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Ideas for a fairer world

Articles and Briefings

Liberty, equality, property

By Mark Leonard. Source: New Statesman, 4 September 2000

The third-world poor hold assets worth as much as all the companies listed on the world's main stock exchanges. So why are they poor? Mark Leonard explains.

For most of its history, the left has followed the philosophy of Proudhon, regarding property as theft. Not quite literally, perhaps - the examples of toothbrushes or shoes will convince almost anybody that some form of private property is necessary - but the left has been preoccupied largely with restricting or constraining individual property ownership, if not actually abolishing it. The idea that property ownership has positive social value has been left entirely to the right. Until now, that is.

Few people in Britain have heard of Hernando de Soto, a 59-year-old Peruvian economist and former adviser to the Peruvian president. But his new book, The Mystery of Capital: why capitalism triumphs in the west and fails everywhere else (published by Bantam on 7 September), has already led the cognoscenti to put him in the pantheon of great progressive intellectuals of our age, alongside such figures as Anthony Giddens and Amartya Sen. Geoff Mulgan, the Downing Street policy adviser who was a founder of the Demos think-tank, describes de Soto as "a genuinely radical thinker".

The basis of de Soto's thinking is that property ownership is the key to ending poverty - but that it will work only if the poor can use their property to generate further wealth. Capitalism, he argues, has not failed outside the west for any of the reasons usually given: cultural differences, lack of enterprise, religion, fecklessness or laziness. On the contrary, the developing world buzzes with hard work, entrepreneurial spirit and ingenuity. As a result, the poor are not really poor at all. They own trillions of pounds worth of assets. "In former communist countries and developing countries," de Soto explained to me recently, from his home in Peru, "most property is in the hands of the oppressed and the labourers. There is no clear distinction between those who own property and those who provide labour."

So what's the problem? It is, according to de Soto, that these assets - houses, land or businesses - are part of what we would call the black economy. They lie outside the established legal framework of enforceable property rights and are, therefore, useless for generating further wealth. In the west, a house is not just somewhere to live, with four walls and a roof; it also has a parallel existence as a producer of capital which we can use to secure credit. In the developing world, because property rights are not adequately documented, assets cannot be traded outside local circles where people know and trust each other, cannot be used as collateral for a loan, cannot be offered as a share against an investment. It is, in de Soto's terminology, "dead" rather than "live" capital. "The lifeblood of capitalism," says de Soto, "is not the internet or fast-food franchises. It is capital. Only 25 of the world's 200 countries produce capital in sufficient quantities to benefit from the division of labour in expanded global markets."

As industries and cities grew in the west, countries such as Britain and the United States drew all their property rights, formal and informal, into a single legal system. This allowed them to participate in an expanded market, made their assets transferable and fungible, accelerated specialisation and division of labour, and allowed them to benefit from economies of scale. Now, although the developing world has also undergone industrial revolution and mass urbanisation, it has not developed the legal frameworks.

So the secret of development is not to get more aid from the west - it is to introduce policies that can unlock the hidden wealth that already exists. De Soto and his associates have spent the past decade working with governments in Peru, Egypt, the Philippines and Haiti, trying to measure the extent of the problem and devising ways to formalise their economies. The tangle of bureaucracy in these countries stacks the odds against entering the formal economy. It would take someone almost a year, working full-time, to complete the paperwork to set up a one-man sewing business in Peru (and the legal costs would be 31 times the monthly minimum wage). And it would take five years of bureaucratic wrangling, including 77 administrative steps in 31 government offices, to get legal authorisation to build a house in Egypt. No wonder that most people build their houses or start their businesses outside the legal system. As de Soto points out, westerners regard the extralegal world as a place for gangsters, "sinister characters of interest only to the police, anthropologists and missionaries". But, "in the third world, it is legality that is marginal".

De Soto estimates that, in countries such as Peru and Egypt, the assets of eight out of ten people are excluded from the formal economy. And the value of extralegal property does not just exceed legal property, it dwarfs foreign aid and investment, too: in Egypt, it is worth 55 times as much as all investment ever recorded (including the Suez Canal and the Aswan Dam); in Haiti, it is worth 150 times all investment. De Soto estimates that the value of real estate held, but not legally owned, by the poor of the developing world and former communist nations is £6.3 trillion: 20 times as much as all foreign direct investment since 1989, 46 times as much as all World Bank and IMF loans to developing countries, and almost as much as the total value of all the companies listed on the main stock exchanges of the world's 20 most developed countries, including those in New York, Tokyo, London, Frankfurt, Toronto, Paris and Milan.

De Soto argues: "Democracy is at the heart of the issue. Democracy saved capitalism in the west by providing incentives to make it more humane and more inclusive." In developing countries, he argues, because of the lack of democratic feedback, governments have not understood that there are considerable assets which 90 per cent of the public own, but which need to be formalised with new legal frameworks.

His thinking has implications for the west as well as for the developing world. For example, the internet is a new frontier in the same way as America's "Wild West" was for pioneers in the 19th century, when dozens of different legal frameworks needed to be brought together. "How many software innovations would Bill Gates have made without patents to protect them?" asks de Soto. "How many deals and long-term projects could he have turned out without enforceable contracts? How many risks could he have taken at the beginning without limited liability and insurance policies?" The debate about protecting intellectual property internationally will demand exactly the sort of legal frameworks that de Soto is talking about.

Ownership is also crucial to the entrepreneurship that the Department for Trade and Industry has been urging us to embrace. The most important source of funds for new businesses in America is a mortgage on the entrepreneur's house. Prophets of the new economy, such as Charles Leadbeater, have argued for employee share ownership. De Soto identifies with these schemes: "The popularisation of capitalism with stock options is a further stage of what I am talking about, responding to the concern that capitalism will only work if it is inclusive - the idea of passing ownership from an elite to the people."

Then there are those at the bottom of the pile in the west. This is where de Soto's ideas excite Geoff Mulgan, who was instrumental in setting up the government's Social Exclusion Unit. He explains: "The left always tended to underestimate the importance of ownership, and how hard it is for a democracy that does not have widespread ownership of assets to be truly democratic. De Soto's central insight is that to escape from poverty you need assets - assets which you can put to work. There is a good deal of historical evidence on his side, as well as abundant contemporary evidence, that ownership tends to encourage self-esteem and healthy habits of behaviour, such as acting more for the long term, or taking education more seriously."

It is estimated that the black or informal economy accounts for between 3 and 7 per cent of British GDP. In areas such as Merseyside, industrial decline in the early 1980s led to a sudden contraction in the formal economy; a big cash economy arose in its place, covering everything from plumbing and building to drugs and organised crime. Mulgan thinks that we should learn from de Soto's principles: "The informal economy does have some virtues - it is highly entrepreneurial and creates wealth of a sort. But there are strong reasons for wanting to bring as much informal activity as possible into the formal economy - to cut the links with organised crime, to reduce benefit fraud, tax evasion, dependence on loan sharks and so on. Britain is a very different economy from Peru. But de Soto is right about the need to create pathways that encourage people to go legitimate, with a judicious combination of sticks to signal that you won't tolerate evasion and fraud, and carrots so that people aren't pushed even further away from the legitimate economy."

As de Soto points out, private property in Britain was born with the enclosures movement. This is why the British associate property with oppression and exclusion of the poor. Since the decision to rewrite Clause Four and to abandon calls for collective ownership of industry, Labour has simply ignored the whole question of property and ownership.

But grappling with the dynamic qualities of property can open up an entirely new front in the debate between left and right. Anthony Eden was the first to talk about creating a "property-owning democracy", and property became even more difficult territory for the left when Margaret Thatcher seized upon this phrase to justify her "right-to-buy" schemes and her cut-price sell-offs of national utilities.

It is a measure of how much these matters have become the preserve of the right that, when de Soto's publishers wanted an endorsement for his book, it was to Thatcher they turned (although whether she actually read it is another matter). De Soto thinks it is time to reverse all this and recast property as something that can empower the poor. Maybe his book will be the turning point.