The Spirit of Capitalism

The triumphant religion of the twentieth century was not Christianity or Islam but economic growth. Over the decades, governments throughout the world jumped onto the growth bandwagon as a way to expand national power, relieve abject poverty, and create social justice. True, they argued and fought over the best way for societies to create and distribute wealth. Communism, capitalism, and socialism in their various forms all vied for supremacy. But now a consensus seems to have emerged. Free trade, free markets, and international investment are the intellectually anointed paths to prosperity. Communism and socialism are definitely out.

Yet the consensus is more fragile than it seems. Not only are there conspicuous dissenters, most visibly the street protesters in Seattle and Prague; there is also the inconvenient fact that today's global capitalism has yet to produce anything like universal prosperity. Much of humanity still lies in the grip of extreme poverty. The World Bank estimates that 1.2 billion people -- a fifth of the world's population -- live on less than $1 a day. Worse, little progress has been made since the late 1980s, when the new global capitalism began flourishing. From 1987 to 1998, the share of sub-Saharan Africa's population living on less than $1 a day remained constant at around 46 percent. The story was the same in Latin America and the Caribbean, where the poverty rate stayed steady at about 16 percent from 1987 to 1998. In South Asia, it fell from 45 to 40 percent, but that region's rapid population growth added 50 million people to the ranks of the poor. Only East Asia (including China) experienced notable success, with the region's poverty rate dropping from 27 to 15 percent.

The truth is that global capitalism's benefits are spotty. Some societies have not tried it, and elsewhere others have achieved only scant success. Global capitalism faces an "hour of crisis," contends the Peruvian development expert Hernando de Soto in The Mystery of Capital, because countries as different as Russia and Venezuela are disillusioned by failed excursions into market economics.

To explain what has gone wrong, de Soto argues that global capitalism cannot succeed without local capital -- and therein lies the rub. Global capitalism's orthodox remedies -- balanced budgets, free trade, foreign investments, and stable currencies -- are not everything. Although they can aid economic growth, local development is decisive for success. But local development founders in most poor nations because a critical catalyst, local capital, is missing. Property rights remain primitive, and what little the poor do have (assets such as huts or small businesses) cannot be used as capital to propel economic growth.

In country after country in the developing world, squatters' rights prevail because the obstacles to obtaining legal titles defeat most of the poor. As de Soto explains,

In Egypt, the person who wants to acquire and legally register a lot on a state-owned desert land must wend his way through at least 77 bureaucratic procedures at 31 public and private agencies. ... This explains why 4.7 million Egyptians have chosen to build their dwellings illegally.

If, after building his home, a settler decides he would now like to be a law-abiding citizen and purchase the rights to his dwelling, he risks having it demolished, paying a steep fine and serving up to 10 years in prison.

Egypt is no exception. In Peru, building a home on state-owned land requires 207 procedural steps at 52 government offices, says de Soto. In Haiti, obtaining a lease on government land -- a preliminary requirement to buying -- takes 65 steps.

According to de Soto, clearly defined property rights generate what economists call positive externalities, or benefits shared by everyone. Not only do property rights help people borrow more easily, because property can be pledged as formal collateral; they also create information needed by markets. If property rights are recorded, for example, utility companies can deliver power and bill customers more easily. But without such rights, markets are untapped and commerce is disconnected from much of the legal system. People deal only with those they know and trust or through informal associations that substitute for formal law. Extralegal arrangements flourish because they are essential for survival. Some of these arrangements are ethical, but others are corrupt. In Peru, for example, bribes raise the cost of running a small business by 10 to 15 percent, de Soto writes.

Aside from depressing economic growth, the denial of property rights destroys any constituency for popular capitalism. Some wealthy investors do enjoy property rights and legal capital. "But they are only a tiny minority -- those who can rely upon the expert lawyers, insider connections, and patience required to navigate the red tape," de Soto says. This makes "capitalism a private club, open only to a privileged few, [enraging] the billions standing outside looking in."

De Soto's book rings true when it describes how grand theories of development stumble on crippling practical details. It builds on his 1989 work, The Other Path, which convincingly revealed the widespread informal or underground economies in many poor countries. That book's argument was similar, noting that the bureaucratic difficulties in creating legal businesses usually compel the poor to skip the process. They instead establish small businesses with few, if any, of the necessary permits or licenses. In the informal economy, street vendors, taxicabs, small bus services, shops, tiny factories, and urban marketplaces predominate.