Delusions of De Soto’s Delusion

John Gravois over at Slate pronounces Hernado de Soto’s ideas a failure in alleviating poverty in the 3rd world. In doing so, Gravois makes what I believe to be a common error among those of the Left: mistaking the formal system for the actual system.

As we learned with “Privatization” and “Deregulation”, even in the 1st world, just because a politician slaps a label on some law doesn’t mean it will actually accomplish what the name implies. Just because a 3rd-world nation passes a law saying that people now have private property, and that specific individuals have title to specific lands, it doesn’t mean that the actual system works that way. If the actual system doesn’t function like something very close to a 1st-world property system then the new laws have failed to establish a working property system.

Of course, one has to be careful not to fall prey to the “the theory is correct, it’s the implementation that is flawed” fallacy advanced so often by communists to explain why real-world communist states failed. In the case of a property system, however, there is a functional threshold that must be passed before it has a hope of generating economic growth and political freedom.

Gravois gives two examples, one in Peru and another in Cambodia. It’s easy to see that neither example shows a working property system.

In the first case, he pronounces the experiment in Peru and similar countries “merely useless” because in the period from 1997-2004 “only” 24 percent of the new property owners received financing, and almost none of that came from private banks. (Of course, this being major media, there are no links to the studies, but I’ll assume they are valid and correctly reported.) Gravois doesn’t say what the loan rate was before, but I am guessing it was significantly lower.

Gravois assumes that the problem in securing private loans comes because the actual property is viewed as worthless. I think the problem is more one of trust in the new title system.

Peru and the other countries mentioned have no track record when it comes to private property. Historically, one’s ability to secure one’s property was based wholly on one’s relationship with the political oligarchs du jour. Peru’s experiment is less than a decade old, and Peru has a poor track record for rule of law. The most likely explanation for the failure of the system so far is that lenders have little confidence in its long-term stability. In the 1st world, loans backed by property are usually long term, running from 5 years up to 30. I doubt lenders in Peru yet have confidence that the property law will remain unchanged 10-30 years out. There is a long track record in Latin America of violent shifts in law based on revolution or even elections. A lender may have every expectation that if a left-of-center government comes to power it will find its liens on mortgaged property to be worthless.

The only cure for this problem is time. The system must be demonstrated to work, and to remain in place between shifts in the political philosophy of the government, before it will begin to function as the capital generator that de Soto envisions.

In the second case, Cambodia, which Gravois describes as “downright harmful,” rich oligarchs chased poor people, who would have acquired title to the property they lived on, off of their land before the property transition could occur. So when the transition occurred the oligarchs got title to the land. This of course has nothing to do with the actual property system and everything to do with corrupt government. Gravois seems to assume it is better to have a corrupt government and no private property than it is to have corrupt government with private property. I don’t think that is the case. I think the real problem is corrupt government.

Even given these short-term abuses, if Cambodia can actually create a functioning property system, the short-term suffering of the squatters will pay off in the long term, just as the suffering caused by England’s Enclosure Acts eventually benefited everybody. The Acts caused a consolidation of farm lands at first but a gradual distribution of land later. In the meantime, they led to a vast increase in agricultural efficiency and cheaper and better food for all.

In sum, it doesn’t matter that we call a reformed property system unless it really acts as a property system. In some places, de Soto’s ideas will provide a smoke screen for scams to enrich the politically connected just like “privatization” did elsewhere. In other places, the reforms are sincere and practical but will need time to alter people’s economic behavior.

(Update: Kerry Howley over at Reason’s Hit and Run comments on the same article and points to some interesting research from Peru on unexpected benefits of property titles.)

4 thoughts on “Delusions of De Soto’s Delusion”

  1. This criticism of de Soto is ironic, since one of the points that he has emphasized about LA countries is the difference between the ostensible regulatory regime, which is well ordered, and the regulatory reality, which is a bureaucratic morass — against which the informal sector appears attractive despite its severe limitations.

  2. It is a nice try, but the posting lacks a sense of reality. Latin America has been providing loans for more than ten years without property backup. Peru is one of the greatest examples of the success of Micro Finance and its impact not only on “commercial financial institutions”, but on the overall economic development of the region. The prospects for Micro Finance Institutions to surpass and outlive their commercial cousins is not only an idea it is a reality. All this energy is fueled by the concept described by De Soto, the informal markets that exist in a parallel economic system, and today as never before access to credit is not anymore linked only to private property. It is connected to credit history and local reputation!

  3. Latinophilus,

    MicroFinance uses social networks to secure the loans. This system has some limiting factors:

    First, the loan are “micro.” The nature of security means that the loan cannot be larger than the network can absorb if it fails. This limits the size the loans can be.

    Two, the enterprises funded tend to be conservative in nature, providing capital for proven ventures. They mostly benefit people who did not have any access to capital in the past due to social and political factors. Micro loans don’t go for swing for the fences experimental ventures.

    Japan has traditionally used a form of social network security for individual and small business loans. The result has been a very conservative and restricted market for capital for all the small players.

    MicroFinance is a great way to start infusing capital into parts of the world that have a weak property system but I don’t think it can do the heavy lifting of capitalism.

  4. That comment you just made over at Reason H&R (about Parisians reversing their positions on our girth measurements) just about makes you my hero.

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