TRUST

AND ENTREPRENEURSHIP $

1. TRUST

Recently a study on expectations was published. The researchers went to about 80 different countries and asked, ‘‘Do you trust other people?’’ When they asked this question in Norway, it turned out that about 65% of a region responded, ‘‘Yes, I do trust.’’ So the cultural theorists might come back and say, ‘‘Ah, see, trust.’’

Trust, in fact, is very important, because in the end, what is a market economy? A market economy is essentially an exchange economy where everybody specializes in something. Somebody makes glasses, somebody purifies water, and somebody cuts the wood. We have to be able to exchange so that we can specialize, and specialization is the basis of wealth. So how can one specialize in something with the expectations that it will be ex- changed for something else if one doesn’t basically trust people?

What about trust in other countries. The survey suggests that about 60%

of Swedes trust other Swedes. Most Europeans, they’re at about 50%. In the United States, trust is just under the 50% line. But in Latin American, the

level of trust is really horrific. Only 4% of Brazilians trust each other, and only about 7% of Peruvians trust each other.

So when I get invited to speak at places like American universities, I am really very happy, because finally I am going to a place where somebody really trusts me. And it’s been a long time, because back home in Peru, some people like me, some people dislike me, but I can see in their eyes that most people don’t really trust me.

When I travel, I often come into the United States through Washington DC, and I really feel the exhilaration. Just recently, I walked through im- migrations in DC and went up to this uniformed officer of Homeland Se- curity with a big badge on his arm.

He asked me to identify myself, and I said, ‘‘With pleasure. My name is Hernando de Soto. I am a native of Peru. My family’s been there for about 380 years since they migrated from Spain. Some actually came from Italy.

The first place they went to was Moquegua. That was actually on my mother’s side of the family. On my father’s side of the family, they went to Arequipa. Then when my mother and my fathery.’’

And this nice gentleman said, ‘‘Will you do me a favor? Please just show me your passport.’’

So I took out my passport, and the moment I took out my passport, I saw this ‘‘Gringo,’’ with his blue eyes, trusting me. He looked at it, ran it through a machine, then came back and said, ‘‘Yes, you are Mr. de Soto.’’

He stamped it, and then I was in free inside your country. So I told myself, ‘‘That’s very interesting. I read about that.’’

1.1. Knowledge by Acquaintance and Description

The philosopher Bertrand Russell wrote that there are really two ways that humans manage knowledge. One is knowledge by acquaintance. When I give speeches, I meet a lot of people. That’s knowledge by acquaintance.

I’ve shaken their hands, touched their shoulders, talked to them, smiled with a few, and had great conversations. Russell says that thebasisof all knowl- edge is acquaintance.

But there’s another type of knowledge, which is knowledge by descrip- tion. Most of the knowledge that wehaveis by description. Most everybody knows, for example, that Kazakhstan exists, but people know it by de- scription. Most people haven’t actually been there. Everybody knows that my country Peru exists, but most people haven’t been there. That’s de- scription.

Bertrand Russell points out that most of the truth is actually known through knowledge by description. Often people actually find out if some- one is right or wrong when somebody is taken to court. In court, somebody comes up with documents and says,‘‘Your Honor, this is the truth.’’ Most of the time attorneys don’t come in and show the court somebody actually stabbing somebody. Instead, the attorneys show a series of documents that prove that he did stab or did not stab somebody, so description actually tries to capture the truth. So I wasn’t surprized that the immigrations officer in Washington, DC was able to begin trusting me, because I had come in by description.

In Washington I always stay at a small hotel. I’ve been going to this hotel for 15 years. They have a very small lobby, and I now know all the people who work there by name. There’s Jack, there’s Herb, and there’s Dionne.

I know them all. One night Herb was working, and I walked up to the registration desk.

As I came in, Herb said, ‘‘Mr. de Soto, good to see you. You haven’t been here for some time.’’

I said, ‘‘Yes, I’ve been busy elsewhere.’’

Then Herb did the usual check-in and said, ‘‘Mr. de Soto, how do you intend to pay?’’

That surprised me. I said, ‘‘Promptly as usual. What you mean?’’

And he said, ‘‘I mean Mr. de Soto, where’s your credit card?’’

So I took out my credit card and realized that after all these years, Herb, that North American, never really trusted me. He trusted my credit card, which of course is knowledge by description. In other words, this piece of plastic told Herb, whether he knows me or not, that I actually have some resources in Peru, and it allows these resources to become liquid and travel through the communication and banking system, get into his computer at that small hotel, and then pay for my lodging.

So I told myself, ‘‘This is really interesting, because it means that there are thingsthat bring you information about something else, something beyond themselves.’’

In other words, as the American philosopher Daniel C. Dennett would argue, there are two types of things in the world: there is ‘‘us,’’ and there are things ‘‘about’’ us. And those things that are about us are those that de- scribe.

It’s a different world now. It’s a world of descriptions. It’s a world of connections that qualifies me such that you can now trust me. It’s what makes the hotel worker, Herb, trust me, because I did get my room at the hotel. And I did get into the United States.

Descriptions are what really establish who I am, my identity. My identity is not born in my body, but rather my identity actually travels in this passport. And my creditworthiness is definitely not established by the fact that I can smile at you or that I do not twitch or tremble. Rather it is established by a plastic card.

Both of these documents are really a visible part of a larger iceberg of laws and regulations that underlies the whole system.

And our wealth depends on it. Consider the example of my apple that I hold in my hand. I actually bought this apple. I have a couple of witnesses at the hotel that actually saw me purchasing this apple. If you look at this apple, in spite of the fact that it is clearly my apple, there is nothing in this apple that says this is Hernando’s apple. There’s nothing in this apple that says that I got it at the inn. As a matter of fact, there’s nothing different between an absolutely legitimate apple and a stolen apple. They are exactly the same, but they can be very different in some purposes. There’s nothing in this apple that says I can sell it, I can buy it, I can lease it, or I can give it as collateral. There’s nothing in this apple that says I can transfer it, or use it as a point of reference to have a dialogue with somebody to get credit, to get electricity, to get clean water, to have the sewage system work. What gives this apple a whole range of different functions, other than simply eating it, happens to be a legal environment.

In other words, humans seem to have created a meta-world. This world now goes beyond the physical world of apples to a world of ideas. We have created a world that has gone from beliefs to becoming enforceable state- ments. It now allows you to take a whole package of resources that are not visible out of physical objects, or out of human relationships, and give significance to these things. Thus, this apple, by itself, has little economic significance. What gives it economic significance is that it can be property.

What gives it economic significance is the institution that sold it to me, or my organization, who bought it.

1.2. The Real Value of Property

Some years ago in Peru, students at my Institute for Liberty and Democracy were invited by the government to examine the privatization of the Peruvian Telephone Company, CPT. At the time, supposedly, the company belonged to all the people who used phones. If you bought a telephone, you got a share in the company. But it was run by the government for all practical purposes. You could sell your shares on the market, and according to this, the company had a total value of shares of $53 million.

When Peru wanted to privatize the telephone company, we had to sell it to someone, but nobody wanted to buy it. The reason nobody wanted to buy it was because the title wasn’t clear, the law wasn’t well defined. So it took us three years to redefine the law. We had to copy the laws of the United States to make them compatible with our laws. Finally, the law was defined, and we called for bids.

The company was finally sold to a consortium headed by Telefo´nica de Espan˜a of Spain, which is one of the largest multinationals today in infor- mation technology and telecommunications. They bought it for $2 billion – 37 times its original value. And we didn’t even touch the telephone building, we didn’t repair any broken windows, the doors still don’t open very well, nobody mowed the lawn, and nobody touched the wires. All we did was give it a‘‘passport.’’ And all of a sudden, the Peruvian Telephone Company was not just real estate and a lot of wires, but rather was something that in a representative manner, through its representation like my credit card, like my passport, could travel to different places, raise money, and issue bonds.

Now one could divide the property up into little pieces of property and call them shares and raise investment. All of a sudden one had functions defined, and they were so well defined that future inventions would be incorporated.

Everybody who bought the company knew exactly what they had, not only on the basis of what they had today, but also on the basis of abstract future definitions, such as advanced telecommunications.

Thus, we are back to the two worlds: the world of facts and the world of beliefs. All the people in developing countries have beliefs. Whenever you go to a developing country, whether for tourism or education, you will always see the things that make us different from you and even different among each other. We have different beliefs. But in the United States, you have beliefs too, but your beliefs are enforceable on a broad scale, and therefore you can be trusted on a broad scale.

Developed legal systems are able to capture nonmaterial values. They allow people to not only organize themselves, but also identify the values of things in such a way that creates wealth.

For example, consider credit. For many years, we all thought that credit was all about how much money you have. And now we know that it’s not true. Latin Americans have issued more money than the United States, but we’re still not any richer for it. So obviously issuing more money doesn’t give one more credit.

Instead, think of the property that is behind credit. In the United States, 80% of employment comes from small and medium enterprises, and 85% of all the credit these enterprises acquire is based on collateral. Collateral is the

basis of credit and why not? Credit comes from Latin‘‘credo,’’ which means

‘‘I believe you.’’ But I believe you because you’ve got something to lose.

I remember having had the privilege of meeting the chairman of the U.S.

Federal Reserve, Alan Greenspan. I was very much honored by this. I asked him two very simple questions. They were, in fact, trick questions. I asked,

‘‘Mr. Chairman, I have a question. When you go out and you put more money into the market, what are the criteria?’’ He knew that I was preparing a talk and would be indiscreet enough to tell the story. So Mr. Greenspan played along and said, ‘‘All right, what tells me how much money is how many transactions there are in the market.’’

I said, ‘‘You must have a very powerful intelligence survey. You’ve got agents out there watching in front of the shops to see how much merchan- dise goes out, how many cars are being sold?’’

And he looked at me with a certain impatience and said, ‘‘No, of course not. What happens is that I look at what the markets say.’’

I said, ‘‘The markets? What markets? Like when John Wayne takes ten thousand head of cattle and goes to the Chicago mercantile exchange?’’

‘‘No.’’ He said, ‘‘What I actually see – and I know where you’re going – is people exchanging property titles. They exchange property titles over com- panies, they exchange property titles over money, they exchange property titles over real estate, and, of course, these are all recorded. I can figure out how much they’re exchanging, and I know how much liquidity to put into the market.’’

I said, ‘‘Very interesting. This is really good stuff, because it substantiates my thesis. Now I have a second question. When you actually give credit, how does it work?’’

‘‘Well, somebody securitizes it one way or another, or they’ve got enough evidence, like the passports, like the credit card, that I’ve got the flow of funds necessary.’’

‘‘And then what does the Central Reserve Bank do?’’ I asked.

‘‘Well, then once a credit is done, we rediscount it.’’

So again, it’s property. It is property that allows one to give or receive credit; it is what allows people to accumulate capital. If anybody ever sees capital that’s not on a piece of paper, please let me know. It is essentially the property system that allows the United States to be the biggest capitalist nation in the world.

The ‘‘symptom’’ of the system is that there are a lot of capitalistic types of people in suits. But behind it essentially is a legal system that is able to capture values. And it is a legal system that has been built over time. It is a system that captures values whether a person knows it or not, and it is a

system that allows people to understand things in a way that developing nations can’t quite understand yet.

It is a system that allows the Federal Reserve to know, for example, how much liquidity to put into the market or how much credit it should allow the banks to give. It is a system that allows one to not have runaway inflation and to put resources in the right hands. Just like one cannot do carpentry with bare hands, one cannot have a market economy with just bare brains.

Developing countries need the foundations of a good legal system. All these economists who have been coming to Latin America, and even our own economists, keep saying, ‘‘you’ve got to get your ‘macros’ right, you got to get your ‘measurements’ right.’’ But if we don’t come in with a legal institutional system that is created by an informed and aware state, there will never be all these other good things a good economy can offer, such as proper credit and better investments. The legal system is what gives you trust.