The Mystery of Capitalism

Why Capitalism triumphs in the West and fails everywhere else

We don’t know how good we have it living in America until we get a glimpse into the developing world’s perspective. My wife constantly reminds me that I’m naïve – not because I’m her husband - but because I’m American-born. As a South African immigrant, she’s seen the unraveling of a third world country and has an outsiders perspective on Americans who take their economic and social status for granted. Her father had built up a sizable company in South Africa, taken it public, and then watched as the country cannibalized itself into a place of corruption and dismemberment. It cratered his company and the country at large. This had me wondering what holds America, and other westernized countries, together in the capitalist construct.

In 2000, Hernando De Soto published The Mystery of Capitalism to explore how the western world properly upholds and creates a thriving capitalist environment and why the rest of the world struggles with the elusiveness of capitalism.  Even for those countries that evolved from communism to capitalism, or have always had some form of hybrid capitalism, they’ve never fully crossed the chasm toward a truly mature and safe haven for capitalist endeavors. Why?

De Soto explains that successful capitalism is a construct held firmly together through a well-established and enforced legal system that recognizes property rights of ownership and accountability. While many nations hold tremendous amounts of assets, they are often times unaccounted and unrecorded, and therefore invisible - denoted in an ‘extralegal’ system. There is something distinctly different between an asset held in a capitalist society and therefore represented as ‘capital’ and an asset held outside of a capitalist system. For example, an oil well in Alaska owned by a corporation and an oil well in Venezuela (owned but undocumented by an individual) producing the same amount of oil might be seen as equal assets but only one of them is seen as capital, representing huge potential.  De Soto argues that in many developing countries, the intent to record ownership is there, but the means to do so discourages market participants from legally recording. Whether the costs of incorporation are too high or the process too burdensome, market participants forego the traditional means of ownership documentation and continue in the underground, under-capitalized form of entrepreneurship. These developing nations have a wealth of production, entrepreneurialism and capability but it’s their lack of legal harnessing that holds them back from peak production and greater capital formation.

While this was written 20 years ago, I’d imagine a lot of this still holds true in many places but De Soto hired a team of researchers to go through the processes to obtain legal business approvals in a few countries. It took 3.3 years to legally convert informal urban property to legal tender in the Philippines. It took 77 steps, 31 entities and roughly 6-10 years to get legal approval to build and access desert land in Egypt. It took 111 steps and 4,112 days to obtain a sales license in Haiti after agreeing to a five year lease contract. These are the types of restraints people face in the developing world to legally oblige. This is why so many people decide to forego the legal labyrinth and participate in the developing economic game through the undocumented path.

It’s interesting to read this right now because we’re in the middle of a great rethinking around ownership. With the emergence of NFTs and the extreme speculation around new stores of value, the notion of ownership has been thrust into the spotlight. The immutability of ownership is fundamental to capitalism. We know this to be true when we buy a home and record a deed and we are reminded of this with the unique ownership of a hash-tagged transaction on a blockchain. This concept however is elusive to many developing nations where ownership is considered questionable.

Would you buy a home if anyone could just lay claim to your property? Would you hold title if it was unenforceable and the centralized legal authorities were not willing to uphold your right of ownership? The answer is NO and that is where the developing world stands today. In developing countries, many assets are left legally unprotected and therefore unable to be held as collateral. If it can’t be held as collateral than you can’t borrow against it. Therefore these assets are left stuck, unproductive and barred from becoming CAPITAL. In these developing countries there is no central recording system of ownership, but rather hundreds or thousands of factions who record ownership. Perhaps that is the blockchain’s promising next act - to help developing countries take their numerous distributed ownership ledgers and record them all on the same blockchain.

In order for the blockchain to be successful for property ownership however, we’ll need to see a huge effort to backfill data. While this might be a consultants’ wet dream to take on this data entry project, finding the disparate records of ownership, upholding them as valid and discernible without disagreement is a tremendous lift and will undoubtedly call into question the very concern around ownership. If a country moves toward a blockchain or a decentralized ledger, what will happen if there is a dispute over ownership lineage? How does one go back and adjust for that error? We can’t just fork a blockchain every time there is a disagreement can we? For this reason, I’m not certain the blockchain solves all of the problems for the developing world as the problem remains in behavior and lack of property rights enforcement once again.

After reading the book, I was left with one sizable takeaway that explained the history of America dating back to the late 1600s and early 1700s when British migrants colonized American land and took up the homestead act. When the majority of the economy is operating extralegally (outside of the formal legal system) then the best thing for a central government to do is to absorb those social contracts and work to embrace the legal systems created outside of the formal system - not oppose them or villainize them. A developing government should embrace and a cooperate with the informal system because that is the first step toward the capitalist transition.