September 2001

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Explaining the Mystery of Capital

by Hernando de Soto

Those of us who founded the Instituto Libertad y Democracia or Institute for Liberty and Democracy (ILD), the “think tank” of which I am now president, came from Europe. We were Peruvians who had lived away from Peru for a long time following the installation of a military dictatorship, which lasted until 1980. We returned to start new businesses in Peru. Our European backgrounds, together with our long absence from home, allowed us to compare Peru with what we had seen outside.

Recognizing the informal sector

I was used to running businesses in Europe, and I soon realized that I had never spent so much time with lawyers as I did in Lima. That was one, first conclusion. Then, as I installed myself in Peru and started building a house and tried to organize my personal life, I found I was continually dealing with people in the informal sector, in the black market. Then I started noticing them all over the streets, and I started noticing their houses surrounding the city, and I said, “My God, what an enormous amount of marginality.” The question then was, is there a relationship between the law and marginality?

As businessmen, we tried to find out if anyone had written about this. We hired about five researchers and went through the whole nation, and inquired abroad to find out if there was an article, a thesis, an essay, somebody who may have determined the relationship between one and the other, but we weren’t able to find anything. So we said, “Now here is an opportunity. Nobody has seen this relationship between law and the marginal sector; there has to be something worthwhile investigating there.” We went on to found the Institute around that issue—the impact of law on the workings of the economy. It was an easy topic to investigate in Peru; a great many of the country’s homes have been built outside of the legal system. The task was to quantify them, which we did.

We had a very big impact in Peruvian and Latin American society when we documented the size of the sector, which permeated everything from transport to labour. After one or two years we noticed that while everybody said how tremendous our work was, nobody did anything about it. So we became more involved and started drafting legislation to try to correct the errors we thought were inherent in existing legislation. Everybody agreed. The polls indicated that over 80—sometimes 90—percent of the people actually found our legislation and initiatives interesting. Then we started learning how to lobby. We got these changes through Congress, but then nobody implemented them. So we started learning to implement and run projects.

Under contract to the government, we began trying to modernize the economy and make the system accessible to the marginalized people, those who did not work within the law, those who lived and worked in what we call the “extralegal” sector, that is, people who have enterprises, own assets, homes and cars, but who do not own them in a sufficiently valid legal form so that those assets can perform other functions that we call capital. For example, these people’s assets can’t be used as collateral. They can’t be burdened with a mortgage. These people’s companies cannot issue shares and therefore cannot welcome investment. These people’s addresses are unofficial, so you cannot really check up on them if you’re going to do collections, nor are they sufficient to warrant the investment of private energy or water to service them. That, to us, was the sector where houses or cars only had a physical life, not a financial or investment life. Using Adam Smith’s phrase, we call that “dead capital,” in other words, non-live capital. To change this situation, we needed to change the law.

Measuring the informal sector

Gradually, as time passed and we started getting into trouble with Peru’s past President Fujimori and we were actually forbidden from working inside the country, other heads of state started calling us, saying, “We hear you’re doing something interesting. Why don’t you come and visit us?” That was in 1996, and we started going abroad. It was a very enlightening stage for us; we started discovering that many phenomena we thought were Peruvian were virtually universal. We were on our way to developing a theory, which is what The Mystery of Capital is about.

One of the first requests we had was from the Government of Egypt. They said, “Come to Egypt. We would like to hear about what you did in Peru because it sounds similar to problems we have in Egypt.” By that time we were organized, we had a work plan, and we said, “We know what will happen. We will come and talk about what happened in Peru, and you’re going to say, ‘You poor Peruvians. It’s not exactly that way in Egypt.’ So what we’re going to do, on the contrary, is propose that we pay half of the study. We will put up $150,000 or whatever it takes, and you can put up the other $150,000. We will send Peruvians over to you, we will hire Egyptians, and after one year we will present you with a progress report on your black economy, on your extralegal sector. That way, we will be talking about reality, and by the end we will be talking about something you understand, and we ourselves will begin to understand a little bit more.”

So it was agreed, and by about 1997, 6 Peruvians and 30 Egyptians had the study ready. We had four volumes for the government and one page for the president and his cabinet (presidents and ministers are busy people). That one page had four pictures on it, which I will go through with you because I think they will put many concepts into a few words.

The first picture is a coloured map of Cairo. Of course the president and his cabinet recognized it immediately, but didn’t recognize the colours. “The 9 colours are codes,” we explained, “and they represent the different ways Egyptians hold their assets extralegally, outside the law. We can tell you about the enterprises and the businesses, but it might be hard for you to believe us because businesses are inside the buildings. But a building, the real estate, is something we can illustrate, because you see them as you criss-cross Alexandria or Aswan. Those colour codes correspond to 9 types of buildings that you have all throughout Egypt. Let us start with the first one. Those are buildings that are being built on agricultural land.”

The Egyptian government officials said that it was terrible to build on agricultural land because Egypt has only one river; agricultural land is scarce and that’s why it’s not only illegal to build on agricultural land, it’s anti-constitutional. “We know,” we said, “this is terrible. But we have finished counting the buildings on agricultural land and there are some 4.7 million of them.”

We went down the list and got to the middle—public housing. One of the government officials said, “Now, you can’t say that public housing is extralegal. We built public housing.” We said, “Yes, but do you remember in this precise street, that when you built them, those building were two stories high? Why are they six stories high today?”

The reply, was that in some cases the entrepreneurs who occupied the first two stories then built the next four stories and found that it was such a good business that they moved to other public buildings and so started circulating throughout Egypt, adding on to public buildings. In most cases, however, the procedures for getting official authorization to build were so formidable that people chose to build without authorization. Therefore, if you look at the records of the Egyptian real estate system now, you can’t know what’s where. You can see where the buildings are, but you don’t know who owns what.

All of those buildings together, we Peru-vians found out, had a very large value—US$241 billion, to be exact—when you add the value of each brick, blob of cement, and piece of iron at constant prices (the prices that you pay to purchase them). Those who live in extralegal buildings in Egypt make up 92 percent of the urban population and 83 percent of the rural population. In business, 88 percent of Egyptian entrepreneurs work extralegally. What government officials see—and this is very important when they look at this—is that the major part of their constituency is extralegal.

The question then comes to mind, how much is US$241 billion? Well US$241 billion in Egypt is 30 times the size of the Cairo Stock Exchange. Or 55 times the amount of all foreign investment in Egypt over the last 200 years—including the Aswan Dam and the Suez Canal. Or 116 times the value of all privatization.

The next question is, are the poor a problem or a solution? The reply, of course, is that the poor are a solution. They form a large entrepreneurial force, but it is a force that can’t leverage. None of the assets that it has been capable of building all by itself since the Second World War can be leveraged.

And that is the situation in all of the developing countries we have been in, and in the former communist nations. There’s no lack of entrepreneurship. There’s no lack of the will to build assets. There just isn’t the legal system that will allow these assets to be lever-aged the way you can in the West, and that is the key to a capitalist system.

The inadequate legal system

But back to our story. One of the government officials asked us, “Why don’t we Egyptians like the legal sector? Is this dislike cultural?” We said, “Sir, that’s a myth. Consider someone who wants to build a house on a vacant sand dune. What does he have to do if he goes to government to get authorization to build? We have done the research. He will have to visit 31 government agencies and carry out 77 bureaucratic procedures there, and it will take him up to 17 years to do so.”

So before we come to the conclusion that culture is what separates the third from the first world, let’s take the laws out of the equation. Laws determine the costs of entry. But laws, or their absence, also affect the costs of remaining formal, and the transactions costs of operating within the formal sector. Behind this is not only the argument that the law gets in the way, but the argument that a certain type of law is not in place.

The fact that certain laws are not in place means that you don’t have ownership to things. This not only means that people can’t certify that you’re the legal owner, and identify you as such, but actually means that the capitalist system can’t work. Let me explain.

You may have seen that I arrived with an apple at the podium. I hope you realize that it is my apple. I’m sure you are willing to acknowledge that it is my apple. So it is my apple. But if you look at the apple there is nothing in the apple that says it’s mine, which means that the sense of ownership or property is not physical, it is not contained within the apple. It is something that all of us think about, and if we all agree simultaneously about the same thing, then this is my apple.

What is interesting is that wherever you go in the world, from Switzerland to the most underdeveloped tribe, things are owned by people. The difference among societies is apparent in this apple and its ownership: all those aspects about the apple, all those things that are not physical but allow you to determine who owns what, who can pledge what, who can rent what, who can give something of value as collateral, who can transfer something, who can actually use it against an investment, all of those things which you can’t say by looking at the apple, all of that is organized on a piece of paper called the property title, in the case of Western countries. You might be able to find out one or two of these things by asking the neighbour, in the case of non-Western countries.

The fact that certain laws are not in place means that you don’t have ownership to things. This not only means that people can’t certify that you’re the legal owner, and identify you as such, but actually means that the capitalist system can’t work. Let me explain. You may have seen that I arrived with an apple at the podium. I hope you realize that it is my apple. I’m sure you are willing to acknowledge that it is my apple. So it is my apple. But if you look at the apple there is nothing in the apple that says it’s mine, which means that the sense of ownership or property is not physical, it is not contained within the apple. It is something that all of us think The facts that I have given you about Egypt are pertinent to about 80 or 90 percent of the people from my part of the world—the Third World—which together with the former communist countries constitutes 5 billion people out of the 6 billion in the world. (The other one billion are you North Americans, the Western Europeans, Japan, and the four tigers.) We in the Third World do not have the pieces of paper and the rule of law that tell us the things not of but about the apples—the assets we have around us—that allow us to create a widespread capitalist system. In other words, the system of laws that you have created regarding property actually goes way beyond ownership. They actually fix a parallel life where surplus value is collected, where the commercial life—the economic life—of things is determined and organized. It is what Bertrand Russell would have called “knowledge by description” as opposed to “knowledge by acquaintance.”

Knowledge by acquaintance is holding the apple. Knowledge by description is being able to read all about the apple, to know all those things which are not in the apple, and therefore allow me to trade apples around the globe without personally having to know the person who owns the apple because the paper (or the computers) tell me.

Knowledge by description

Written representations connect one thing to another. For example, when I arrived at Canadian immigration, I didn’t need to say, “I’m Hernando de Soto. I was born in Arequipa, Peru. This is my background. I don’t have a criminal record. I do this…” The immigration officer merely asked for my passport— an example of knowledge by description. My identity is no longer in my physical person; my identity is captured in a document that is uniform and standardized. Nothing in the world—no payment, no investment—travels without being described.

Ninety percent of the developing and former communist nations do not describe their property. In your country, ownership is clearly determined. You are able to give the different pieces of paper that relate to you—not of you, but about you—that give a series of functions their meaning. When I got to this hotel, they said, “Mr. de Soto, how will you pay for the incidentals?” I said, “Oh, I always pay my debts. Ask anyone back in Peru.” They said, “Mr. de Soto, please, your credit card.” And so I handed over the standard documents that actually allow me to prove to everybody that I can pay my debt. I said, “I would like to make a phone call back to Peru.” They said, “Mr. de Soto, please use your AT&T card.” Then I said, “Am I going to be the only one in my room?” They said, “Absolutely, Mr. de Soto.” And they gave me the key, the representation of the access of the property right to my room for the next 48 hours. The capitalist world is a world of representations. It lives on paper, it lives on plastic, and it lives in representations. These representations are extremely impor-tant. The thing is, we have never really thought about them in relationship to poor people. That has been one of the great dilemmas of people who actually believe in markets.

The Peruvian Telephone Company

You still may think that culture is the key to the difference in development. Let me give you a different example. Third World governments have already proved that they can reform inadequate property systems, at least when it comes to dealing with wealthy people. In 1990, Peru began to privatize some of its state-owned enterprises. One of the organizations that we were involved in privatizing was the Peruvian Telephone Company. The Peruvian Telephone Company was basically organized and run by the state, but it was owned, theoretically of course, by the people who owned the telephones. It was quoted on the Lima Stock Exchange at US$53 million.

When the Peruvian government and the special team went to find someone to buy the company, nobody wanted to do so because the property title wasn’t clear. Nobody in the West, we found out, buys things. They buy the rights to things. So a hot-shot Peruvian team got together and started consulting with telephone companies. They asked, “how do you want title to work?” (It was the first time a Peruvian lawyer actually asked people how they wanted things to work.) The results were very efficient. In effect, we started organizing that information, and started standardizing the terms of a Peruvian property title so that a Canadian, or an American, or a Japanese, could understand them. Initially, we thought the Peruvian courts could resolve any problems. But Peruvian courts are corrupt, so we created an alternative dispute mechanism system that jibes with Peruvian law, but also jibes with your law so that you understand it.

We fixed the property rights about the apple (the new laws of privatization) on paper; we organized not the apple (we didn’t touch the Peruvian Telephone Company, we didn’t even paint it or put a new door in it), but our economic thoughts about it in such a way that they became understandable to everybody without touching the apple, without touching the phone company. In the end, in 1993, we sold the Peruvian Telephone Company to Telephonica of Spain for US$2 billion, a great deal more than US$53 million. That’s the power of a good property system. The creation of capital depends on it.

Developing property systems

Capital is surplus value, as Karl Marx said. It is the additional value that is hidden in any object once human beings cooperate around it. Marx and Adam Smith both realized that capital, or something that could be monetarized or could not be monetarized, is the most important thing in economics, not money. It is important that capital be captured in such a way that it is under-stood, because, as Marx said, “capital is metaphysical.” It’s the value people give to things and our actions relating to these things. In The Mystery of Capital we add that those things are only possible with a property system (which Marx either didn’t like at all or didn’t quite understand—given its stage of development at that time) because a property system is where you can capture capital.

All the values we have about this apple are things that can be captured by a piece of paper and can be organized in such a way that, without knowing me, you can do something about that apple.

When you Westerners invented modern property systems, you actually invented something much bigger than you thought you had, which is the possibility to organize the world around a series of very strict concepts. When you go out and defend private property, you are actually defending much more than ownership; you’re defending the very basis of a capitalist system, and no capitalist system can work unless property is there. It is not available only to the wealthy, but available to everybody.

When money passes from a first world country into the hands of a head of state in a third world country to help the poor, it is just charity. This will not really help the poor. They have to be brought into the system and given access to the leveraging tools the system provides.

The notion that capital can be stored through law and stored on paper really originates in deep Western thought developed over a long period of time. It begins with representations. How we represent things gives efficiency to a civilization. Once we invented musical notes, we no longer had to teach one another songs. We could write them down, and everybody could have them and play them. But you need the code, the numbers, the language. Property, too, is a language. The language of property hasn’t yet reached everyone. That’s why Karl Popper used to say that he who believes in a market society has to understand that there is a third world— actually, not a third world, a World Three—which is not the physical world and not the world of abstractions or representations, but the world of all those things that we have been able to organize through our ideas. Whoever understands World Three will dominate the world, or will reach prosperity. That is also what Michel Foucault was saying, for those who prefer French deconstructionist theory. He said, “The horizon of possibility only exists in the abstract and it is dictated by representations and the way of handling things.” Therefore, property actually has constituted an abstract reality for you in the West, which we don’t have, or only ten percent of our population has. Which, by the way, is one reason why capitalism never manages to hold concretely in Latin America or much of the Third World.

Creating a property rights system

Five times since the 1820s, we Latin Americans—who have admired the US constitution, have admired what you were doing in North America, have admired the French Revolution—actually lowered our tariffs, welcomed private investment, and sold our railways and the rights to them to the British. Five times we brought the system down. The same thing will happen again if only a minority of people benefit. Sociologists know this phenomenon well. They call it “levelling.” If somebody gets something that’s very good, and the rest don’t get it, the majority doesn’t like it and brings it down.

The challenge is in front of us. How do we make capitalism popular the way it is in your country? How do we make it something that basically everybody knows they could have access to if they wanted it, so they don’t consider the system grossly unfair?

I should note that it’s not as easy as just handing out property rights. In Peru since the Spanish Conquest we have titled our country 22 times, and it hasn’t stuck. To actually make a credit card that works, or a passport that is believable, is an art and a discipline.

Making laws that work

There are different realities, and there are different cultures. To try and illustrate this briefly, about seven years ago my first book, The Other Path, was published in Indonesia. The Indonesians asked me if I would make a presentation on it, to which I agreed. When I met with the Indonesian cabinet, they summarized their question to me this way: “Ninety-two percent of Indonesians live in houses, but we don’t know who owns what, so how can we assign title? How can we give people the title to their cars, their buses, their trucks, their factories, their machines, their homes, and their office buildings? How can we know who owns what?”

In the course of my travels, I had gone to Bali. Bali is very beautiful. It has rice fields where the rice matures at different times, so some fields are green, some are yellow, some orange and beige, and they are all surrounded by palm trees. In Bali, you walk everywhere. But I always knew when I was changing from one property to another because a different dog would bark.

The fact is that Indonesian dogs know where the boundaries are, because in Indonesia, as in Egypt and every part of the third world and the former communist nations, there are two laws. There’s the official law that doesn’t work, and there’s the real law that is used by the majorities. The meshing of that real law that does work with official law is the reason why, whether you’re aware of it or not, you North Americans have triumphed.

You think that you are the daughters and sons of the common law (at least they do in the US), but when you find out how property was actually distributed throughout the United States, you’ll find that the reality is quite different. For example, when the Californian Gold Rush took place, 3 million guys with beards and long guns came in and took away property from the Latinos and established claims. They didn’t consult the common law. They didn’t even go to the Mexican law. They just went out and claimed what they wanted, organized themselves and made up their own laws. There was a time in 1850 when California was divided into some 800 jurisdictions, each one extralegal, and each one enforced at gunpoint. The marvellous thing about the US is that it built the big law on that, which ended, after 32 pre-emption acts, in the Homestead Act. The reason that the law worked in the US is because it related to real people; it followed the collapse of the common law on property. There comes a time in a people’s history, as they move from the patrimonial system to the feudal system, that a second law is created in the process. Most people can participate in this law. This law is such that most people can actually distribute things themselves.

We always know that whatever developing country we go into, we will find a second law, and it too is a market economy law. We have a market economy law, but it is dispersed in small parochial circles at the level of the poor. In fact, in our recent work in Haiti, the poorest country in the Western hemisphere, we haven’t been to one place or one shack where we haven’t found some form of title. It’s just that none of the titles are issued by the government. Often they are issued by the myriad of shantytown authorities themselves, the informally elected ones. In other words, wherever we go, Egypt or anywhere else, people have their own titling systems. If you create a new one that is modern, computerized, and isn’t grounded in the law of the land in the same way that you Canadians create your laws by consulting and talking among yourselves, it isn’t going to hold.

At the end, democracy is very much at the bottom of law. Law, as the old British judges used to tell us, isn’t something you build, it’s something you discover. You discover it by talking to people, by having democratic institutions where you listen to the poor and the rich. Everybody basically agrees to the rules of the game. Economics is not too different from soccer. If you drop the rules, there’s no game. If we were to play in Peru with 23 players on one side and only 11 on the other, the rules would break down and you couldn’t have a soccer game.

The capitalist system is essentially a system of rules, and rules hold when everybody believes in them and the system can be, to a great extent, self-enforced. What we have discovered as we have worked throughout the world, despite what my critics say, is that the rule of law is absolutely critical.

Questions for Hernando de Soto

Michael Walker: Since you were the most popular person in Peru for the presidency, could you tell us what is happening, or what is likely to happen as a consequence of the outcome of the forthcoming Peruvian elections?
 
Hernando de Soto: Peru is basically a very good country. It’s full of real law. What’s missing is for it to be codified, to be put into place so that everybody can participate. It’s a good country, with good people. The problem is the politicians; the candidates aren’t as good as we would like them to be. But you never can tell what will happen in the future. The important thing is that there is a democratic process taking place. Nobody at this moment wants to go back to what existed before.
 
MW: Have you any comments about how we should deal with the native land claims issue here in Canada?
 
HS: I’m not going to be able to tell you what you can do in Canada because I have no idea if it’s applicable. I would have to study it. But let me tell you what we have done with native people in Peru. We don’t only title people in shantytowns, which are where the majority of our native people live today, but we have also titled people in communities in former Peruvian state cooperatives. Supposedly what you have is a communitarian agreement, a form of reservation. These were established in Peru by the Spaniards at the time of the Conquest and some 6,000 are still there. Instead of talking to the native leaders, what we do first is talk to the natives in order to keep the whole thing non-political. When you talk about the barking dogs, it means that everybody agreed that certain property was communal. Some part of the land is communal, like your streets and parks, and some of it is private. The important thing is to find out which is which, instead of having it determined before-hand by politicians or tradition. So we come in with a menu, and we say, “what we want is get you out of politics. Politics is not the domain where property survives. Law is the domain where property rests.” Anything handled by political representatives ceases to be real property; it is about sovereignty, which is a different matter altogether.
 
We explain our approach this way. Human beings have established two basic concepts: sovereignty (which is very political), and property. Sovereignty is very unstable, as you know. Just look at a map of Europe over the last hundred years to see how unstable it is. But despite the instability of sovereignty, people still live on their same property, no matter what jurisdiction it falls under. Property is much more stable than sovereignty. So here is our recommendation. If you want to remain a sovereign nation, do so. But you many want to think about this, the way the West did. You could be a kibbutz, if you want to. You can also organize yourself as a limited liability corporation, a private corporation. We don’t care as long as you stay within the law; the law will protect you much better because it’s not political. Here’s the menu. Keep it, and we’ll come back in a year.
 
A year later we go back and find that 70 percent of the people want private property. Then we put them within the law. I don’t know the details of your native issues in Canada, but perhaps this distinction between sovereignty and property is helpful. If people have recognized rights to their property, the overarching political system doesn’t seem to be as important. Anyway, that’s what we are doing in Peru.
 
MW: Will you have more influence with Toledo or Garcia in Peru?
 
HS: Garcia is a socialist at heart. He is an interesting fellow because he reflects the mentality of a lot of our clients abroad. They are all leftists, not to say Marxists, but what is important to understand is how these people tick. Whatever their personal behaviour, their ideals are to let the poor have a break. They feel we are seeing too many rich appropriate all the wealth. If you come along with a capitalist model that takes care of the poor people expressly, they have no problem with that. In 1989, Garcia called us in to make a few of the required legislative reforms, and we did them. That allowed Fujimori to actually begin structural adjustment and privatization later. We don’t have that same relationship with Toledo but we would be delighted to support him if he gets into power. We are helping other nations, so we have to help our own, regardless of who gets into power.
 
MW: You see the shortfall in the Third World’s legal system as the core prob-lem, but are these legal systems not sim-ply the mechanism by which the ruling class perpetuates control? The blind spot is the perception that the pie is finite in size and the tension is around dividing it, whereas the answer is to rec-ognize the possibility of growing the pie.
 
HS: That’s a very good question. The fact is that at the end of the day, the problem is political because politicians produce laws. The bottom line is that you have to get your politics right. Let me give you an example of how this works in Peru, because in political terms, it is probably the situation I know best.
 
We went out to find out how many laws (these laws that the dogs don’t bark at) have been made by the Peruvian gov-ernment since the Second World War. On average, the Peruvian Executive Branch issues 28,000 laws a year. The Congress issues 350 laws. That is to say that 99 percent of the rules by which we live in Peru (and in Latin America) are actually made by the Executive Branch. This is why, prior to each election, our institute (which is the equivalent of The Fraser Institute), puts out an add saying, “Now we are going to elect our next dic-tator.” In fact, what you are doing is giv-ing a blank cheque to whoever comes in. He can enact all the laws he wants to and nobody can do too much about it. Twenty-eight thousand laws a year means 106 laws a day.
 
Who is the beneficiary of those laws? Those who can afford to pay the high-powered Lima law firms and have con-tacts in government. But these people don’t want the laws to exploit the poor. Nobody really wants marginality. Nobody wants a lot of beggars walking the streets, and nobody wants a lot of people working in black markets. What these people do want is laws that will enable them to have a semi-monopoly and work quietly at their business with-out having to deal with any unfair local or foreign competition. But in the pro-cess, of course, they create a huge tangle which nobody can work through.
 
The solution comes by changing the legal system. This is our approach in all the countries we are working in, and in so doing, we will also be able to change the political system. In other words, since we can’t get at the political system because we are foreigners and we have no say (as we might in Peru), we aim to at least get property law within the dem-ocratic sphere. As we are doing that, we encourage feedback from all interested parties and avoid creating additional laws that don’t help anyone and are not transparent. In the property area, we create a small degree of democracy.
 
So the reply to the question is yes, some of these laws actually benefit rich peo-ple, or those 10 percent who are the top of the crust. The important thing to understand is that under the existing laws, neither the government nor the country is actually receiving a benefit. A great deal of agricultural land in Egypt, for example, has buildings of extralegal origin on it—4.7 million, in fact—so they are not happy with that situation. Everybody today knows that the old laws, which favoured a few, don’t actually even favour them, because they are continually subject to illegal competition. These favoured few continually have to deal with enormous social problems and some are even losing assets to a growing infor-mal sector. What my Institute does is use graphs and studies to illustrate that there is no need for anyone to lose from reform. In fact, it shows how, as in the case of the Peruvian Telephone Company, the right laws can release the tremen-dous amount of potential held back by bad laws or the lack of the right ones.
 
We think we have reached, due to the large migrations that have taken place since the Second World War and that have seen Lima’s population expand 7-fold, the situation that Britain and Europe reached in the nineteenth cen-tury. In Henry VIII’s time, the English issued “poor laws” to keep the poor in the provinces. But they went to Man-chester, Liverpool, and London. No one could get rid of them. The favourable circumstances that occurred in Western countries in the nineteenth century are beginning to occur in our countries in the twenty-first century, and that’s what we will build our reforms on. We don’t think that that a minority of privileged people will get in the way, provided things are correctly presented to them.
 
MW: Do you think that drug decrimi-nalization will help Peru?
 
HS: This is a very delicate question. I’ll tell you why. Among the many hats that I wore during the first two years of the Fujimori regime was one of so-called drug czar. Here’s what we did, and it involved decriminalization on our side of the border.
 
The drugs problem is not simple. There are countries without big drug entrepre-neurs but that have valleys that are very secluded from the mainstream of eco-nomic life with very poor peasants who will welcome any opportunity to produce cash crops. Peru is one of those coun-tries; it has valleys that are very similar to the valleys of Lebanon. We are the proletariat side of the drug trade. Our peasants actually don’t earn much for their efforts. The average Peruvian peas-ant who actually cultivates the coca leaf has an average income a year of about US $700. It’s not a big deal for him.
 
Other countries, like Columbia, are home to the entrepreneurs. These guys buy the coca, take it to Columbia, pro-cess and package it, and then send it abroad. Still other countries, like Mex-ico and Jamaica, find out how to infil-trate North American and European markets and distribute the drugs even further. That’s the chain.
 
Early in the 1990s, we told the Ameri-cans that our strategy was to decrimi-nalize not the drug traffickers, but the peasants, because the peasants were as much victims as anyone else. If you are a Peruvian peasant growing coca, you are dealing with a bunch of Columbian bullies, corrupt Peruvian policemen, the Shining Path, and the MRTA terrorists. They are going to date your daughter and they’re going to try to recruit your son. You don’t like that, no matter how much money you make; nobody likes that.
 
We knew the peasants wanted the thugs out. So we proposed to the US that we redefine the terms of criminality, and decriminalize the peasants. That way, the peasants feel that they are part of our society. We can then guide them toward our culture, toward our morals, our law, and among other things, we can title them. Why?
 
One of the tremendous attributes of plants like coca is that they grow easily; coca’s like a weed. You plant the stuff, and three months later you have a crop. Other crops like the palm are actually six times more profitable than coca. But to plant them and be able to reap the results, you have to own and work that land for at least six years. Now, since there are no property rights among these poor people, they go for the coca bush. When the cops come in and destroy the plants, the peasants just keep on moving and planting in other places. Of course in doing this, among other things, they destroy the environment.
 
What we started to do was grant them title as much as we could. We made agreements with them. The result is that Peru, which in 1990 was responsible for 60 percent of the total production of coca, is now down to 25 percent of pro-duction. Unfortunately, most of the production moved to Columbia; the drug trade hasn’t stopped, and our efforts in Peru aren’t the total solution. What our efforts do show, however, is that legal status in the fight over drugs is very important. We have done our part; it will be interesting to see now what the West does.

Hernando de Soto spoke to a Fraser Institute audience on May 25 in Vancouver. Fraser Institute Executive Director Michael Walker provided the introductions and served as chairman.
 
Hernando de Soto founded, and is currently the president of, Peru’s Instituto Libertad y Democracia (the Institute for Liberty and Democracy, or ILD) an organization headquartered in Lima, which has proved to be enormously successful in changing ideas, not only in Peru, but in the world. In a special May 1999 issue of Time magazine, “Leaders for the New Millennium,” Hernando de Soto was chosen as one of the 5 leading Latin American innovators of the century. Additionally, the Economist deemed the ILD as the second most important think tank in the world.
 
Mr. de Soto was born in Arequipa, Peru in 1941 and did his post-graduate work at The Institute Universtaire Hautes Etudes Internationales in Geneva. He has served as an Economist for the General Agreement on Tariffs and Trade; as President of the Executive Committee of the Copper Exporting Countries Organization; as Managing Director of Universal Engineering Corporation; as a Principle of the Swiss Bank Corporation Consultant Group; and as a Governor of Peru’s Central Reserve Bank. Mr. de Soto was President Alberto Fujimori’s Personal Representative and Principle Advisor until he resigned at the time of the president’s coup d’etat. During that period, he and the ILD were responsible for some 400 laws and regulations which, by replacing some 400, 000 laws or regulations, that modernized Peru’s economic system, stabilized its economy, tamed inflation, and allowed Peru to return to international financial markets.
 
As his principle activity, Mr. de Soto, together with the ILD, is designing and implementing capital formation programs for the poor in Asia, Latin America, and the Middle East. Mr. De Soto’s new book, The Mystery of Capital: Why Capitalism Triumphs in the West and Fails Everywhere Else, is Peru’s best selling book ever, and is among the 10 best business and finance books for 2000 in the US and the UK.

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