To generate economic growth, the institutions of property, of credit and debt, of money creation, and of a self-reliant citizenry must be fostered. This is universal and applies to both developing and developed countries. The Peruvian pioneer in this area, Hernando de Soto, has clearly seen this and formulated policy prescriptions addressing these issues for the developing world.
De Soto refers to vast economic resources that are untapped because they are unharnessed. He calls this “dead capital.”[1] In order to harness this “dead capital” a system of property rights (in the service of credit and debt rather than as mere possession) needs to be implemented that covers not merely the privileged segment of society, but all of society, including the poorest of the poor. Hence, his penetrating conclusion: “Much of the marginalisation of the poor in developing and former Soviet nations comes from their inability to benefit from the six effects that formal property provides. The challenge these countries face is not whether they should produce or receive more money but whether they can understand the legal institutions and summon the political will necessary to build a property system that is easily accessible to the poor” (p. 179).
What are the six effects provided by a system of property rights, as De Soto understands them? They correspond closely to the common-law understanding of the economy as put forward here. To wit:
- Fixing the economic potential of assets. The asset nature of the specific object as property is set down in an official document such as a title deed. This secures the property right so that it can be used as the basis of further transactions. “Legal property thus gave the West the tools to produce surplus value over and above its physical assets. Whether anyone intended it or not, the legal property system became the staircase that took these nations from the universe of assets in their natural state to the conceptual universe of capital where assets can be viewed in their full productive potential” (p. 171).
2. Integrating dispersed information into one system. This is the benefit of establishing a uniform, common, legal system. Information registered in rights is accessible across the entire area over which the legal system holds sway. “It may surprise the Western reader that most of the world’s nations have yet to integrate extralegal property agreements into one formal legal system. For Westerners today, there supposedly is only one law – the official one. Diverse informal property arrangements, however, were once the norm in every nation – the West’s reliance on integrated property systems is a phenomenon of at most the last two hundred years” (p. 172). The economic imperative of a common law lies partly, therefore, in its capacity to integrate this otherwise dispersed, and so unharnessed, information.
3. Making people accountable. The shift away from dispersed and confused legal systems to a uniform legal system enabled property owners to escape the regime of favoritism and move into the regime of law. “The integration of all property systems under one formal property law shifted the legitimacy of the rights of owners from the political context of local communities to the impersonal context of law” (p. 172). Property ownership shifts the locus of accountability to the property owner. Restrictions are removed – but accountability is increased. This fosters a self-reliant citizenry.
“By transforming people with real property interests into accountable individuals, formal property created individuals from masses. People no longer needed to rely on neighbourhood relationships or make local arrangements to protect their rights to assets. They were thus free to explore how to generate surplus value from their own assets. But there was a price to pay: once inside a formal property system, owners lost their anonymity while their individual accountability was reinforced. People who do not pay for goods or services they have consumed can be identified, charged interest penalties, fined, and embargoed, and can have their credit ratings downgraded. Authorities are able to learn about legal infractions and dishonoured contracts; they can suspend services, place liens against property, and withdraw some or all of the privileges of legal property” (p. 173).
Furthermore, where there is no property, there can be no contracts, no security, no arrangements for mutual gain with anyone other than close friends or kin. “The lack of legal property thus explains why citizens in developing and former Soviet nations cannot make profitable contracts with strangers and cannot get credit, insurance, or utilities services: they have no property to lose. Because they have no legal property, they are taken seriously as contracting parties only by their immediate family and neighbours. People with nothing to lose are trapped in the grubby basement of the pre-capitalist world” (p. 173).
4. Making assets fungible. By creating a layer of assets atop the layer of physical goods and services, the property regime allows for assets to be packaged in ways impossible with the physical objects themselves, thus putting them in the service of a variety of transactions. “Unlike physical assets, representations of assets are easily combined, divided, mobilised, and used to stimulate business deals. By uncoupling the economic features of an asset from its rigid, physical state, a representation makes the asset ‘fungible’ – able to be fashioned to suit practically any transaction” (p. 173). Standardized descriptions and records facilitate the comparison of assets. Assets may also be parceled out at the level of property rights, without the physical object being divided, such as in shareholdings. Standards also facilitate the measurement of an asset’s attributes. “By providing standards, Western formal property systems have significantly reduced the transaction costs of mobilising and using assets”(p. 173).
5. Networking people. The regime of property rights enables people to develop far more integrated and complex networks of cooperation and integration than otherwise. It has “converted the citizens of the West into a network of individually identifiable and accountable business agents” (p. 174). It is not so much protection of ownership that makes the difference here, but the enhanced flow of information regarding assets. “The property system’s real breakthrough is that it radically improved the flow of communications about assets and their potential” (p. 175). This information helps people to manage risk better, as they can better assess that risk, and can pool it. This networking seems to take place at a level beyond most people’s awareness. “Few seem to have noticed that the legal property system of an advanced nation is the centre of a complex web of connections that equips ordinary citizens to form ties with both the Government and the private sector, and so to obtain additional goods and services. Without the tools of formal property, it is hard to see how assets could be used for everything they accomplish in the West” (p. 175).
6. Protecting transactions. The titles, records, and other carriers of information regarding assets are all “continually tracked and protected” (p. 175). Public agencies, “the stewards of an advanced nation’s representations” (p. 175), are responsible for maintaining an accessible system of tracking the myriad forms of assets and transactions taking place as part of a modern economy. Here the security of both property and contract is in view, although the latter is given particular attention. The emphasis on contract keeps property from becoming imprisoned in static relations. “The Western emphasis on the security of transactions allows citizens to move large amounts of assets with very few transactions. In most developing countries, by contrast, the law and official agencies are trapped by early colonial and Roman law, which tilt toward protecting ownership. They have become the custodians of the wishes of the dead” (p. 176). In other words, restrictions on freedom of contract with regard to inheritance – the sacrifice of the individual to family interests – in many instances have kept property from being harnessed to productive activity.
So the Western legal system has provided its citizens with a range of tools to leverage their resources so as to multiply productivity and generate sustained economic growth. These institutions need to be adopted and adapted by the developing world. De Soto himself characterizes this as “lifting the bell jar,” an image he takes from the French economic historian Fernand Braudel.
Braudel posed the question, “why that sector of society of the past, which I would not hesitate to call capitalist, should have lived as if in a bell jar, cut off from the rest; why was it not able to expand and conquer the whole of society? … [Why was it that] a significant rate of capital formation was possible only in certain sectors and not in the whole market economy of the time?” De Soto would like to see capitalist institutions expanded to societies across the board, including the poorest of the poor, so that they too might participate in wealth creation and a dynamic economy. He sees the solution in expanding the rule of law and civic virtue to all levels of society, so that the bell jar of the privileged few is removed. Hence, a promising economic environment is one in which the institutions of capitalism are expanding and being implemented at all levels. Property rights are extended and recognized; citizen status (equality before the law) is accorded all; the capacity to encumber property and create assets, thus monetizing hitherto hidden, merely possessed, resources, is promoted and taken advantage of.
How is one to track progress in the developing and developed world? Two indices are worthy of particular mention.
First, the International Property Rights Index, published by the Washington, D.C.-based Property Rights Alliance. The index surveys 125 countries respecting the legal and political environment, physical property rights, and intellectual property rights (follow this link for information and country rankings).
The subcategory breakdown is significant:
1. Legal and Political Environment
- Judicial Independence
- Rule of Law
- Political Stability
- Control of Corruption
2. Physical Property Rights
- Protection of Physical Property Rights
- Registering Property
- Access to Loans
3. Intellectual Property Rights
- Protection of Intellectual Property Rights
- Patent Protection
- Copyright Piracy
Most of the key criteria are included here. Of specific interest are: independence of the judiciary, control of corruption, protection of property rights, and access to loans. These are closely intertwined: property cannot be protected when the courts can be hijacked and when officials can be bribed, and if property is not protected, credit cannot be securely established. Thus, a capitalist economy cannot be maintained without these pillars being put in place.
But there is a blind spot to this index, which is rather odd considering that the Property Rights Alliance is an affiliate of Americans for Tax Reform. And that is, that there is no index component tracking a country’s tax burden, either in general or on entrepreneurs and businesses. This is curious indeed, considering Chief Justice John Marshall’s dictum, “the power to tax involves the power to destroy.”
Such a component is of twofold importance: for one thing, a heavy tax burden has the tendency to hinder economic growth and therefore to slow the rate of growth, and the taxation of capital and investment has a direct discouraging effect.
Given this anomaly, the rankings resulting from the International Property Rights Index are heavily weighted toward northern European, and specifically Scandinavian, countries, which of course enjoy solid legal systems and a lack of corruption, but the tax burden of which is extreme.
Another such index, although broader in scope, does include such relevant parameters as the tax burden – the Index of Economic Freedom (follow this link). Components include:
- business freedom, “an individual’s right to establish and run an enterprise without interference from the state;”
- trade freedom, or the openness to international trade;
- fiscal freedom, or the level of taxation;
- government spending, whether, and to what degree, excessive and oppressive to the private sector;
- monetary freedom, or “a stable currency and market-determined prices;”
- investment freedom, reflecting the freedom enjoyed by entrepreneurs and businesses to act, and the absence of restrictions on the flow of capital to investment opportunities;
- financial freedom, reflecting the health and transparency of the financial sector, specifically banks, but also other credit and capital providing institutions;
- property rights, their recognition and protection, with enforcement of contracts, through an effective, independent judiciary;
- freedom from corruption, or freedom from the need to appease officials and bureaucrats rather than meet the requirements of law, and, e.g., freedom from corrupt officials embezzling public funds;
- labor freedom, or the freedom of laborers to determine their own conditions of labor, and of employers to determine conditions of employment.
These rankings give quite a different picture than that provided by the International Property Rights Index. In particular, the Scandinavian and northern European countries drop far down, and the reason is the “fiscal freedom” and “government spending” categories. Nevertheless, both of the indices are useful tools.
What this shows is that the context of the adoption and adaptation of the institutions of prosperity is sovereignty. For nations are the sovereign entities in today’s world, and it is nations which succeed or fail in implementing the necessary reforms. So much is evident from both the International Property Rights Index and the Index of Economic Freedom, which rank nations.
[1]Hernando de Soto, “Dead Capital, Fluid Capital, and Money,” in Otto Steiger, ed., Property Economics: Property Rights, Creditor’s Money and the Foundations of the Economy (Marburg, Germany: Metropolis Verlag, 2008), p. 167. The following citations and summaries are derived from this article, pp. 167-180. The article is itself an updated version of ch. 3, The Mystery of Capital: Why Capitalism Triumphs in the West and Fails Everywhere Else (New York: Basic Books, 2000).