Friday at the Mercatus Chief of Staff Retreat, Hernando DeSoto spoke on the work that they are doing in Egypt. Hernando DeSoto founded the Institute for Liberty and Democracy in Peru, successfully fighting the Maoist Shining Path guerillas in Peru. DeSoto laid out the economic and philosophical argument for why law, liberty and democracy are fundamental foundations of development in The Other Path. His most recent book, The Mystery of Capital, delves into the consequences of the lack of legal ownership and property rights in poor societies.
DeSoto and ILD have been working in Egypt for 4 years, mapping out how much of the asset base in Egypt is actually “owned” and operates beyond the confines of existing law, and how much economic activity takes place in an underground economy. They have found that 92 percent of Egypt’s asset base is in the hands of Egypt’s working poor, and that ownership of these assets is not supported or enforced by Egypt’s legal system. DeSoto and the ILD have been working to persuade the Egyptian government that bringing law and property rights to the Egyptian people will not only create an environment in which they can be economically productive, it will also be a good political move to be the government that empowers such a large percentage of the voting population.
This was the first time I have heard DeSoto speak, and he truly is inspiring. He is able to move from the specific features of Peru or Egypt to the general benefits that accumulate when societies have the legal institutions that support the move from personal to impersonal exchange. Trust is an important precursor to exchange, and institutions that enable trust among strangers and thus facilitate exchange are important precursors to economic growth. Another aspect of trust is the longevity of the business. To paraphrase from DeSoto’s remarks, in poor societies you worry more about whether the businessman is going to have a heart attack, because the legal institutions do not exist that support the longevity of his business beyond his life. This lack of longevity shortens timeframes, meaning few or no long-term contracts and diminished investment.
Another interesting point that he made is that in economically vibrant countries like the US, most small business is initially funded by mortgages and second mortgages on homes. The ability to borrow against your home is not available in many poor countries because of the lack of legal ownership. As he put it, in the US your home can do many things for you simultaneously. In poor countries, it does one thing: provides a roof over your head.
And as DeSoto said, these legal and economic institutions are more important than roads or ports, so if we really want to help the poor in developing countries, we should focus on institutions that create business longevity, facilitate impersonal exchange across larger markets, and enable people to borrow against their assets.