Dean's World

Why are poor countries poor?

A commenter's reference to "dead capital" reminded me of DeSoto's excellent book on the subject, which had a profound impact on me when I read it several years ago. Here's an essay from DeSoto that captures the point nicely:

Walk down most roads in the Middle East, the former Soviet Union, or Latin America, and you will see many things: houses used for shelter; parcels of land being tilled, sowed, and harvested; merchandise being bought and sold. Assets in developing and former communist countries primarily serve these immediate physical purposes. In the West, however, the same assets also lead a parallel life as capital outside the physical world. They can be used to put in motion more production by securing the interests of other parties as "collateral" for a mortgage, for example, or by assuring the supply of other forms of credit and public utilities.
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The lack of legal property thus explains why citizens in developing and former communist nations cannot make profitable contracts with strangers and cannot get credit, insurance, or utilities services: they have no property to lose. Because they have no legal property, they are taken seriously as contracting parties only by their immediate family and neighbors. People with nothing to lose are trapped in the grubby basement of the precapitalist world.

Read the whole thing.

In his book, DeSoto shows the incredibly strong positive correlation between GDP per capita and well-defined, well-regulated mechanisms for collateralization and capital transfer. The statistic that stuck with me was one about the impoverished nation of Haiti, where, after all the bribes and forms and required permissions from various departments, it takes on average fourteen years to transfer ownership of real estate.

Imagine for a moment you are trying to sell your home, and you have to warn potential buyers that it will probably take a decade and a half before title can be transferred; it would obviously be a huge disincentive, and many potential transactees could not even expect to survive the length of the transaction. It's easy to see how the prevalence of this kind of barrier could cause an economy to grind to a halt.

In poor countries, the net result of this is to reduce the transferable value of the main asset of the poorest — their homes — to near-zero. Imagine the effect on the United States if all property values in America suddenly dropped 99%, and you'll begin to understand what a crushing burden this "dead capital" inflicts on poor countries.

Of course, this also means that if efficient capital-releasing mechanisms can be established in poor countries, it's highly likely they can become wealthy. As we help newly liberated Iraqis and Afghanis toward self-sufficiency, this provides hope they will be able to build the kind of prosperity (long taken for granted here in the West) that helps establish stability and security, if these lessons are properly applied.