Why the World's Poor Stay That Way

Why Capitalism Triumphs in the West and Fails Everywhere Else

By Hernando de Soto
Basic Books -- 276pp -- $27.50

Centuries ago, poverty was inevitable. Castles and jewels aside, even kings and queens were poor in a way, scraping along without indoor plumbing, phones, or refrigerators, let alone low-fat cheese snacks and Internet hookups. Today, though, parts of the world are fantastically rich. So why is so much of the rest stuck in poverty?

The persistence of poverty amid plenty is the most troublesome conundrum in all of economics, and it's the topic of a provocative and elegantly written book by Peruvian scholar Hernando de Soto, The Mystery of Capital: Why Capitalism Triumphs in the West and Fails Everywhere Else. Although de Soto oversimplifies the solution to poverty, he performs a valuable service by highlighting a problem that's often underestimated: the failure of the legal system to acknowledge and respect the property of the poor.

De Soto says that people in poor countries are just as smart and entrepreneurial as people in rich countries. The key difference, he asserts, is that most of them live as squatters. Because they don't have legal title to their land, homes, or businesses, they can't use them as collateral for loans. They often can't get services such as water and electricity. And if they do accumulate any wealth, they're vulnerable to shakedowns by the authorities.

The Mystery of Capital says that legal systems in the developing world have failed to cope with ''a gigantic movement away from life organized on a small scale toward one organized in a larger context''--from farms to cities. That failure has produced shantytowns on the outskirts of every major city in the developing world. Writes de Soto: ''What national leaders are missing is that people are spontaneously organizing themselves into separate, extralegal groups until government can provide them with one legal property system.''

As de Soto sees it, capitalism will be justifiably hated in developing countries as long as the poor can't accumulate any capital. He and colleagues have calculated that poor people around the world unofficially own approximately $9 trillion in assets, mainly their homes. This is more than all the foreign aid ever supplied to developing nations. But because the properties aren't recorded anywhere, they can't be borrowed against. De Soto argues that reforming the legal system would free that ''dead capital'' to become an engine for growth, as capital is in rich countries.

De Soto advocates turning squatters into mini-capitalists by giving people legal title to what they already consider theirs. In a fascinating chapter, he explains how the U.S. did exactly that in the 19th century, when Congress and the Supreme Court grudgingly granted property rights to squatting settlers and gold prospectors.

De Soto first gained attention in 1989 with The Other Path, a book focusing on barriers to entrepreneurship. As an adviser to Peruvian President Alberto Fujimori, he led a project to secure property rights and cut red tape. (He and fellow researchers found it took 728 steps for a squatter to obtain, from the city of Lima, legal title to a home.) His Lima-based Institute for Liberty & Democracy has also studied Egypt, Indonesia, and Haiti. These days, de Soto is advising Mexico's President-elect, Vicente Fox.

The villains of de Soto's story aren't the rich. He says they benefit from reform because it stimulates the economy and reduces crime. His villains are lawyers: Most attorneys in poor countries, he says, have been trained to defend the system exactly as they found it. ''No group--aside from terrorists--is better positioned to sabotage capitalist expansion,'' writes de Soto. ''And unlike terrorists, the lawyers know how to do it legally.''

Unfortunately, de Soto overreaches by dismissing other theories about the persistence of poverty. His message that capitalism would work if only the lawyers played along makes him popular with the likes of economist Milton Friedman and former British Prime Minister Margaret Thatcher, who supplied book-jacket blurbs. But de Soto's is not the whole story. Economists such as Jeffrey Sachs and Robert Barro have written persuasively about how flawed macroeconomic policies can stall development. Meanwhile, Michael Porter's The Competitive Advantage of Nations and Michael Fairbanks' and Stace Lindsay's Plowing the Sea underscore the role of corporate strategy, explaining that companies in developing countries need to get away from relying on cheap labor and natural resources and focus more on understanding their customers.

While de Soto mostly ignores those theories, he's downright hostile to another explanation for poverty--culture. He argues, for instance, that Protestants don't have a monopoly on the work ethic. That's true enough. But de Soto's own analysis has a cultural component: He says that property reformers should discover the makeshift, often unwritten laws that already exist rather than imposing rules on populations. And what are such improvised laws but manifestations of a culture?

De Soto discovered while traversing rice fields in Bali that, while he didn't know their boundaries, the dogs did. ''Every time I crossed from one farm to another, a different dog barked.'' The Mystery of Capital is about recognizing the wisdom of those dogs.

Coy is associate economics editor.

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Why the World's Poor Stay That Way

PHOTO: Cover, ``The Mystery of Capital''

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