An Analysis of Why Capitalism Doesn�t Work for Developing Countries?
The Mystery of Capital (de Soto)
Heterodox economics refers to the school of thought which do not confirm to the mainstream paradigm of neoclassical economics. This school of thought tries to focus on the dynamics of an economy, and claims to explain the more complex phenomenon of an economy. Hernando De Soto (De Soto), a Peruvian is one of the heterodox economists who has time and again tried to explain informal economies. He claims that the poor people are the solution, not the problem. In his book, The Mystery of Capital, De Soto tries to explain why capitalism has not worked for the Third World and Communist nations. He claims that the major problem with such economies is the lack of proper legal system that should be present for the economy to realize its full potentials. Moreover, De Soto claims that the concept of �Capital�, as explained by Smith, and perceived by the West, has not been understood by the Third World. The thesis of my paper analyzes De Soto�s theory and its validity. I shall also discuss whether there are additional factors involved in the failure of capitalism in the Third World.
De Soto starts by the necessity for the Third World countries to realize the problem of what he calls �extralegal� economy. De Soto, like classical economists, favors capitalism. �Capitalism stands alone as the only feasible way to rationally organize a modern economy.� He then goes on to explain that the triumph of capitalism only in the West could be a recipe for economic and political disaster. �If the Third World and former communist nations cannot escape the influence of the West, neither can the West disentangle itself from them.� De Soto claims that lack of information and skills to utilize the concept of capitalism in the Third World people and culture are not adequate explanations to the failure of capitalism. He claims that the major stumbling block that keeps the rest of the world from benefiting from capitalism is its inability to produce capital, and this inability is to be blamed at the legal system of the country. He claims that the idea of capital is difficult to grasp because one knows it exists but cannot see.
He explains his theory of lack of understanding of capitalism, firstly by explaining the missing information problem in Third World countries. De Soto says that 80% of the population of the Third World country led their lives in extralegal economy. De Soto goes on to explain how extralegal economies existed. When technical revolution occurred, most people had rising wages in the cities. Recognizing the lucrative offer, more people moved into the city. Moreover, there was an increase of population due to increasing sophistication in medical science. Therefore, due to too much movement into the city, there existed shantytowns, and hence occured, unplanned constructions. �4.7 Million Egyptians have chosen to build their houses illegally�It is very nearly as difficult to stay legal as it is to become legal.� De Soto claims that most people stay illegal because the cost of staying legal is more than benefits of becoming legal. De Soto emphasizes the importance of the governments to recognize such an economy, and how the government should try to legalize it. �Undercapitalized sectors throughout the Third World buzz with hard work and ingenuity.� When people buy lands, and don�t inform the registry office, the exchange economy becomes constrained and sluggish. And hence, there is a start of the extralegal sector.
De Soto then talks about the �Dead Capital� syndrome that occurs because although the poor people own the capital, there is no way they can invest, or do anything productive with it. �Dead capital, virtual mountains of it, lines the streets of every developing and former communist country. In Peru, 53% of city dwellers and 81% of people in the countryside live in extralegal dwellings.� Therefore, De Soto claims, as opposed to the popular belief of Economists, �international poverty� is not accurately viewed. �By our calculations, the total value of the real estate help but not legally owned by the poor of the Third World and former communist nation is at least $9.3 trillion.� He claims that this asset is ready to be used, and to be transformed into capital.
De Soto then moves on to talk about the lack of concept as a problem that occurs in the Third World, mainly, the mystery of Capital. He uses it to explain why capitalism fails in the Third World and former Communist nations. De Soto blames the West for having forgotten how they changed assets into capitals, and hence, their inability to teach the Third World countries how to do so. He emphasizes the importance of distinguishing physical assets from the real capital. Real capital is that part of country�s assets that initiates surplus production and increases productivity. De Soto also refers to Smith and Marx when he explains this idea.
�Smith emphasized one point that is at the very heart of the mystery we are trying to solve: For accumulated assets to become active capital and put additional production in motion, they must be fixed and realized in some particular subject �which lasts for some time at least after that labour is past. It is, as it were, a certain quantity of labour stocked and stored up to be employed, if necessary, upon some other occasion.�
De Soto claims that the concept of capital is not recognized by Third World countries. Third World countries are infamous for inflating their economies with money, while not being able to generate much capital. Bringing dead capital into life requires a process for fixing an asset�s economic potential into a form that can be used to initiate additional production. For instance, the land owned by people in the Flavelas of Brazil cannot be used for collateral because it has not been registered with the government. Ownership changes hand so fast, that when an investor wants to purchase such lands, he doesn�t bother to go through the legal procedures either. Therefore, all the income of the economy is being highly minimized.
Moreover, De Soto moves on to emphasize that the system of private property ownership as a way to recognize capital was discovered by the West. It is the formal property that provides the process, the forms, and the rules that �fixes� assets in a condition that allows us to realize them as active capital. He moves on to explain the some effects of Formal Property System that worked for the West, but which the Third World countries have not yet discovered. Firstly, capital is born by representing the asset in writing. The description should contain economically and socially useful concept as opposed to mere visual description of the asset. Oftentimes, no papers exist for such provisions in Third World. In the West, one person from one country can buy lands based on the title, without having to physically go there. Secondly, such representation of writing needs to be integrated into one major formal system. In the Third World, dozens of organizations have this, but not a single concrete system exists. In the West, the asset can be evaluated and exchanged easily due to such a formal system. Lastly, De Soto points out the fact that releasing owners from restrictive local arrangements and bringing them into a more integrated legal system facilitates accountability. The authorities are able to learn about legal infractions and dishonored contracts. In my opinion, this is one major important issue Third World countries have to deal with. Legitimizing business deals and winning the confidence of investors remains a challenge for most Third World countries to this day.
De Soto moves on to explain the mystery of political awareness that Third World countries should solve. He explains the concept of Braudel�s Bell Jar in the society. He also looks at the reason why the Governments do not realize the concept and existence of bell jar. The concept looks at the fact that the legal society, which is very small in proportion to the extralegal, is inside the bell jar. The extralegal sector, outside the bell jar, cannot enter the legal sector due to political and legal system. �The failure of the legal order to keep pace with this astonishing economic and social upheaval has forced the new migrants to invent extralegal substitutes for established law�.the migrants in the developing world can deal only with people they know and trust.� A legal failure that prevents enterprising people from negotiating with strangers defaults the division of labor and fastens would-be entrepreneurs to smaller circles of specialization and low productivity. I agree with De Soto in the limited productivity forced by lack of supportive legal system, and that the political leaders of the country need to realize that legalizing such sectors is the key step to leading their countries towards developments. Moreover, De Soto emphasizes that political blindness consists of being unaware that the growth of the extralegal sector and the breakdown of the existing legal order in the Third World are ultimately due to a gigantic movement away from life organized on a small scale toward one organized in a larger context.
De Soto merely touches on the problem of international trade in this section. �When migrants move from developing and former communist countries to advanced nations, well-developed institutions eventually absorb them into a networked property system that helps them produce surplus value.� I feel that De Soto should have put more research into this particular arena. This is one problem most developing countries are facing today. Most of their educated and skilled countrymen are pulled by U.S., Canada and eastern European countries through migration and skilled visa programs. More people have abandoned Third World countries, and the demographics have resulted in more skewed ness towards ageing and dependant population. De Soto does not address this problem as to why the Third World Countries have not been able to move forward in the corporate battlefield.
De Soto, after having promoted capitalism thus far, moves on to bring some of his Marxist beliefs. �These extralegal systems, in my opinion, constitute the most important rebellion against the status quo in the history of developing countries since their independence...� He said that the biggest rivals of the extralegal sector is the government itself, and since the extralegal sector is so large, the government is not able to fight against it. Therefore, when people get frustrated with the system, they will fight back. Most governments have realized this, and De Soto claims, have started recognizing such extralegal sectors. Eventually, all governments will have to compromise and legalize the extralegal sectors, but the question of timing is the key mantra for a Third World country�s success claims De Soto. This mixture of capitalistic and Marxist belief makes De Soto a truly heterodox economist. However, De Soto does not back up this argument with any factual evidence. He discusses the history of United States, but the West has always been, and for a long time shall continue to be, different than the Third World countries. Therefore, in my opinion, the evidence in the West cannot convince the rest of the world.
In the last section of his book, De Soto enlightens the readers with the failure of legal system, and some of the misconceptions one operates with in the Third World countries. The misconceptions De Soto talks about are as follows:
1. People stay in the extralegal sector in order to avoid paying taxes.
2. Enacting mandatory law on property is sufficient, and governments can ignore the costs of compliance with that law;
3. Existing extralegal arrangements or �social contracts� can be ignored.
4. People�s conventions on how they hold their assets, both legal and extralegal can be changed without high-level political leadership.
De Soto moves on to discuss these misconceptions. He mentions that according to his research, the cost of lack of insurance, the potential market the businesses could make the cost greater than the tax they could avoid. He also points out that the challenge today in most non-western countries is not to put all the nation�s land and buildings into the same map, but to integrate the formal legal conventions inside the bell jar with the extralegal sector outside the jar. De Soto emphasizes that no major legal change has gone without major political responsibility. De Soto explains this through the �meta-rights� theory, where he claims that the citizens should get the right to the property rights. �The demand for codification is a demand of the people to be released from the mystery and uncertainty of unwritten or even of case law.�
Overall, I think De Soto points out a very important arena that most Economists had not explored, or bothered to think about. His view on the legal system, the lack of strong political stance is something we can observe in every Third World country. For example, Zimbabwe, Nepal, and Liberia � all these countries are going through a strong revolution in an effort to unite all sectors of their divided economy. However, some of the claims De Soto makes is questionable. De Soto gives the illusion of rigorous study, but gives no proof. He does attach some charts, but with no explanation of what those charts say. For instance, he never says how he and his team determined whether a building was formal or informal. Moreover, according to Table 2.1 in his book, the calculation assumes that 85% of urban dwellers are informal. This percentage is much higher than that in three of the four countries for which De Soto provides detail- Peru (53%), the Philippines (57%), and Haiti (68%) . Only in Egypt is the number higher (92%). This is a classic example of how statistics can lie in one�s analysis.
In the countries that De Soto studied and came up with the solutions, one must ask, why did he choose such countries? Each of the country De Soto studied (Haiti not included), has the second or third highest level of informal activity in its respective region. This makes them ideal countries for De Soto to study. But it makes them less ideal countries from which to extrapolate estimates of informal activities or assets in other countries. Moreover, the policies, or the level of explanation De Soto gives has been that for the governments that have somewhat come in terms with the informal sectors. De Soto nowhere talks about countries like Liberia, or Libya to discuss what those kinds of Third World countries should do.
Another point where De Soto�s argument can be debated over is that he clearly dismisses the cultural orientation of the country, and people�s mind set as something secondary which has nothing to do with why Capitalism did not work there. In most Third World countries, Capitalism is a western idea which represents the idea of �Social Darwinism.� What people do not understand is, only if they are productive and the best will they reap the benefits of the society. Moreover, the East has always valued stability and certainty in standard of living. Capital economy is an anarchic chaos, constantly threatened by mass unemployment, stagnation, and collapse. For the present, advanced capitalist countries maintain prosperity by military spending and foreign dumping. This is something Third World countries oppose. Moreover, such countries see a lot of Multinationals penetrate their country, and reap profits while their domestic firms are forced out of the market. De Soto fails to see all these prejudices which lies in the Third World populations� mind.
Overall, De Soto�s book �The Mystery of Capitalism� is a good one, in that it focuses on the major issue of lack of good integrative legal systems in the Third World countries. This comes out to be true in general. However, De Soto should take other factors into consideration, and also include some Eastern countries in his research to get a concrete result.
BIBLIOGRAPHY:
1. De Soto, The Mystery of Capital, 2000
2. H. Alger & S. Legree, �Capitalism� East and West, 1961
3. www.redflag.org, Capitalism�s Agenda for Poverty in Africa.
