Capital: It’s All in Your Head Just as Einstein showed that a single atom can be split to release tremendous energy, so capital lets us discover and unleash the energy locked in bricks. Yes, bricks. People, rich and poor alike, have accumulated lots of capital in the form of buildings.1 But not everyone can extract the capital from their bricks (buildings).
The nature of capital is at the core of Hernando de Soto’s theories on capitalism. In his best-selling book, The Mystery of Capital: Why Capitalism Triumphs in the West and Fails Everywhere Else, de Soto argues that capitalism’s success in the West depends largely on a formal system of documented property—the key to unlocking capital.
The root of the term capital comes from the Latin capita, or head—as in head of livestock. Livestock was one of the main assets in ancient times and remains so in most places on earth. To de Soto, it is fitting that the word for capital refers to livestock. But it is also interesting that capital, as such, exists in the head—which is to say it is an abstract concept:
The moment you focus your attention on the title of the house, for example, and not on the house itself, you have automatically stepped from the material world into the conceptual universe where capital lives.
There is another version, which is that capital comes from capita, head, but in the sense that it’s a concept—that because it is a concept, it can only be captured in the head. In other words, capital doesn’t exist in things, it is the potential of things that we can see once they are described in a certain organized way.2
Thus, the term capital is doing two jobs at once: capturing the physical asset (livestock), as well as its potential to generate surplus value.
For de Soto, the conceptual aspects of capital are the most critical.
There’s an invisible potential to just about everything on earth. For example, mankind has long known that water was good for drinking, irrigation and floating boats. But with time we also discovered that water held a form of energy. Energy is invisible and intangible. Still, you can see what water energy does: e.g. turns wheels, moves ships along a river, turns a turbine for making electricity, etc. A few hundred years ago, mankind learned that water possessed that potential energy. In the 19th Century, water powered mills and factories. Today, river currents turn generators in large hydroelectric dams.
Capital, like energy, is a dormant value. Bringing it to life requires us to go beyond looking at our assets as they are to actively thinking about them as they could be. It requires a process for fixing an asset’s economic potential into a form that can be used to initiate additional production.3
The same can be said for business and property. If you structure business and property correctly, you can get more out of them. That additional value de Soto refers to as the surplus value of capital.
You’ve never touched capital. You’ve never seen capital. It’s the additional value things have that you can capture on paper. And just as you cannot create energy with your bare hands, you cannot create capital with your bare brains. You need machinery behind it to capture it. That’s what property rights do. They capture on paper the additional value of your production.
To de Soto, this combination of elements is unique to the West and the main reason for the West’s incredible economic growth over the last 150 years:
What creates capital in the West, in other words, is an implicit process buried in the intricacies of its formal property systems. The formal property system is capital’s hydroelectric plant. This is where capital is born.4
With legal property and the modern corporate legal structure, the advanced nations of the West held the key to development. Their citizens had the means to discover and exploit the most productive aspects of their resources.
Formal property became the staircase to the conceptual realm where the economic meaning of things can be discovered and where capital is born.5
In the West, wealth is taken for granted. But the West wasn’t always this wealthy. It’s only been with us for the last 100 to 250 years, with a series of legal changes that allowed the common man to:
Wealth is all about combining resources, to make pencils, to make clocks, to make machinery. And the way you bring things together is by knowing precisely who owns what. To be able to use possessions to guarantee credit. By being able to issue shares over assets so that people will finance or invest. By having contracts that people will trust. That is what the Europeans got over the last 100 – 150 years ago and managed to go from poverty to wealth.
Capital is unleashed by representing in writing – via a title, a security or contract – the most economically and socially useful qualities about the asset. “The moment you focus your attention on the title of the house,” says de Soto, “and not on the house itself, you have automatically stepped from the material world into the conceptual, where capital lives. Formal property forces you to think about the house as an economic and social concept. It invites you to go beyond viewing the house as mere shelter – known as a ‘dead asset’ – and to see it as living capital.”6
A formal property representation such a title is not a reproduction of a house in the way a photograph is, but a representation of information about the house.7
“Just as a river needs a hydroelectric plant to produce useable energy,” says deSoto, “assets need a formal property system to generate significant surplus value. Without formal property to extract their economic potential and convert it into a form that can be easily transported and controlled, assets of developing world are like water in a lake, high in the Andes—an untapped stock of potential energy.”
References:1 de Soto, Hernando. The Mystery of Capital: Why Capitalism Triumphs In the West and Fails Everywhere Else, New York, NY: Basic Books, 2000. p40.
2 Ibid. p41.
3 Ibid. p45.
4 Ibid. pp46,47.
5 Ibid. p51.
6 Ibid. pp49,50.
7 Ibid. p50.
8 Ibid. p48.
Editor’s Note: Much of the content of this page is from de Soto’s book, The Mystery of Capital: Why Capitalism Triumphs In the West and Fails Everywhere Else, New York, NY: Basic Books, 2000.