An interview with Hernando de
Soto
INTRODUCTION
The 1980s witnessed a sea change in economic thought -- and
the beginnings of reform in economic policy -- in countries around the world. In
Central and Eastern Europe, shortages of basic goods and economic stagnation
hammered home the point that socialism was bankrupt. In developing countries in
Africa, Asia and Latin America, policies that echoed socialism -- state
ownership of enterprises, heavy regulation of markets and economic isolationism
-- had strangled growth in dozens of promising economies. But while the
socialist experiment lay in ruins, no one had yet presented a clear blueprint
for market-oriented economic reform.
Peru's Hernando de Soto was one of the first to take up
this challenge. In his landmark 1986 book, The Other Path, Mr. de Soto
identified the barriers to private sector growth that had been invisible to
others. The key barrier, he argued, has long been weak institutions. The
institutions that make markets function efficiently in the developed world --
including contract law, financial markets and respected judicial systems -- are
too often lacking in countries such as Peru. A casual visitor to Lima can attest
to the vibrant markets that exist for local products, but the absence of a solid
institutional framework means that the full potential of the nation's
entrepreneurs goes untapped.
Perhaps the most important -- and least noted -- of these
institutions is property rights. Owners of land, corporate shares and even
intellectual property are loath to invest in the upkeep and improvement of their
property if their rights as owners are insecure. Just as importantly, if
property cannot be bought and sold with the confidence that the authorities will
uphold the transaction, the market itself will fail to generate dynamic growth.
Indeed, the absence of property rights is one factor that drives people out of
formal markets into the informal sector.
The Other Path became an international bestseller, and Mr. de Soto's
ideas changed the terms of debate on economic policy. In 1987, for instance,
CIPE and the US Agency for
International Development sponsored a conference focusing on property rights
as a necessary condition of economic growth, and representatives from groups in
35 countries attended. By the 1990s, his insights had gained broad
acceptance.
Economic Reform Today recently spoke with Mr. de Soto about the
institutions policymakers and business leaders have yet to establish to
guarantee property rights in the world's emerging markets. As the following
interview attests, the labor has just begun.
ERT: When you look at the Western democracies, all of them
have strong systems protecting property rights. Is it important for emerging
democracies to create such systems?
MR. DE SOTO: I think the first thing that is striking about
the Western democracies is that they enjoy property rights. They may have
different land-tenure and property rights systems, but they all have one thing
in common: they protect the right of people to "transact" their
property rights. It is not only important to know that if you are the original
owner of something, you can enforce this right; but also, that if you decide to
sell it, whoever buys it or uses it as collateral for commercial purposes feels
secure about the transaction.
In many developing countries or emerging markets, property
rights do exist. However, they do not have the complementary legal
framework that is present in developed countries and that allows these property
rights to become currency. This legal framework provides a kind of scaffolding
which allows property to move to its highest valued use with a great deal of
security.
In most of the emerging markets from Russia to Latin
America, there are people today who own property that did not before. But the
government machinery -- the executive, legislative and judicial branches -- has
not kept up with building the kind of framework and institutions needed to
protect property rights.
There is the problem of well-meaning groups who claim
property rights do not exist in those countries simply because they aren't there
in legal terms. These groups in countries such as yours, which I'm sure have the
best intentions, wish to protect indigenous property rights. However, they do
not realize that in many cases what they are talking about is protecting or
promoting the sovereignty of a special ethnic group, not property rights. This
results in a needless confrontation between the protection of sovereignty of an
ethnic group and the property rights of individuals within such a group.
In short, the important thing is whether there will be
enough political savvy in emerging markets to create the legal framework that
protects private property rights. These do exist in most countries, though maybe
to a lesser extent in hunter-gatherer societies. So the first step is one of
discovering which property rights exist. The second is to learn from the
evolution of the various models used in the Western world and how organizations
were created so as to best organize and protect these rights legally. Many of
these systems were spontaneously generated over many centuries and have existed
over the last 50 to 200 years.
ERT: How would you describe the relationship of strong
systems of property rights to democratic institutions?
MR. DE SOTO: The relationship between the two is very
strong. Democracy has a lot to do with establishing a good system of property
rights in the sense that it's not really possible to build such a system unless
you know how people think about their relationship to objects, land and assets
at the grassroots level. Only after you do this can you incorporate property
rights into a body of law that is truly effective.
In the United States, for example, throughout the 19th
century and the beginning of the 20th century, there were various mechanisms
that recognized the role of pioneers in staking out land claims even though
initially the country didn't have a legal framework for them. Instead of keeping
with the British tradition which accepted what the king and judge made law, the
US government accepted that people on the ground had their own ways of settling
many property issues and had effectively built local social contracts. As a
result, an effective nationwide property rights system was set up that worked,
but not using the law brought over from England. Instead, it was built on a
system of grassroots democracy and principles of equity that flowed from the
fact that a lot of poor people in the US went out and staked claims which were
basically approved by the majority of the population. That's why they
stuck.
The preemption acts and occupation of lands via adverse
possession were nothing other than the US government (including the legislative
and judicial branches) continually backing away from imported law and
recognizing the emerging rights of squatters in Texas and gold-rush miners in
California, for example. Yet, these new claims had a legitimacy the old laws
didn't have. The preemption acts, in effect, legally recognized that what the
people had created was probably stronger than an old parchment title that had
been in place before. If democracy is government by the people, it means among
other things that people's social conventions are being acknowledged and
protected. It means a country is in touch with evolving conventions, and has
gradually woven these property rights into a more sophisticated and far-reaching
social contract.
That type of democracy doesn't exist in countries like
mine. But what may be more instructive for people from emerging markets is to
look into the history of the US to understand what state of development they are
in, and what democracy means, rather than looking at the US at the end of the
20th century when all the underpinnings for strong property rights and democracy
are already in place but are also, unfortunately, invisible.
As for Latin America, for the last 170 years we've been
trying to become like the Western democracies, and we've been failing for 170
years. We have systems, for example, to elect a political party, bring a
government to power, etc. But our democracies do not have in place mechanisms
similar to the US preemption acts, homesteading and recognition of existing
arrangements among common people regarding land and assets. What we've done
instead is to simply import a legal system that tells us that, regardless of
what the existing local conventions are, property rights are determined by
prefabricated legal structures from alien social contracts that develop from
different realities and contexts.
ERT: Why have past efforts, particularly by international
donor agencies, failed to result in broader ownership of land titles in emerging
democracies? How can you see future efforts generating a better track record in
this regard?
MR. DE SOTO: If you look at the inventory of failures and
successes -- as we've done over the course of several years at ILD, with a lot
of help from CIPE -- there are various reasons why international donor agencies
have failed to promote broader ownership of land titles.
The first problem is that they have failed to realize that
we are not at the same historical point as the US. As a result, when they come
to countries such as Peru, they emphasize the role of time-consuming and
expensive activities, such as photogrammetry, fine maps and electronic
organization of the existing information. All the equipment and detailed maps
are useful, but they do not clarify the actual situation of who owns what
because who owns what and what rights they have to trade it or use it are
basically determined at the grassroots level and not by graphical or
computerized documentation. This information can be determined only by political
and legal means. Only once these are in place can the equipment be put to good
use.
As I said earlier, property is a type of social contract
between people, and it is a very political thing. There are places, for example,
where people really do have a sense of community regarding grasslands to be used
to pasture animals and which can't be parceled off. Other cases may involve
public grounds in towns and cities to which people may have accepted temporary
usage rights. By contrast, most of the projects done by international donor
agencies emphasize the technically-driven aspects of making boundaries more
precise rather than finding out what the existing social contracts regarding
land ownership are. Too many experts forget that before the West had computers
and photogrammetry, people had already agreed on property rights.
A second problem is the tendency of many donor agencies to
work directly with existing property registries which don't reflect what's
actually happening. In Peru, for example, you will find a total mess if you look
only at the registries. Many of the registered titles are not valid because the
country has been titled and re-titled -- with and without foreign assistance --
over forty times. As a result, there are sometimes dozens of titles per parcel
of land, and the question remains, "Which of these titles are the ones that
really count?" This is especially true when someone inadvertently wakes up
a "dormant title," which is what happens when some so-called experts
inadvertently trigger expectations by breathing life into ignored statutes,
which may be perfectly legal on paper, but have been effectively substituted by
much stronger conventions.
In short, property means not simply honoring pieces of
paper just because they exist. First, law changes over time, and the genius in
creating property rights lies in determining the current social contract
regarding rights to a particular asset, then building on that reality. This is
what happened in Japan after the Second World War when the American occupation
forces respected the rights determined at the grassroots level by the Japanese
themselves as the source of law.
In short, the problem with many donor agencies is that they
have missed the point altogether: that property is a living thing, and is
incorporated in social conventions that have a lot to do with democracy. This is
not to say we don't need surveying, mapping and computers that enable us to
process data better. The problem in Latin American countries and the former
Soviet Union, for example, is that the machinery may be in place, but they lack
the mechanisms required to locate, decode and systematize the crucial
information people at the grassroots level have about who owns what and what
their basic rights are. The only good solution is to be able to pick up on what
people have already spontaneously created.
ERT: Would it be possible to repackage the type of work
that different donor groups have done, or is this too complicated a process to
put it on the right track?
MR. DE SOTO: First, as I said before, donors must recognize
that in our countries, aside from the written law, there is often unwritten law
which is much stronger because it is recognized by most of the population. If
the advisors are helping to write new laws, they must make sure these laws
actually reflect what people believe; they must structure the laws on the basis
of the existing social contract so that people obey them and they thus become
enforceable. Otherwise, what you are doing is simply strengthening the paper
rights of those people who have political power or privileged access to the
judicial system versus the rights of those people who actually own the land and
whose ownership is generally respected.
Every time a donor comes in and decides to fight for what's
on paper because that's what he finds when he opens the books, he may be
bringing back to life outdated political charters which, in many of our
countries, no longer reflect who the real owners of land and other assets are.
For example, if the US had sent in a technical mission to Japan after the Second
World War whose only mission was to modernize the system of land record keeping,
surveying and mapping, the end result would have been to reaffirm the rights of
feudal lords over the land when, in fact, during the previous four hundred
years, the real rights over land were held for all practical purposes by small
farmers, although their feudal lords taxed them heavily.
I'm rather pessimistic as to just how much can actually be
done unless donors become fully aware that one of the most marvelous things that
occurred in most of the European countries and the US during the 19th century
was a huge property revolution. What used to be patrimony -- that is, assets
that belonged to only a few families -- was converted into a modern property
rights system where assets became accessible to everyone and easy to
transact.
For the moment, of course, the big issue in most emerging
markets is that the majority of people live, work and use land for which they
have no legal title even though their neighbors recognize it is theirs, and
governments wouldn't even dream of tampering with that land. Without such a
title, however, there is no way to build a system of securitization that gives
them access to credit or water, telephones or electricity. Private companies can
provide these services only as long as the fundamental risks of doing so can be
controlled.
That is the key problem for us today. However, many of the
experts who work with the donor agencies instead transferred to our countries
issues that are not the most important to our countries -- at least not for the
moment. Take the case of intellectual property rights. How can you explain to
someone who has no legal property rights over something as tangible as his home
that he cannot replicate a brand-name watch in his workshop or that if he
creates a song, he has exclusive rights to it and that it can't be duplicated or
plagiarized? Intellectual property rights are crucial, but unless they are
brought about in a context meaningful to the majority, they will be very
difficult to enforce.
So I would recommend that donors accept they may have lots
more to learn about what's happening in our countries at the grassroots level
before some of their assistance may be useful. They also must accept that many
convoluted political processes in Latin America, Asia or the former Soviet Union
occur because some state organizations are way behind the reality at the
grassroots level.
ERT: You have worked for many years trying to make it
easier for informal sector businesses to register their enterprises and become
legitimate. How successful have your efforts been in lifting the standard of
living of people in the informal sector, and what needs to happen to push that
process forward?
MR. DE SOTO: The first thing to remember is that the
projects we did with CIPE had very low budgets if you think in terms of what
other countries have spent and yet have few results to show for them. Second,
these programs were really private ones, and the results have been
impressive.
During President Fujimori's administration, registered
titles to over 300,000 plots of land have been awarded. Production on these
titled properties has risen by about 40% compared to properties which were not
titled and registered. About 25% of the owners now have access to bank credit
since they can use the titles to guarantee their bank loans. Although some of
them had access to credit before from microenterprise organizations and small
banks, most had to rely on loan sharks who charged them extremely high interest
and other charges. Meanwhile, the value of homes in urban areas has increased by
an average of 200% since they were titled and registered three years ago, and
their value will continue growing.
We have brought over 276,000 enterprises from the informal
sector to the formal one. This was done by re-engineering the whole process and
cutting the delays and red tape for entrepreneurs to legally register a business
from about 300 days to less than a day. The weight of the process is now on the
bureaucracy rather than on the business owners. Now that these enterprises are
in the formal sector, the government is collecting hundreds of millions of
dollars more in taxes than before. These enterprises are also employing more
people. Over 500,000 new jobs have been created just with this process because
people now own legal businesses, they can advertise and don't have to pay bribes
for protection.
The land titling and business registration process has been
so successful that the Fujimori government has decided to expand it since it has
helped Peru achieve one of the highest growth rates in the world. These
programs, which were carried out largely in the Lima area, are to be reinforced
and adequately financed so they can cover the whole national territory by the
year 2000 or thereabouts.
ERT: In the last issue of ERT we explored the impact of privatization
in emerging markets and the work that remains to be done. Do you see a way
that stronger property rights and privatizations can be accomplished in tandem?
MR. DE SOTO: I don't see privatization schemes actually
working unless you finally settle the property rights issue. There are several
reasons for that, as the experience of Latin America shows. We began
privatization a long time ago. Even our railroads used to be privately owned by
the British, and we had seven consecutive waves of privatization efforts between
the 1820s and the 1990s. But we always swung back to renationalize the assets
that were privatized.
Today, many people in the region accept, sometimes very
grudgingly, that our governments have to privatize because they are broke and
must reduce the public deficit because it produces unbridled inflation and debt.
But the whole process hurts the people after a while if they don't understand
what's going on. Giving away property to Enron, General Electric, British Gas,
or whatever other company may just look to them like handing over sovereignty or
creating a foreign enclave. For a person to understand that private property is
a good thing and that a foreign company can get rights to it, he must have an
opportunity to get private property as well.
The first thing then is to formalize the social contract at
the grassroots level so that everybody can understand what property rights are
about, and then to understand the distinction between sovereignty and property
rights. Governments have to show that they are not giving up sovereignty, but
only rights to companies to run enterprises and services privately in everyone's
best interest.
The next thing, of course, is to ensure that everyone
benefits from privatization. In other words, if I see a private company coming
in, having access to credit, electricity and clean water while I'm not getting
any, I will resent that situation unless I too have private property that I can
use to get the same things. Once I too have a chance to own private property or
know that I have a possibility of acquiring it, I will not resent privatization
because I'm basically part of the process. We have already seen the connecting
links between property rights programs for the majority and successful private
investment in infrastructure projects whether they be independent power
producers and/or utilities involved in the distribution of energy and water.
In short, I don't think many privatization programs are
durable unless property rights or access to property rights are available to
everyone in countries such as mine. If they are not, there will be nationalist
backlashes, and politicians who depend on the public's vote will be tempted not
to respect privatization contracts they have signed. Unfortunately, there are
many examples from history to buttress my point of view.
ERT: Recognition of collateral is at the root of the
financial system of every country in the West. How do you see better recognition
of property rights in this regard dovetailing with efforts to bolster financial
systems in emerging democracies?
MR. DE SOTO: Clear-cut property rights are indeed essential
since you can only pledge collateral if you own something. If you give somebody
a valid, respected, secure property title, it's really the first step in the
securitization process. Let's take the US as an example. I understand that
asset-based securities account for about $4 trillion of the $13 trillion in its
financial markets. These asset-based securities in the end all rest on mortgages
and the rediscounting of mortgages. There are other mechanisms that make this
whole system more secure, including national mortgage intermediaries like Ginnie
Mae, Fannie Mae, Freddie Mac and others that help create secondary markets. But
what is at the bottom of these mechanisms is the fact that somebody who owns
land or other private property can pledge it as collateral. This engenders a
great deal of the capital markets in the US and even anchors the rest of its
financial system.
By contrast, in countries such as Peru and probably most of
the former Soviet Union, over 70% of the people cannot be linked legally to a
piece of land or real estate. Therefore, the first stages of what you can call
securitization -- turning illiquid assets into liquid ones -- is the process of
formalization, which in turn leads to the creation of collateral essential to
establishing large financial markets.
The US began moving in this direction in the 19th century
by first creating county land registries. It then compensated for deficiencies
in the registers through the creation of title insurance companies and legal
conveyances in titles which guaranteed there were no defects in the title,
thereby making unmarketable property marketable. As a result, in the US today a
house is shelter, land can produce agricultural goods, and a tractor allows its
owner to reap the wealth of the land. But these assets are also capital because
one can use them as collateral to obtain and create capital, and that's because
title to them can be clearly determined. The title reflects a social contract
that is respected by everyone.
While real estate accounts for some 45% of the assets of
families in the US, it represents anywhere from 70% to 80% of the assets of
Peruvians. But since it is not duly securitized in Peru by a good property
formalization system, there is no way a country like Peru can build a mortgage
market or a capital market that will allow it to prosper. This also is the
reason why the country continually has to obtain international financing.
ERT: What can businesses in the US and other Western
countries do to help establish stronger mechanisms for protecting property
rights in emerging democracies?
MR. DE SOTO: There are many Western businesses that have
the know-how to be able to do this. I just don't think they've become aware of
the opportunities in emerging markets, and how to take advantage of them. The
market for their services, however, could be equivalent to over 40% of the GDP
of countries that don't belong to the OECD. These companies could also enjoy
higher profits in emerging markets than those they typically earn in the
industrial nations.
Again, the US is a good example since the consumer credit
revolution and the so-called non-bank banking started there. It began first with
the establishment by the large manufacturers, such as General Electric and
General Motors, of basically their own financial affiliates to extend credit to
cash-poor consumers in order to sell more dishwashers, refrigerators, cars, etc.
These affiliates created mechanisms to collect credit more effectively and also
to securitize it.
More recently, the credit revolution has gotten a major
boost with the establishment of credit-rating systems such as TRW that use
information technology and automated systems to facilitate a person's ability to
obtain financing. Poor people can even go to companies such as The Money Store
to obtain credit, and this credit revolution has now reached the point where
experts such as Robert Litan, now at the US Office of Management and Budget, are
documenting how these new credit organizations are starting to displace the
traditional big banks or forcing them to merge.
All of these kinds of second-tier providers of consumer
credit have developed numerous mechanisms to mobilize the assets of relatively
poor people and bring them into the financial markets. Some of these
institutions also are able to buy small debts, consolidate them and thus convert
them into solid paper that can be traded in the financial markets.
The problem with these consumer credit institutions is that
most of them are not internationally oriented. The traditional bankers also must
reorient their activities not only to serve governments and their usual wealthy
private customers, but also to get to know and service the average consumer, as
they have learned to do so well in the US.
ERT: Do you see a role as well in this process for the
whole title insurance industry and other institutions in the US that are
involved in helping people obtain secure titles to their property?
MR. DE SOTO: Definitely. These kinds of organizations and
the bankers that are familiar with their techniques can indeed play an important
part in emerging economies. One of the reasons is that many of the conditions in
these economies today are more similar to the environment in which these
institutions were born in the US than they think. I don't know of other
organizations which are more aware and have more tools to assist emerging
markets in this effort than those in the US. I would include in this not only
title insurance companies but also mortgage and commercial banks, insurance
companies and other businesses that help build a country's infrastructure.
The challenge they face is not a small one, however. One of
the main reasons is that generally most of these companies have not yet seen the
connecting links between property rights and their businesses nor where the cash
collection points are. Moreover, they tend to be very domestically oriented and
rely on fuzzy criteria for risk analysis in foreign markets and "Power
Purchase Agreements" that are totally oblivious to the necessary
association of their rights to those of the final consumers who, after all, will
always be the primary concern of the governments they contract with.
It also takes time because you must first understand what
formalization is about (converting the informal into the formal. But if these US
industries don't internationalize, other organizations that may not have their
know-how and expertise will move in and take away from them the opportunities
opening up in emerging markets.
Another thing to remember is that the whole US economy
would also benefit if its insurance and credit companies worked in these areas
abroad. They would not only help enormously with what the emerging markets need
to do in terms of property rights, they also would do wonders for US business
working in these markets. Insurance firms -- as well as consumer-credit
organizations -- would be able to make the process of investing and making money
overseas a much more secure and fruitful endeavor than it is today for many
other kinds of US companies, especially in infrastructure.
Reprinted from Economic Reform Today Property
Rights and Democracy
Number 1, 1996
