Celebrated Peruvian economist Hernando De Soto speaks to Dhiraj Nayyar on a diverse range of issues from the financial crisis to land acquisition and slum redevelopment and how they are all inextricably linked to property rights

You wrote a famous op-ed in 2001 titled, ?Why capitalism works in the West and not elsewhere.? Have you changed your mind after the financial crisis?

No. Because what I said is that the recordation of assets submitted to the rule of law is what gave capitalism its strength, whether we liked it or not. The recession that you now have is because a majority of the assets in the financial world of the West today, which are called derivatives securities, are not recorded as property.

Roll back to October 2008. Secretary Paulson of the US comes in and says that he?s going to establish a programme to fight the recession that?s coming. Since the problem is with troubled assets, he wants $780 billion from the US Congress, so that all of these can be taken out and put into a bad bank. Two weeks later he comes out and says that he has decided not to use the $780 billion to help the banks clear these assets. And that he?s going to use the money in a different way. He said he was going to use it to create a stimulus programme, and give money to the biggest banks so that there is no run on the banks even if they hold toxic assets.

At that moment, I went to US. Incredibly, nobody, including journalists, was looking at why they changed programmes. But I decided that I was going to look at it. That?s what I am writing a book on. I know Greenspan and other senior officials. And I asked them, why did Paulson change his plan? And the reply was that Paulson wasn?t able to find the toxic assets. So I spent 7 months in the US researching and found out that these derivatives are the only unrecorded property asset in the world.

I still believe that the centre of capitalism is recorded assets as property. The problem of the recession is not a failure of the system but rather that the system was not followed.

So, what?s your prescription for financial regulation: recording these assets?

Absolutely, they have to be recorded. But when you record them, and it becomes clear that there are $600 trillion of them, let me tell you what happens. The first thing that you start finding out is which banks have got them. So you start getting rid of the banks that don?t know how to make business. And the people who will pay for the recession will be the ones who made the bad investments. You protect the savers and protect the savings, but the market turns around.

But I think that you can?t have the cure until you get the facts. And the biggest problem today in the world economy is that it?s not India that has the biggest shadow economy in the world, it?s not

Peru or Mexico, it?s the West. They have got the biggest economy where nobody knows where the majority of the assets are?that?s a shadow economy.

According to my calculations, there are $170 trillion of stocks and bonds in the global market, $110 trillion of physical goods and that in total the world may have $400 trillion worth of assets. But you have anything between $600 trillion and $1 quadrillion (BIS estimates) worth of derivatives. There?s too many of them.

And when you don?t know where the assets are, that?s how you get Dharavi. What?s the problem in Dharavi? You walk in there and say who owns what. I?ve just been there. Nobody tells you. You ask, do you get credit? They say no. They are in a permanent credit crunch. Why? Because if you give a loan to somebody, you don?t really know who?s going to pay and who?s not. That?s a shadow economy. Now the biggest shadow economy is in the West. It?s in the hands of the big banks and it?s not following the rule of property, which requires identification of the owners of the assets.

Would you then go as far as saying that derivatives should be banned?

No. Let me tell you why. First, we don?t know the facts. We have to determine how many there are. Second, we need to find out how many types there are. There may be 70-80 idiosyncratic types. So we have to find out: where are they? Who owns them? How many types are there? The next thing you need to know is

what?s their value? $600 trillion or 1 quadrillion? In the old days, you had a mechanism called mark to market. But for derivatives it was seen as unfair.

So now, for a start, put out a regulation that makes it compulsory to declare this information. That which isn?t declared doesn?t count. This will take care (of compliance).

After getting all the information, you can decide whether these derivatives are weapons of mass destruction as Warren Buffet and George Soros say, and whether you have to ban them; or whether some are good, some are bad; or whether it?s all okay. But right now, we don?t know.

How do you explain the remarkable rise of China despite its weak property rights?

Now, 300-400 million people in China have property rights that they didn?t have before. That?s on the east coast. And that?s the part of China that?s growing. The part of China that has got about 900 million people that don?t have property rights is the part that?s still poor. Property rights ensure that you know who is responsible and accountable for what. Without knowing India, I can tell you it?s the same thing here.

Land acquisition is a big problem in India. Do you think the State should acquire land from farmers for industrialisation? Or should the private sector do this?

I don?t know India, but I know the sickness. I ask you, why doesn?t private industry just buy the land? You find a poor farmer; he makes $1000 a year? Offer him $80,000 for his land. That?s the way to make a slumdog millionaire. Why doesn?t private industry just do that?

Let me try and guess why this doesn?t happen. It?s probably because you don?t have a good property rights system, and you don?t really know how to buy. I?m guessing. Because you lack legal titles, you don?t know what you?ve bought. The next day a farmer can come back and say sorry, but you bought it from my cousin and I?m the real owner. So why do you ask the government to come in? You ask because it can bring a law to expropriate, compensate and in a way create the property title you don?t have. So the problem in India is not whether government should buy or not but whether the private sector can make a deal with the farmer when the rights aren?t clear. That?s my guess.

There?s a similar problem with slum redevelopment and rehabilitation, identifying those who have rights.

You see, property isn?t only about real estate. It?s about business. Every place I visited in Dharavi, you went inside, and upfront you had wares, then the factory, then in the loft there was the stock and behind it the housing. So if you go in and offer good housing, I?m going to say you are addressing me as a homeowner but that?s not enough because you have to address me as a merchant and as an industrialist. So it?s not just a housing problem. It?s a property problem. Until you don?t understand that?s it?s not housing, it?s property?which means the legal environment as to who controls the assets?you are not going to be able to deal with the issue.

How do you best define cut-off periods for slum rehabilitation?

When you are addressing property rights, you are not talking just about legalising the squatters. You have to address the other problem, which is why are people squatting in the first place? Why don?t they come in and buy property? Your question presupposes that squatting is costless. But squatting is an expensive proposition. You have to make deals with the mafia, cops, lawyers, Ngos.

Property isn?t only about legalising those who are there. Since migrations will continue for decades, the challenge is to make it more interesting for people to come in and buy homes on credit. It will be cheaper and more secure because you get title in the beginning. The moment you do that, you don?t have a cut-off problem. If you simply legalise all the time, it will just invite more squatters. Fundamentally, you have to therefore ask why Indians have to squat? Because property rights are out of sync. I can say this without knowing India.

What is your opinion of India?s Unique ID number programme?

It?s a good programme. But how will it work without property rights? It will be easy to give numbers to those whose place of residence you know. For the rest, it will be difficult. Identity is crucial but it needs a geographical dimension, especially if you want to follow where people are. Because the only thing on Earth that doesn?t move is land.

Property rights is the best identity, because it not only tells you who you are, but also where you are, where you work, what you own, what you are in debt with. It?s a lot more information than in your identity card. With an ID card, all I know is you is you.