governments at their discretion can seize my property, how valuable are
my property rights? Under constant fear of expropriation, what effort will
I put forward to improve my property? And what price can I set for it if I
choose to sell it?
It has been startling to see over the years what even a little private
ownership will do. When China granted highly diluted rights of ownership
to the rural residents who tilled vast community-owned agricultural plots,
yield per acre and rural standards of living rose measurably. It was an unrelentingly
embarrassing stain on the Soviet Union's central planning that a
very substantial percentage of its crops came from "privately owned" plots
that covered only a small fraction of tilled land.
As living requires physical property—food, clothing, homes—people
need the legal protection to own and dispose of such property without the
threat of arbitrary confiscation by the state or mobs in the street. To be sure,
people have to and do survive in totalitarian societies. But theirs is a lesser
existence. John Locke, the seventeenth-century British philosopher whose
contributions to the Enlightenment evoked a set of principles that profoundly
influenced the notions of the Founding Fathers of the United
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States, wrote in 1690 that man "hath by nature a power" to preserve "his
life, liberty and estate, against the injuries and attempts of other men."*
Regrettably, the notion of rights to capital and other income-earning
assets remains conflicted, especially in societies that still believe that profit
seeking is not quite moral. A key purpose of property rights, after all, is to
protect assets in order to use them to profit. Such rights are not supportable
in a society that holds any significant remnant of the Marxist view of property
as "theft." That notion rests on the presumption that wealth created
under a division of labor is produced jointly, and hence is owned collectively.
Any rights inhering in an individual therefore must be "stolen" from
society as a whole. Such a view, of course, predates Marx and has deep roots
in many religions.
The presumption of individual property ownership and the legality of
its transfer must be deeply embedded in the culture of a society for free-
market economies to function effectively. In the West, the moral validity of
property rights is accepted, or at least acquiesced in, by virtually the whole
of the population. Attitudes toward property ownership are passed from
one generation to the next through family values and education. These attitudes
derive from the deepest values governing social interaction that
people hold. Hence, the transition from the so-called collective rights of
socialist economies to the individual property rights of market economies
can be expected to be slow. Altering what a nation teaches its children is
difficult and cannot be accomplished overnight.
Clearly, not all democracies protect the private right of property with
the same fervor. Indeed, they vary widely. India, the largest democracy in
the world, has so much regulation of business activity that it significantly
weakens the right to freely use and dispose of individual property, an essential
measure of the degree of property-rights protection. Nor is it the
'"Locke's assertion, in his Second Treatise ofCitnl Government, is worth citing in full: "Man being
born, as has been proved, with a title to perfect freedom, and an uncontrouled enjoyment of all
the rights and privileges of the law of nature, equally with any other man, or number of men
in the world, hath by nature a power, not only to preserve his property, that is, his life, liberty and
estate, against the injuries and attempts of other men; but to judge of, and punish the breaches
of that law in others, as he is persuaded the offence deserves, even with death itself, in crimes
where the heinousness of the fact, in his opinion, requires it" (chapter 7, section 87).
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case that all societies with firmly protected property rights bend invariably
to the majority will of the populace on all public issues. Certainly in its earlier
years Hong Kong did not have a democratic process but a "list of rights"
protected by British common law. Singapore, from a similar heritage, protects
property and contract rights, the crucial pillars of market efficiency,
but lacks other characteristics of Western democracies with which we are
familiar. Nonetheless, democracies with a free press and protection of minority
rights are the most effective form of government that safeguards
property rights, largely because such democracies rarely allow discontent to
rise to a point that leads to explosive changes in economic regimes. Authoritarian
capitalism, on the other hand, is inherently unstable because it
forces aggrieved citizens to seek redress outside the law. That risk is capitalized
in higher financing costs.
While the debate over property rights and democracy will doubtless persist,
I was taken with an observation made by Amartya Sen, the Nobel Prize
winner in economics: "In the terrible history of famines in the world, no substantial
famine has ever occurred in any independent and democratic country
with a relatively free press. We cannot find exceptions to this rule, no matter
where we look." With the media in authoritarian regimes tending toward self-
censorship, market-interventionist policies—the most prevalent cause of disrupted
distribution of food—go unreported and uncorrected until too late.
The importance of property rights is a larger issue than that of creating
incentives to invest by established business or even incentives for inventors
tinkering in a garage. Hernando de Soto, the Peruvian economist, came to
the Federal Reserve in January 2003 to brief me on a seemingly radical idea
to elevate the standard of living of a significant segment of the world's impoverished.
One of the aspects of my job was meeting with foreign visitors
who passed through my office when they were in town. These opportunities
were a valuable source of information for me and the Fed staff members
who often sat in on the meetings. De Soto's reputation, at least as
best I could judge it, was of a well-intentioned but misguided idealist, or
somewhat less flatteringly, a Don Quixote attacking windmills. His simple
notion was that most poverty-stricken squatters had effective use of
property—homes or land—but suffered from the lack of legal title that
would enable them to sell the property for cash or use it as collateral for a
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loan from a bank or other financial institution. If a clear, legal title to the
property could be established, large amounts of wealth would be unlocked.
I thought it a novel idea worth considering; certainly other theories of development
had little to show for themselves, despite the vast sums of official
foreign aid spent on them since World War II.
In any event, I was sufficiently intrigued to meet with de Soto. His calculations
suggested untapped property values exceeding $9 trillion worldwide.
If even remotely accurate, it would be a notable addition to the value
of legally protected property. He had been meeting with politicians in
many developing countries to try to bring legal clarity to much of the poverty-
stricken world's de facto land ownership. De Soto was optimistic, but I
did not believe he was likely to make as much progress as he hoped.
After he departed, I wondered: Is it possible that he is onto something
that we have somehow missed? It was evident to me that he would have
difficulty persuading often corrupt politicians to cede the rights to what
amounted to de facto, if not de jure, state property. There were two seemingly
insurmountable barriers to de Soto's goals. First, a significant number
of developing-world politicians believe in some form of collective ownership,
even if they shy away from the notion that property is theft. Perhaps
more relevant, granting legal authority to sell or collateralize squatters' land
would empower a significant segment of a society, with a comparable dilution
of politicians' power. Legalization would remove the latent power to
confiscate at will large segments of squatters' land. However, recent incidents
in China suggest how politically destabilizing that can be. In the endeavor
to modernize, many provincial and local Chinese authorities in their
version of creative destruction periodically confiscate peasants' land for development.
Riots have been widespread. Granting clear legal ownership
rights to peasants for the land they till would go a very long way toward
putting an end to such discontent.* Though the means to get there may not
be altogether clear, Hernando de Soto's goal is a very appealing one.
Protection of property has always been a moving target as the law continually
tries to keep up with the nature of economic change. Even in the
*"Recognition" of property rights by China's National Congress of the People in March 2007
shied away from granting unequivocal rights to rural land.
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United States, where property rights are broadly protected, the claims of
property owners in New London, Connecticut, whose land was taken over
by city government in 2005 for commercial redevelopment, were brought
to the U.S. Supreme Court. The Court's ruling in favor of city government
provoked loud outcries in the Congress. So it's not surprising that different
cultures have different views as to whether and to what extent property
should be protected. This issue is becoming pronounced as property is becoming
increasingly intellectual. I explore that thicket in chapter 25.
While the rule of law and property rights appear to me to be the most
prominent institutional pillars of economic growth and prosperity, other
factors are also clearly essential.
Historically, societies that seek high levels of instant gratification and
are willing to borrow against future incomes to achieve it have more often
than not suffered inflation and stagnation. The economies of such societies
tend to run larger government budget deficits financed with fiat money
from a printing press. Eventually, the ensuing inflation leads to recession, or
worse, often because central banks are forced to clamp down. Then the
process starts all over again. Many countries in Latin America have been
particularly prone to this "populist" malady, as I discuss in chapter 17.1 regret
that the United States may not be wholly immune to it.
A rarely discussed, but important, macroeconomic determinant of economic
success is the extent of an economy's flexibility and hence its resilience
to shocks. The bounceback of the U.S. economy following 9/11 is
testament to the importance of flexibility, as I've pointed out. Moreover,
flexibility and the extent of property rights are related. To obtain flexibility,
the competitive marketplace must be free to adjust, which means market
participants must be free to allocate property as they see fit. Restrictions on
pricing, borrowing, affiliations, and market practice more generally have
slowed growth. Its obverse, deregulation, is increasingly associated with
"reform." (As recently as the 1960s, "reform" was associated with regulation
of business. Ideas govern policy.)
Another important requirement for the proper functioning of market
capitalism is also not often, if ever, covered in lists of factors contributing
to economic growth and standards of living: trust in the word of others.
Where the rule of law prevails, despite everyone's right to legal redress of a
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perceived grievance, if there is more than a small fraction of outstanding
contracts that require adjudication, court systems would be overwhelmed,
as would society's ability to be governed by the rule of law.
This implies that in a free society governed by the rights and responsibilities
of its citizens, the vast majority of transactions must be voluntary,
which, of necessity, presupposes trust in the word of those with whom we
do business—in almost all cases, strangers. It is remarkable that, as I noted
in an earlier chapter, large numbers of contracts, especially in financial markets,
are initially oral, confirmed by a written document only at a later time,
even after much price movement. It is remarkable how much trust we have
in the pharmacist who fills the prescription ordered by our physician. Or
the trust we grant to automakers that their motor vehicles will run as certified.
We are not fools. We bank on the self-interest of our counterparties in
trade. Just contemplate how little business would get done if that were not
the prevailing culture in which we lived. The division of labor so essential
to our standard of living would not exist.
As I noted earlier, material well-being—that is, wealth creation—
requires people to take risks. We can't be sure our actions to acquire food,
clothing, and shelter, for example, will succeed. But the greater our trust in
the people with whom we trade, the greater the accumulation of wealth.
In a market system based on trust, reputation will have a significant economic
value. Reputation, capitalized formally as "goodwill" on business balance
sheets or otherwise, is an important contributor to the market value of
a company.
Reputation and the trust it fosters have always appeared to me to be
the core required attributes of market capitalism. Laws at best can prescribe
only a small fraction of the day-by-day activities in the marketplace.
When trust is lost, a nation's ability to transact business is palpably undermined.
In the marketplace, uncertainties created by not always truthful
