The Mystery of Capital

A review

by Benjamin Reeve

Hernando de Soto's The Mystery of Capital is subtitled an explanation "Why Capitalism Triumphs in the West and Fails Everywhere Else." The short version of the provided account is that in the West there exists a "bell jar" (the term de Soto uses) surrounding an environment within which property rights are sufficiently formalized (or "legalized" -- the two words are used almost interchangeably) to be used successfully capitalistically.

I believe the explanation (also in the longer, more elaborate, and more articulate form de Soto indeed provides) to be in one part right and two parts wrong. Favorably, the parts that are not right offer the considerable benefits of illustration and instruction; they are explanatory and helpful.

De Soto's book has been selected as one of the most "important" of the year and a "must read' by such organs of enterprise and enterpreneurialism as The Standard. Whether it really threatens to become the next guideline work for widespread international economic fashion or not, some attention to what might be important about it is due.

Perhaps the most significant truth de Soto speaks is that capital in not a physical thing. Capital indeed is an informational thing. Capital is a form of relationship. It is not gold; it is a set of relations with respect to the handling of gold. This is a point that has been and continues to be lost on far too many not to be appreciated in de Soto.

Despite having thus said the right things as doctrine, however, he does then suffer something of the old confusion in comparing economics to physics. A subchapter is titled "The Potential Energy in Assets" and at one point he supposes economic value to be " the potential nuclear energy in Einstein's brick." The mistake when used as the introduction to an analysis trips, as it always has, over the fundamental differences between physical things that are (with only certain exceptions in quantum physics) subject to conservation and symmetry principles, and informational things which are not conserved in the technical sense of the term.

But no terribly great matter. de Soto recognizes and comments intelligently upon the truth that, as between two nations, each with a pile of blocks as physical assets, one may have capital and the other not, and that the difference has to do with a network of relationships embodied in the society surrounding the goods available. He correctly notes several times that the basic raw value in market terms (even in the depressed markets of third world countries) of the real estate in those countries is many orders of magnitude greater than the foreign aid that has been given to them over decades. The answer to national poverty in poor nations will not be to give such nations increments of money while they cannot capitalize assets within the country. Since the world has acted without the apparent benefit of this understanding for so many years now, de Soto's contribution is substantial.

That much said, however, Mr. de Soto does not manage well the truths a) that legality is not a singular thing and not of a single nature, and that law and its processes can oppress as readily as they can enable, or b) that money, although purely informational, is very low quality information, and that most structures of financing are highly self-reinforcing, feed-forward systems, many of which shed or actively displace higher quality relationships as they proceed. Even though he provides descriptions (complete with fine-line charts), of the ridiculously many bureaucratic steps involved in registering or confirming a titular interest in various countries (Peru, Egypt) in which process requirements clearly defeat much of the value in much of the possible property, he does not offer similar understanding, for example, of the wholesale economic defeat that may ensue from corruption, particularly sanctioned corruption, in which government is given the prerogative to presume upon value even before it is much created. One would not learn from him, at least not from this book, that constitutionality, in the very best sense of the term, has real capital value at least as great as (often much greater than) mere legality. In short, the book evinces little concept of relational depth, particularly the real terms of relational depth in legal and economic structures.

de Soto does understand that the important attributes of successful property systems are not well set out by GIS printouts or by political mandates. He includes a long discussion of the practical development of property rights in the American West, and usefully narrates the histories of various ways in which informal property relationships have been brought to formality, most of them through a complex realpolitic of adjusted interest between distinct segments (miners, squatters) and the greater society. One can tell, he explains, where territorial property begins and ends in Bali by noticing where intrusion is greeted by the barking of which dog. He advocates proceeding from such distributed indicia, systematizing them. But that is to persuade us that there exist structures within the social reality upon which the ascriptions of property can be based. Of this the reader should not require much persuasion. Wherever people live, even in the simplest ways, we do so according to patterns, many of them intricate and complex, most of which can be used for further social and legal purposes, distinguishing property rights often among them. It is in the other direction that de Soto does not look. And not looking, does not see. Formalization, fine, but it is not mere formalization that enables transaction. Although the simple certainty of legal title arguably enables the simple act of representational exchange (money, of which capital is a form, is an entirely non-physical thing created by means of transactions, most of which have the color of "lending" of some sort), the value associated with the transaction (and thus the amount of capital to be created by engaging in it) depends profoundly upon the wider economic and legal environment. Simple and absolute title to a simple isolated thing is no economic good. Like an ecosystem in which each form of life lives not in isolation but in relation to many other forms, capital is valuable in accordance with its participation in an economy at whole scale.

de Soto's principal prescription for the Third World is: formalize property rights. The better first prescription (even as a purely economic remedy, for the sake of becoming capitalist worthy of the name) for those very same nations, however, would be: engage in super-constitutionality; adopt and adhere to constitutions an entire measure above those of the United States and Western Europe, that more meaningfully restrain the prerogatives of money and power, that civilize police forces and hold them accountable even to the most poverty stricken honest citizen, that more articulately preserve a scope of rights in all individuals and the various associations of citizens, that contain freedom of speech and information provisions that provide meaningful transparency, articulation and access, that emplace a genuinely impartial judiciary and preserve a thorough extent of expeditiously available judicial remedies. That achieve all of the traditionally liberal (in the philosophical sense of the term) values of western society, and more. That take as politically developmental a view of the information age as the American Constitution took of the industrial age.

A semi-organized group of citizens with a modicum of technical skills among them can achieve a formalization of property rights. A system of economic capitalism, however, if it is to be productive rather than destructive, if it is to enhance the welfare of a nation, rather than contort its soul, infect its vision and bleed it dry, requires a multitude of carefully crafted and assiduously maintained social institutions to guide the raw and oftentimes abusive or destructive processes of capital formation and use. These cannot satisfactorily be established merely through formalizations.

de Soto nowhere betrays any awareness that if all of the assets he describes as readily capitalizable in the Third World were capitalized, and nothing more, they would all be owned with newly formalized certainty by agencies of the First World in less than a decade. To every extent the resources of the Third World are made monetizable and exchangeable for money, the First World will yet have much more money and a much greater capacity to create money and can thus buy them all and own them as formally as you please. It is as if de Soto has chosen to ignore the extent to which money is begot of money, and would advocate a host of Third World leaders join with him to offer up that which has been somewhat insulated from the leverages of capital.

The reasonably self-interested Third World leader who has some view to developing wealth among his people will implement substantive justice at a rate at least as great or greater than the rate of formalization of property capital. That same leader will encourage and participate in acts disconnecting some of the self-reinforcements of existing finance in order to give newly formalized local finance true development opportunity.

These are the kind of political commitments that require great courage, particularly in the Third World context of uneducated, impoverished masses, marginal infrastructures, available raw materials the means for improvement of which often are out of reach. Nevertheless, honest people know, and will say, there is no simple substitute for real commitments of this sort.

To read de Soto is to have as many counter examples brought to mind as examples are provided. When de Soto is describing a certain success in ordering the real holdings of small business owners in Peru, one cannot help but bring to mind the systemic failures of the "big-hoodlum" capitalism that burden basic businesses in Russia. When deSoto prescribes Western legalisms for Egypt, one cannot keep one's inner eye from focusing on the evident insufficiency of Western legalisms, particularly those associated with property, to alleviate poverty in India.

It is not that one bears de Soto any ill will. He has announced the important truth that it is not stuff, but what we do with stuff, how we build relationships around stuff, that really counts, particularly in parts of the world that don't have a lot of stuff, in which stuff has not collected. For that we should appreciate him. We would redouble our appreciation, however, had he offered the further profound recognition that the reach of this truth is much deeper than formalization.