hundred days, working eight hours a day, to open the shop, to get the authorization to open the shop.

Peter Robinson: Because the bureaucratic overhang is that heavy.

Hernando De Soto: Because of the legal overhang. The reason I use legal, rather than bureaucratic, is because we tend to blame bureaucrats for laws that are produced by politicians. So I think that if we really want to get to it, we shouldn't look at the bureaucrats, we should look at the politicians that are behind this.

Peter Robinson: Alright. But this is distinct now. Forgive me if what I'm about to say is in any way offensive, I don't mean it to be so. But, for a North American to look from Mexico south, the first word that comes to mind is "corruption." You're talking about something different, you're not talking about having to go around to various offices in Lima and pay people off, you're talking about the simple amount of time it takes for the legal system to process documents to produce a clear title.

Hernando De Soto: When we talk about the three hundred days, that doesn't include the cost of corruption, but corruption comes into the process because if you're faced with three hundred days, what most people do, is bring it down to fifty. Let me tell you about corruption, something that's important, so as to…

Peter Robinson: Right.

Hernando De Soto: …classify. To get a view of what the law means to most of the population, we interview the population, wherever we work. And in a recent interview in the Middle East, as I was talking to one of the--my people were talking to one of the black market entrepreneurs, which were part of our work, I talked about corruption, graft, and which is called there "baksheesh."

Peter Robinson: Baksheesh.

Hernando De Soto: And I said, "Tell me now that we have sufficient confidence, and you won't be offended, what do you think of baksheesh?" And the reply was, "Baksheesh, I love baksheesh." I said, "How interesting, why do you love baksheesh?" He said, "Because, you see, baksheesh gives me predictability." In average governments like ours, for example, the Peruvian government, produces about twenty-eight to thirty thousand rules a year. That means to over a hundred per working day. In that atmosphere, where there are politicians writing off regulations and technocrats in some case, at a speed that you can't control, corruption or buying off a policeman or buying off a judge, gives you predictability. So he said, also it allows me to distribute money among poor policeman and other people. But I know what I have to expect in the future. So the…

Peter Robinson: And so if you have a judge on the take, you can get a predictable result from that.

Hernando De Soto: You can get a predictable result. So what happens in your country, the United States, and what happens in Western countries, is that your legal system is much more predictable than the Mafia. What happens in our countries, because of legal underdevelopment, is that the Mafia's much more effective than the law. And the challenge we face in the Third World, and the former Soviet Union, is producing a legal system, that once and for all becomes much more predictable than the Mafia. And then we will win over corruption in the same way that you, two hundred and a hundred years ago, beat your own corruption, because all Western Countries, at a certain point in history, were very corrupt. Look at the British, which today, are the epitome of good behavior. Well, Oliver Goldsmith, the British historian, wrote about them two hundred and fifty years ago, or so, and he used to say, "A British judge is a living creature that will be willing to sell one dozen laws against half a dozen chickens." My God, they used to knight Sir Francis Drake. They knighted him, and all he did was steal Peruvian gold and silver, or Spanish gold and silver, whatever you want. I mean it was as if Al Capone got the Bronze Medal of Honor. So what I'm trying to say is we were all corrupt at a certain point, until the rule of law came into place, and that's the challenge in my part of the world.

Peter Robinson: I want to tackle this question of the relationship between culture and capitalism one more time.

Title: Property Rites

Peter Robinson: Why did legal rights, clear property title, arise in the West instead of in the Third World? Now perhaps you can give me a--let's say, it wasn't all that long ago, eighteenth century, Lima was a bigger, more prosperous city than New York. Flash-forward a couple of centuries, and of course it's much the reverse. How come? Why? What happened there?

Hernando De Soto: Well, there's a variety of explanations. I think one of them has to do with migrations after a while. The other has to do with the Common Law. As the Common Law was a much more flexible system, and so the Industrial Revolution that is to say a law that was adapted to business was better hammered out under a Common Law system, because it was a judge-made law…

Peter Robinson: Okay.

Hernando De Soto: …So the British got a head start, for example, in Europe before countries that had Roman Law, like the Germans, like the Swiss, like the French…

Peter Robinson: French, right.

Hernando De Soto: …Then what happens, seeing the advantage of the Anglo-Saxon countries, is that all the other countries, the Roman Law countries, like mine, had to re-engineer their law, and in effect Germany followed, and France followed, and Switzerland followed in that re-engineer. But the idea was that you--the situation rather was that in Europe, you had the Common Law begin, and then the neighbors are reacting, because they were falling behind…

Peter Robinson: So…

Hernando De Soto: …In our part of the world, like in the rest of the Third World countries, our large migrations, our coming to the Industrial Revolution has only begun in the last years. You know what happened to you a hundred and fifty years ago, is beginning to happen to us now. So that could be one explanation for your head start.

Peter Robinson: Let me give you a good chance then to hit Max Weber smack in the nose. Weber, of course is the one who famously linked culture to capitalism in his work The Protestant Ethic and the Spirit of Capitalism. So, was he on to a little something, that there is a particular culture, informed as Weber believed, by Protestantism, where thriftiness, savings were encouraged. A certain industrious attitude was encouraged. Sobriety was encouraged, and that there is some link between this particular cultural flavor, or brand that arose in northern Europe and the emergence of capitalism. Do you buy that? Do you say, I buy it for a couple of hundred years ago, it's of no relevance now? Do you reject it entirely?

Hernando De Soto: Could be that it gave Protestants and maybe Anglo-Saxons or Calvinists a head start, maybe. But it's really not relevant today. Let me give you an example of the European Union. The European Union is put together by Jean Monnet, Robert Schuman, and the likes of Konrad Adenauer and de Gasperi. And instead of going and saying, you know, these--our countries, France and Germany will never get along because it's a wine-drinking country, you know, one of these broad-brush things, the way Weber writes. And the other one is a beer-drinking country. And they're never compatible, and instead of doing that, they put it under the microscope instead of in the telescope, and they start saying, let's stop talking wine and stop talking beer. Let's start talking coal. Let's make an agreement on coal, let's make an agreement on steel. Let's make an agreement on company law, let's make an agreement on property rights. Let's make an agreement on education equivalences, and under the microscope then, all of a sudden different cultures began getting together, in spite of the fact that they'd been at war for hundreds if not thousands of years…

Peter Robinson: Okay.

Hernando De Soto: …When the European Union decides that now they want Portugal and Spain, Catholics, Latins, Third World, siesta time, to come inside the system, they don't start saying, now how do we get a Spaniard to stop fighting bulls? No. What they start doing is, again, getting into the nitty little details of forming a larger Common Market, and all of a sudden, Spain, that twenty years ago, was receiving foreign aid, is today, a country that's developed…

Peter Robinson: Right.

Hernando De Soto: …So I really think that all of this Protestant mumbo jumbo is really irrelevant today.

Peter Robinson: We've explored culture and capitalism, on to democracy and capitalism.

Title: The Rules of the Game

Peter Robinson: I'm quoting you now, "It should be no surprise that all the countries that have good politics, and democratic politics, are all the countries that are wealthy." So, what is the connection then between democracy and capitalism and property?

Hernando De Soto: The connection is the following one: that democracy allows governments to bring out rules that people understand, and that have less transaction cost, because they continually get feedback. For example, how is a rule made in the United States? You've got comment and notice periods, you pre-publish your drafts. The Office of Management and Budget does cost-benefit analysis on the law. All your Congresspersons or men, get elected on a district basis, which means that the politicians are not just accountable to the nation in general, they're accountable to specific audiences that are continually following their track-records; as opposed to Latin America: no comment and notice periods, no cost-benefit analysis, and all our Congressmen are not elected on a district basis, they're elected under one political list…

Peter Robinson: So they're responsible to the party or…

Hernando De Soto: …I could give you a hundred measures that the Westerners have on how they produce law, that we don't have in developing countries, and that makes the difference. The advantage of a democracy, understood not only as elections, but also as the accountability and transparency under which you produce rules means that in your countries, the rules are relatively easy to follow compared to other--or let's say that even if they're complicated, they're structured in such a way that they don't tilt the…

Peter Robinson: So…

Hernando De Soto: …rule of law in favor of somebody's position.

Peter Robinson: So for your purposes, you're not exalting democracy because of the inherent nobility of it, you're exalting democracy because of its practical genius.

Hernando De Soto: Absolutely…

Peter Robinson: I see.

Hernando De Soto: …I do think that there is, by the way, other values to it…

Peter Robinson: Of course.

Hernando De Soto: But aside from it, democracy is like a constant marketing program, it allows you to get the feedback and knowing that you take out a product that is useful to everybody.

Peter Robinson: Since the fall of the Berlin Wall, we've seen two great big experiments taking place. Russia has put into place a democracy, of sorts, but a democracy, and seen its economy collapse, recovering some now, but for the first decade it was just a free fall. China has no interest in democracy, it remains very much centrally controlled. But it has permitted markets to flourish, I'm assuming, perhaps you can fill me in, that there has to be some underlying understanding about property rights for the markets to flourish. Which is the better model for a Peru, for an India, for an Egypt?

Hernando De Soto: One must not confuse elections with democracy. You see, we Latin Americans have been having elections for hundreds of years, not a hundred years, a hundred and eighty years…

Peter Robinson: Right.

Hernando De Soto: …and we continue to elect dictators. Because you see, if the government in my country, in average per year, produces twenty-eight thousand rules, norms, regulations, laws, that means a hundred and six a day. And there is no way to hold it accountable except that the next general elections, which are five years hence. We actually elect dictatorships. So to me, elections is just one part of the game. Much more interesting to find out is, once the government is in place, hopefully through elections, because that's one first stage of transparency, from then on, how are rules made? And obviously in China, somebody's been doing the right thing. You get places like Singapore, which may not have had elections, but before they put a rule into craft, a rule into place, there's a lot of consultations going on at another level. So we have to stop thinking of democracy just only in the traditional Western terms, we have to get into the nitty gritty details of finding out if people are accountable and especially how are rules made?

Peter Robinson: Next topic: putting Hernando's theories into practice.

Title: Cuanto Caliente el Sol?

Peter Robinson: How much have you been able to accomplish? Give me what you've done in Peru, and what the practical result has been in Peru. And then I'd like to talk about where else you're active in the world.

Hernando De Soto: Of course. In the case of Peru, we set up a new property system…

Peter Robinson: When you say, "we," you'd better go ahead and name your organization.

Hernando De Soto: …Yes, of course, I have an organization, which is a foundation called the Institute of Liberty and Democracy of Peru…

Peter Robinson: And it's how old, Hernando?

Hernando De Soto: …And it is now about seventeen years old.

Peter Robinson: All right, fine.

Hernando De Soto: …Fine. And it started out by being a think tank. We thought about these problems, and then we became an act tank because if we didn't implement them, we saw that these things wouldn't happen, so we drafted legislation, and then we actually ran the government offices, which implemented the legislation. In what fields? Well, first of all we helped set up the ombudsman in Peru. The ombudsman is, you know, a defender of the people. One of the purposes was of course, to make sure that government could listen to people the way it does in the United States, and the Western countries. We also created a property system where the poor could participate in the awarding of titles. So we made sure that the property law, was always connected to how the poor perceived them. And so far, that has allowed us to title in Peru about one million six hundred thousand urban properties. We also set up a system called…

Peter Robinson: Is this almost entirely in Lima?

Hernando De Soto: …Oh, no, all over Peru.

Peter Robinson: All over.

Hernando De Soto: All over Peru.

Peter Robinson: And what sort of years has this taken place?

Hernando De Soto: This started--the design of this was done under the Garcia government from 1988 till the year 2000. And implementation began in the year 2000, practically with President Fujimori. We created another system called the Registro Unificado with the purpose of which was to bring in black market firms, mainly small and medium-sized into the legal market, and over four hundred thousand firms came in. And during the time when most of the surge occurred, Peru grew at a rate of about thirteen per cent, which was the highest growth rate in the world. We set up the political framework for the substitution of the coca plant, from which cocaine is derived. Peru used to be responsible for sixty to seventy per cent of the production of the world's coca. We're now down to twenty-five per cent…

Peter Robinson: And this is all property, you're not doing anything to affect the tax structure? Or what about the currency? Who runs the central bank?

Hernando De Soto: …No, we didn't touch the tax...

Peter Robinson: You didn't touch any of that?

Hernando De Soto: …But the reason we were successful is because of all the costs of being legal, the tax was only a small part, in our case.

Peter Robinson: I see.

Hernando De Soto: In other words, for example, what you paid in bribes, if you were in the extra-legal sector, was nearly as high as the tax, so we didn't have to touch the tax, we just touched the cost of doing things. We just talked about it. For example a sewing machine, to become legal and operate…

Peter Robinson: Three hundred days.

Hernando De Soto: …three hundred days.

Peter Robinson: But nobody wants to repeal your work?

Hernando De Soto: No.

Peter Robinson: In other words, it's formed a base on which other people are now building. Where else are you active in the world?

Hernando De Soto We're not really happy what's going on in Peru, but it's a lot better than if we hadn't been there. In other words, it could be operating much better.

Peter Robinson: Okay.

Hernando De Soto: We're now--we've been working in the Philippines. We are now working in the Philippines, in Mexico with President Vicente Fox, in Haiti, with President Aristide, in Egypt. We had our first conversations in Russia with President Putin.

Peter Robinson: Last question: what can we in the West do to help?

Title: Don't String Me Along

Peter Robinson: Lorne Gunter of the Canadian National Post: " The world's wealthiest nations could all double their foreign aid contributions; they could triple or even quadruple them; they could forgive the debt of the forty or fifty poorest nations, and poor countries would still be poor." In other words, the argument there is that foreign aid, sheer transfers of wealth from the First World to the Third World, will make no lasting difference. Now President Bush said recently in Monterey, Mexico, that the United States would expand its foreign aid budget by fifty per cent. Will we just be wasting our money if we do that?

Hernando De Soto: It depends what you do with the money…

Peter Robinson: Okay, what should we do? You're now advising George W. Bush. What strings should he attach to that money?

Hernando De Soto: Well, I think I would tell President Bush, that you know, foreign aid has alleviated poverty. In some cases, it's actually helped our projects, I mean, we get funding from USAID and that's been very helpful. But if you really want to help development, and not just alleviate poverty, I would put much more emphasis on supporting the transformation of legal and institutional structures. And the fact is that there are proofs that this works. When you occupied Japan, between 1945 and about 1950, basically what MacArthur did is set the basis for massive legal transformation of the property rights structure of Japan. And what was used there before, a feudal system became a property market system. The Europeans today, when they're dealing with Romania, Bulgaria, when they're dealing with the accession of Portugal to the European Union, you don't just throw tons of money at them, you sit down and work out the nitty gritty of the legal system, so that a Frenchman can invest in this bond, or can invest in Madrid in the same way that he can do it in Paris. And that's what's created wealth. I would say, go back to your successes, and you will see now that most of foreign aid is not dedicated to the change of institutional legal system, but it's essentially, your institutional legal systems that work. Latin Americans, who back home, and for example, in Peru, don't obey the laws, don't necess--are not very necessarily productive, when they get to the United States, they stop at the red lights, they obey the law and they're sending the money back home. The same with Mexicans. What has changed? Their culture? No. What's changed is the legal system.

Peter Robinson: Okay. Hernando, it's television, alas, so let me just ask you two final questions: in Peru today, forty-nine per cent of the population, alas, still lives below the poverty line. In twenty years, what will that percentage be? This is a question about how optimistic are you?

Hernando De Soto: Oh, I'm very optimistic. Let me give you some statistics that are much more meaningful than the ones that you've just tossed at me…

Peter Robinson: Please. All right, please.

Hernando De Soto: All right. How much do poor Peruvian's own today? We've calculated it, how much do they own, in terms of building and machinery? They own ninety billion dollars worth of assets. At not even market value, just replacement value. In market value, it would be much bigger. How much is ninety billion dollars worth of assets? Well, it's about forty times all the foreign aid you've given us, including World Bank loans. It is about ten times the size of the Lima Stock Exchange and it is about twenty-nine times the size of all foreign direct investment. So I'm optimistic that Peruvians will get out of poverty, the day that they receive a legal infrastructure similar to yours, which allows their entrepreneurship to thrive.

Peter Robinson: Last question: Egypt, Pakistan and Afghanistan, three Islamic countries, much on our minds today. The proportion of the population now living below the national poverty line, Egypt, about a quarter, Pakistan, about a third, Afghanistan, about half. Are you optimistic about the Islamic world, about those three countries?

Hernando De Soto: We've worked with the Egyptian government. We've been privileged to work with the Mubarak government and we have found out that about ninety per cent of Egyptians own their assets and trade their assets outside the legal system. In other words, the informal sector of Egypt is ninety per cent of the population. And that ninety per cent of the population that is generally poor, actually owns assets for a value of two hundred and forty-five billion dollars, the poor of Egypt own two hundred and forty-five billion dollars outside the law. Therefore, am I optimistic about the future of Egypt? Definitely. The Egyptian people have proven that they are full of entrepreneurship. What they're missing and what the government of Egypt is intent upon doing now is and we're helping them as much as we can, is creating a legal system, whereby all of these assets can be leverage and they can finally be globalized…

Peter Robinson: How long? How long? How long will it take?

Hernando De Soto: Oh, it's a long process. It'll take ten to fifteen years, if we're lucky. That's how long it took Japan. It took you in the United States, two hundred years. It's a long process. You have to overhaul the legal system.

Peter Robinson: But within our lifetimes, yours and mine, we'll see change?

Hernando De Soto: Oh, we can see a change, absolutely, if I get to live another fifteen years.

Peter Robinson: Hernando De Soto, muchisimas gracias.

Hernando De Soto: Encantado, senor.

Peter Robinson: For Uncommon Knowledge, I'm Peter Robinson. Thanks for joining us.