Book Review: The Mystery of Capital by Hernando de Soto

In Hernando De Soto's most influential work, The Mystery of Capital, he proclaims that integration of extralegal settlements is necessary for the economies of developing and former communist countries to prosper. He explains that the informal economy is caused by legal failure, and that assets held extralegally are what he calls "dead capital."

The book begins by explaining how capitalism only works if the majority of people possess capital. De Soto shows how the key manifestation of capital is land, which people can use to receive loans. By receiving loans on land owned, that land carries out two lives, one that is real, and one that is more economically useful and represented by titles and deeds.

This second life of assets is only possible with formal property, the absence of which, De Soto claims, renders the economic potential of the asset useless. It is here that he analyzes what he calls "extralegal settlements": informal economic activity that has become predominant in developing and former communist countries. In these extralegal settlements, people have constructed homes on land that they did not own, and have formed a cottage industry to support their well-being.

De Soto recognizes six benefits of owning formal, rather than informal, property. The first is fixing the economic potential of assets, which is done by allowing economic activity regarding the asset to be carried out using a representation (title) of the asset. Next is integrating a variety of social contracts that have already been agreed upon into a formal system, which is essentially codification of law. The third effect is making people accountable, for in an integrated formal system of law anonymity becomes impossible. Another effect is making assets fungible, which he means to give a value in dollars to a variety of assets. The fifth effect is networking people, where credit records allow for more investment of greater yield. The final aspect of formal property is protecting transactions, where law guarantees safety in trade of large quantities of assets.

De Soto substantiates his claims through analyzing the history of the United States. He presents 19th century settlers in the U.S. to being in a similar situation as in developing countries today. In the wake of the ever increasing amount of squatters in the western United States, these extralegal settlements were integrated into formal property law by observing existing social contracts. De Soto argues that this integration must be mimicked by developing and former communist countries today in order for them to become integrated into global capitalism.

Throughout the book, De Soto places the blame for these extralegal settlements entirely on labyrinthian legislation and short sighted lawyers. It is because of the difficulty to obtain legal property that people choose to behave informally. He demonstrates this by trying to open a clothing store in Lima, Peru. It took him an entire year to open the store legally, and they soon found that it is just as difficult to maintain legal status as it is to get it.

Although this book has been highly acclaimed and has been implemented into several government policies since, I see De Soto's understanding of capitalism fatally flawed. Particularly, his conception of capital is highly influenced by his bourgeois lifestyle and he is unable to understand that the reason for poverty in developing countries is because of capitalism, not the lack thereof.

Capitalism allows for great wealth to be amassed, but it would be with great naiveté to believe that "capital" is the Higgs boson of economic growth. It is evidenced by the disparity of income in developed countries that the wealth of the capitalist is gained at the expense of those he employs. For the capitalist, capital is everywhere, and once found, he can exploit it.

To demonstrate this point, let us examine the capitalist practice of renting property. Because the poor cannot afford to own property, they are forced to rent this property. This rent is paid to the capitalist, but results in no accumulation of assets, and absolutely no return on the money spent. You see, the capitalist is not creating any value in owning this property, but he rather is capitalizing on the wage disparity in his country in order to exploit the labor of the proletariat. The very existence of the bourgeoisie is entirely due to their ability to exploit the proletariat.

In this light, money can be viewed as merely a stock, or share, of the nation's scarce resources. Money is a representation of the useful properties of commodities, similarly to how a title is a representation of a plot of land. This implies the finite nature of money, where capitalism only disproportionately allocates resources to achieve a facade of national prosperity. Capitalism, very much like a Ponzi scheme, is inevitably doomed to fail, and as Marx argued is merely a means to an end.

It is this concept that entirely escapes De Soto in writing this book. He sincerely believes that capitalism will benefit the poor if they only are integrated into the formal property system. This view is an utterly unsophisticated oversimplification of global poverty. In the developing world, extralegal settlements essentially make up the middle class. Were his idea of integration to come to fruition the wealthier squatters would ascend to higher classes, but the rest would lose the few assets they had. This integration would destroy the middle classes of these societies and pave the way for creating a new, developed, society, where the rich become richer as the poor lose their niche in an overly industrialized society.

Where De Soto claims that extralegal settlers have assets that are "dead capital", they rather have assets that they refuse to allow to be exploited by capitalism. Where De Soto says "capital" he really means money, as for the rich, money appears to be the sole means of production. De Soto fails to recognize that in these pre-capitalist societies in developing countries, the workers see the full benefit of each ounce of their labor. They pay no taxes on their land, and operate in swift cottage industries reminiscent of 19th century Switzerland.

Entirely self-supporting, the strength of these informal economies is derived from their refusal to integrate with the formal economy. It is this refusal to integrate that allowed these societies to flourish; with non-hierarchal social constructs they developed a community that was entirely their own. De Soto's attempt to integrate these great communities will surely spell their demise.

Extralegal settlements are not new to society, and go back even further than De Soto would care to notice. The fall of the western Roman Empire was largely caused by extralegal settlements. Lus privatum (private law), stipulatio (contract law), and rei vindicatio (property law) encompassed all of the laws relating to property, but all of these laws were designated to only apply to Roman citizens. After massive germanic immigrations, a huge informal economy was developed by these immigrants. This informal economy threatened the sovereignty of the Roman minority, and resulted in the secession from the greater Roman empire. When an informal economy becomes prevalent or even stronger than the formal economy, the state will inevitably lose sovereignty over its subjects. What De Soto is arguing for in this book is the protection of global capitalism from informal economies that could challenge the status quo.

De Soto is the president of the Institute for Liberty and Democracy, a think tank advocating neoliberal imperialism. In the 1990's the ILD drafted legislation on behalf of Alberto Fujimori to formalize the informal sector of the Peruvian economy. Working with the World Bank to enact massive legislation in Peru which successfully formalized their economy. Peru was then completely prepared to be exploited by global capitalism.

Under the direction of new president Alan Garcia, the United States - Peru Trade Promotion Agreement was signed into law on April 12, 2006. This bill essentially destroys all trade barriers meant to protect their markets from american corporations, as well as rendering all agricultural products exported by the U.S. tariff and duty free. Also, as stated on official documentation on the bill, "Peru has agreed to exceed its commitments made in the WTO, and to dismantle significant services and investment barriers, such as measures that require U.S. firms to hire nationals rather than U.S. professionals and measures requiring the purchase of local goods." This legislation was entirely made possible by De Soto's manipulation of the Peruvian people by masking his imperialist agenda by one of mere populism.