A tale of two civilizations in the era of Facebook and blockchain

My work illustrates that in many countries in the world, the poor have become a new class of entrepreneurs. It also aims to explain why and how the poor organizes themselves outside the law. It makes the case that social and political peace will not be possible until all of those who know that they are excluded feel they have a fair chance to achieve the standards of the West. My first book, The Other Path (de Soto 1989), was based on extensive research that my colleagues and I did in Peru and sets the scene for reform.¹ It was also a landmark in the ILD’s own development from a traditional “think tank” to the “think and acting” organization that we became in the 1990s, first in Peru then worldwide. Based on facts, numbers, and historically based analyses, The Other Path makes the following major points:

A main argument in the book is that the existing legal system in Peru at the time did not work in favor of the poor. Instead, it excluded them. Based on real case histories and simulations, the book demonstrated that in Peru, for example, it took a new entrepreneur 13 years to overcome the legal and administrative hurdles required to build a retail market for food that would help take vendors off the street; 21 years to obtain authorization to construct a legally titled building on wasteland; 26 months to get authorization to operate a new bus route, and nearly a year, working 6 hours a day, to gain the legal license to operate a sewing machine for commercial purposes.

In the face of such obstacles, new entrepreneurs hold their assets outside the law and therefore do not have access to the facilitative devices that a formal legal system should provide to help them organize and leverage resources. Because they have no secure property rights and cannot issue shares, they cannot capture investment. Because they have no patents or royalties, they cannot encourage or protect innovations. Because they do not have access to contracts and justice organized on a wide scale, they cannot develop long-term projects. Because they cannot legally burden their assets, they are unable to use their homes and businesses to guarantee credit. If European and American businessmen did not have access to the limited liability systems and insurance policies that the law allows, how many risks would they run? How much capital would they accumulate without legally created paper that can represent value? How many resources would they be able to pool without legally recognized business organizations that can issue shares? How often would Europeans or Americans choose bankruptcy and try to start all over again if the law did not allow them to convert their debts into shares?

Because the poor cannot hold assets or trade within the law, they cannot be part of the global economy either. How can you fill in a bill of lading if you do not have a legal address or an officially recognized business? How can you move an asset in the international market place if it is not fixed in a formal property system? Obviously you cannot, and that is why the excluded will not benefit very much from globalization. Moreover, can you understand what the poor feel when a foreign investor comes into their country with clear legal property rights that can be enforced both nationally and internationally, while they have none? Do you think they will sympathize with globalization, or do you think they will feel it is exclusive and unfair?

My ILD colleagues and I realized that property is more than just ownership; it is the hidden architecture that organizes the market economy in every Western nation. Without a legal property system, efforts to create a sustainable market economy are doomed to fail, as I have argued at length in my other major book, The Mystery of Capital: Why Capitalism Triumphs in the West and Fails Everywhere Else (de Soto 2000).

The connection between the formal property system and the creation of wealth is something that the rich nations of the West take for granted. But this essential connection became clear to us only when we realized that in spite of owning houses and businesses, most Peruvians could not generate wealth because their assets were held outside the legal property system. And thus in numerous articles and pamphlets, posters and TV spots, the ILD argued that without property institutions and organizations, a modern market economy cannot work. Why? Because ownership cannot be certain, addresses cannot be systematically verified, assets cannot be described according to standard business practices, people cannot be made to pay their debts, authors of fraud and losses cannot be easily identified. As a result, buildings and land cannot be used to guarantee credit or contracts. Ownership of businesses cannot be divided and represented in shares that investors can buy. Without property law, capital itself is impossible to create because the instruments that store and transfer value, such as shares of corporate stock, patent rights, promissory notes, bills of exchange, and bonds, are all determined by the architecture of legal relationships with which a property system is built.

Gaining this insight not from books but by talking to the poor and observing how they lived, we were able to design and implement a legal property system around the objective interests of the poor themselves. The legal devices we created worked because we made sure that they were compatible with the principles that the poor already used in the extralegal economy. More importantly, by relying on the poor for rule making and support, the Peruvian government could now push for reform, but not in the name of a foreign ideology, philosophers the people had never heard of, or the dictates of an international financial institution. They could institute major reforms in the name of the nation’s poor. This allowed us to convert (at least for a while) the transition to capitalism and liberal democracy into what it should always be—a truly humanist cause, a genuine war against exclusion, rooted in the best interests of the nation. This provided the Peruvian head of state with a formidable argument: “The majority of the nation’s population is cut off from the official market economy and access to capital as starkly as apartheid once separated white and black South Africans and we are going to correct that.”

ILD undertook several measures to resolve issues of the Peruvian legal system. For example, ILD put into place all the legislation and mechanisms required to bring into the law most extralegal real estate and businesses. On the real estate side, we brought down the administrative time needed to record the property of the poor from more than a dozen years to 1 month, and cut the costs by 99%. By 1995, such reforms had brought into the legal system some 300,000 owners whose property on average at least doubled in value. Twenty-five credit institutions began giving loans to these now legal owners. By 2000, some 1.2 million buildings on urban land had entered the legal system, about 75% of the extralegal market.

On the business side, we cut the cost of entering business from some 300 days down to 1. We also put registration offices in the right places and made the government bureaucracy more user-friendly for small entrepreneurs. By 1994, over 270,000 formerly extralegal entrepreneurs had entered the legal economy, creating over half a million new jobs and increasing tax revenues by US$1.2 billion.

ILD’s goal was to figure out ways of bringing the majority of Peruvians into a legal system that had traditionally shut them out and thus stunted the nation’s economic development.

What I came to understand was that a massive social and economic revolution was underway in the developing world rivaling the Industrial Revolution in the West that gave rise to market capitalism. In the last 40 years, some 4 billion people, who had been living in the hinterlands of developing countries and former Soviet nations, have abandoned their traditional way of life. They are moving away from small, isolated communities towards a larger and more global division of labor in the expanding markets that both Adam Smith and Karl Marx had seen emerging in the West 200 years ago, and that are now struggling to emerge outside the West.

The difference between today’s industrial revolution and the one that began in the West more than 200 years ago is that this new revolution is roaring ahead much faster and transforming the lives of many more people. Britain supported just 8 million people when it began its 250-year progression from the farm to the laptop computer. Indonesia is making that same journey in only 4 decades—with a population of more than 200 million. Is it any wonder that Indonesia’s institutions have been slow to adapt? But adapt they must. A tide of humanity has moved from isolated communities and households to participate in ever-widening circles of economic and intellectual exchange. It is this tide that has transformed Jakarta, Mexico City, São Paolo, Nairobi, Bombay, Shanghai, and Manila into megacities of 10, 20, 30 million and overwhelmed their political and legal institutions.

Instead of helping them, the law excludes them. It is this legal lag that produces a pervasive sense of alienation—of being a class apart. Some have argued that the appearance of small enclaves of prosperous economic sectors in the midst of large undeveloped or informal sectors marks the dawn of an uneven but nevertheless inevitable and easy transition to capitalist systems. I do not buy this. The existence of prosperous enclaves in a sea of poverty conceals an abysmal retardation in many nations’ capacities to create channels of communication with these excluded people—the majority of their citizens—and to make available the underpinnings of the rule of law by providing them with formal property rights.

Human communities transformed themselves into civilizations when they titled and recorded the indefinite property rights they respected in rule-bound ledgers, thus providing entrepreneurs the knowledge and means to securely combine rights to inconsequential single assets into more valuable wholes.

The result today is two unequal civilizations:

The consequences of most of the world not having the property rights needed to combine are, to a great extent, terrorism, conflicts over the environment, migration, the lack of public services, and even revolution.

Peru and other countries in the developing world encounter several problems. Below I list what I consider to be the most important problems that I have come in contact with in my work around the world.

In my experience, giving property rights might help end violence, provided it is a bottom up process, i.e., that rights are given in terms of the social contract which underpins the disconnected ledgers. The authorities managing the local ledgers have to be engaged directly with their constituencies addressed through crowd sourcing media.

In the uphill process of figuring out how to give appropriate property rights to those that do not have them, we learnt through trial and error how to think and act in a world split into two civilizations. I am not saying that these methods are applicable in all circumstances nor that they should meet everyone’s approval but they are the ones that worked for us.

Why was it so difficult to recognize that the Arab Spring—and all the other revolutions in the lagging civilization—are motivated by the desire of millions of ordinary people operating outside the law to protect and combine assets and thus join the Industrial Revolution? One difficulty could be that some Westerners bundle property rights with the notion of privilege and have difficulties in treating them separately. Whatever the case, we are now divided into two distant civilizations, the complex and the simple, which means we are still a long way from becoming a global village.

Another difficulty is that the difficulty of visualizing the institutions that hold together the societies of the lagging civilization. These institutions are housed in thousands of disconnected ledgers and hidden in millions of pieces of legislation, statutes, and regulations. I now believe that can be remedied by editing that information so that it fits on digital screens, aggregated and linked to the current affairs that concern us—and thus clearly seen.

Reading over what I have just written, I believe more and more that rule bound property ledgers are an extraordinary creation of mankind. Unlike tigers and wolves, who bare their teeth to protect their territory, we humans, much weaker animals physically, have used our minds to create a legal environment where on the basis of consensuses materialized in ledgers; we can protect our territories with rights instead of fights.

In the process of structuring a legal system to settle claims, we have inadvertently created a system that has taken on a life of its own, providing us the knowledge we need to improve the lives of poor entrepreneurs around the world. As Alexis de Tocqueville once wrote: “Knowledge of how to combine is the mother of all other forms of knowledge.”