Imagine a country where nobody can identifywho owns what, people cannot be made topay their debts, resources cannot convenientlybe turned into money, ownership cannotbe divided through documents, descriptionsof assets are not standardized and cannot be easily compared, and the rules thatgovern property vary from neighborhood toneighborhood or even from street to street.You have just put yourself into the life of adeveloping country or former communist nation;more precisely, you have imagined lifefor 80 per cent of its population, which ismarked off as sharply from its Westernized eliteas black and white South Africans were onceseparated by apartheid.
Over the last 10 years, with varying degreesof enthusiasm, Third World and former SovietUnion nations - where 5 billion of the world's6 billion people live - carried out the macroeconomicpolicies the West recommended:they balanced their budgets, cut subsidies,welcomed foreign investment, and droppedtheir tariff barriers. Yet from Argentina to Russia,capitalist reformers are now intellectuallyon the defensive, increasingly derided asapologists for the miseries and injustices thatstill plague the poor.
As a result, we are now beginning to realizethat you cannot carry out macroeconomic reformson sand. Capitalism requires the bedrockof the rule of law, beginning with that ofproperty. This is because the property systemis much more than ownership: it is in fact thehidden architecture that organizes the marketeconomy in every Western nation. What theproperty system accomplishes is so central tocapitalism that developed nations have cometo take its success for granted; indeed evenmost property experts are unsure about theconnections between property systems andthe creation of capital. Yet these connectionsexist. Without them, buildings and land cannotbe used to guarantee credit or contracts.Ownership of businesses cannot be dividedand represented in shares that investors canbuy. In fact, without property law, capital itself- the instrument that allows people to leveragetheir assets and their transactions - isimpossible to create: the instruments that storeand transfer value, such as shares of corporatestock, patent rights, promissory notes, billsof exchange, bonds, etc., are all determined bythe architecture of legal relationships withwhich a property system is built. And the problemis that 80 percent of the population of developingand former communist nations do nothave legal property rights over their assets,whether it be homes, businesses or intellectualcreations.
When property law works, the capital valueof assets rise in developing nations. In 1990,for example, the Compañía Peruana de Teléfonos(CPT) was valued on the Lima stock exchangeat $53 million. The government, however,could not sell the CPT to foreign investorsbecause they found that the company'sproperty title over its assets, and Peruvianproperty law itself, were unclear. Consequently,the Peruvians put together a hotshot legal team to create a legal title that would meet thestandardized property norms required by theglobal economy. Documents were rewritten tosecure the interests of other parties and createconfidence that would allow for credit andinvestment. The legal team also created enforceablerules for settling property disputesthat bypassed the dilatory and corruptionpronePeruvian courts. Three years later, CPTentered the world of liquid capital and wassold for $2 billion - 37 times its previous marketvaluation. That's what a good propertysystem can do.
The enterprises of the poor are very muchlike the Peruvian Telephone Company beforeit had good title and could issue shares orbonds to obtain new investment and finance.No less than 80 per cent of the people in ThirdWorld and former Soviet nations have goodproperty representations. As a result, most ofthem are undercapitalized, in the same way thata firm is undercapitalized when it issues fewersecurities than its income and assets wouldjustify. Without property records and representations,their assets remain financially andcommercially invisible: they are dead capital.
In the West, by contrast, every parcel of land,every building, every piece of equipment isrepresented in a property document that is thevisible sign of a vast hidden process that connectsall these assets to the rest of the economy.Thanks to this representational process,assets can lead an invisible, parallel life alongsidetheir material existence. They can be usedas collateral for credit. The single most importantsource of funds for new businesses inthe United States is a mortgage on the entrepreneur'shouse. These assets can also providea link to the owner's credit history, anaccountable address for the collection of debtsand taxes, the basis for the creation of reliableand universal public utilities, and a foundationfor the creation of securities. By this process,the West injects life into assets andmakes them generate capital.
Why have these reforms not been made?One reason is that conventional macroeconomicreform programs have ignored the poor,assuming they have no wealth to build on.Big mistake. My research team and I have recentlycompleted several studies of the undergroundeconomy throughout the ThirdWorld and they prove that the poor are, infact, not so poor. In Egypt, the poor's assetsin real estate are worth an estimated $241 billion- 55 times the sum of all foreign investmentin the country in the last 150 years, includingthe Suez Canal and the Aswan Dam.In Mexico, the estimate is $ 315 billion - 7 timesthe worth of the national oil monopoly.
The problem is that most people outside theWest hold their resources in defective forms:houses built on land whose ownership rightsare not adequately recorded, industries locatedwhere financiers and investors cannotsee them. Because the rights to these possessionsare not adequately documented, theseassets cannot readily be turned into capital,cannot be traded outside of narrow localcircles where people know and trust each otherand cannot be used as collateral for a loan.
Legal property is 'mind-friendly'
How is it that a piece of paper representingownership can create value? Not everythingthat is real and useful is tangible and visible.Time, for example, is real, but it can only beefficiently managed when it is represented bya clock or a calendar. Throughout history, humanbeings have invented representationalsystems - writing, musical notation, doubleentrybookkeeping - to grasp with the mindwhat human hands could never touch. In thesame way, the great practitioners of capitalism,were able to reveal and extract capitalwhere others saw only junk by devising newways to represent, through property systems,the invisible potential that is locked up in theassets we accumulate. The genius of the Westwas to have created such a system.
What distinguishes a good legal propertysystem is that it is 'mind friendly'. The revolutionary contribution of an integrated propertysystem is that it solves a basic problem of cognition.Our five senses are not sufficient forus to process the complex reality of an expandedmarket, much less a globalized one.We need to have the economic facts aboutourselves and our resources boiled down toessentials that our minds can easily grasp. Agood property system does that - it puts assetsinto a form that lets us distinguish theirsimilarities, differences, and connecting pointswith other assets. It fixes them in representationsthat the system tracks as they travelthrough time and space. In addition, it allowsassets to become fungible so that we can easilycombine, divide, and mobilize them to producehigher-valued mixtures. This capacity ofproperty to represent aspects of assets informs that allow us to recombine them so as tomake them even more useful is the mainspringof economic growth, since growth is all aboutobtaining high-valued outputs from low-valuedinputs.
I do not believe that the absence of this processin the poorer regions of the world - wherefive-sixths of humanity lives - is the consequenceof some Western monopolistic conspiracy.It is rather that Westerners take thismechanism so completely for granted that theyhave lost all awareness of its existence. However,it is this system that has given the Westan important tool for development. The momentWesterners were able to focus on thetitle of a house and not just the house itself,they achieved a huge advantage over the restof humanity. With titles, shares and propertylaws, people could suddenly go beyond lookingat their assets as they are (houses usedonly for shelter) to thinking about what theycould be (security for credit to start or expanda business).
In the West, this formal property systembegins to process assets into capital by describingand organizing the most economicallyand socially useful aspects about assets, preservingthis information in a recording system- as insertions in a written ledger or a blip on acomputer disk - and then embodying them in atitle. A set of detailed and precise legal rulesgoverns this entire process. Formal propertyrecords and titles thus represent our sharedconcept of what is economically meaningfulabout any asset. They capture and organizeall the relevant information required to conceptualizethe potential value of an asset and soallow us to control it. Property is the realmwhere we identify and explore assets, combinethem, and link them to other assets. Theformal property system is the place where capitalis born.
Injecting life into dead capitalAny asset whose economic and social aspectsare not fixed in a formal property system isextremely hard to move in the market. Howcan the huge amounts of assets changinghands in a modern market economy be controlled,if not through a formal property process?Without such a system, any trade of anasset, say a piece of real estate, requires anenormous effort just to determine the basicsof the transaction: does the seller own the realestate and have the right to transfer it? Can hepledge it? Will the new owner be accepted assuch by those who enforce property rights?What are the effective means to exclude otherclaimants? In developing and former communistnations, such questions are difficult toanswer. For most goods, there is no placewhere the answers are reliably fixed. That iswhy the sale or lease of a house may involvelengthy and cumbersome procedures of approvalinvolving all the neighbors. This is oftenthe only way to verify that the owner actuallyowns the house and there are no other claimson it. It is also why the exchange of most assetsoutside the West is restricted to localcircles of trading partners.
As we are now discovering, these countries'principal problem is not the lack of entrepreneurship:according to the studies done bythe Institute for Liberty and Democracy in Peru, the poor of the developing world haveaccumulated nearly 10 trillion dollars of realestate during the past forty years. What thepoor lack is easy access to the property mechanismsthat could legally fix the economic potentialof their assets so that they could beused to produce, secure, or guarantee greatervalue in the expanded market.
Centuries ago, scholars speculated that weuse the word 'capital' (from the Latin for'head') because the head is where we hold thetools with which we create capital. This suggeststhat the reason why capital has alwaysbeen shrouded in mystery is because, like energy,it can be discovered and managed onlywith the mind. The only way to touch capitalis if the property system can record its economicaspects on paper and anchor them to aspecific location and owner. Property, then, isnot mere paper but a mediating device thatcaptures and stores most of the stuff requiredto make a market economy run.
As Margaret Boden (1992: 94) puts it,"Some of the most important human creationshave been new representational systems.These include formal notations, such as Arabicnumerals (not forgetting zero), chemicalformulae, or the staves, minims, and crotchetsused by musicians. Computer programminglanguages are a more recent example". Representationalsystems such as mathematics andintegrated property help us manipulate andorder the complexities of the world in a mannerthat we can all understand and that allowsus to communicate regarding issues that wecould not otherwise handle. Through representationswe bring key aspects of the worldinto being so as to change the way we thinkabout it. The philosopher John Searle hasnoted that by human agreement we can assign"a new status to some phenomenon,where that status has an accompanying functionthat cannot be performed solely in virtueof the intrinsic physical features of the phenomenonin question" (1995: 46). This seemsto me very close to what legal property does:it assigns to assets, by social contract, in aconceptual universe, a status that allows themto perform functions that generate capital.
Therefore, formal property is more than asystem for titling, recording, and mapping assets- it is an instrument of thought, representingassets in such a way that people'sminds can work on them to generate surplusvalue. That is why formal property must beuniversally accessible: to bring everyone intoone social contract where they can cooperateto raise society's productivity.
How can modern property systems be establishedin non-Western countries? As thingsstand, most arrangements that govern theholding and transaction of assets in non-Westernnations are established outside the formallegal system. Extralegal property arrangementsare dispersed among dozens, sometimeshundreds, of communities; rights and otherinformation are known only to insiders orneighbors. To modernize any of these countries,all the separate, loose extralegal propertyarrangements characteristic of most ThirdWorld and former communist nations must bewoven into a single system from which generalprinciples of law can be drawn. In short,the many social contracts 'out there' must beintegrated into one, all-encompassing socialcontract.
How can this be accomplished? How cangovernments find out what the extralegal propertyarrangements are? That was precisely thequestion put to me by five members of theIndonesian cabinet. I was in Indonesia andthey took that opportunity to invite me to talkabout how they could find out who owns whatamong the 90 percent of Indonesians who livein the extralegal sector. Fearing that I wouldlose my audience if I went into a drawn-outtechnical explanation on how to structure abridge between the extralegal and legal sectors,I came up with another way, an Indonesianway, to answer their question. During mybook tour, I had taken a few days off to visitBali, one of the most beautiful places on earth.As I strolled through rice fields, I had no ideawhere the property boundaries were. But the dogs knew. Every time I crossed from one farmto another, a different dog barked. Those Indonesiandogs may have been ignorant of formallaw, but they were positive about whichassets their masters controlled.
I told the ministers that Indonesian dogs hadthe basic information they needed to set up aformal property system. By traveling their citystreets and countryside and listening to thebarking dogs, they could gradually work upward,through the vine of extralegal representationsdispersed throughout their country, untilthey made contact with the ruling socialcontract. "Ah", responded one of the ministers,"jukum adat" (the people's law)!
Discovering "the people's law" is how Westernnations built their formal property systems.Any government that is serious about reengineeringthe ruling informal agreements intoone national formal property social contractneeds to listen to its barking dogs. To integrateall forms of property into a unified system,governments must find out how and whythe local conventions work and how strongthey actually are. This may sound oxymoronicor even subversive to Western readers whohave come to believe there is only one law toobey. But my experience visiting and workingin dozens of developing nations has made itclear to me that legal and extralegal laws coexistin all of them.
Over the last 15 years, what we have learnedto do at the Institute for Liberty and Democracy- not only in South America, but also in theMiddle East, Asia, the Caribbean and NorthAmerica - is to identify the written or unwrittenextralegal norms and their representations,disembed them from their surroundings and,on the basis of the common denominators wefind, bring them together in one professionallycrafted code acceptable to all. This processof moving norms and representations frominformal and local contexts towards a formaland universal context we call the 'representationalascent'.
In each country we work in, once we haveidentified the main traits of the extralegal normsgoverning extralegal systems, we comparethem to the official law which is essentially an'elite law' because it is obviously rejected ornot applicable to most of the nation. Then,through a process of consultations with boththe extralegal and legal leaders, we blend thebetter parts of extralegal local laws with theacceptable parts of elite law so as to producea unified formal code applicable throughoutthe land.
The reason we take extralegal law seriouslyis that it is stable and meaningful for thosewho work outside the legal system. Nowherewe have visited have we encountered peopleworking extralegally oppose integrating intothe legal sector, provided that the law which isproposed to them is grounded in their customsand beliefs, explained to them in theirvocabulary, and does not involve high transactioncosts they cannot afford.
We learned how to discover extralegal arrangementsand how to integrate them into onelegal system by studying how, over centuries,Western nations and Japan made the transitionfrom dispersed, informal arrangements toan integrated legal property system on thebasis of which the rule of law was established.This historical knowledge accounts for someof the inputs we obtained to make a transitionprocess. Most of the knowledge, however, weobtained through our own empirical researchin developing countries. In the field, we brailledour way through extralegal worlds and eventuallylearned how to get in touch with thesocial contracts that underlay property rights.Discovering these arrangements is nothing likesearching for proofs of ownership in a formallegal system. The extralegal sector does nothave, among other things, the centralized recordingand tracking bureaucracy that is atthe center of formal society. What people inthe extralegal sector do have are strong, clear,and detailed understandings among themselveson the rules that establish who ownswhat. Even the dogs obey them.
Consequently, the only way to find the extralegalsocial contract on property in a par184ticular area is by contacting those who liveand work by it. Obtaining synchronic informationtakes fieldwork: going directly to thoseareas where property is not officially recorded(or poorly recorded) and getting in touch withlocal legal and extralegal authorities to findout what the property arrangements are. Thisis not as hard as it sounds. Although oral traditionsmay predominate in the rural backwoodsof some countries, most people in theextralegal urban sector in developing countrieshave found ways to represent their propertyin written form according to rules that theyrespect and that government, at some level, isforced to accept.
In Haiti, for instance, no one believed wewould find documents fixing representationsof property rights. Haiti is one of the world'spoorest countries; 55 per cent of the populationis illiterate. Nevertheless, after an intensivesurvey of Haiti's urban areas, we did notfind a single extralegal plot of land, shack, orbuilding whose owner did not have at leastone document to defend his right - even his'squatting rights'. Everywhere we have beenin the world, most poor people living on themargins of the law have some locally craftedor adapted physical artifact to represent andsubstantiate their claim to property. And it ison the basis of these extralegal representations,as well as records and interviews, thatwe are everywhere able to build a concept ofthe social contract undergirding property.
Once we get our hands on extralegal representations,we have found the Ariadne'sthread leading to the social contract on whichone can build self-enforcing codes. Representationsare the result of a specific group ofpeople having reached a respected consensusas to who owns what property and whateach owner may do with it. Reading representationsthemselves and extracting meaningfrom them does not require a degree in archaeology.They contain no mysterious codes tobe deciphered. People with very straightforward,business-like intentions have writtenthese documents to make absolutely clear toall concerned what rights they claim to haveover the specific assets they control. Theywant to communicate the legitimacy of theirrights and are prepared to provide as muchsupporting evidence as possible. Their representationshave nothing to hide; they havebeen designed to be recognizable for whatthey are. This is not always so obvious because,regrettably, when dealing with the poorwe tend to confuse the lack of a centralizedrecord-keeping facility with ignorance.
When we obtain documentary evidence ofrepresentations, we can then 'deconstruct'them to identify the principles and rules thatconstitute the social contract that sustainsthem. Once we have done that, we will have allthe major relevant pieces of extralegal law. Thenext task is to codify them - organize them intemporary formal statutes so that they can beexamined and compared with existing formallaw. Encoding loose systems is also not a problem.In fact, it is not much different from governmentprocedures to make legal texts uniformwithin countries (such as the US UnifiedCommercial Code) or between countries at aninternational level (such as the many integratedmandatory codes produced by the EuropeanUnion or the World Trade Organization). Bycomparing the extralegal to the legal codes,government leaders can see how both have tobe adjusted to fit each other and then build aregulatory framework for property - a commonbedrock of law for all citizens - that is genuinelylegitimate and self-enforceable becauseit reflects both legal and extralegal reality. Thatwas basically how Western law was built: bygradually discarding what was not useful andenforceable and absorbing what worked.
Giving governments the tools for reform
At the end of our work, we present the hostgovernment with a step-by-step program forreforming existing institutions that will allowto integrate under one law all the economicstock and activities in the country. This will require replacing bad law and administrativepractices with statutes and procedures thatmake assets fungible by attaching owners toassets, assets to addresses, ownership to legalaccountability, commitments to enforcement,and by making all information and thehistory on assets and owners easily accessible.The goal is to create a formal propertysystem that converts a previously anonymousand dispersed mass of owners into an interconnectedsystem of individually identifiableand accountable business interlocutors thatare able to create capital.
This includes boiling down the reform programto a comprehensive mission statementalong with publicity devices that allow politiciansto motivate their constituencies towardreform. Such a communications program tailorsthe message to each constituency: thepoor must be convinced that they will prospermore within a legal economy than outside it;private businessmen and banks must see thatintegrating the extralegal economy meanslarger markets with goods and services; politiciansmust be convinced that the government'stax base will be broadened so as toincrease its revenues and reduce its relianceon foreign aid; and the whole nation must seethat inclusion will decrease macroeconomicdeficiencies and reduce the expansion of blackmarkets, criminality, mafias and drugs.
If all this sounds more like an anthropologicaladventure than the basis for legal reformand economic development, it is becauseknowledge about the poor has been monopolizedby academics, journalists, and activistsmoved by compassion or intellectual curiosityrather than by what it takes to create a suitablelegal framework for economic reform.
If we push for reform, not in the name of anideology, Western values, or the agendas ofmultinational firms and international financialinstitutions, but rather, with the interests ofthe poor in mind, the transition to a marketeconomy - in whatever shape you want ('ThirdWay', 'social market economics' or just plain'capitalist') - will become what it should alwaysbe, a truly humanistic cause and an importantcontribution to the war on poverty.
1. This article is a condensation of claims and material from Hernando de Soto's The mystery of capital: why capitalism triumphs in the West and fails everywhere else (London, Bantam Press), 2000.
Boden, Margaret 1992. The creative mind. London: Abacus.
De Soto, Hernando 2000. The mystery of capital:why capitalism triumphs in the West and failseverywhere else. London: Bantam Press.
Searle, John, R. 1995. The construction of social reality. New York: The Free Press.