Absence of property rights - a constraint on development

“Dead capital” is economist Hernando de Soto’s term for an asset that cannot easily be bought, sold, valued or used an investment. De Soto’s work argues that even those who live in slums possess far more capital than anyone realises. These possessions, however, are not represented in such a way as to make them effective financial assets because of an absence of property rights. Dead capital cannot, therefore, create value for the poor.

When you arrive in many developing countries, what you’re really leaving behind is the world of legally enforceable transactions and property rights.

The developed world has devised a formal property system of titles, title registries, and property law that covers real estate used for homes or businesses. We tend to take that system for granted, perhaps because it is invisible to us. De Soto argues that this is in a large factor determining why some nations are rich while others remain in poverty. A legal system with clear property rights gives banks the assurance they need to offer a mortgage. The bank will hold the official title or deed for an asset until the debt has been paid. But in the cities of the developing world, the legal infrastructure for mortgages is weak, so home mortgages in the developing world are rare.

In both the developed and developing world, homes are most people’s main asset. People in the developed world can get home equity loans. By one estimate, nearly two thirds of all small businesses in the US were started using funds derived from home equity. This is not the case in the developing world. Home equity loans are exceedingly rare. In fact, for the vast majority of buildings worldwide there are no titles. The problem is even bigger in rural areas, where land ownership can be hazy. Land and buildings are their owner’s largest asset, but because it’s difficult to prove ownership, it’s difficult to make those assets work.

All but the very poorest of the world have assets, but they lack the process to borrow against their property and create capital. They have houses but not titles, and lands but not deeds. Eighty percent of the world’s population are unable to use their assets as collateral for loans. As long as the assets of poor people are not properly documented and tracked within a legal system, they are effectively invisible to the marketplace. Developing world entrepreneurs will be unable to convert their assets into working capital.

De Soto believes that, “Without formal property, no matter how many assets the excluded accumulate or how hard they work, most people will not be able to prosper in a capitalist society. They will continue to be beyond the range of policymakers, of the reach of official records, and thus economically invisible.”