Why are countries like the United States so rich, and some countries so poor?
This is the question that Hernando de Soto seeks to answer in his incredible book, The Mystery of Capital.
He finds that the rest of the world isn’t as poor as people think. De Soto and a large team of researchers went out to countries like Peru, Egypt, Philipines, and Haiti, and they meticulously documented the value of the property that people in these countries live on. What they found is absolutely incredible.
There is a large group of people living in the Third World that owns considerable amounts of property. They just can’t use it because their governments, and their legal systems, don’t recognize or protect it. De Soto writes,
In Haiti, untilted rural and urban real estate holdings are together worth some $5.2 billion. To put that sum in context, it is four times the total of all the assets of all the legally operating companies in Haiti, nine times the value of all assets owned by the government, and 158 times the value of all foreign direct investment in Haiti’s recorded history to 1995.
The value of extralegally held rural and urban restate estate in Peru amounts to some $74 billion. This is five times the total valuation of the Lima Stock Exchange before the slump of 1998, eleven times greater than the value of potentially privatizable government enterprises and facilities, and fourteen times the value of all foreign direct investment in the country through its documented history.
The data looks very similar for the Philipines and Egypt. This is, in fact, a recurring pattern throughout the Third World.
Why isn’t it a problem for wealthier, more advanced countries? De Soto looks at the United States for answers, finding that similar problems did affect the U.S. early in its history and that the U.S. government, and its court systems, took special steps to give property owners the safety and protection they needed.
Why do property rights matter?
Imagine that you want to start your own business. To your name, you have a bank account with some money and you have a house that you own. If you go to your bank, you can apply for a loan and use your house as collateral. If you can’t make your payments, the bank will use the house to recoup its credit line.
In most Third World countries, the average person cannot do this because their property rights are not secured. There is no government agency measuring and recording their property, ownership is oftentimes murky and conflicting, and people are forced to buy and sell their property on black markets. These countries don’t develop advanced financial services for the middle class, like those in the United States, because one of the most important elements to such a system is missing. That is, in countries like Egypt, Peru, and Haiti, most people can’t go to their bank, present their house as collateral, and take out a business loan. There is no property rights system that the bank can trust in, so it does not want to extend credit.
What is so amazing is that de Soto’s research team found an overwhelming evidence of entrepreneurship. But, because of the lack of property rights and financial markets, this entrepreneurship remains within narrow circles. Meaning, an Egyptian entrepreneur can only do business with so many people. It’s much more difficult to grow and expand, because their property rights, the limits of trust, and the extent to which their businesses are secure are limited to small communities where they are recognized by people who know each other. These systems are local, they are not national laws that the government enforces, and so once the Third World businessman steps outside their narrow network, their protections disappear.
In the United States, we enjoy a legal system that has been developed to protect the entrepreneur. Our wealth, our standard of living, and the power of our country all stem for our respect of the entrepreneur and in our steadfast belief on the right to our property.
How the Law Makes America Thrive
As it turns out, the U.S. went through a period in time where the situation for many property owners was similar. When we broke away from Britain in the War of Independence, there was a lot of unsettled land that was eventually occupied by squatters, people we now know as frontiersmen. Their property was not formally recognized, in fact their occupation of their property was considered illegal. This wasn’t true just west of the Appalachias, it was also the case in not-yet-states like Maine. In fact, in the case of Maine, its statehood has much to do with the legal (and sometimes physical) battle between the Massachusetts government, which owned Maine until 1820, and squatters.
The situation remains similar as the U.S. expanded west during its Manifest Destiny. As settlers started to settle on federally-owned land, whether recognized by the government or not, in the Louisiana Territory and then further westward, such as here in Texas and further west in California, the issue of squatters, their wellbeing, and the ability for these areas to be developed became particularly heated.
Speaking of the property rights mess in the U.S., Supreme Court Justice Joseph Story wrote,
Ages will probably lapse before litigations founded on [the U.S. property laws] will be closed.
The U.S. tried to remedy the situation in many ways throughout the early 19th century, but early property reform was not successful. Rulings that came down against these squatters often failed, because the government could not deploy the necessary force to remove as many squatters as there were from the property they occupied.
Finally, the U.S. government found a solution that worked: they worked with the settlers and frontiersmen, rather than against them.
If previous attempts to remedy the situation had simply clashed with the reality, rather than working with it, the U.S. began to introduce new rules that rewarded frontiersmen who settled on land to improve it and make a living. Much of this positive change started at the state-level. State governments oftentimes contradicted Supreme Court rulings, such as Green v. Biddle, which gave western Virginia lands to the new state of Kentucky, but restricted Kentucky’s ability to undermine Virginia’s existing property titles. Kentucky ignored the ruling, as did states like California, Wisconsin, Arkansas, and Mississippi. Older states along the east coast began to cooperate more with these changes as the political climate in the U.S. changed, leading up to the Civil War, and existing states sought to compete for influence in the west.
Finally, the Federal government began to accept that settlers, and the states that benefited from them, would not relent. The U.S. government started to offer Federal land for set sales rates, starting in 1830 when a coalition of Western and Southern congressmen passed a preemption act that allowed a squatter to buy up to 160 acres of land at $1.25 per acre. This law would evolve over time, either to change the amount of eligible land for purchase or the price per acre. This effort culminated with the Homestead Act of 1862, which offered property rights and citizenship to any settler who occupied a piece of property and improved it over a period of at least five years. This law would also continue to evolve over time.
Smart Governance, Smart Law
U.S. law and its culture is unique, having evolved from British Common Law. Did you know that the British do not have a Constitution? They have a living, breathing set of laws that evolves as the situation “in the weeds” changes. The U.S., taking the concept in its own direction, is very similar in the degree of flexibility, and this was reinforced by a firm belief in states rights and the ability for states to do what was best for them — as long as it helped the U.S. grow, become wealthier, and continuously improve the living standards of the American people.
The law is an incredibly potent force when it comes to providing security, not just from crime, but more so overall security in life. What makes it so is the beautiful constitutional republic that we live in, the respect for our leaders of the law, and a general culture of respect for the entrepreneur.