By Hernando de Soto

Throughout the Third World and the formerly communist countries, neighborhoods buzz with hard work and ingenuity. Streetside cottage industries have sprung up everywhere, manufacturing anything from footwear to imitation Cartier watches. There are workshops that build and rebuild machinery, cars, even buses. In many countries, unauthorized buses, jitneys, and taxis account for most public transportation. Often, vendors from the shantytowns supply most of the food available in the market, from carts on the street or from stalls in buildings they built themselves. The new urban poor have created entire industries and neighborhoods that have to operate on clandestine connections to electricity and water.

Such "extralegality" is often perceived as a "marginal" issue. In fact, it is legality that is marginal; extralegality has become the norm. When international agencies jet their consultants to the gleaming glass towers of the elegant quadrants of town to meet with the local "private sector," they’re talking to only a fraction of the entrepreneurial world. The emerging economic powers of the developing world are the garbage collectors, the appliance manufacturers, and the illegal construction companies in the streets far below.

In spite of their obvious poverty, even those who live under the most grossly unequal regimes possess far more than anybody has ever understood. These possessions, however, are not represented in such a way as to produce additional value. When you step out the door of the Nile Hilton, what you are leaving behind is not the high-technology world of fax machines, ice makers, television, and antibiotics. The people of Cairo have access to all those things. What you are really leaving behind is the world of legally enforceable transactions on property rights. In Cairo and similar cities, mortgages and accountable addresses are unavailable even to people who would probably strike you as quite rich.

Outside Cairo, some of the poorest of the poor live in a district of old tombs, called the City of the Dead. But almost all of Cairo is a city of the dead -- of dead capital, of assets that cannot be used to their fullest. The institutions that give life to capital -- that allow one to secure the interests of third parties with work and assets -- do not exist here.

To understand how this is possible, one must look to 19th-century America. The United States inherited from Britain not only its fantastically complex land law but also a mess of overlapping land grants. The same acre might belong to one man who had received it as part of a vast land grant from the British Crown, to another who claimed to have bought it from an Indian tribe, and to a third who had accepted it in place of salary from a state legislature -- and none of the three might ever have actually laid eyes on it. Meanwhile, the country was filling up with immigrants, who settled boundaries, ploughed fields, built homes, transferred land, and established credit long before governments conferred on them any right to engage in these acts.

Those pioneers believed that if they occupied land and improved it with houses and farms, it was theirs. State and federal governments believed otherwise, and sent troops to burn farms and destroy buildings. When the soldiers left, the settlers rebuilt and returned to scratching out a living. That past is the Third World’s present.

English Unsettlement

Initially, colonists in British North America attempted to apply the doctrines of English property law. But most colonists comprehended few of the technicalities of English law; many did not know or care to know the differences between legal writs, law, and equity, or other subtleties. More importantly, the common law of property was often ill-suited to deal with the problems that confronted the colonists. A superabundance of land presented the first settlers with opportunities unimaginable in the Europe they had left. Not all of this land was fertile, well-drained, or within easy reach of meadows to supply hay for the settlers’ cattle and horses. In their search for suitable land, the colonists often moved at whim, laying out boundaries, cultivating fields, building houses -- and then abandoning it all to move on to more fertile territory.

The result for property rights was a great deal of variability and extralegality. In England, occupying a plot of land for a long period without a title -- "squatting" -- was against the law. In America, squatting on available land quickly became a common practice. According to Amelia Ford’s study of the colonial precedents of the U.S. land system, "Before the arrival of the Massachusetts Bay Company in New England, there were settlers without charter or grant living at various places within the limits of the Bay....The first Connecticut settlers were legally trespassers on their territory and could base their rights only in occupation and purchase from the Indians." During Maryland’s early years, Frenchmen and other non-English people resided on land that they were incapable of owning under the conditions of the grant. And in 1727, Pennsylvania legislators protested those who "sitt frequently down on any spott of vacant Land they can find." These colonial American squatters had already occupied and improved 100,000 acres of land without legal permission.

There were no effective legal means to reconcile many of the conflicts that arose. As a result, squatters turned to de facto devices that created openings for legitimizing squatting. One of the most intense conflicts took place on the largely vacant outlying territory now known as Vermont.

Prior to the American Revolution, both New York and New Hampshire claimed the territory of Vermont. In order to circumvent New York’s claim, Gov. Benning Wentworth of New Hampshire, "acting on the principle that possession was nine tenths of the law...made free grants in the region to both New Hampshire and Massachusetts citizens," notes author Aaron Morton Sokolski. Following closely on their heels, squatters with little allegiance to any state soon overran the territory. Although both colonies attempted to thwart the squatters’ claims by repeatedly bringing ejectment proceedings against them, squatter dominance of the territory was so complete that Ethan Allen and his "squatter followers" won independence and then statehood for Vermont following the Revolution. A primary result of this extraordinary triumph of squatter power was formal recognition of their property arrangements.

Squatting was often fueled by propertied politicians eager to develop and exploit a colony’s resources. In most colonies, politicians believed that territorial development could be accomplished only through immigration. To accomplish this goal, colonial politicians gave grants to individuals and groups to settle on undeveloped land, predicating their title on occupation and improvement. In Virginia, according to Ford, "to seat the tract meant to build a house, plant one acre, and keep stock for one year; if this were not done within three years, the land lapsed to the state." Under Massachusetts law, a settler’s duties "included taking actual possession and within three years, building a house of a certain size, usually eighteen or twenty feet square, and clearing five to eight acres for mowing and tilling."

In securing the rights they hoped to achieve through such settlement policies, squatters often found the formal system too burdensome or complex. In the chaos surrounding law, land, and property, the migrants realized that if they were going to live in peace among themselves, they had to establish some sort of order, even if it had to be outside the official law. Squatters began inventing their own species of extralegal property titles known as "tomahawk rights," "cabin rights," and "corn rights."

Tomahawk rights were secured by deadening a few trees near the head of a spring and marking the bark of one or more trees with the initials of the person who made the improvement. Cabin rights and corn rights meant staking out land by building a log cabin or raising a crop of corn. Significantly, these extralegal rights were bought, sold, and transferred -- just like official titles. And although such cabin or corn rights may not have legally entitled anyone to the land, there is no question that they helped avoid quarrels, were widely accepted in America’s frontier communities, and became the source of legal title years later.

Free Associations

Often geographically isolated from the political and constitutional debates over property, many squatters did everything they could to secure the land they occupied. Some even paid twice for the same parcel, while others paid lawyers enormous fees to help them make their land legal. Many did not have the means to cover the costs of the official legal system, so they established their own extralegal arrangements, thus creating new avenues for accessing and holding property on the American frontier. For all practical purposes, they took the law into their own hands -- and forced the legal establishment to follow their lead. It took the politicians some time before they awakened to the fact that alongside the official law, extralegal social contracts for property had taken shape, and that they constituted an essential part of the nation’s property rights system. To establish a comprehensive legal system that could be enforced throughout the nation, they would have to catch up with the way people were defining, using, and distributing property rights.

Consider the claim associations that proliferated throughout the Midwest during the first half of the 19th century. These were originally formed by settlers to protect their rights against speculators or claim jumpers. Two claim clubs in Iowa, for example, agreed in their constitutions to protect each member’s claims for a period of two years after the land sales. One Iowa historian noted that "when an actual settler -- one who wanted land for a home and immediate occupancy ...settled on a portion of [an association’s] domain, he was immediately set upon by the bloodhounds, and it was demanded of him that he either abandon the claim or pay them for what they maintained was their right." If "the settler expressed doubt to their having previously claimed their site, the [claim association] always had one or more witnesses at hand to testify to the validity of the interest they asserted."

These associations provided their own strict and primitive justice. A local minister once asked an association member what would happen if a claim jumper succeeded in buying his claims. The squatter replied, "Why, I’ll kill him; and, by agreement of the settlers, I am to be protected, and if tried, no settler dare, if on the jury, find a verdict against me." More typically, however, claim associations provided at least the illusion of due process, by convening juries of fellow squatters to sit in on cases of claim jumpers. In one Iowa county, a claim jumper who attempted to occupy a vacant second tract owned by a member of a claim association was "within an hour" brought by "a score of earnest, angry men" before a settler jury.

Each claim association drafted its own constitution and bylaws, elected operating officers, established rules for adjudicating disputes, and established a procedure for the registration and protection of claims. Their function also extended into the official law. One association’s constitution candidly describes its mission: "Whereas, we have, by the sanction of the Government become settlers on its lands, and have expended out time and money in improving them, we feel justly entitled to buy them at the regular price. And whereas there may be persons disposed to interfere with our rights, and thus create distrust, excitement, and alarm; Therefore it is Resolved, that in our case there is safety, only in Union -- and a determination to settle amicably any disputes amongst us, to reciprocate concessions, and avoid every thing, that may have a tendency to create distrust and excitement -- to abide explicitly by the wards of the several committees, and defend them in the discharge of the duties assigned to them." The document bears striking resemblance to the settlement contracts that squatters make throughout the Third World today.

Although members of claim associations denounced large speculators, they themselves were, as one historian points out, "small-scale speculators." The claim associations of American history were more than just a scheme to protect the homestead; they were also used to protect the trade in claims.

And thus claim associations helped create a new body of laws. The settlers, however, did not displace official law completely. Their extralegal arrangements served as temporary rest stops on the road to legal respectability.

Rules on the Ground

Despite the implicit acquiescence of local politicians to such arrangements, squatters still encountered a hostile world. Many constantly provoked conflict with Native Americans by invading their lands. But squatters were also a threat to the elite, who feared losing their vast properties. One member of that elite -- George Washington -- complained in 1783 of the "Banditti who will bidd defiance to all Authority while they are skimming and disposing of the Cream of the Country at the expense of many." But when he tried to eject the people who had squatted on his Virginia farmland, his lawyer warned that, in Ford’s words, "If he succeeded in his suit against the settlers on his estate, they would probably burn his barns and fences."

Relations between states and squatters also began to heat up. Even before the Revolution, migrants from Massachusetts had already begun to settle in Maine, a territory Massachusetts had claimed as early as 1691. After the Revolution, with its treasury bankrupt and its currency depreciated, Massachusetts started seeing the vast lands of Maine as a major source of new revenue -- and the squatters as an obstacle to the sale of large blocks of land. In 1786, the governor issued a proclamation prohibiting squatting in Maine.

To reassure potential purchasers, Massachusetts appointed a committee to investigate and demand payment from illegal "trespassers." Most squatters, however, simply refused to move or to pay for their lands. Rather than compromise, the state ordered sheriffs to enforce legal eviction procedures, igniting a virtual war. When a sheriff was killed trying to oust a squatter, juries refused to convict the alleged murderer. Massachusetts eventually withdrew from the fight, and Maine became a state in 1820.

Other colonies did their best to suppress squatting. In Pennsylvania, Scots-Irish settlers began moving into Indian lands as early as 1730, and the Native Americans fought back. From 1763 to 1768 the Pennsylvania Assembly tried to deter squatting by threatening the death penalty, while Gov. William Penn ordered soldiers to remove illegal settlers. Despite these measures, the number of squatters doubled. In response, writes economic historian Stanley Lebergott, "the infuriated governor then proclaimed that those settling on Indian lands would be executed. But no judges could be found for such prisoners, or compliant juries and secure lockups."

In a country where every settler was either a migrant or related to one, some colonial authorities were bound to realize how difficult it would be to apply English common law to many new settlements. Under English law, even if someone squatted mistakenly on another person’s land and made improvements, he could not recover the value of what he had done. In the colonies, however, given the lack of effective government and reliable records and surveys, authorities had to accept that improvements made on land, taxes paid, and local arrangements among neighbors were also acceptable sources of property rights. As early as 1642, the colony of Virginia allowed a wrongful possessor to recover the value of any improvements from the true owner. Moreover, if the rightful owner was unwilling to reimburse the squatter for these improvements, the squatter could purchase the land at a price set by a local jury. This statute was soon copied by other colonies.

This legal innovation of allowing a settler to buy the land he had improved before it was offered for public sale was known as "preemption" -- a principle that would be the key to the integration of extralegal property arrangements in American law over the next 200 years. Politicians and jurists began to interpret "improvement" in ways that heavily benefited squatters. In North Carolina and Virginia, cabin rights or corn rights counted as improvements. In Massachusetts, tomahawk rights were included. By the Revolution, the corn rights of the itinerant squatter had been transformed, in many people’s minds, into the occupancy rights of the hardy pioneer. Even as George Washington was lamenting the "banditti" who had invaded his land, elsewhere in Virginia politicians were protecting squatters’ extralegal titles. (For states with little money, preemption was also a source of revenue. They would charge squatters for surveying the land they had improved and for issuing legal title.)

Digging In

Having won many battles, the squatters were still far from winning the war. In 1785, Congress passed a resolution explicitly prohibiting squatting in the public domain and giving the secretary of war authority to remove unlawful settlers from federal lands in the Northwest Territory. This policy went into effect in the spring of 1785 at the juncture of the Muskingum and Ohio rivers, where the Army destroyed 10 families’ homes and built a fort to prevent them from returning. Four years later, President Washington ordered the removal of families who had settled on Pennsylvania frontier land owned by Native Americans.

In the two decades after the Constitution was adopted, Congress steadfastly held to its antagonism toward settlers residing illegally on the public domain. In 1796, it raised the minimum price for public lands from the $1 per acre set in the Land Ordinance of 1785 to $2 per acre. In 1807, Congress passed a measure that provided for fines and imprisonment for any squatter who failed to comply with the law once notified, and authorized force to remove illegal settlers if necessary. An 1812 document of the House Committee on Public Lands noted, "Promiscuous and unauthorized settlement on public lands are in many respects, injurious to the public interest."

But Congress didn’t understand the sheer dimension of the pressure from squatters. Nor did it have the means to impose its mandates. Even the General Land Office, established in 1812 to survey, sell, and register the public lands, could not do its job. Charged with confirming land patents sent in from the district offices, the new federal agency also had to oversee the record keeping of purchases made on credit. All these tasks soon overwhelmed its small staff, which quickly fell behind in most of their duties.

In addition, the young nation had limited financial resources and often resorted to land grants to compensate certain sectors of the population. From 1780 to 1848, Congress provided 2 million acres of land for the soldiers who fought in the Revolution, 5 million to veterans of the War of 1812, and 13 million for those who fought in the Mexican-American War. Between 1851 and 1860, Congress added another 44 million acres for those who had performed military service. By the mid-19th century, a thriving black market in land scrip emerged, fueling both squatting and speculation. For every 100 soldiers who received land scrip, 84 sold their rights in the black market.

The federal government also gave 318 million acres -- almost one-fifth of all federal lands -- to the new railroads crisscrossing the continent. Although much of the land was of little economic value, a sizeable portion did contain minerals or was arable. The lion’s share went to the transcontinental railroads, which received only every other section of land along their routes, creating a checkerboard pattern of alternating government and railroad land. Congress believed that the railroads would sell the land they didn’t need quickly and cheaply to encourage settlement. Yet once again, the realities of land settlement conflicted with the hopes of politicians. The checkerboard arrangement, according to historian Richard White, had "delayed settlement on millions of acres of the best lands and had closed them to acquisition." In certain cases it even led to open warfare between the railroad companies and settlers.

One conflict arose in 1880, in California’s southern Joaquin Valley, then called Mussel Slough, when farmers and ranchers establishing themselves on railroad properties could not come to a sales agreement with the rail companies. This eventually led to a shootout in which five settlers died; the responsible marshal admitted he was "not certain who fired first." Editorializing on the incident, the San Francisco Chronicle condemned the railroads: "Whatever might be their strictly legal rights, it is undeniable that all the equities were in favor of the settlers." In any case, physical force was also on the side of the settlers: Officials estimated that dislodging them would require between 200 and 1,000 good soldiers. The government’s efforts to construct an orderly land system could not overcome the will of the common people to assert their right to the national domain.

The turning point came in Kentucky, where the property system, as in many states, was in complete disarray. (The new state’s land claims added up to three times its area.) In 1821, the Supreme Court declared Kentucky’s occupancy law -- which recognized a right to land based on improvements made on it -- unconstitutional. The case involved the heirs of John Green, who was a large landowner, and Richard Biddle, who had settled on Green’s land illegally. The decision explicitly favored only those people who held legal title to the land they occupied. According to the court, the Kentucky law "operated unjustly and oppressively because the lawful owner is compelled to pay, not merely for the actual ameliorations in the land, not its increased value only, but the expense incurred by the occupant in making pretended improvements, whether they are merely useful or fanciful, and matter of taste or ornaments only dictated by his whim and caprice." After rehearing Green v. Biddle, the court reaffirmed its previous decision in 1823, emphasizing that the occupancy laws deprived "the rightful owner of the land, of the rents and profits received by the occupants."

Politicians who had been cultivating the support of their extralegal constituents lambasted Biddle as "most ruinous" and causing "great alarm" for Kentuckians. The Supreme Court might be oblivious to the new political and legal reality taking shape on the rapidly expanding frontier, but Western politicians only had to look out their windows to see how quickly the country was changing. Tens of thousands of hardy migrants had trudged westward from the original colonies over the Appalachians to settle on fertile, virgin lands. In 1620, there had been approximately 5,000 settlers in all of British North America. By 1860, the U.S. population was more than 30 million and counting. Fifty percent of that citizenry lived west of the Appalachians.

In the minds of many politicians and newspaper editors, the villain was now the Supreme Court. One local paper spoke of the "treacherous conduct" of justices who threatened to "exterminate" the rights of "nonresidents and aliens." In the midst of the furor over the court’s authority, Kentucky’s powerful Sen. Richard M. Johnson declared that the decision would lead "to much litigation where questions had been settled for years, and put everything respecting landed property into the greatest confusion." Kentucky’s other senator -- the even more influential Henry Clay, who generally opposed liberally extending squatter rights -- conceded the point: "They build houses, plant orchards, enclose fields, cultivate the earth, and rear up families around them....In this way, thousands and tens of thousands are daily improving their circumstances and bettering their conditions." Both the governor and the state legislature joined the chorus.

In an extraordinary turn of events, even Kentucky’s courts rejected the decision. In a similar case two years later, a Kentucky judge noted that Biddle could not be followed because the case "was decided by three only of the seven judges that composed the Supreme Court of the United States; and being the opinion of less than a majority of the judges cannot be considered as having settled a constitutional principle." In 1827, another Kentucky judge rejected Biddle, emphasizing that the occupying claimants law was constitutional in "cases too numerous to be quoted."

In the middle of the dispute over Biddle, Andrew Jackson, a vocal supporter of the pioneers, almost won the presidency. Four years later, he did become president. During his two-term administration, sympathy for the rights of squatters increased. So did public animosity toward judges and attorneys, who were perceived as eager agents of the rich and the powerful. Between 1834 and 1856, Missouri, Alabama, Arkansas, Michigan, Iowa, Mississippi, Wisconsin, Minnesota, Oregon, Kansas, and California all adopted occupancy laws similar to the Kentucky law rejected in Green v. Biddle. Paul Gates writes, "No case decided by the Supreme Court had been so completely overturned by state legislation and state courts, by failure of the federal courts to make use of the case, and finally by the unchallenged act of Congress extending the coverage of federal courts to occupants."

By 1830, the 13 original states were 24, including seven in the West whose representatives in Washington were fully committed to policies favoring the squatters. To gain the support of this increasingly influential bloc, Northern and Southern states competed to show how pro-Western they were. Members of Congress began drafting legislation that helped ease the way for settlers’ arrangements to be absorbed into the legal system. At its center was preemption. In 1830, a coalition of Western and Southern congressmen passed a general preemption act that applied "to every settler or occupant of the public lands...who is now in possession, and cultivated any part thereof in the year one thousand eight hundred and twenty-nine." A squatter could claim 160 acres of land, including lands he had improved, for $1.25 per acre. Payment was required before the land was set for public auction, and transfers or sales of preemptive rights were strictly forbidden.

In 1832, 1838, and 1840, Congress renewed the General Preemption Act of 1830. Each time it attempted to strengthen further the rights of the lowest squatter, while trying to block some of the abuses of the preemption principle. For instance, the 1832 act lowered the minimum amount of land a squatter had to purchase from 160 acres to 40 acres. By 1841, the preemption principle had become so firmly established that Congress enacted a general prospective preemption bill. The 1841 act covered not only existing squatters but "every person...who shall hereafter make a settlement on the public lands." The settled land had to be surveyed, but even this provision was eventually overturned.

Settled Issue

As the 19th century progressed, Congress continued to play catch-up, absorbing extralegal arrangements in official statutes. The California Gold Rush, for example, produced a rich system, organized from the bottom up, to let miners stake their claims and adjudicate disputes with other fortune-seekers. Legally, they were trespassers, since most of the land they were prospecting had hundreds of competing interests: Mexican land grants, absentee owners, rival settlers, and the absence of a federal law that could be enforced. But most politicians came to support the miners’ claims, and the courts proceeded to sanction their extralegal arrangements. In 1861, a justice of the California Supreme Court commented on the legitimacy of the miners’ extralegal arrangements in Gore v. McBreyer: "It is enough that the miners agree -- whether in public meeting or after due notice -- upon their local laws, and that these are recognized as the rules of the vicinage, unless some fraud be shown, or some other like cause for rejecting the laws."

At the end of the 19th century, American politicians and judges had come a long way in the area of property law -- and it was the squatters who led them there. This was also true for housing: In 1862, when the celebrated Homestead Act gave 160 free acres to any settler willing to live on the land for five years and develop it, it was only sanctioning what settlers had already done by themselves. "Between 1862 and 1890," writes Richard White, "the population of the United States grew by 32 million people -- but only about 2 million of them settled on the 372,649 farms claimed through the Homestead Act." By the time Congress finally approved it, the settlers already had many legal alternatives for gaining title to public lands.

The American experience is very much like what is going on today in the Third World and the formerly communist countries: The official law has not been able to keep up with popular initiative, and government has lost control. Third Worlders are organized in modern-day claim clubs, and their governments have begun to give them preemption rights.

They’ve done a lot else as well, not all of it consistent with the rest. In August 1999, Bangladeshi authorities demolished 50,000 shanties in the capital city of Dhaka. Where demolition is impossible, governments have built schools and sidewalks for the squatters. At the same time, they have supported microfinance programs to assist the sweatshops that are transforming residential areas into industrial zones throughout the world. They have improved the stalls of sidewalk vendors, removed hordes of drifters from their city squares and planted flowers instead, and tightened construction codes to prevent buildings from collapsing as they did in Turkey during the 1999 earthquake. They have tried to force the independent jitneys and shabby taxis that glut traffic to meet minimum safety standards; they are cracking down on theft of water and electricity, and are trying to enforce patents and copyrights. They have arrested, jailed, and executed gangsters and drug traffickers. They have tightened security measures to control the influence of extreme political sects among the uprooted multitudes.

What they have not done is craft a formal legal system that recognizes those multitudes’ property rights and lets them create capital. In other words, they have not learned the lessons of U.S. history. Until they do, they’ll remain citadels of dead capital.

Hernando de Soto is president of the Institute for Liberty and Democracy in Lima, Peru, and the author of The Other Path. This article is adapted from his new book, The Mystery of Capital: Why Capitalism Triumphs in the West and Fails Everywhere Else (Perseus). Copyright ©2000 by Hernando de Soto. Reprinted by permission of Perseus Publishing. All rights reserved.