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Wednesday, May 25, 2011

Must a Formal Legal System Come Before Prosperity?

Capital Letters

It was disheartening to read John Stossel’s uncritical endorsement of Hernando de Soto’s diagnosis of the causes of poverty in Third World nations as their lack of street addresses and legal titles to property (“Why Do the Poor Stay Poor?,” March 2011). The error of these claims in De Soto’s The Mystery of Capital (2000) has been pointed out by several authors. . . .

First, people who have property that would qualify for a street address, if such address system existed, . . . are not among the poor. Second, in the same Third World country, there are rich as well as poor people. The lack of a street address thus cannot explain why the poor are poor. Third, in the formal and informal sectors of Third World countries, people acquire loans all the time without the presentation of government certified titles to property. Indeed, de Soto himself describes the vibrancy of economic activity in Brazilian favelas where, for example, “street cottage industries have sprung up . . . manufacturing anything from clothing and footwear to imitation Cartier watches and Vuitton Bags.” Fourth, Stossel buys into de Soto’s mistaken view of lawlessness in most of the Third World: “They need the rule of law. But many places in the developing world barely have law.” But de Soto contradicts himself on that claim, too: “[A]sset owners in the extralegal sector are . . . relatively well organized [and] ‘law-abiding,’ although the laws they abide by are not the government’s.” Furthermore, people “in the undercapitalized sector do have . . . strong, clear, and detailed understandings among themselves of who owns what.” (For more on de Soto’s self-contradictory claims, see “Mystifying the Concept of Capital: Hernando de Soto’s Misdiagnosis of the Hindrance to Economic Development in the Third World,” Independent Review, Summer 2008.) In fact, only in the most chaotic countries or failed states are crimes against private property not punished by law.

De Soto’s claims have fascinated some in the libertarian community who find someone, originally from a Third World country, Peru (but who did not grow up there), arguing that adopting capitalism and the rule of law would eliminate poverty around the world, to be a useful ally. But de Soto has an incorrect understanding of the economic history of the more developed countries, including such recent ones as South Korea and Hong Kong, as well as of the hindrance to economic development in the less-developed countries. He does not recognize that economic development or the growth of wealth preceded the development of legal titles to property in the now-developed countries. Thus he seeks to reverse the order of causality: Institute legal titles to property and economic development will follow! He also does not recognize that savings constitute the “capital” that may be borrowed with or without the presentation of legal titles to property. Titles to property may qualify someone for a loan, but without savings in the community, there would be nothing to lend. Indeed, de Soto believes that knowledge of the source of “capital” for economic development is a “mystery” for people in both the more-developed and less-developed countries. But Adam Smith explains that in the Wealth of Nations (1776), which de Soto fails to recognize.

Stossel would do better to point his readers to Adam Smith’s explanation of the institutions and policies that promote the creation of wealth among nations than to endorse de Soto’s mistaken and frequently self-contradictory views about the hindrance to economic development in the Third World.

—James C. W. Ahiakpor
Department of Economics
California State University, East Bay
[email protected]