While flying to Houston for my sister’s wedding, I read Hernando de Soto’s brilliant The Mystery of Capital: Why Capitalism Thrives in the West and Fails Everywhere Else. It may sound strange, but this was a fascinating book on poverty economics and property law. Rudy C. recommended it, and it was worth the read.

De Soto’s argument is fairly easy to summarize, so I may be able to save you the read, but it’s also quite captivating, so I’m glad I read it for myself (though Rudy C. had already told me the gist of it). Here’s my take:

Capitalism allows the creation of wealth because people can use their assets (such as land and savings) to generate more income. If you have a condo, you can rent it out. If you have cash, you can invest it. Most people understand this benefit of assets. But there is a second, equally important function of assets: The ability to use property as collateral for loans, especially to start small businesses.

The global poor own a ton of property - more than twice the total amount of cash in the USA. The rub, in third-world countries, is that they do not have legal title to their land and buildings. Most of the houses they live in is built “extralegally,” that is, without going through the proper government channels. Technically, they are squatters.

Typically, middle- and upper-class Americans don’t have much respect for extralegal property arrangments, which could also be called illegal. However, the the third-world poor aren’t avoiding the proper legal steps intentionally. De Soto says that the laws in these countries are so convoluted and difficult to follow that the poor are forced into extralegal arrangements. These arrangements are recognized locally, by neighbors and in many cases local governments, and they work for the vast majority of the poor.

The problem, of course, is that if you don’t have legal title to your land, you can’t use it as collateral, and you can’t sell it. You are forced to either live there or give it up. No one is going to buy your land from you if you can’t prove that you own it. This is why “dirt farmers” are left with smaller and smaller plots each generation: the family land isn’t legally owned (even though it may have been held for generations), and it gets divided among all the heirs. None of them can prove that they own it, so they can’t sell their shares to each other to maintain reasonably sized farms.

This also creates a situation in which more than one party can claim ownership of the same land. If a conflict arises over the use of the land, the poor almost always lose, because it is the wealthy - who can hire lawyers and push for legislation favorable to themselves - who legally own the property, even if they’ve never lived on it.

So why don’t the poor just take the proper steps to gain legal title to the land? Are they too lazy? Too stupid? No. They are intelligent, industrious, and creative, but the procedures to obtain legal title are nothing short of absurd. It takes, for example, an average of 19 years to legally purchase a home in the Philippines. Getting permission to build on government-owned land in Haiti requires 5 processes, the first of which has 207 steps with something like 31 different agencies. It takes over a year of full-time work just to fill out the paperwork and go through the bureaucratic steps. No wonder the poor can’t operate under the law.

It is equally difficult to start a legal business, so most of the micro-businesses operate without government registration. As a result, they spend a lot of money on bribes to get local officials to look the other way, and they can’t use normal supply chains or channels of distribution. Black markets become the norm - think of post-communist Russia.

The difference in the West is that a single, unified property law system emerged over time. It was not a quick process, though; claim jumpers in the California gold rush and homesteaders in the westward expansion of the US had to fight every step of the way to gain legal title to land. The US has gone through all of the property problems being experienced today in the third world. For example, de Soto says that Kentucky had once granted land titles totalling three times the amount of land that actually existed. Conflicts between absentee landownders and squatters/settlers were inevitable. Ultimately, the settlers won, mostly because the government came to recognize the local arrangements that the settlers had worked out.

One key difference, though, is that the US had much smaller numbers of people to deal with. Mexico City today has more people than the US did in the early 1800’s. The bureaucracies in third-world countries are so backlogged that paperwork takes forever to process.

De Soto says third-world governments must do the same today: Find out what arrangements people are using, and make them legal. Do away with the 700-step processes to gain legal title to property. Make it realistically possible for the poor to obey the law. The problem is that Westerners have no idea how their property law system emerged; it has been forgotten and taken for granted. That’s why de Soto’s work is so important.

It’s rare to find a book on economics that is as captivating as The Mystery of Capital. De Soto is a Peruvian economist and consults with third-world governments to help them work out their property systems in ways that are fair to the poor. In sharing his work through this book, he presents a solution to the problems of global property, while explaining with great clarity “why capitalism thrives in the west and fails everywhere else.”