Slumdogs vs. Millionaires

Although it's hard to believe, Wall Street's Gucci-wearing financiers actually have quite a bit in common with slum dwellers in Kenya and Mumbai at the moment—they're both mired in shadow economies, where basic facts like who owns what are nearly impossible to determine. That murkiness, says Peruvian economist Hernando de Soto, is the source of the continuing credit crunch gripping New York, London and other financial capitals, and a basic fact of life for much of the developing world. (Read de Soto's article on the subject here. De Soto, who now runs the Institute for Liberty and Democracy, a global think tank, spoke with NEWSWEEK's Barrett Sheridan from his office in Lima. Excerpts:

NEWSWEEK: Your bestseller, "The Mystery of Capital," tackles the idea of property rights and their impact on economic development.
Hernando de Soto: What makes a market economy possible is that people are able to find out facts about each other and about their enterprises in spite of the fact that they don't have direct physical contact. So the question is, how do you get to know things? How do you get facts? You will find out that most of the facts you want are in property papers. One of the things that developing countries miss is that close to 80 percent of their enterprises are actually not fully recorded as property.

And the simplest way in which this idea takes shape is that a lot of poor people in the developing world don't have deeds to their houses.
They don't have recorded deeds. They may actually have a deed, but it's not in the knowledge system, therefore you can't read about it.

So this knowledge of who owns what is not standardized.
It's not standardized and it's not distributed. I may have a manuscript here that actually says—from the King of Spain—that ever since the Spaniards landed in Peru, I own this land. But you may not know about it unless I record it.

Why does ownership matter so much?
Ownership means that I have something to lose. If you're a banker, it means that you've got collateral. It also means that I'm credible, so you can give me credit. When you think about it, whether it's ownership, whether it's credit, whether it's capital, whether it's identification, none of the things that make a modern economy are possible without property.

How does this relate to the financial crisis?
The enormous amount of derivatives that had poured into the market—there are close to $600 trillion of these papers around—are also not recorded in a global or centralized manner, or in a manner that allows you to begin to quantify them. [Former SEC Chairman Christopher] Cox thought that maybe the toxic part of all of these assets was $1 trillion to $2 trillion. [Treasury Secretary Timothy] Geithner told us there's maybe $3 trillion or $4 trillion. Nobody really knows, so in a way [they've created an] informal or shadow economy. This unidentified paper is the source of uncertainty and the credit contraction.

So they're unidentified in the same way that ownership of, say, a slum in Peru or Africa is unidentified.
That's right. We have worked in places like Tanzania and Egypt and Ethiopia. When you go visit a home there you don't find justification for it through the books. In other words, it's not centrally available information. When you talk about shadow economies in many places, it's not only the economy of gangsters. It's also economies that are legal in every respect except for the fact that the paper, which backs up the ownership or the evidence that something exists, is not easily and publicly available. That creates the shadow.