Why Poor Countries Stay Poor?

According to economist Hernando de Soto, in poor countries the main road block to growth is not lack of wealth. The issue is that most of the wealth held by citizens cannot be leveraged as collateral for any kind of routine financial or economic transactions:  like getting a mortgage, a consumer loan, or a commercial loan in order to start, expand or purchase a business. In the U.S. in Europe, and elsewhere there are deeds held by property owners and accessible public documents that clearly define the boundaries of a property and allow anybody to reliably trace its lawful owners. Whenever properties are bought and sold, the records are updated to reflect all transactions. All this is clear and transparent.

Owners in turn can use their legally owned real estate assets as collateral in order to get credit from banks or other financial institutions. In emerging countries, for most people access to credit is almost impossible, because most people do not “legally” own what they have. Therefore they cannot use it as collateral that would be accepted by banks in order to get a loan.

Now, we all know that commercial credit is the yeast of all capitalist economies. It is really hard to have economic growth without commercial loans. Other means may exist within the informal sector, (think “loan sharks”), but they are generally extremely onerous in terms of short repayment terms and exorbitant interest rates; and therefore unappealing in most cases.

And how much “dead capital”, (meaning capital that exists but cannot be leveraged), are we talking about? Well, according to de Soto, an enormous amount:

“By our calculations, [de Soto and his team spread over several countries to conduct their research] the total value of the real estate held but not legally owned by the poor of the Third World and former communist nations is at least $ 9.3 trillion”.

“This is a number worth pondering: $ 9.3 trillion is about twice as much as the total circulating U.S. money supply….It is more than twenty times the total direct foreign investment into all Third World and former communist countries in the ten years after 1989, forty-six times as the World Bank loans of the past three decades, and ninety-three times as much as all development assistance from all advanced countries to the Third World in the same period”.

–Hernando de Soto, The Mystery of Capital, published in 2000

These are truly amazing figures. Yes, poor countries are poor. But not as poor as we would think. The problem is that whatever wealth most individuals hold in these countries, it cannot be used as an asset. This is a major impediment to growth. It should be stressed that this impediment has nothing to do with how much or how hard people work in these countries. People do work and they acquire assets.

The problem is all about the failure to create a modern property laws system that would allow citizens to gain legal title to what they own, this way transforming “dead capital” into “live capital”. In the light of de Soto’s remarkable findings, this institutional modernization effort should be priority one for both governments and donors who want to fast track economic growth in developing countries.

NOTE: Data cited in de Soto’s book goes up to the year 2000. Since then the picture may have shifted somewhat. But there has been no dramatic transformation, because in most developing countries property is still held mostly without proper legal title. Therefore, it cannot be used as collateral for commercial loans and/or any other form of financing.