Why Capitalism Triumphs in the West and Fails Everywhere Else

Hernando DeSoto, “Why Capitalism Triumphs in the West and Fails Everywhere Else” Basic Books, 2000, 228 pps  

Another worth-while book I highly recommend. 

The world’s poor nations, including the ex-communists, have plenty of resources, estimated at $9.3 trillion.  But the resources are held in defective forms: houses built on land whose ownership rights are not adequately recorded, unincorporated businesses with undefined liability, industries located where financiers and investors cannot see them.  Because the rights to these possessions are not adequately documented, those assets cannot readily be turned into capital, cannot be traded outside of narrow local circles where people know and trust each other, cannot be used as collateral for a loan, and cannot be used as a share against an investment.  This lack of a formal titling system, that strangers (read banks) will accept, is why Capitalism is failing outside the West.

My Notes:

Pg. 1:  The hour of capitalism’s greatest triumph is its hour of crisis.  The fall of the Berlin Wall ended more than a century of political competition between capitalism and communism.  Capitalism stands alone as the only feasible way to rationally organize a modern economy.  At this moment in history, no responsible nation has a choice.  As a result, with varying degrees of enthusiasm, Third World and former communist nations have balanced their budgets, cut subsidies, welcomed foreign investment, and dropped their tariff barriers.  However, their efforts have been repaid with bitter disappointment. From Russia to Venezuela, the past half-decade has been a time of economic suffering, tumbling incomes, anxiety, and resentment.  Their failures are met with advice from American and European leaders to stabilize your currencies, hang tough, ignore the food riots, and wait patiently for the foreign investors to return.

Pg. 5:  The major stumbling block that keeps the rest of the world from benefiting from capitalism is its inability to produce capital.  Capital is the force that raises the productivity of labor and creates the wealth of nations. The world’s “poor” nations actually have vast resources (authors estimate $9.3 trillion, p. 35). 

Pg. 29:  Since the fall of communism, the former Soviet states have been slipping into the same pattern of informal ownership of countries such as Haiti.  For instance, Business Week reported that four years after the end of communism, only ‘some 280,000 farmers out of 10 million own their land’ in Russia.  Mechanisms used in market economies to protect land rights are still in their infancy. 

Pg. 48:  Capital cannot be generated from assets if a formal property system is not in place.  Without formal property to extract their economic potential and convert it into a form that can be easily transported and controlled, the assets of developing and former communist countries are like water in a lake high in the Andes—an untapped stock of potential energy,

Pg. 58:  By making assets fungible*, by attaching owners to assets, assets to addresses, and ownership to enforcement, and by making information on the history of assets and owners easily accessible, formal property systems converted the citizens of the West into a network of individually identifiable and accountable business agents.  The formal property process created a whole infrastructure of connecting devices that allowed the assets to run safely between people.  Formal property’s contribution to mankind is not the protection of ownership; squatters, housing organizations, mafias, and even primitive tribes manage to protect their assets quite efficiently.  Property’s real breakthrough is that it radically improved the flow of communications about assets and their potential.  It also enhanced the status of their owners, who became economic agents able to transform assets within a broader network.

*fungible: Able to be substituted for something of equal value or utility; interchangeable, exchangeable, replaceable.

Pg. 71:  A legal failure that prevents enterprising people from negotiating with strangers defeats the division of labor and fastens would be entrepreneurs to smaller circles of specialization and low productivity.

Pg. 74:  The poor in developing and former communist countries constitute two-thirds of the world’s population—and they have no alternative but to live outside the law.  Their property rights are not defined by any law. 

Pg. 109:  Property-systems open to all citizens are a relatively recent phenomenon—no more than two hundred years old.  In most nations of the West, the major task of widespread property reform was completed only about a century ago; in Japan it has been in place for less than fifty years.  Furthermore, the whole process that created integrated property systems was more the result of unconscious evolution than conscious planning. 

Pg. 120:  In the U.S. a legal innovation of allowing a settler to buy the land he had improved before it was offered for public sale was known as preemption.  This principle was the key to the integration of extralegal property arrangements in American law for over two hundred years.  Politicians and jurists began to interpret “improvements” in ways that heavily benefited squatters.

Pg. 121:  From about 1784 to 1850, the U.S. acquired almost 900 million acres through conquest and purchase.    

Pg. 132:  In 1620, there had been approximately 5,000 settlers in all of British North America.  In 1860, the U.S. population would be more than 30 million, and fifty percent lived west of the Appalachians.

Pg. 127:  At the end of the nineteenth century, American politicians and judges had come a long way in the area of property law—and it was the squatters who led them there.  This was also true of housing: In 1862, when Congress passed the ‘Homestead Act’ that gave 160 free acres to any settler willing to live on the land for five years and develop it, it was only sanctioning what settlers had already done by themselves.

Pg. 153:  Nearly every developing and former communist nation has a formal property system.  The problem is that most citizens cannot gain access to it.  They have run into a bell jar, an invisible structure that reserves capitalism for a very small sector of society.  They can only live and do business in the extralegal section, without ever being able to convert their assets into capital.

Pg. 187:  Nobody planned the evolution from feudal and patrimonial systems to the modern property systems that exist in the West today. However they systems were tremendously helped when reformers embarked on deliberate programs to make property more accessible to a wider range of citizens, these programs were successful because they were supported by well-thought out political strategies.  That is what Thomas Jefferson did in Virginia at the end of the eighteenth century when he increased the fungibility of property by abolishing among other things, the practice of entail (not being able to transfer property outside the family). 

Pg. 208:  The American economist Lester Thurow points out that as recently as 1941 the U.S. and Great Britain were essentially the only (major) capitalist countries left on the face of the earth.  The rest were fascists, communists, or Third World feudal colonies.  The 1930s depression had brought capitalism to the edge of extinction. 

Pg. 209:  The lifeblood of capitalism is not the Internet or fast food franchises.  It is capital.  Only capital provides the means to support specialization and the production and exchange of assets in the expanded market.  It is capital that is the source of increasing productivity and therefore the wealth of nations.’

Ten years ago (1989), few would have compared the former Soviet bloc nations to Latin America.  But today they look astonishingly similar: strong underground economies, glaring inequality, pervasive mafias, political instability, capital flight, and flagrant disregard for law.

Pg. 212:  Most economic reform programs in poor economies may be falling into the trap that Marx foresaw.  The great contradiction of the capitalist system is that it creates its own demise because it cannot avoid concentrating capital in a few hands.  By not giving the majority access to expanded markets, these reforms are leaving a fertile field for class confrontation—a capitalist and free market economy for the privileged few who can concretize their property rights, and relative poverty for a large undercapitalized sector incapable of leveraging its own assets.

Misery in developing and former communist nations is not contained in pockets (as in the West); it is spread throughout the majority of their societies.  What few pockets exist in those countries are pockets of wealth. 

Addenda (taken from the authors notes on his website):

    When Western attempts to bring the poor nations into a capitalist system fail, Westerners all too often respond by blaming Third World peoples for their lack of entrepreneurial spirit or market orientation. If they have failed to prosper despite all the excellent advice, it is because something is the matter with them: They missed the Protestant Reformation, or they are crippled by the disabling legacy of colonial Europe, or their IQs are too low. But the disparity of wealth between the West and the rest of the world is far too great to be explained by culture alone.

In the West every parcel of land, every building, every piece of equipment, or store of inventories is represented in a property document that is the visible sign of a vast hidden process that connects all these assets to the rest of the economy. Thanks to this representational process, assets can lead an invisible, parallel life alongside their material existence. They can be used as collateral for credit. The single most important source of funds for new businesses in the United States is a mortgage on the entrepreneur's house. These assets can also provide a link to the owner's credit history, an accountable address for the collection of debts and taxes, the basis for the creation of reliable and universal public utilities, and a foundation for the creation of securities (like mortgage-backed bonds) that can then be rediscounted and sold in secondary markets. By this process the West injects life into assets and makes them generate capital.

The poor inhabitants of these nations—five-sixths of humanity—do have things, but they lack the process to represent their property and create capital. They have houses but not titles; crops but not deeds; businesses but not statutes of incorporation. It is the unavailability of these essential representations that explains why people who have adapted every other Western invention, from the paper clip to the nuclear reactor, have not been able to produce sufficient capital to make their domestic capitalism work.

It is not only former communist and Third World countries that have suffered all of these problems. The same was true of the United States in 1783, when President George Washington complained about "banditti ... skimming and disposing of the cream of the country at the expense of the many." These "banditti" were squatters and small illegal entrepreneurs occupying lands they did not own. For the next one hundred years, such squatters battled for legal rights to their land and miners warred over their claims because ownership laws differed from town to town and camp to camp. Enforcing property rights created such a quagmire of social unrest and antagonism throughout the young United States that the Justice of the Supreme Court, Joseph Story, wondered in 1820 whether lawyers would ever be able to settle them.

Do squatters, bandits, and flagrant disregard of the law sound familiar? Americans and Europeans have been telling the other countries of the world, "You have to be more like us." In fact, they are very much like the United States of a century ago when it too was an undeveloped country. Western politicians once faced the same dramatic challenges that leaders of the developing and former communist countries are facing today. But their successors have lost contact with the days when the pioneers who opened the American West were undercapitalized because they seldom possessed title to the lands they settled and the goods they owned, when Adam Smith did his shopping in black markets and English street urchins plucked pennies cast by laughing tourists into the mud banks of the Thames, when Jean-Baptiste Colbert's technocrats executed 16,000 small entrepreneurs whose only crime was manufacturing and importing cotton cloth in violation of France's industrial codes.

That past is many nations' present. The Western nations have so successfully integrated their poor into their economies that they have lost even the memory of how it was done, how the creation of capital began back when, as the American historian Gordon Wood has written, "something momentous was happening in the society and culture that released the aspirations and energies of common people as never before in American history." The "something momentous" was that Americans and Europeans were on the verge of establishing widespread formal property law and inventing the conversion process in that law that allowed them to create capital. This was the moment when the West crossed the demarcation line that led to successful capitalism—when it ceased being a private club and became a popular culture, when George Washington's dreaded "banditti" were transformed into the beloved pioneers that American culture now venerates.