I had scheduled time this weekend to write my annual report on real estate sales within the Bay of Banderas for 2004. Before I started to write, I picked up a magazine, which I had put in the stack of "Read Later." The content in Hernando de Soto 's address was the front page article in the CIPS first Quarter 2005 "Global Perspectives in Real Estate."

I was so impressed with the content of Hernando's speech and his research in Mexico for President Fox, that I decided this address is important for everyone to read who owns property in Mexico , or who is considering owning real estate here.

Transforming Nations
By Hernando de Soto

From an address by Hernando de Soto at the Cato Institute Biennial Dinner honoring him as the recipient of the 2004 Milton Friedman Prize For Advancing Liberty Thursday, May 6, 2004, The Ritz Carlton Hotel, San Francisco, California.

In the middle 1980s, Milton and Rose Friedman sent me a book, called "The Tyranny of the Status Quo." It was about the "iron triangle" of beneficiaries, politicians and bureaucrats, who hold on to the status quo in developing countries and resist necessary change. And though they may be a minority, I believe we must break down the triangle, and release that grip, or things are not going to go well.

That book impressed me very much, because, by that time, there were already hundreds of people associated with our institute-the Institute for Liberty and Democracy (ILD), which was organized to find out what people need and to convert it into political policies-working in those countries.

- The Underground Economy

In the book, the authors say how difficult it is to create transformational change and how important it is to have a strategy. That started us thinking about what had to be done to break that Iron Triangle. At ILD, what we discovered that has been the key to our success, especially in political terms, is that there is a very large constituency for change in developing countries. Although labeled "the poor," we understood that these poor wouldn't be surviving if they weren't also entrepreneurs. They just needed something more in order to prosper.

Also, while people are saying there are a billion people living on a dollar a day and perhaps three billion people living on two or three dollars a day, nobody is saying there are four billion people who are poor, who are entrepreneurs, and who are completely excluded from the global economy, and even from their own national economies. Why? We think it is because of the lack of a legal structure that supports the way the people actually live and work.

This is one of the primary insights of the work that my colleagues and I have been doing. It is not the rural 1960s in the Third World anymore. The population of Port-au-Prince has grown seventeen times in the past thirty-five years. The population of Algerian cities has grown fifteen times. Ecuadorian cities: eleven times. Countries that were mostly rural twenty years ago are urban today, and the people have moved into business through the division of labor that cities offer.

- Bringing It into the Light

The sorts of solutions that poor countries need today are the kinds of things that the developed countries did in the nineteenth century, not what they are doing today. In other words, today's developing countries are where the developed countries of the West were in the nineteenth century. "Oliver Twist" has come to town. But Oliver Twist and his friends haven't yet been recognized by international financial institutions or included in most bilateral programs from developed countries. Even worse than that, those people in developing countries who think that street vendors are a problem haven't really recognized him, or that illegal manufacturing creates faulty products. But the truth is the industrial revolution has already arrived in those countries, sub-rosa.

We believe that the more people who become aware of the real conditions in developing countries-home to five billion of the world's six billion people-the more politicians will discover that their biggest constituencies for change are poor businessmen. We believe this is what will create change.

We believe that legal and political reforms will reinvigorate many of the world's economies. For example, for ten years, my country, Peru, had a Japanese-Peruvian president, Alberto Fujimori, whose family was one of a million families that emigrated from Japan to Peru and Brazil in the 1930s and 1940s. The fact that the Fujimoris came to Peru and the Yoshiyamas went to Brazil isn't what is important. What is important to understand is the reason the Toledos and the Lulas didn't go to Japan: It was because Peru had a per capita GNP of 25 percent above Japan 's in 1940, and because Brazil 's was 50 percent above that.

- Learning the Lessons of the Past

Obviously, Japan has done something in the last fifty years that has made it ten times richer than Peru. What happened? Why are Peruvians now eager to go to Japan? 
After the Second World War, a plan was implemented under General MacArthur's supervision. His team planned the postwar regime in Japan. Like Mao Zedong did in China, they destroyed the feudal system, which they believed was at the heart of Japanese expansionism within Asia. But unlike in postwar China, MacArthur's team created a basis for a widespread private property system.

By breaking down the feudal system and creating a large constituency for a market economy, they transformed Japan and its two colonies, Taiwan and South Korea. In 1978, Deng Xiaoping turned around and said, "You know, I don't care what color the cat is as long as it catches mice." And now China, the giant of Asia, is turning around by means of property.

To study the Japanese methodology for ILD, I got a grant and brought together the seven surviving octogenarians who had designed the Japanese reforms instigated by the U.S. in the 1940s. These men told us how they had created the Japanese property system and built a modern nation. We have come to believe the only way to create a market economy is to literally engineer it. It will not come through the courts. The good news is that it has been done for us before.

- Fomenting Change

Right now, ILD is working for change around the world. We began working in Peru, and now nearly thirty heads of state have called us in to study their situations. So we've made some inroads-we have moved the understanding of what is needed for change from the bottom levels of society up to the leaders of developing nations.

Although the developed countries have showed us the way, we don't seem to remember, which has had a profound effect on the real task of nation building. The money goes elsewhere. It means we don't repeat our past successes and that sometimes our foreign policy goes wrong.

In 1988, I gave a speech entitled "The United States: Why I Think You're Talking to the Wrong People" at an Open Forum held by then U.S. Secretary of State George Shultz. The point I tried to make was that most Americans talk to westernized third-worlders like me-and that most of us have vested interests. We're not really capitalists open to competition, we are mercantilists looking for privileges. Still, we have graduated from your schools and we talk your language. The really interesting guys, however, are the authentic entrepreneurs. But, they are poor and small, and the U.S. hasn't made contact with them. 
We believe this is a dangerous vacuum, because somebody is always there to fill a vacuum. There are enormous numbers of people in the developing world who believe in the market system. You can see it by their actions. They have to be reached if we are to help them build a modern nation. And if we don't reach them, someone else will.

- Two Examples: Mexico and Egypt

We have been working with President Vicente Fox in Mexico, where we've just finished the numbers. They show that roughly 80 percent of the Mexican population is in the extralegal economy. These underground entrepreneurs own approximately six million businesses, 134 million hectares of land, and eleven million buildings. Together, they are worth $315 billion. This is seven times the size of the Mexican oil reserves and twenty-nine times the size of all foreign direct investment since Spain left.

This sort of pre-capitalist economy with capitalist orientations is emerging all over the world. In Egypt, the poor own-outside the law-92 percent of all the buildings and 88 percent of all the enterprises, worth around $248 billion, the equivalent of fifty-five times the value of all foreign direct investment in Egypt since Napoleon left, including the Suez Canal and the Aswan Dam. This is thirty-five times the size of the Cairo Stock Exchange, forty times the value of all World Bank loans to Egypt, and seventy times all the bilateral aid they have received.

In other words, most of the resources of these countries do not really come from the West, which contributes a drop of water compared to the ocean-real wealth here grows from the efforts of entrepreneurs who bring resources together and divide labor efficiently among them to raise productivity.

- Sovereignty versus Property Rights

In other places we've been called, we found an interesting reality. In Ghana, for example, not only President Kufour, but also the tribal chiefs seem to be wiser than the indigenous people of North and South America. They have read our stuff and have concluded that they don't want sovereignty anymore-they want property rights! Sovereignty is something all people violate; property rights are much more solid because they are based on a social contract rooted in the reciprocity of one person's interests to another's, not one nation's to another.

If you look at a map of Europe over time, you can see that sovereignty is extremely unstable. It starts off with a big Germany that shrinks as the Austro-Hungarian Empire expands. Then Austria shrinks and the Balkans split into many pieces: Very unstable! 
But, look at Alsace-Lorraine, a territory that has been divided up time and again between the French and the Germans, and you will find that, no matter who has owned it, Monsieur du Pont still lives where he has always lived, and Herr Schmidt lives where he has always lived. Property rights are the result of a grassroots contract that sticks even when sovereignty falls apart.

When President Mkapa invited us to Tanzania, where we're also beginning work, we interviewed his tribes and found that, among the Masai, there are 800,000 enterprises. So, our initial conclusion was that those who contend it's either the tribe or the enterprise are wrong. The real question is the choice between a tribal and a government structure. The enterprise is already born; it's already in place.

- The Seeds of Understanding

China and Russia have been examples of failed ideologies for millennia. If entrepreneurs don't find their expectations met by their governments, they will look for other leadership. We believe this creates open territory for terrorists, and open territory for all the failed doctrines of the past.

At ILD, we are working to convince political leaders in developing nations that the iron triangle of corruption can be broken. We think we can do this by showing them that they already have an enormous constituency for change to a market economy. Further, we wish to demonstrate that a market economy is essentially a legal construction and not the physical things-such as roads, bridges, airports and ports-that the West wants to give them, and that this legal construct begins with property rights.

If you look at the laws of nations, they all look like this: family law, international public law, international private law, criminal law, and even property law. If you're poor, however, all you basically have is a piece of land or a place where you work, whether you're street vending or milking a cow. There is nothing more precious for you than your property. To preserve it without the law, you must satisfy tribal chiefs, crooked cops, corrupt politicians, bad judges, your difficult neighbors, or even terrorists. If the law comes in, however, and says your property rights are recognized, not only by your neighbors but by the police and the whole nation, now you can trade them nationally and even internationally-and the law will protect you. Then you become interested in the Rule of Law. Then it means something. Then you begin to understand it.

- It Begins with Property Rights

We believe that the genesis of the Rule of Law-that which will allow a modern nation to grow and, thus, bring peace, stability and prosperity to the world-is the right to own property. We believe that is where it actually begins. And, it is the Rule of Law that will actually generate prosperity.

Adam Smith, the eighteenth century Scottish economist and philosopher, said that the new productivity was due to the division of labor, and that this was bringing prosperity to Europe. Smith's example is very simple. He said he had seen a couple of people, working outside the walls of Glasgow, making pins. In eighteen steps, the two were able to make twenty pins each a day. In another place, he saw ten people dividing those eighteen functions among themselves, and producing 48,000 pins a day. And the way he broke it down is that one person bought the wire, another covered it with tin, a third drew the wire, two others cut it, someone put points to the wire, somebody headed it, and together, they were able to produce 48,000 pins a day-an increase in productivity of 240 times.

Developing countries really have no small businesses, because there is no legal framework to support them. What they have are family enterprises-and families have trouble finding ten people to work; perhaps they can find four, and of those four, two are the lazy brother and the alcoholic brother-in-law-guys who weren't meant to make pins.

Entrepreneurs know how you combine resources and whom you employ to work is important. But, if you have no property rights, you cannot get credit or use collateral to create a business within which you can divide labor, or efficiently organize inputs and outputs. You can't separate the assets of shareholders from those of creditors or of workers. You'll never be able to compete in the global marketplace.

- The Time Has Come

Our objective, as we go around the world, if to prove that value is not only raw manpower but also the power of man to divide labor. Value doesn't just come from simple labor. It comes from intelligent political and economic solutions that can raise productivity enormously. To build modern nations, we have to learn how the poor work and then structure law that fits their needs. In the end, Peruvians, Chinese, and Americans want essentially the same things: life, liberty, and property. We believe the only way to achieve this for all is to build on a market economy based on the Rule of Law, and that our real enemies are the people who do not believe in the potential of human beings liberated by this simple premise.

From his Peruvian roots, de Soto now can be seen traveling throughout the world, meeting with current and future heads of state. President Vicente Fox of Mexico sought out de Soto for help when he was the governor of the state of Guanajuato, and today de Soto is working with the Fox administration on property rights reform. Egyptian president Hosni Mubarak's son, Gamal, approached de Soto and today a property rights program is about to be implemented in Egypt. Both Philippine presidents Joseph Estrada and Gloria Arroyo have invited de Soto to help. The New York Times reports that African presidents are faxing him.

Hernando de Soto is President of the Institute for Liberty and Democracy (ILD) headquartered in Lima , Peru , and, in that capacity, is primarily concerned with designing and implementing capital formation programs to empower the poor in Asia, Latin America and the Middle East. He is a member of the World Commission on the Global Dimension of Globalization; the UNDP Taskforce to Examine Private Resources for Development; and the Expert Group on Development Issues, EGDI, established by the Swedish Government. He has published two books about economic and political development: The Other Path, and The Mystery of Capital: Why Capitalism Triumphs in the West and Fails Everywhere Else, which have been translated into some 20 languages.

Harriet Cochran Murray

This article is based upon legal opinions, current practices and my personal experiences in the Puerto Vallarta-Bahia de Banderas areas. I recommend that each potential buyer or seller conduct his own due diligence and review.