But What About the Poor?

Exclusive to STR

March 9, 2007

Eighty percent of humanity is living in squalor. Why?

The Peruvian economist Hernando de Soto asked and answered that in his 2000 book, The Mystery of Capital"--well worth reading, and the subject of a 2004 STR article here. His analysis of the cause of these anomalies is stimulating; in my view his prescription for a fix, less so.

De Soto discovered everywhere he went that poor people are industrious and entrepreneurial, seeking trade wherever it can be found--and saw no evidence that they are poor by choice or indolence. Instead, he identifies two causes of abject Third World poverty:

• ' * Governments make it difficult and expensive for them to join the community of "legitimate" businesses, which are able to raise capital by issuing shares and selling bonds; hence, expansion is hobbled.
• ' * Governments make it difficult and expensive to obtain clear and well-documented title to assets, notably houses, which might be used as collateral for business expansion loans.

He and his team of economists did their research the right way: they went where the poor live, in a range of countries from Russia to Egypt to Haiti to the Philippines to South America , and found out what was actually happening. His report of the anomalies is colorful. In the Philippines, he found that legally to own a house built on public lands would take 168 steps with 53 agencies over 13 to 25 years--and to do the same in Cairo, Egypt would take 77 steps through 31 agencies over 5 to 14 years . . . etc., etc. ad nauseum.

Large-scale investors building plants in developing countries like China will echo de Soto 's concern about property rights--they need to be sure that profits will be returned intact. His point here is, however, a bit different--the need is considered from the viewpoint of the borrowers, and millions of small ones at that. Is he right? I'm not sure. Of course, it's always desirable to know whether or not you own your own home--but why for the specific purpose of securing a loan? He argues that if you add up the value of 1.5 billion lean-to shacks worldwide, you get collateral for $9 trillion to fund the termination of world poverty. And yes, you would, assuming it all stays in the control of the small-business entrepreneurs. But that also assumes they would all put their homes at risk so as to expand their workshops and fresh fruit stands. Would they? Would you? Why not use other sources of expansion capital such as just plowing back what's been saved out of profits, and leave the family home unexposed to business risk?

Further, assuming that investors have $9 trillion ready and waiting for good opportunities, would they not be just as happy to lend it on the basis of the merit and promise of each of the business ventures themselves? Secured, then, by properly recorded bonds or ownership shares? Whether the capital comes from outside or from the owner himself by plowback, the first of the two factors above becomes the main one to address, not the second; the investor needs to be sure the business can continue to function and grow without interference by government meddlers.

De Soto asks rhetorically how much of his huge wealth Bill Gates would have amassed if he'd been unable to patent his software innovations, enforce his long-term development contracts, take risks without insurance and limited liability, store accumulated capital without unambiguous property records, pool resources without fungible property representations and make other millionaires without recorded stock holdings. Not much, perhaps. But did you notice the unstated premise? That those desirable things must be provided by government. Oops!

De Soto's whole emphasis, throughout the book, is to set out to reform governments so that they provide the services of asset and business registrations much more cheaply than now and with far less red tape. He seems to assume that the massively expensive tangle of obstacles got there by some form of accident or oversight or at worst by bad management, and displays no understanding that the erection of artificial restraint on trade competition is exactly what governments are bound to do, by their very nature--it's what they have normally done, throughout history. Now and again, it's true, a government may be reformed or reduced so as to remove impediments to business growth (examples: 19th Century America and Britain, 20th Century Hong Kong), and with spectacular results; but such reform is likely to be short-lived. Every year in America , as we all know, bureaucracy increases again towards the choking point, and in most states, over 150 professions are subject to government licensure, with deadening--and intended--effect on low-price competition from new entrants. As proof, I offer the US health care industry.

So it follows that while clear title to homes is "good" and may help finance growth, its absence is not a crushing impediment to upward social mobility in the Third World . The main one, as above, is the existence of laws to keep businesses "illegitimate" so that they stay inconspicuously small, for fear that visibility will attract thieving, meddlesome bureau-rats like bugs to a lamp.

Government barriers to trade are deliberate and endemic; they are elected by the well-connected precisely so as to protect their several interests from low-price entrants. When Chavez of Venezuela nationalizes the highlands of that country's economy, he's not doing it to champion the poor, as advertised. He's doing it to favor his wealthy friends so that they will in the future face no competition. The result in due course will be more poverty in the very working class he is so skillfully fooling.

De Soto argues that membership in the "black" market has its costs (e.g., bribery of government officials, usurious rates paid to loan sharks), which compare to the taxes levied on legitimized businesses, and so most black-marketeers would prefer to go legit even at the cost of paying those taxes. Well, maybe. But how very much more attractive yet it would be if "going legit" did not involve paying taxes at all--because the prime culprit, government, had been very properly removed.

It's a particularly cruel myth that governments exist to help the poor, when in reality they exist to protect rich clients from the poor. But it has always been so, and widespread poverty will continue until the myth is exposed. What a shame that this somewhat free-market economist stopped short; that, having seen much of the cause of poverty, he wants to make that government-myth work, instead of ripping it to shreds. Such is the major difference between conservatives and market anarchists.