Why does capitalism only seem to work in the West?

'What the masses in the post-communist and developing worlds lack above all is property rights'

Question: if the construction industry in Brazil in 1995 was reporting no growth, why did sales of cement increase in the same year by more than 20 per cent? Why do peasants at the source of the Amazon take huge risks by growing coca for the international drug market when they could make six times as much money, medium term, by legally growing oil palms?

Question: if the construction industry in Brazil in 1995 was reporting no growth, why did sales of cement increase in the same year by more than 20 per cent? Why do peasants at the source of the Amazon take huge risks by growing coca for the international drug market when they could make six times as much money, medium term, by legally growing oil palms?

Answer: Because cement was being bought by the - mainly urban - poor to build flats, buildings and businesses which are outside the formal legal system, have no permits, and never find their way into official statistics. And because the Amazonian peasant can never use the land he tills as collateral to borrow the money he would need to make the five-year investment necessary to make a success of oil-palm growing.

These are among scores of examples which illuminate the central thesis of a revolutionary new book to be published next week: that what the overwhelming masses in the developing and post-communist worlds lack above all is a legal system that allows uniform property rights, which in turn mean that the poor can convert their actually huge collective assets into working capital.

Not many economists need the protection of armed police in their own country. But then the Peruvian Hernando de Soto was for several years top of the hit-list drawn up by the Maoist Shining Path guerrillas. Although he brings a neo-Marxist, demystifying, rigour to his analysis of the rapidly growing inequalities between the small numbers of rich and the vast numbers of the poor in the developing world, he dared to suggest that they existed because the masses are being prevented, by the deficiencies of their countries' legal systems, from participating in what we call capitalism.

De Soto's The Mystery of Capital may not be in the class of Das Kapital, Adam Smith's Wealth of Nations or Keynes's General Theory. But if the criterion for joining that exclusive club is a capacity not only to change permanently the way we look at the world, but also to change the world itself, then there are good grounds for thinking that this book, subtitled "Why capitalism triumphs in the West and fails everywhere else", is surely a contender.

Essentially, what de Soto has done is to document the extraordinary vitality and scale of what he calls the extra-legal economy in the developing world and the former communist countries and then suggest ways of demolishing the barriers which still exclude its billions of protagonists from sharing in the spoils of conventional global capitalism.

De Soto is no mere theoretician. He has now been retained as a consultant to the new Mexican presidency. In Peru, where 90 per cent of the agrarian land is untitled, he helped to draft laws to bring both the rural and the urban extra-legal sector - massively expanded by migration from the countryside - into the economic mainstream.

And his book comes at you from the favelas of Brazil, the shanty towns of southern Africa, the barrios marginales of Mexico, the pueblos jovenes of Peru, everywhere in fact where local economies flourish but without the legal rights which would allow them credit and the right to transact in the formal market place. It isn't that the poor in the developing or post-communist world own nothing. Haiti is a classic example - in which de Soto estimates that the assets of the poor are 150 times greater than the total of foreign investment over the last two centuries. And for the local economies to function at all the poor have well-developed local informal trading practices and unwritten laws. But because their property rights are not recorded, and because they cannot rely on the legal systems which global capitalists take for granted, those assets can't be grown in the way those of the conventional global capitalist can. They are "dead capital".

In a dazzling history lesson, de Soto demonstrates how the process he envisages for the developing world parallels that in England from the 16th century - when there was a flourishing extra-legal sector of industry outside municipal regulation and the guild system - and in the US from the 17th century - where the pioneers, squatters and gold miners established through possession, hard work - and sometimes downright violence - their rights to property to which they had no titles.

There are omissions. Many economists would regard liberal democracy and uncorrupt government at least as high a priority as property law. But de Soto's thesis is thrillingly subversive in the way it demolishes some of the standard myths about Third World poverty - first and foremost that of "culture".

Entrepreneurship, he argues persuasively, exists all over the world. The problem of the developing world is that it lacks a legal system to underpin it. OK, says de Soto, Bill Gates is a genius - but his success stems not because of that mystical construct, the "protestant work ethic", but because of the US legal system. He has the patents, enforceable contracts, limited liability and property records he needs to accumulate capital and make it sweat.

Next week de Soto will discuss his ideas in public with the Downing Street Policy Unit's innovative Geoff Mulgan, part of whose interest lies in whether the ideas have an application for social exclusion within the West itself. Partly on account of the way the benefit system penalises those with savings, the proportion of the UK population without realisable assets has grown about threefold from 15 per cent in the past 20 years. At the same time "off-the-books" black economy - some of it merely cash-based tax-avoiding services from plumbing to child care, and some of it overlapping with drug-based criminal activity - has doubled.

Gordon Brown is seeking to put moral pressure on the banks to release capital into deprived neighbourhoods for legitimate business, rather as the US is doing with its Community Reinvestment Act. At the same time, experiments are under way to allow - say - informal childminders drawing benefit to continue working for a prescribed period while they put their profits to one side to allow them to start businesses legitimately. And the Social Investment Task Force under the venture capitalist Ronald Cohen is seeking ways of making communities less in thrall to loan sharks, channelling small-scale credit for legitimate self-employment and small businesses, and trying to ensure that public money for alleviating poverty stays in the local economy - and isn't just spent at Tesco's.

This seems a world away from de Soto's prescriptions for the favelas of Rio or the extra-legal world which accounts for at least 50 per cent of Russia's gross domestic product. But in fact both are attempts to apply a similar kind of transformation. De Soto says for him capitalism is not a credo; freedom, respect for the poor and equal opportunity are much more important. But it is, he says, the "only game in town" - the one tool we know for creating surplus value.

The challenge for the politicians is to create the legal and moral framework in which it works for the masses and not just the élite few.

* d.macintyre@independent.co.uk