The Promise and Peril of Property Rights Formalization

Abstract

Free trade, free markets, and international investment are the paths to prosperity, but despite widespread adoption of these staples of the Washington Consensus more than 1.2 billion people still live on less than $1 per day. The search for determining the missing factor beyond these orthodox remedies for relieving poverty has led some to conclude that it is the growth of local capital markets built on robust, formalized property rights regimes that has led to uneven rates of economic development. This paper offers a critique of this hypothesis put forward in the property rights formalization literature, in particular Hernando de Soto’s work The Mystery of Capital that sparked popular interest in the field.De Soto generally has one big idea per book. In The Other Path, he argued that the reason that informal economies existed was the large degree of bureaucracy in developing countries that forced small businesses to stay unregistered, and caused land to be untitled. The big idea behind The Mystery of Capital is that formalized, state-sanctioned property rights generate capital and promote economic development, as seen in the relative success of the legal systems of developed countries that have formalized their informal economies. This formalization allowed property to generate capital and grow developed economies. The explicit argument then is; if it worked for the West, it will work for the rest. In essence, De Soto and his compatriots argue that “This [formalized property] is the mystery of capital. Solving it requires an understanding of why Westerners, by representing assets with titles, are able to see and draw out capital from them.” Formalizing property rights is a popular idea. Endorsements range from Ronald Coase, Milton Friedman, Francis Fukayama, Jeanne Kirkpatrick, to David Owen, and Margaret Thatcher. Bill Clinton publicly declared that de Soto was “probably the world’s most important living economist” for his work on property rights formalization. Even the World Bank now largely agrees with de Soto’s analysis, stating that “[l]and is a key asset for the rural and urban poor.” The goal of this paper is to determine whether such widespread praise for property rights formalization is justified based on an analysis of the available empirical literature on the subject. Particular attention will be paid to the importance of considering the various derivations of property rights in culturally relative terms.The paper is structured as follows. Part I offers a general introduction to the property rights formalization literature, along with de Soto’s thesis and primary claims. Part II critiques de Soto’s methodology and data. Part III compares de Soto’s results with those of other empirical studies measuring the efficacy of property rights formalization. Part IV focuses on how these lessons have been applied using a case study from Indonesia and examples from South Africa. Finally, Part V summarizes the promise and perils of property rights formalization. In conclusion, property rights formalization does hold the promise of unlocking capital and spurring economic development, but reform must be both comprehensive and culturally relative considering the unique cultural, social, and political heritage of the societies in question.