Book Review
The Mystery of Capital: Why Capitalism Triumphs in the West and Fails Everywhere Else by Hernando De Soto
Property rights and property registration systems are key components of properly functioning capitalist systems, at least according to Peruvian economist Hernando de Soto’s 2000 book “The Mystery of Capital.” The book addresses the issue of why Western economies have better-functioning capital systems than the economies of the post-Soviet sphere and developing world. Early in the book de Soto clearly proffers his opinion, saying of the peoples of these post-Soviet spheres and developing world economies and their property:
But they hold these resources in defective forms: houses built on land whose ownership rights are not adequately recorded, unincorporated businesses with undefined liability, and industries located where financiers and investors cannot see them. Because the rights to these possessions are not adequately documented, these assets cannot readily be turned into capital, cannot be traded outside of narrow local circles where people know and trust each other, cannot be used as collateral for a loan, and cannot be used as a share against an investment.
He immediately goes on to juxtapose the legal-financial systems of the developing world with those of the West:
In the West, by contrast, every parcel of land, every building, every piece of equipment, or store of inventories is represented in a property document that is the visible sign of a vast hidden process that connects all these assets to the rest of the economy.
The Mystery of Capital then is implicitly about the legal structures that enable capitalist economic life to flourish. In examining these structures, de Soto focuses on the “five mysteries of capital.” These mysteries are: (1) the mystery of missing information; (2) the mystery of capital; (3) the mystery of political awareness; (4) the missing lessons of US history; and (5) the mystery of legal failure: why property law does not work outside of the West.
On a personal level, I found this book to be very interesting because it hints at some issues that I’m interested in, particularly secured transactions and bankruptcy. A secured transaction in a business deal is where a borrower guarantees the payment of a loan by giving a security interest in property. A security interest is just the ability to claim ownership of the property in the event of a default on the loan or other triggering event. Bankruptcy is the legal process of giving debtors relief in the event that they are unable to pay their debts. To some degree, de Soto is arguing for the implementation of laws that will enable secured transactions and bankruptcy. Though the explicit argument addresses the need to formalize de facto property ownership through systems like business and property registries and to encourage incorporation, what de Soto wants is for the peoples of developing economies to be able to use that now formalized property as collateral in other business transactions. These other business transactions would necessarily be secured transactions.
However, property and business formalization and secured transactions are only part of the equation. Effective bankruptcy law ensures that entrepreneurs and others are not permanently held down by bad business decisions and unfortunate circumstances. American-style bankruptcy law that views bankruptcy as a process for managing creditor-debtor relations and working toward recouping as much value for the creditor as possible, as opposed to treating the debtor as a criminal is a significant advantage over systems that treat insolvent debtors otherwise. Of course, American law does seek to prosecute cases of fraud or other criminal conduct that is tied to insolvency. Yet, because criminality is not assumed with American bankruptcy, but rather treated as a process for managing a contentious economic dispute, Americans are better able to quickly iterate economically. This system forces creditors to lend in ways that take potential debtor insolvency into account in terms of an economic equation. This means that creditors may charge higher interest rates overall or for debtors who meet specific criteria. It is my belief that many countries can benefit from American-style bankruptcy law that allows for the swift discharge of consumer or corporate debts, as well as both financial reorganization or asset liquidation, as opposed to systems such as Ireland’s that do not allow for swift discharge of consumer debt, or a complete lack of consumer bankruptcy law, as was the case in Italy prior to 2022.
Fundamentally, much of what de Soto is advocating for is clear and effective legal systems that make property legible and usable in financial transactions. However, thinking beyond these basics to more complex transactions enables countries to improve their economic outcomes. There is evidence that bankruptcy law has an impact on angel investing, which is something that policymakers should take into account when drafting legislation, as quantity and quality of risk capital investments will have a real impact on the health of an economy. “The Mystery of Capital” does a great job of providing a framework for thinking about why developing world economies lagged behind those of the West. I think that this book is a necessary read for policymakers in the developing world, though at nearly 25 years old, the lessons within are necessary for developing countries to compete in today’s global economy, they are not sufficient to compete well.
