The Mystery of Capital

Periodically, Jimmy J, who does as much as any commenter here to keep things cordial and enlightening, sends me a longer note to post, which I am always pleased to do.   When I recieved this note last week, it inspired me to purchase Hernando de Soto's book, "The Mystery of Capital."  I have not yet had time to read it but it is on my short list for the near future.

Over my adult life I have been interested in the stock, debt, and real estate markets. When I have had some money available, I have put it to work in those markets. My investments have not always been successful, but over a period of 52 years I have accumulated a nest egg, which allows me to live comfortably in retirement. I've been retired now for 13 years. One night a few years ago I was asking myself how I got so lucky. Here I was a kid from a rather poor family that lived in a small mountain town in Colorado and I had managed to live an interesting life, educate my two children, and accumulate a decent retirement. Sure was a long way from the "debtor's prison" that my mother always threatened I would end up in.

About that time I watched a program on C-SPAN where a man named Hernando de Soto, a Chilean, talked about his book, "The Mystery of Capital."  After listening to Mr. de Soto explain his ideas I was struck by how simple, yet profound, his ideas were. I knew Third World countries were at an economic disadvantage, but here was a man who knew what they needed to do to change their economies. I had been taking advantage of his ideas all my life without really grasping their meaning.

In 1997 my wife and I traveled to Kenya, Africa for a two week safari.

Our first day in Nairobi we were taken to Karen Blixen's (author of "Out of Africa") farm outside of Nairobi. Along the way we stopped to browse at a furniture market where there was beautiful furniture crafted from exotic African wood. The prices were quite reasonable and I asked our guide if they exported any of their wares. His answer, "Oh no, if they become too successful the government will come in and take over the business." I was astounded. I thought maybe he was pulling my leg. I made inquiries while we were there and found that, yes, businesses had to be careful not to get too successful lest they be taken over by someone in the government. Daniel Arap Moi was the president at the time and I have learned that his government was a kleptocracy of the first order. He is no longer president, but his successor has had little success in changing things. I began to realize then why so many Third World countries seem mired in poverty. Most have dictatorships, theocracies, or sham representative governments that are kleptocracies.

I want to share parts of an essay I found on the Internet that was written by a young Kenyan woman, June Arunga.  June grew up in a middle class Kenyan family.

"Growing up in the Kenyan middle class, I watched as the standard of living in our household and that of my friends drastically declined over a span of 20 years even though my mother (the family breadwinner) invested in two houses, was promoted at work and got raises in her salary.

I watched my younger siblings being moved from school to school as their former schools got too expensive. We quit eating breakfast as bread, butter, and milk became too expensive. We quit doing household shopping because we could not afford it anymore.

My friends and I theorized about wealth creation and wondered if there was a formula behind it or if it was just chance. Why did some countries have so much wealth and we were so poor?..................

I knew that something was wrong and wondered how I could make it better. It pained me to see people with even masters degrees living in slums. What baffled me most was why the people in government made promises that did not come true.

Surely if other governments had plans that worked to facilitate the creation of wealth, our leaders needed to abandon the plan they were following and imitate the magic formula of prosperous nations...........

I wondered whether there was a fixed amount of wealth in a given territory demarcated by political boundaries. If that wealth was the raw materials within those boundaries then it required careful planning to determine the most efficient way to allocate those resources so everyone could gain."

June then speculated about whether corruption was a genetic trait and only Africans were cursed with it.

She tells of wise people telling her the government just needed to step up and fix this program or that one and all would be well. She marvelled at how smart government bureaucrats had to be in order to plan the economy for 30 million people.

A younger brother, Owuor,  obtained a scholarship to study for a time in Seattle, Washington.

"He attended several seminars that focused on the role freedom could play in expanding the choices and opportunities people could enjoy. He carried this newly acquired understanding back to Kenya to share with us.

I listened to his ideas about how freedom worked but was very skeptical since the anti-globalization arguments had reached me first, and I was actively promoting them.

Although the anti-globalization arguments did not make perfect sense, they offered a scapegoat for our problems, painted free markets as bad, and made me feel better by arguing that we were victims of a complex system of trade by which the rich were exploiting the poor."

In spite of her thoughts about globalization her brother's ideas had sparked her curiosity and she began reading books on freedom and free economic systems.

"The insights they offered were crystal clear. They presented questions I had never contemplated before such as what the proper role of government is, and the idea that the protection of life, liberty and private property was the only proper  function of government.

I felt relieved and elated. Relieved because I expected the creation of wealth to be very complex, and now I realized that in comparison to the task of central planning, deregulation and liberalization were simple.

I was elated because this made me see that that Africa did not have to be plunged into eternal poverty. Our parachute could open and the cycle of poverty could be broken as we steered our own destiny.

Hernando de Soto's "Mystery of Capital offered the final piece in the puzzle, demonstrating how vital a comprehensive property law system is to awakening dead capital.

The lack of a rule of law that upholds private property and provides a framework for enterprise is the challenge we must meet before we can reap significant gains from liberalizing our economy."

June then talks about how hard it is to know that there is a solution to their economic problems, and watch as the government continues to resist change while demoralizing and impoverishing the people of Kenya.

"Who is going to be the voice of freedom, which will introduce, promote and defend the role of free markets to high school and University students in Kenya? I plan to create an organization for young Kenyans that will help them understand the power that freedom and private property laws have to improve the lives of all Kenyans."

This young woman is very brave to undertake to try to reform the laws in Kenya. The kleptocrats that run Kenya will not want her to succeed and will fight her at every turn. I often wonder how we in the West could help young people in Africa who have begun to understand what it will take to get their countries out of poverty.

Additionally, many in the West do not understand that private property ownership backed by courts and reasonably honest representative government are the bed rock on which our economic success is built. Yes, it takes people who are hardworking, have a vision of better things, willing to save and invest, and realize they cannot look to government to manage the economy.  But Africa has a lot of people like that. What they don't have is the chance to hold merchantable title to property that can help them create wealth.

de Soto's book explains that if a country has a reasonably honest representative government, (Kenya has a parliamentary democracy but it is deeply corrupt.) and a system of laws allowing citizens to own merchantable title to property and that ownership is backed by courts, then the environment for business success is enhanced immeasurably. Amazingly, these conditions only exist in the developed free world. And it is one of the reasons why so much of the world is mired in mediocre economic growth or poverty.

It became clear to me while I was in Kenya that we could send them billions in aid every year and it would do little to lift them out of the economic slide they are in. The money would be stolen by government officials and their cronies or put into uneconomic enterprises that would not promote sustained increases in employment and new business growth.  Such sustained improvements in economic growth can only come when Kenya's citizens can own and sell property with minimal interference from the government.

It's surprising to me that it took a man from Chile to study the situation that we have here in the West and see what it is that makes the West an economic juggernaut compared to the rest of the world. Many in the Third World and even here in the West like to believe that much of the wealth is stolen; or that the system is rigged; or that unequal outcomes in capitalist countries are evil; or people in these Third World countries are stupid, lazy, and worse; or that there is a way for a government to be smart enough to successfully micro-manage an economy. They fail to look at and accept what works.

And why do we have this system in the West? It's been the result of trial and error, a lot of heated debate, some first rate thinking about property's role in economics, and some bloodshed over a period of the last 250 years. Most of the developments took place in England and Scotland. (The following ideas are from the book, "How the Scots Invented the Modern World" by Arthur Herman.) A Scot named Lord Kames (Harry Home was his given name) was one of the first to propose a theory of private property in 1751. This is what he said, "This is yours and this is mine. And let's keep it that way. I'll respect yours if you respect mine. That is why we create society and government in the first place; so that each person can enjoy without hindrance that which he or she has come to own by his or her efforts. It is a principle of the law of nature and essential to the well being of society that men be secure in their possessions honestly acquired." This was not immediately accepted because it struck at the heart of the old feudal property system.  But many leaders in Scots and British business saw the possibilities in this idea of private property.

It was left for the Scots, David Hume and Adam Smith, to push these ideas further. With Hume's book, "Reason," where he extolled the principle of self interest as being the major thing that all people have in common and the necessary starting point for any system of moral government. Hume believed that men who were only governed by self interest were likely to cheat and steal if they believed they could do so without regret. Therefore Hume was adamant that there needed to be adequate legal remedies to discourage shady/illegal business practices. He believed that, in all moral governments and societies, there is a perpetual struggle between liberty and authority, and neither of them should be allowed to prevail in the contest.  Thus, the early concept of free, but regulated markets and private property laws.

Smith's contribution was the ability to understand that the market, with it's myriads of invisible transactions, (The Invisible Hand) was the fairest, most moral way to determine supply and demand for goods and services, which, in turn, determined fair prices.

What the West has today is a complex version of these men's visions that has evolved over the last 200 years. And what we have is not, IMO, necessarily the best of their ideas, but it works well enough to provide the greatest economic benefits to the greatest number of people of any known economic system.

We know it works. We've seen it planted and take root in such disparate countries as Germany, Japan, South Korea, and Taiwan.  Visionaries like Thomas P.M. Barnett believe that it is the West's moral duty to export this economic capability to all the Third World, by force if necessary. He believes bringing the Third World into the modern world is the best way to discourage war and at the same time improve the miserable lives of millions of suffering people around the globe. This is, of course, a huge undertaking and Barnett is under no illusions that it is going to be easy or quick. 

We are trying to do this by force in Iraq and Afghanistan. It is very tough and the jury is out on whether it will meet with success. That is being thoroughly debated in government and the blogosphere everyday. And we won't know the answer for possibly several years.

My question today is how can we convince a country like Kenya to change without violently overthrowing the government? Could the UN be used to put pressure on these types of failed, non-belligerent states to make the needed changes to their property laws as well as  deregulating and liberalizing their economies? Could the U.S offer help to young leaders like June Arunga and help her educate the people of Kenya? Will getting a country in Africa up and running successfully on capitalistic principles foster more change?

Or is it immoral to try to help these people? Should the West just let them stew in their own misery and use force as necessary to keep them restricted to their part of the world?