The Hudson Institute International Development Seminar - Transcript

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Herbert London - Let me just introduce a couple of people. Grant Aldonas, the Under Secretary of International Trade Association is here. Tom Bassett, the National Commander of the Salvation Army is with us. I thank you for being with us. We have Max Singer, a board member at the Hudson Institute. Always happy to see Max. He was one of the founders of the Hudson Institute. Grover Norquist, the Americans for Tax Reform. Alex Chafuen, who has been working with us very closely from the Atlas Economic Research Foundation, happy to have him as well. My dear friend, Jack Kemp who I think will be here momentarily. Jack, as some of you know, is one of the great figures in Washington. Of course, Ken Adelman, who is here for a variety of reasons. Not the least, of course, is that his wife is going to be making the introductory remarks. But it is always a pleasure to have Ken with us as well, who is formerly associated with the Reagan Administration. So, thank you all for being here. It’s really a pleasure to have you.

Many of you, perhaps all of you, know Hernando de Soto. He does not need an introduction. But let me make a couple of remarks nonetheless. It is fitting that he joins us at the Hudson Institute where we have put a great emphasis on free market principles. On the idea that developing societies can prosper with free market principles. In fact, Herman Kahn, the founder of the institute, believed that the developing world gained more from modernization than the developed world. This modernization is what our distinguished speaker is here today to talk about, on the eve of his trip to Egypt, where he will be participating in the unveiling of a new plan for property rights, and business law modernization.

I remember Hernando de Soto speaking at the Council on Foreign Relations… a couple of years ago. At that point, he pointed out if in fact title existed for the property of poor people in Egypt it would be more than the entire value of the entire stock market in Egypt, a point that I’m sure he will make this afternoon. I also noted when I was chatting with Mr. de Soto just a little while ago that my first introduction to him was a rather imperspicuous occasion. My friend Mark Malloch Brown invited Mario Llosa, who was then running for President of Peru, and yours truly to a lunch. I said to Mario Llosa, “tell me a little about your economic plans for the future of Peru.” He looked at me and he said, “well I can say it to you very simply, Hernando de Soto. He has already provided the architecture for the future of Peru’s economy.” For the last two decades Hernando de Soto has been a central part of the entire debate on property rights, which is really a debate on development and nation building. During that time, as he and I’ve already indicated, Carol Adelman, one of our Senior Fellows here at the Hudson Institute, collaborated on promoting his important work on developing countries while Carol was at USAID. Now, I’m going to ask Carol to provide the introduction. But, let me say again, it is a great honor and a privilege to be in the presence of Hernando de Soto, [who] I consider one of the great economic voices in the world today. Carol the floor is yours.

Carol Adelman - Thank you, Herb and welcome to everybody here. I first met Hernando through Peter Schaffer, Hernando’s representative of the Institute of Liberty and Democracy here in Washington, DC. I was overwhelmed by his ideas, having worked in the field of foreign aid and development economics. The new way that he had for us to look at development, understand what was working, why what we were trying wasn’t working, more importantly, and what we needed to do. So, Peter suggested that we have a dinner and try to help introduce Hernando to some influential thinkers but, more importantly people who loved the world of ideas. So, we put together a dinner with then, Senators Dan Quayle and Pete Wilson, then business executive, Don Rumsfeld, and then Congressman Dick Cheney of course. They proceeded to be overwhelmed as well. I remember at one point in the dinner, Mr. Rumsfeld turning to someone and saying, “who is this guy?” Hernando made a wonderful impression then, as he continues to do. It was at that dinner that we learned that Hernando had started off with many hats and had been the CEO of a Swiss engineering firm. It was in his European experience that he asked (inaudible)... and the very brilliant people ask brilliant questions. His question was, “why are Peruvians economically well off in Europe and not economically well off in Peru. What is happening here? Something must be going on. I know my countrymen and I know that they are smart and know that they can make it.”

That then led to his book the Other Path, which really explored the business infrastructure constraints, the reasons for the black market, how to get people out of that black market, and into the prosperity of a market economy. Then he was later given a platform by President Fujimori of Peru to implement that plan, which I think really was fundamental in the defeat of the shining path guerilla movement. His second book, The Mystery of Capitalism, was really a more in-depth exploration of the ideas in the Other Path. It was really looking at what he terms “the hidden architecture of capitalism,” primarily, property rights and the importance of property rights to wealth creation, again, to the bubble up, trickle up theory of development. He will talk about all of those things today. I think that it is not surprising that the Egyptians did want to work with Hernando and he has been doing that over the last two years. He’s going to talk about that today - the plans and what he has been talking about with them. Not surprising that they wouldn’t be impressed with this. He is off to, after this talk today, to a conference in Egypt that will be occurring in about four days time. It’s not just the Egyptians. Hernando and his ideas are leading leaders throughout the world. I don’t know if many of you tuned in or saw copies of President Bush’s speech yesterday in Monterrey. But, I want to read you what was in that speech. It is indicative of his influence on not just our then Senators and Congressman but on the current leaders and our current President. In the speech, President Bush said, “we must also chart a clear course towards a vibrant free market that will help lift people out of poverty and create a healthy middle class. We must increase the credit available to small businesses that generate the majority of jobs in all of our economies, and reduce the time that it takes to start a business. We must strengthen property rights so that land can be leveraged as a source of capital to start businesses or hire new workers.” So, I would say that this is not plagiarism but this is a direct lift, out of your two books. (Laughter) So, without any further a due, I want to introduce one of the greatest thinkers of our time and a great practitioner, which he’ll tell you about today, and a dear friend. Welcome Hernando.

Hernando de Soto - Thank you very much, Herb and Carol, for your very kind words and for talking about my ideas. In fact, my ideas are nothing more than your ideas because all I do is ... I’m sort of your ghost of Christmas past. All I do is inspire myself in your 18th and 19th century. I keep on reminding you that was a very important part of your history. That you should remember it, since you are the only world power, as frequently as possible. What I would like to come to talk to you about, because as Carol said, I’m on my way to Egypt, is what’s going to happen with this project that started to be designed some five years ago. That has involved about 20 Peruvians and over 100 Egyptians. We have been designing directly with the Egyptian government over this long period of time and is now going to be presented officially, shall we say, to Egyptian society. On the 17th of January, we will be meeting with the Egyptian economic cabinet….The Minister of Finance, Medhat Hassanain, who has been our continual interlocutor, Youssef Boutrous-Ghali, the Minister of Trade, etc. Then on the 18th of January, we will be meeting with about five hundred people, the inner circle of people who run the Egyptian political system to talk about the project for one whole day. This will be led by the Minister of Finance himself. We will have two champions of private property also present. One is the State Secretary for International Development of Norway and the other one is Jack Kemp. At the request of the Egyptians themselves, on the 19th of January we will meet with the Prime Minister and the Cabinet and all of this is in preparation for a May conference already with a thousand people, and authorities are invited from all over the Middle East. As the Egyptians plan on their own with our technical support to propose extending what they are doing to other Middle Eastern countries, we would like to very much help them. That is why talking about this with Carol and through Peter some weeks ago, they said this would be interesting for a US audience. I talked to my Egyptian counterparts and they thought it was also a great idea. So, I come here fully authorized. (Laughter).

The plan is about essentially ... about taking all of the extra legal sector of Egypt and integrating it under the rule of law. That means taking all of their enterprises… from street vendors to cottage industries into a new legal system. It will involve cutting business costs by about seventy five percent, providing new mechanisms for the enforcement of contract, the Swiss settlement of commercial disputes, and of course, the settlement of a property rights system. This actually started off, interestingly enough, at the initiative of the Egyptians themselves between 1995 and 1997 when we were [still] very busy actually looking at things in Peru. The Egyptians kept on calling us, but Egypt was so far away and at the end we got very curious. They had read the Other Path, which had been translated into Arabic. They said, in spite of what Samuel Huntington says, [that] “we seem to have many things in common.” We would like to find out what these things are. What these things are about. We got very curious about the whole thing. We went to Egypt. The Egyptians said, “why don’t we do the first thing that you’ve already done in Peru and El Salvador and let’s find out how big this extra legal sector is in our country.” We agreed to that. That was our first major foreign contract outside of Latin America. It lasted about a year. We called it the diagnosis. What we do there is simply find out how many people are inside the law. How many businesses are inside the law. How much real estate is inside the system because these are, of course, the major assets or the stalk of assets of any one country. Then on the basis of that, if the government is satisfied that these numbers are right they generally ask us so forth and then go to the second stages, how do we correct all of this. All of this in the case of Egypt is the fact that we found out that about eighty-eight percent of all businesses in Egypt operated outside of the legally system. Ninety-two percent of all real estate actually was not inside of the records. It doesn’t mean they don’t have title. It means that the title isn’t recorded. So, it’s like walking around with someone else’s credit card. It’s about officially forty percent of all workers.

As Herb was mentioning, the total amount of the assets of the extra legal sector, has a value of two hundred and forty-eight billion dollars of replacement value. Those two hundred and forty-eight billion dollars are, as Herb said, “much bigger than the Cairo Stock exchange.” It’s thirty times bigger than the Cairo stock exchange. It’s thirty-seven times bigger than all world back loans received (all hundred and twenty-three of them) by Egypt. It’s fifty-five times the value of foreign direct investment in Egypt which includes the Swiss Canal and the Aswan Down. When you get news like that, you find out that your own citizens have participated, and you’ve got the best technicians of Egyptians on your team, you obviously want to change that, because if you are a government you find out that you are actually not ruling most of the activities. You’re not in charge. You want to become in charge. That is the reason of being of a state. It’s a collective of people and territory and you have to have the rule of law. Now the other thing, of course, in detail is most of the people that were close to us ... this also meant that all of a sudden the idea of a market economy wasn’t just simply an idea imported from the United States. There was an Egyptian constituency but, it wasn’t in touch. This was the moment of bringing it in touch with their own particular cultural traits. The idea, of course, that they liked about it [is] that we didn’t propose to simply photocopy, which is what we generally do in Latin America. All of the laws that we find that are neat in the United States and Europe, [but when we] translate them to Spanish try and enact them, nobody follows them, because they’re not rooting the peoples beliefs. But, actually going to the extra legal sector and saying well you are all private enterprise. You are obviously not following the official rule but you are following other rules. Otherwise you couldn’t make contracts. You wouldn’t be able to produce. So, what we are going to do is systematize it. We’re going to modernize it. We’re going to professionalize it, we’re going to add ... (inaudible) If there is any changes we are going to talk to you. Because otherwise, we know they can’t be enforced because they will be outside of the social contract. That is basically what we are talking about. Making a social contract. The idea is to then also find out from our point of view, because we are very curious. We were told that there is something about the Latin American culture that is not compatible with capitalism. We don’t see that. It would be interesting what results we do get in the Middle East because there are also other people that believe that you are part of another reality.

Now, we’ve done that and I’m going to talk to you about what it is that we found out. The interesting thing, of course, is that we’ve also tried to see how far this can go. In other words, what kind of a difference will it make to Egypt if we integrate their extra legal sector under an efficient rule of law. We actually, sort of share the belief with many economic thinkers in the United States, that it’s not necessary to quantify the future effects of policy reforms, if you know that the impact and direction of these reforms can be determined. In other words, life is much too complicated to be captured in a numerical formula. What we have are concrete results which were only bringing together and sprucing it up. They’re disbursed throughout the world. First of all, the effects of our own projects in Peru with seventeen million dollars from USAID and 1.2 million dollars from SEIP.… There will be a study coming out of this shortly officially, some of it coming from the World Bank itself that indicates with that money that we received from you and additional twenty-eight million dollars that the Peruvian government that is from the World Bank we were able to produce net benefits for the poor of 9.4 billion dollars. That is to say, that it would be equivalent of an annual rate of return of one hundred and seventy three percent. That’s pretty good. All of that by simply changing two regimes. Not as much as we would have liked to because we were cut back. We had severe losses here and there. But, nevertheless, we were able to increase the value of homes. We were able to increase, as a result of it property rights under the better business law, the access to credit and the access to investment. The incomes interestingly enough in all homes in Peru that are titled there are two incomes for home and of those that aren’t titled there is only one income. Because for very simple reasons that, like you leave the wife at home or leave the husband at home, you don’t perceive that you have a total property right and you better be around so nobody takes it from you. When you do believe in the rule of law and the title that is given to you the record corresponds. Somebody else goes out and works and then your income starts doubling. So, all of that is in those 9.4 billion dollars. There are other things, of course, which are not in the 9.4 billion dollars which were recently brought up by a magnificent Princeton study that was done without our participation, which we actually only found out through a one page that was given to the New York Times…. In homes that are titled and in businesses that are authorized, of the sons and daughters of people that own the homes, twenty-eight percent of them go to school which they wouldn’t if it weren’t titled. It’s the same way that your wife goes out and gets the job if you are titled. You also let some of the children go to school because they don’t need that much more defense. So, in fact of all titled homes, child labor has gone down by twenty-eight percent. We haven’t quantified that. That is not in the 9.4 billion dollars. But, we have also seen other figures that are starting to come together.

Like for example, in China today, per capita income for Chinese farmers has increased from 1978 to 1988 by about one hundred and ninety-two percent. The productivity growth of all total crop output in China in titled farms, even though they don’t have a fee simple, but they have shorter titles and now they reaffirmed that recently, has increased by forty-eight percent. In Japan after the reforms that were encouraged and some times formulated by MacArthur and his intellectual teams, the farmer income between 1952 and 1958 of those who were titled went up by about eighty percent. In the Ukraine, just recently of the 6.7 families working in communes, three million were privately titled. Their income has gone up in the last three years eighty-one percent above those that have not been titled. We generally know that we are going in the right direction. Recently, we were also given by the Rural Development Institute of Roy Prosterman in Seattle, the Russian numbers, which is that reforms have gone very slowly in Russia. But, the five percent of land that has been titled mainly, of course, in the agricultural sector, which is the number that they have today produces, fifty percent of all the gross agricultural output of Russia. All the signs are there that it is not a bad thing. It is a good thing.

Nevertheless, it’s a little bit like when I go to the doctor and say, “ok doctor what are the chances that you can cure what I’ve got with pills without going putting me through surgery.” He says, “I don’t know. We’ll have to see.” But, I say, “give me percentages.” He says, “well I think we have ninety percent.” I feel good. I’m sure the doctor has no idea if it’s ninety percent or sixty percent. He’s just giving me something in the air. So, we also found out that our clients wanted to know what are the chances of growing in spite of the fact that we believe that there is no real way of predicting. It’s just going to be a lot better.

When we have collaborated, we have been very happy with the help we have gotten from all the way from Heritage Foundation, the Frazier Institute. We’ve talked to Harvard Professor Robert Barrow, Al Harberger at UCLA, and the McKenzie Global Institute, who have by the way, come to the [same] conclusion on the base of it’s productivity studies, not in the extra legal sector but just in general economic growth. That [is] if people were to adopt our reforms (this is the way it is stated by the India Financial Express), our reforms would produce in a country like India an increase in the gross domestic product per capita five percent per year after the fifty years. If you go to richer countries like Brazil, it would be a two percent growth. Having all of those figures floating around, of course, the Egyptians demanded numbers. We did a joint venture with the Frazier Institute and the University of Florida and managed in a short time to take their cross country regression out of this model, and take four of our twenty reforms and then predict what would happen to Egypt if only four of the twenty packages that are reform proposals were put forward. If they were implemented in Egypt, the result is that Egypt’s gross domestic product per capita output would be two percent by the fifth year. In other words, we could double just by giving the poor their homes, their title for their homes, and their businesses. We could double the growth rate, with only four of the whole twenty reforms. Our own microeconomic growth model indicates that total benefits after ten years will actually be over thirty-two billion dollars. So, all of the signs are good whether all this comes out or not. At least, all of the churches of microeconomic schools seem to be pointing in the right direction. Now regarding, the reforms themselves, most of these reforms are basically about identifying what are the costs to the poor. This takes a long time because it means living with them. It means actually getting objective measurement of what it cost them to live with Egyptian law. There we have found out, for example, the [cost of] building a home in a sand dune, not unlike Peru or any other country in the world. In other words, Egypt is no different from any other developing countries. It takes seventeen years to get authorization to build a home or if you want to have authorization to build a bakery it could take up to five hundred forty nine days. Those are only the entry costs. Apart from that there are the operation costs, there’s the expansion cost, and there are the exit costs. Because you’ve got to be able to get out and reconstitute a business if things are clear. So, what we have done is basically eliminate seventy five percent of those costs. We’ve taken three hundred dispersed laws and decrees that refer to how you operate businesses and property [and] how you run property into one and only one set of laws. We have taken fifty-six different uncoordinated government agencies and proposed that they be, some of their functions be put into just one organization, a one stop sort of licensing system. We have a system so that the time required to enforce a pledge by the judiciary could be reduced by seventy-seven percent. The time required to enforce a mortgage… has been reduced by fifty-five percent, etc. This is real stuff. Because the real cost reduction is probably as Al Halberger has said, “the major thing you can do for development. Just lower transaction cost of all sorts.” But, I would like to tell you what is behind these measures instead of giving you an enumerable, an unfinished list which will be unending. Essentially, we are aiming at three things. We are aiming at making sure that all Egyptians have a right to divide labor among themselves inside their organization. Number two, we are aiming at seeing that all Egyptians are allowed to specialize in an expanded market and not just the neighborhoods, which is what happens when you don’t have law. You’ve got to know your clients. You’ve got to know your partners. The third thing, is that they have property rights. These are the three objectives. Now the division of labor is a very old concept but, it’s a very crucial one in our part of the world, and all of the former Soviet Union. This is was well illustrated by Adam Smith when he had said that, albeit on the basis of personal observations, that when one or more people run a pen factory, they are lucky if they get to produce one pen a day. But, he had seen that when eleven people had gotten together to produce pens, this is again back in the eighteenth century, they were able to produce up to forty eight thousand pens a day. How was that done? He said, “the division of labor.” Division of labor, of course, is a concept that goes all the way back to Plato and even before Plato. It talked about how husband and wife should divide labor and how productive that was. Then Aristotle came and said, “not only husband and wife but how you divide it with your slaves as well.” It’s gotten more democratic since then, but, this is more or less the tendency. What Adam Smith was trying to say and Marx, concurred is, “why all of a sudden have we begun to have re-growth in Europe?” They said, “we have just found better ways of dividing labor.” In that context, the pen factory they said, “is when we saw eleven people things just got better?” So, as Smith explains how one would purchase the wire, another person within the eleven would draw the wire to make sure that it was perfectly stretched out, another person would cut the wire, two others ones would put a point in the wire, another one would put the head on the wire, and at the end because you divided labor in a chain, you were able to do forty eight thousand pens versus one pen a day. He said, “that is the source of it all.” That is why Marx comes along and says, “yes, it’s the division of labor.” That is why Lenin follows and talks about the socialist division of labor because there is no doubt that is where it’s at. But, now the question that we have asked ourselves in Peru, as we start saying well why can’t Peruvians divide labor as well as, everybody else? How important it is to have a business organization? You see, most of the people who are poor in the world work within an organization, the family. In the family, it is very difficult to work because it is mixed up with emotions, and with other functions. So, for example you can go some place and say “who is the CEO of this family?” It looks like the father and somebody looks around and says, “you know, I really think it’s the mother.” Somebody comes back and says, “grannies influence on all of them is absolutely crucial.” You don’t really know who you are dealing with [or] who really controls the funds. How much of property can you actually commit or engage or not engage is a problem. You may also not be able to associate for the best people in the neighborhood because you have no way to contract them. They have to come work your families. So, you are obliged to work with your retarded brother and the scoundrel of your brother-in-law… whether you like him or not. But, these are the only people in which you have peer pressure.

What happens, if all of a sudden, you are given business organization? Well, if you’ve got a business organization, you know who is the CEO, and what he’s accountable for. You know who is share holders are. You know who holds the assets and which ones can be committed for credit. You know who can issue shares and therefore, you know where to invest. You’ve got clear rules that protect mortgages, that protect workers, [and] that protect investors. You’ve got clear company policy. You’ve got statutes that determine what you can and what you can’t be charged with. You’ve got perpetual succession, which means when you make a deal with a company and if dad dies it doesn’t matter, because, as Vasquel used to say, “we finally created an immortal person, which is the moral person.” It can just keep on going if it’s successful. Well, if you make a deal with someone in Peru or Egypt, you better go out and give them a medical examination to find out if he’s going to last, because if he doesn’t last past tomorrow, you’ve got a very bad deal.

There is no asset for partitioning. There is no protection and innovation. It is of course, extremely difficult to get eleven people under one roof. It is very hard to have a family where you have eleven able people. Therefore, the possibility of making Adam Smith’s pen factory is very small. If it takes you five hundred and forty-nine days to adapt that legal structure, to buy your rights to that legal structure, that’s only the cost of entry in Egypt. Obviously, you have very low productivity. So, one of our first objective is to get people into enterprises. The argument against us is always but you are destroying traditional family values. But, then we’ve gone back to the statistics and eighty percent of US companies are still family run, so obviously it doesn’t destroy the family. On the contrary, it helps it, because not everybody has to run the family business. You create an unemotional space in which to deal with business and emotionally spaces in which to deal with other family stuff. So there is no such thing as this thing going counter to all of these values. The first thing that we do with all of our objectives is ... (inaudible) how do let people quickly get, to have the possibility of dividing labor internally in the same way that Americans only got a right to in 1840s? Before 1840, in the United States you could only do it with an Act of Congress or the local Congress. Before that with the Brits, it was with the King. The Brits only got a right to do without political authorization in the 1870s and the French in about 1848. This is a brand new right that is only about one hundred fifty to one hundred sixty years old. But, it is a right that doesn’t exist for the majority of the people in the third world and the former Soviet Union. So, how do you expect the market economy to work, if you don’t have the shell, the contraction that is needed to do the division of labor which according to every economist in the world is the very first source of productivity?

The second thing has to do with fiscal allocation. People have got to be able to deal with other people that are not in their neighborhoods, so as to divide labor or if you wanted to exchange on the broader market. The thinker behind this is of, course, was David Ricardo, who kept on saying if you are able to trade on the basis of comparative advantage in ever widening circles, you can then specialize to the point that, of course, your productivity also rises. You can’t do that in the extra legal sector which predominates, as I said before, ninety-two percent of all real estate in Egypt and eighty-eight percent of their enterprises because you’re are not titled, you’re are not authorized to. I’m sorry, I’m going to use an example that some of you might have seen before…[about] when I came in here to the United States. At this time... I was asked at your immigrations desk, [and] as opposed to what Herb said, “Hernando certainly needs no introduction,” I did need an introduction, (Laughter) because when I said, “I’m just Hernando de Soto,” they said, “that is not enough.” In fact, this time they took my finger prints in addition. But I still didn’t get pass until I showed a standard document which identified me, which is my Peruvian passport. So, if you think about everything that moves in the world in the legal economy, whether it’s a value of your shares, whether it’s a person, everything moves including your automobile with a license plate of some sort. That’s the only way that a world of six to seven billion people we are able, we may be all brothers and sisters, but that is the only way to identify each other….There are just too many of us. The market only works with as much as you can identify yourself with other people. The question then is, “what happens when you do not have a passport? What happens when you don’t have a license?” You can only do a deal with your neighbors. If you do that, your chances of specializing in a wider market are of course enormously reduced. Not only that you can’t get credit. Who is going to give you credit if they don’t know what assets you own? You can’t get investment. How are you going to be