Interview with Hernando de Soto

21st April, 2004

Hernando de Soto, President of the Institute for Liberty and Democracy (ILD), and recently named by Time Magazine as one of the twenty most influential thinkers in the world, has long been a champion of the idea that the majority of people would be lifted out of poverty if only they were allowed to live and work in a legal environment that encouraged entrepreneurship. The work of the ILD in Peru and beyond has been made famous by Mr de Soto’s books, The Mystery of Capital and The Other Path. After his recent visit to the World Bank and the IFC, we spoke to Mr de Soto and asked him to tell us about his ideas, his plans, and his view of the World Bank’s work in this area.

For those who have not encountered the approach you laid out in your books The Other Path and The Mystery of Capital, can you give us the central ideas?

There are various points that both these books try to make. First of all, that the majority of people in the world are not governed by the rule of law.

Second that this has consequences: you can’t take full advantage of a market economy because you can’t cooperate with people outside your immediate neighborhood or tribe, enforce contracts, transfer goods or money, achieve economies of scale, and can’t take advantage of the division of labor. All these have been recognized for 200 years as crucial to growth.

Third, that the genesis of the rule of law comes through property rights. For four billion people, the poor of the world (and two-thirds of the world’s population) the things they have which are most dear to them are their land, the buildings which they live in, and the business that allows them to eke out a living. If the law can be constructed in such a way as to give people security over their most precious assets, they will understand the benefits of the rule of law and want more of it. They’ll then support any reforms of the administration of justice, because they refer to the law that protects their assets. They’ll want more democracy, because it refers to the rules contained in the rule of law. They’ll be concerned about other people’s human rights because they reflect on their own. They have a stake in the system.

Last, that legal property systems as constructed in the West today are the vehicles that allow humans to capture, symbolize and transfer capital. It’s very hard for anyone to show me any value they have for generating new causes or enterprises that’s not captured in property rights written down on paper – be it a title to a home, share certificates, bonds, or whatever. Let’s not forget that two thirds of the world can’t do that and are therefore totally isolated from what both Adam Smith and Karl Marx considered the crucial element for the West to begin its rapid ascent to growth 200 years ago.

What ideas would you like to put in your next book? When should we expect it?

Generally speaking I don’t think of my life in terms of books – I’m not really a professional author. What happens is that we at the Institute for Liberty and Democracy (ILD) have got interested in such an interesting field of research that facts and ideas that seem new keep on popping up as a result of our practical work to try to build property systems across the world. There comes a point at which all of them together justify a book. The reason we like books is because… well, I was convinced a long time ago by the person who’s now my agent, that books are the best way for bringing new ideas and proposals across.

In the course of the last year or two I’ve come across some facts, which I’m transforming into data, that indicate why firms are crucial to growth, and what it is that’s special in a firm. These are ideas that have not been written up by very good friends of mine like Ronald Coase and Michael Porter. I think there’s enough material there to build an interesting book. I hope to get started on it in a serious manner once we’ve finished reconstructing the Institute so as to grow rapidly in the course of the next year.

Can you give us a sneak preview?

There are similarities with The Mystery of Capital. In that book I show that in the world of law there are not-so-obvious ingredients that glue the edifice together. Equally, in company law in the West there are also some not-very-explored dimensions, crucial ingredients which don’t exist in developing and former soviet nations. It would be hard to outline them at the moment, because although I have the idea quite clearly in my head, I can’t yet break them into the little pieces which would be required for my book or this interview.

An important part of the success of every book today in the 21st century is about how to make it very understandable without dumbing it down. That’s why I probably spend two years more than any author would in writing a book, making sure that it can get to people. We forget how important writing is – not so much the style, but how it is that you transmit ideas. This becomes obvious when you compare modern writing to, say, Adam Smith or Marx’s writing. They really were terrible writers. I’m not surprised they took decades to catch on. I’m sure most of their followers never read them, but read summaries. So I have to break my ideas up until they can be captured by the alphabet.

You’ve certainly succeeded in the past at making your ideas compelling, but in many countries entrepreneurs continue to struggle with bureaucratic barriers. Why isn’t reform happening everywhere? In your experience, how can obstacles to business enterprise be removed?

I try to explain some of this in Chapter 6 of The Mystery of Capital, for those who want to read in detail. But here are some reasons:

First, regulatory and legislative bodies in any developing country will rarely change on their own. If they are your counterparts on a development project, it will be like asking Louis XIV to help set up a republic. International institutions are usually talking to the wrong people – the people you have to talk to are the politicians who have everything to gain: in a democracy they gain votes, in an autocracy they gain legitimacy. You would have to be a very cruel dictator indeed not to want growth for the people.

Second, regulations are taken on as though a skin-deep phenomenon. You cut red tape from 200 days to 1 day, and then feel you’ve done your job. But that is just the tip of the iceberg. The body of ice that sustains that tip has got to be dealt with as well: how official decisions are made in developing countries. To do that you need to work in tandem with the head of state – that’s the level of authority you need. At the start, clients of ILD (we call them clients, although we are a non-profit organization) were very few because we only accepted contracts from heads of state.

Third, the methodology that allows you to change elements of decision-making process is a long-term task. We were partially successful in Peru, our pilot – but only partially successful. It’s later, as we learned from our failures, and from the punishment that you get in life, that we were able to perfect this stuff. What doesn’t help us is that the very people who were the causes of the failure of our projects were subsequently employed by the World Bank. So it’s an uphill struggle.

Since you raise the subject of the World Bank, you may have seen the Doing Business project, which is measuring, in more than 130 countries, the obstacles to small-scale entrepreneurs – including some of the barriers you’ve highlighted, such as the difficulty of formally registering property or businesses. What are your thoughts about this work?

I think Doing Business in 2004 is right on. It’s a very well organized document, and it covers enough countries for us to indicate that the problem of regulatory obstacles is endemic. And it will eventually move a lot of governments and opinion makers, if it is not doing so already, to start taking faulty institutions seriously and recognizing the major cause of underdevelopment.

As you know, we did some of our original work in Peru on obstacles to business entry, administration, and exit – so there’s no way we’d disagree with that. The authors have also developed the methodology to make it possible to extend it across many countries. So a lot of poor people will thank them for having done that as the years go by, and as the essence of the message is absorbed by people who move things. Ideas take time to travel – so one must be patient. The same is true with good research.

What projects is the Institute for Liberty and Democracy now involved in, and where would you like to take the work next?

We’ve been called by 30 Heads of State from all parts of the world. For example – in the Former Soviet Union, I met with President Putin of Russia, President Nazarbayev of Kazakhstan, and President Burjanadze of Georgia. In Asia, I met various heads of government including President Macapagal-Arroyo of the Philippines and Prime Minister Thaksin of Thailand. In Africa I met with President Mkapa of Tanzania, President Kufor of Ghana, and President Obasanjo of Nigeria. There are some I’ve yet to meet. I’m on my way now to meet President Portillo Cabrera of Guatemala, and then Prime Minister Meles of Ethiopia.

My intention is to sign contracts with all 30 of them, as they have requested. To do that I have to completely reengineer my organization. I’ve been doing practically nothing else but that for the past 6 months. I’ve been generously helped in this task by many consultants including Michael Porter of the Harvard Business School, who called us in and has made very interesting contributions to help us with the singular work we’re doing. We can’t find case histories, so we can’t take advantage of other people’s mistakes – this makes it a difficult task but it’s not impossible.

The reforms, of course, include doing a lot more franchising and training than originally conceived – internationalizing ourselves, bringing many more foreigners on board. This is hard for us because we’re located in the wrong corner of the world: the lower half of Latin America. If, instead, I was operating from London, then the Philippines would be 11 hours away instead of 32. As it is, Dar-es-Salaam is 26 hours away instead of 8. Algeria is 22 hours away instead of only 4.

But we’re where it’s important to be, in terms of being in a developing country that you know well. Understanding what underdevelopment is begins each day by reading 5 local newspapers. Whether I’m in Peru or Mexico, in Karachi or in Algiers, reading those 4-5 newspapers already begins my education as to why we don’t function. Even the sports page tells you how it is that faulty institutions screw everything up. So we’re not going to move.

So the trick is – how do you, in a country that traditionally only knows how to organize subsidiaries, organize a head office instead. Doing this is nearly as mind-boggling and as much of a torture chamber as writing a book. We’re bringing in many foreigners – we have to internationalize. We’re bringing in people from as far away as Papua New Guinea, plus British, Canadians, Africans. They all have a lot to contribute, and we’ll do our best to make them at home in Peru – which is a country in which sometimes even we find it hard to feel comfortable.

Finally, how do you see your relationship with the World Bank?

We’re really delighted at the interest of different World Bank officials in our work. We know we’ve always gathered part of the interest of World Bank presidents. People like James Wolfensohn have been very supportive. But the Bank is a confederation of independent republics and the fact that some of these republics have been calling us in is heart-warming. It makes us very happy, because we don’t consider the Bank a competing organization like McKinsey, but rather like brothers in the fight against poverty and the fight for growth. I really hope that this will become reciprocal – we need each other.

I conducted this interview with Mr de Soto for the World Bank, and it is published here:

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