Hernando’s Mystery

Hernando’s mystery is the poor’s misery. Hernando de Soto is one of the leading economists in the developing world. In his book The Mystery of Capital the Peruvian economist reviews how real estate owned by the extreme poor could be mobilized to raise phenomenal amounts of capital that could trigger sustained episodes of economic growth and prosperity throughout the developing world.

In his masterpiece the Lima-based economist intends To demonstrate that the major stumbling block that keeps the rest of the world from benefiting from capitalism is its inability to produce capital. Hernando concludes that:

These extralegal systems, in my opinion, constitute the most important rebellion against the status quo in the history of developing countries since their independence and in the countries of the former Soviet bloc since the collapse of communism.

Hernando is right. In many developing countries a major part of the economic activity remains on the informal side of the economy. Individuals do not have access to bank accounts and basic financial services. Individuals own property but cannot officially attest it is theirs because there is no official registry where it is recorded to whom belongs what.

In his research Hernando confirms that staying away from the legal system compensates for paying taxes. On the other hand staying away from the legal system limits the ability of the extreme poor to mobilize their assets and capitalize the value of their real estate collateral. It is no longer a debate left versus right. Hernando points out:

Government programs to give property to the poor have failed over the last 150 years whether they followed the bias of the right (private property rights through mandatory law) or of the left (protecting poor people’s land in government-run collectives). The crippling political agendas of the left vs right are largely irrelevant to the needs of most people in developing countries.

Roy Cullen underscores Hernando’s insight when he comments that When informal resources are examined, such as potential land value, the domestic assets that can be tapped are much larger than cumulative FDI or private portfolio flows. Ambassador Danilovich points out a similar view:

Women and children across the globe face many laws and customary practices that don’t protect women’s tenure rights. Yet, a woman’s ability to inherit and hold onto rights to her land is a crucial social safety net that protects her and her children. The lack of tenure rights worsens the plight of HIV/AIDS widows, for example. It threatens children with homelessness, hunger and loss of education. Children sometimes forgo school to guard their homes and farms for fear of being evicted while their mothers work. This is unacceptable in today’s world.

Hernando concludes that Economic reformers have left the issue of property for the poor in the hands of conservative legal establishments uninterested in changing the status quo. Like in western countries the pirates of heartless capitalism of the developing world represented by the conservative legal establishments are stopping today’s world from moving ahead. It is time to fight the pirates of heartless capitalism. We know where they are. We have been ignoring their presence.

Only in Hernando’s native Peru the poor’s assets are worth $90 billion, which is forty times the sum of foreign assistance Peru has received since World War II. The figure is even more impressive for Egypt. The assets of the Egyptian poor are worth a total of $240 billion, or fifty-five times the value of all foreign direct investment in the past 200 years.

From 20 to 24 June 2009 I was in Lima (Peru). I decided to travel to Hernando’s headquarters to determine the validity of his approach. Hernando is based in Lima and heads one of Latin America’s leading think-tanks, the Institute of Liberty and Democracy (ILD). Victor Endo is the Vice President of International Operations at ILD. I met Victor on Monday 22 June 2009 in Lima (Peru). ILD is active promoting an agenda of land reform whose priority is to bring informal property to the formal economy, so that the extreme poor can mobilize their assets. What incentives should be available so that the extreme poor are willing to legalize their properties and bring them to the informal side of the economy? Victor referred to the ability the poor would have to mobilize collateral for entrepreneurial purposes if their properties were legalized in a formal registry.

I met Gianfranco Castagnola on Monday 22 June 2009 in Lima (Peru). Gianfranco is the Executive President of Apoyo Consultoria, Peru’s leading economic and financial consultancy. For Gianfranco Hernando de Soto’s approach to formalizing the informal property is only the beginning of legal reform that may allow to mobilize assets. A more neutral and effective judiciary system is only the next obvious step.

I met Raul Salazar on Tuesday 23 June 2009 in Lima (Peru). Raul is Managing Partner of Macroconsult, Peru’s prominent macroeconomic consultancy. For Raul Hernando de Soto’s approach emphasizes the importance of utilizing the poor’s collateral to demand credit, but undermines the poor’s paying capability, linked not to the collateral per se, but to their economic activity.

I met Pedro Pablo Kuczynkski on Wednesday 22 June 2009 in Lima (Peru). Pedro Pablo was Peru’s Finance Minister in 2001-2002 and 2004-2005 and Peru’s Prime Minister from 2005 to 2006. For Pedro Pablo redistribution is a key element of a country’s economic agenda and there must be cross subsidies that help finance basic public goods to the most vulnerable.

Hernando de Soto’s superb work shows ways of transforming dead capital into live capital which the poor could use to borrow against. Collateral matters. A revolution lies ahead of us, a silent revolution that will mobilize trillions of dollars. According to Hernando Citizens inside and outside the bell jar need government to make a strong case that a redesigned, integrated property system is less costly, more efficient and better for the nation than the existing anarchical arrangements.

Aggregate dead capital amounts to $9.34 trillion. This phenomenal sum is only the beginning. If only dead capital were released from the cage the political elites built in the developing world, perhaps I would not be writing about poverty eradication. If only dead capital were released from the prison of thought the economic elites built in the developing world, foreign aid would not play such a significant role.

Jaime Pozuelo-Monfort is the multidisciplinary European and author of The Monfort Plan