Bound to fail in developing nations?

Marco Kusumawijaya, Contributor, Jakarta

The Mystery of Capital -- Why Capitalism Triumphs in the West and Fails Everywhere Else; By Hernando de Soto; Basic Books, New York, 2000, 275 pp.; US$27.50.

To the question posed by the book's subheading, de Soto -- author of The Other Path, president of the Institute for Liberty and Democracy (ild.org.pe) in Peru, adviser to the country's president and initiator of its economic and political reforms -- offers an answer using freshened-up old facts and seasoned new perspectives.

Because, outside the West, the five-sixths of humanity living in developing and former-communist nations have not been able to "globalize" capital within their own countries. Worse, they are embarking on globalization without the means to produce capital. They are looking less and less like the United States -- the presumed successful role model of capitalism -- and becoming more and more the same as, say, Indonesia, with its informal sector that has caused its city governments to lose their patience. Witness the shambles in Argentina today.

The path to prosperity is, therefore, to build a populist capitalism. Those five-sixths of humanity must be able to capitalize on their assets. Capitalism must not be kept -- not even for smug, good intentions to protect the poor -- as a privilege only for the elite.

De Soto believes the key to this is a legal system that could absorb the majority of what is currently extralegal into the capitalist system. "Extralegal" is used to refer to a more specific, definable state of being of the informal sector that collectively is not poor at all, as de Soto shows in his book. This specific term is of utmost importance, when currently there is so much misunderstanding about "the informal sector", as to automatically bracket it together with "the poor".

Extralegal arrangements have been the basis for the majority of the population of developing and former communist countries to do their business. Such arrangements need to be understood by politicians, and taken as sources for a new legal system that is responsive and which allows the "extralegal" to have rights to property and hence to capitalize on it.

It is important to make the point that de Soto is not proposing a blindfolded agrarian reform to either simply redistribute to the poor all the land of private holdings and public control, or expropriate all holdings back to the state. This is important as, despite his attempt to go "beyond right or left", de Soto's ideas can be understandably misunderstood by a generation of Indonesians with a phobia of communism. Ironically, de Soto has, as well, been accused by some leftists as being "too hopeful" of capitalism.

De Soto is concerned more with "meta rights" -- access or rights to property rights -- than the property rights per se. His book aims at proposing that billions of extralegals in developing and former communist countries should be able to convert their assets into productive capital. Legality is a means to capitalization. The principal problem of developing countries is neither the lack of assets nor entrepreneurship. They have plenty of assets, but "dead" ones, and no "capital" yet .

Extralegals, many of whom are indeed poor individually, have accumulated trillion of dollars of real estate during the past forty years. But they are either unacknowledged by the market or rejected by the state, such as in the case in Jakarta recently. What they lack is easy access to a property mechanism that could legally "fix" (a term borrowed from Adam Smith) the economic potential of their assets so that they could be used to produce, secure, or guarantee greater value in the expanded market, or simply the market at all.

De Soto and his team believe that by their calculation, the total value of the real estate held but not legally owned by the poor of the Third World and former communist nations is at least US$9.3 trillion. This is twice as much as the total U.S money supply in circulation and very nearly as much as the total value of all the companies listed on the main stock exchanges of the world's 20 most-developed countries.

According to most estimates, the extralegal sectors in the developing world house 50 percent to 75 percent of all working people and are responsible for one-fifth to more than two-thirds of total economic output of the Third World.

Imagine all those assets being capitalized, potentially used as development capital! These assets not only far exceed the holdings of the government, the local stock exchanges, and foreign direct investment; they are many times greater than all the aid from advanced nations and all the loans extended by the World Bank. As such, relieving the poverty of the extralegal sector will no longer be a charitable cause to be undertaken only when it is fashionable or politically correct. The future of the extralegal is the future of nations and is the source for growth!

De Soto argues it is therefore more important to establish a (legal) system that would allow assets to be readily used by the majority of the world's population to create a surplus of wealth by taking advantage of the expanding market economy, than to simply deliver property to them.

De Soto suggests that the consensus-based extralegal arrangements that have been prevailing in developing and former communist countries should be made the source of legitimacy in laws that would legalize extralegal arrangements. "Law must be discovered before it is enacted", he wrote. He recalled his time in Indonesia, and wrote that one source of law should be the "Jukum Adat". He means "hukum adat", the traditional arrangements among many Indonesian ethnic communities.

More than just legal confirmation of ownership per se, a legal system that de Soto argues for must include a mechanism that allows the population at large to fix economic rights over their assets in representations protected by law in a way cheaper than their competitors in the extralegal world. His argument comes in the form of a rediscovery of the history of capitalism in the now advanced nations.

His reading of miners, squatters and settlers in the U.S. during the 18th and 19th centuries is, for example, relevant to the problems faced by Indonesia everywhere. A current example is Palu, Central Sulawesi, where local lawmakers have to decide to whom to give mining concessions: the traditional individual miners, who have been there for decades, or big corporations that are only now requesting a concession.

Even if Indonesians do not agree with this book's main proposition, it points to one issue that all would probably agree upon. This is that whatever legal reform we wish to make, the crucial change is to adapt the law to the social and economic needs of the majority of the population. In other words, our lawyers and lawmakers need to take a much more progressive stance and work hard from that. Otherwise, they will simply prolong the frustration that many of us have felt about a lazy, uninspired, positivist attitude among many of them.

With the advance of capitalism itself, we might wonder if the concept of property should not be expanded to include other properties, such as intellectual property, upon which people in developing nations have much to capitalize if only a good legal system were in place. Intellectual property rights are as important to the rich as the poor, especially within the context of multicultural Indonesia, where people have for centuries collectively invented many crafts, techniques and medicines not represented in modern records -- hence not easily capitalized.

Moreover, perhaps a detailed study of Japanese history of capitalism would have been perceived as closer to home than the American and European examples. It is curious, therefore, that de Soto did not include such a study. But his argument is essentially an anticulturalist approach. He does not believe that the failure of capitalism outside the West has to do with native cultures. However, does he include Japan when he referred to "everywhere else" outside the West?