Interview: Hernando de Soto

He turned from international business to the black market-to study it. Hernando de Soto talks about the surprises he found among Peru's poor.

This summer, when Hernando de Soto became famous throughout Latin America for helping to lead the political opposition to Peruvian President Alan Garcia's bank nationalization, he already had something of a name for rattling the establishment. Since 1980, he and his Lima think tank, the Institute for Liberty and Democracy, have been studying what de Soto calls the informal market, what others would call the black market.

Turning from a successful business career overseas, de Soto founded the institute when he began to suspect that the "informals," operating outside the law, without state protection or subsidies, were Peru's "real entrepreneurs" and the key to any true economic development.

Through several years of study, he and a team of researchers found that two out of three urban workers were employed in the underground. They have their own factories, transportation systems, business guilds, and even a well-developed system of property rights enforced by their own, informal, legal code. In Lima, these entrepreneurs carry on 90 percent of the clothing business, 75 percent of furniture, 60 percent of construction, and 95 percent of public transportation.

De Soto's institute also detailed why these entrepreneurs operate outside Peru's official legal system: in Lima, it takes 289 days of red-tape cutting to get a business registered—compared to three and one-half hours in Tampa or four hours in New York City. It takes nearly seven years to get a piece of real estate if you are poor and have just come to the city, and over seven months to legalize a fishing boat.

The results have now been published in El Otro Sendero ("The Other Path," a play on the name of the country's violent Maoist insurgency, Sendero Luminoso). Its introduction, written by the Peruvian novelist Mario Vargas Llosa, was translated and printed in The New York Times Magazine last February.

In a country where a book is a bestseller at 5,000 sales, El Otro Sendero quickly passed the 40,000 mark. Pleas to publish it in Mexico, Colombia, and Ecuador indicate that the problems, and search for hope, uncovered by de Soto are widespread in Central and Latin America.

John Fund, an editorial writer for the Wall Street Journal, interviewed Hernando de Soto in New York City in September, when the proposed bank nationalization in Peru still hung in the balance.

Reason: How did you become interested in the informal sector?

De Soto: I was, I still am, an entrepreneur myself. I worked in Europe for a long time, as chief executive for one of Switzerland's largest engineering companies. I traveled the Third World a lot, and I was always very curious as to what was the source of development. Some of my colleagues came from rich countries and some of us from poor countries. So, I always wanted to find out why—why, if I am just as good as he is, does he come from a much wealthier country? A country that may be 14 times wealthier per capita than my country.

I didn't much believe in an ethnic or racial or national/cultural explanation, because I never saw anything that made me much different from anybody else. So, I was very interested in looking at institutions—the law, legal institutions. And wherever I went, whether I landed in Cairo, in Lagos, in Lima, there was a large part of the economy where people weren't beggars, where people were working very hard building cities. It is quite obvious that these were entrepreneurs. The question is, How many are there? And why is it that if they work so hard they are so poor? And so, it came to life for me one day that if we studied the informals we would be able to find out a lot more about our institutions. Because if these informals had chosen not to live within the legal institutions, there must be something wrong with those institutions.

Reason: What do you mean when you say that you saw the informals "building cities"?

De Soto: It is one of the most visible manifestations of their entrepreneurial spirit. For example, when I went to supervise the engineering business of my company in Peru, during the first years, every time I arrived in Lima there was desert on both sides of the road from the airport to the hotel. Just barren land. Then one time, surprisingly, where my eyes had become accustomed to seeing barren land, I saw literally thousands of houses, strawmat housing with Peruvian flags on top of them. I realized that the land had been invaded.

And every trip, about four or five times a year, every time I used to pass this strawmat housing there seemed to be some remarkable change. The housing gradually started changing and becoming brick and iron or steel. Then all of that would be painted, and there would be stucco. There would be sidewalks and roads, then telephones and trucks coming and going, then buses. And then signs with businesses being advertised. So I actually saw, over a period of, say, three to four years, a city growing in front of my eyes.

Reason: Why did this strike you as odd?

De Soto: Well, I thought, what a funny way to build a city. Because the infrastructure came afterwards. That was one of the things that made me think it was illegal, because I was in the building business at that time, I knew that the first thing that you do is to draw a map. Then you put in the sewers, the water, the electricity, the phone lines. Then you put in the sidewalks and the roads. And then you put the houses in.

Here you started off with the houses and afterwards, four years after, I saw some of the houses being uprooted and they started putting in the sewage and water systems. Why would people do things the other way around? That was when I saw that this really wasn't well planned, that it was people lunging for private property. So, I said, well, somebody has got to explain this. As a businessman, I said, here is an opportunity.

Reason: Would the informals in Peru be affected by President Garcia's plan to nationalize the banks?

De Soto: He says that one of the reasons for taking over the banks is to give credit to the poor, to those who never got credit. But 80 percent of credit was already in his hands—80 percent of the banks were already nationalized—and he hadn't done anything with it. Only 0.3 percent of credit was going through the state banks to the informals. So if that was Garcia's real concern, he would have started by "democratizing," as he says, the 80 percent that he does control.

Reason: What is his real concern, then?

De Soto: What it does give him is more power—more power at a time of economic failure. He is moving from an economic manipulation scheme to a political thing. As Mario Vargas Llosa said, Garcia now controls all the credit that goes to the press. If you take into account that maybe 40 percent of all advertising comes from government, aside from the fact that government has all import licenses, all export licenses, control of 80 percent of the freight, 40 percent of publicity, and now 100 percent of the credit, his power is just simply immense. So when Vargas Llosa reacts—he is the first one of all of us to react on the banking: "My God, there is a totalitarian direction of sorts"—he is right.

Reason: Did he issue a statement after the decree?

De Soto: Right after the decree, which was on July 27, he wrote an extraordinary article in the editorial pages of one of Peru's most respected newspapers. And he said that this was a step toward totalitarianism and that one had to go out and fight it. And then there was reaction, of course, from the public. So he organized with a group of friends over at the institute [de Soto was traveling] an ad in the newspapers which said, If you agree that there is a threat to liberty, and you would like to simply "solidarize" yourself with our position, please sign up. This kind of campaign got the whole country moving. Vargas isn't the only person who moved on this, but his article being the main one, he became sort of like a magnet for all opposition to this move and all the fears that had been accumulating in a great deal of the Peruvian population. And then on the 21st of August there was a massive rally in Lima.

It was an extraordinary event. First of all, because of its size—it was, according to the BBC, about 100,000 people. Second, people gave a lot of importance to freedom. Usually freedom is related vis-á-vis a political abuse, but here it was an economic abuse. It was a meeting about the freedom to do enterprise, and this was said repeatedly during the meeting, where Vargas Llosa was the main speaker.

Reason: Tell us a little bit about the speech. What were the rhetorical points that were made?

De Soto: His big thing was that he thought that Peru was going the wrong way, because bankers were being persecuted just for being bankers. He started off by saying that the government said that this square "would be full of bankers and a few snobs." But Vargas said, "As I look into the sea of heads that loses itself in the night, if there were only so many bankers in Peru, Peru wouldn't be the poor, underdeveloped country it is today." And he said, "Garcia said that we were going to smell, tonight, French perfume. But the only perfume I smell is the perfume of liberty."

Then he went on to say that we are not here—he emphasized that—to defend a few bankers. We are here to defend everyone. He quoted from The Other Path and the work of the institute, and he said, look, this state which has wanted to help poor people has ended up doing things in such a way that it takes 300 days to queue up and register for a sewing machine. That it takes 6 years and 11 months if you want a home or a few square yards to put your sewing machine. And he asked, This kind of state is the one that is going to run banking in favor of the poor? They just can't. And so, you've got to do something, you've got to stop moving toward totalitarianism and inefficiency.

And he said, we have, as far as I am concerned, a crusade that is started now—a crusade amidst the historical movement of the state toward people's private lives, a crusade for the right to develop and the right to have wealth and especially our right to be continually well informed. And there is no guarantee that there is going to be any wealth if the state owns all credit. He said, credit is the lifeline. It is the blood of the body, and if you can control credit, you can in fact control everything.

Reason: There were also rallies outside of Lima?

De Soto: That is right. In Arequipa there was also a huge meeting. And thugs were sent to disrupt the manifestation. About 30 people were taken to the hospital. And in the north there was also one of the biggest rallies ever seen.

Reason: So what do you think will happen?

De Soto: Well, the fact that Garcia has a lot of opposition doesn't mean that he is in a minority position. The majority of people, in spite of the big rallies, feel that nationalization would work to their benefit. In effect, if the issue were only bankers' property, maybe a large majority would have voted for nationalization, or "stateization," as we call it. I wrote an article for the local press trying to remind businessmen that they have an obligation, not only toward themselves, but as a community to ensure that even the poor businessmen have rights, and to defend those rights.

Reason: To the extent that wealth speaks of privilege in the popular perception, how would you answer those who call for land reform?

De Soto: I think land reform is probably necessary in many places in Latin America and Peru. You proceeded to land reform just after the war with Japan, and you've encouraged land reform wherever you've gone. In many cases, it is simply because land is unjustly held or cannot be justified being in those people's hands because it is based on privilege. But land reform doesn't necessarily mean expropriation. For example, in my country today, what has happened is that, after the first land reform, we now need a second land reform process. The first process collectivized a great deal of land holdings in the country. If you look at a map of property holding in the agricultural sector of Peru, you will see large cooperatives supposedly centrally managed. But go down there and ask, Whose property am I stepping on?—they will tell you, "Juan Sanchez" or "Pedro Romez."

Reason: Property rights have reasserted themselves.

De Soto: Yes, but since they are not legally enforceable, they are very weak. So investment in the land is also weak, because they don't know who it is going to belong to the next time. So you do need land reform in the sense of reaffirming a good property rights system, which ensures that those who are most efficient will get at the land.

Reason: Are large sections of Peru or of other Latin American countries owned directly by the state? In other words, could the land be redistributed…

De Soto: Oh yes. In my country 96 percent of the land is owned by the state. The "invasions" of poor people are on state land. That is why we say, if the state owns 96 percent of the land in Peru and it is being put to no productive use by the state, why should it take six years and eleven months working eight hours a day to have access to what is obviously an abundant resource and which produces so well in private hands?

Reason: Has the impact of "liberation theology" extended much beyond the clergy in Latin America?

De Soto: Yes, of course. And it is very important not to take liberation theology lightly. It doesn't propose any formula, it justifies an old formula, which is communism. In many cases, it is really an epilogue—justifying communism is an epilogue to most of the literature. Most of liberation theology seems to be concerned with making sure that Catholics are conscious of poverty and do something about it. It justifies political action.

Up to there, I would even say that my institute is in sympathy with liberation theology. We do think it is a good idea that Christians be concerned about the poor. But what I don't think you can do is promote Marxism. Especially if you study the poor.

So we have challenged the liberation theologians: Look at the poor. You should see what we have seen. What we have found is private enterprise. If you want to defend the poor, keep the options open. Private enterprise is obviously a solution. Discuss it seriously.

Reason: Regardless of the outcome of the debate on the banks, what do you think you can now do, having the sympathy of the popular imagination, to promote democratization and the free market?

De Soto: We are working on creating a front of entrepreneurs to defend the economic rights of the population. That is not an easy task, because it means putting together people who have some interests in common, like the liberty to exercise their initiative, but they also have many ethnic and social differences.

But also, economic rights are not well known. You take many things for granted in the United States that are not written in your constitution. One of these, for example, is rule making. Every North American in one way or another participates or influences. If you don't like what happened in a court in Iowa with a democratic jury, with a prosecutor, somebody can take it to a higher court and it can become a national issue. You participate through executive-branch rule making—hearings and cost-benefit analysis and pressure groups and lobbyists. And you can participate in your legislative branch by communicating with your legislators, because they depend on grass-roots elections. You can monitor their votes, and if you don't like the way they are voting you can pressure them and you can make them accountable.

None of those mechanisms that I have just described exist in our country. In Latin America it is the power of the presidency and those who surround the presidency.

Reason: How many rules are issued by the president and how many by the congress?

De Soto: Well, the executive branch, which is governed directly by the president, issues 99 percent of all rules in Peru. At the national level, we create 27,400 rules a year on average for the last 40 years. Of those, more than 27,000 are made by the executive branch itself. That means about 111 every working day—without any form of control or participation by the people or by businessmen.

Reason: What are the long-term prospects for democratic limited governments in Latin America? Are we constantly going to see this cycle of dictatorships and democratic governments?

De Soto: There is an old theory or suspicion in Latin America that many coups d'état are self-inflicted. When a democratic ruler sees that through the institutions that are given to him by the democratic process, he can't solve the country's problems, he invites the coup d'état. And he invites it by doing something and the military are forced to oust him. And he thereby extends his political life, because of course his democratic mandate has been interrupted, and after five, ten years of dictatorship he is the most likely candidate to return, because he was the last democratic figure that was around.

Reason: Like taking a vacation.

De Soto: It is like taking a vacation. I think most political analysts would tell you that there is no immediate danger of that in Peru. But you know that it has always been the last resort of the social fabric in Latin America to want the military to come in and impose discipline.

But just as we have incomplete markets, we also have incomplete democracy. The reason why a democracy loses its legitimacy to the point that a coup d'état can be effected against the democratic regime with even popular support is really because democracy is not working. And I repeat, democracy is not only elections. Elections are exclusively the way a democracy is born. And in Latin America, from the moment a government is elected, it no longer has any public participation in the act of government day after day. It is really an electoral process with a dictatorship.

Now, in a country like mine, and let's go before the 28th of July, it is the 27th of July of 1987. What does democracy mean? The government controls 80 percent of credit, as a result of which the press was really very respectful, excessively respectful, of government. Chances are that if you had to say something severe, aside from one or two publications which had autonomous financing, you couldn't say much against the government, you couldn't raise certain issues.

If you now say, democracy failed, it is not true. The problem is not that there was too much democracy. The problem is that there was not sufficient democracy. And it is just like the markets. Markets have failed in Latin America? Well, how can you say we have markets if it takes me seven years to get into the market through red tape?

Reason: At the recent meeting of the Mont Pelerin Society in Indianapolis, there was some discussion of the question of whether or not free-market institutes should accept government funds to carry on their work. Have you gotten money from the National Endowment for Democracy in the United States and…

De Soto: We have gotten money from CIPE, which is the Center for International Private Enterprise, the national Chamber of Commerce. Now, I understand that some of the funds that CIPE gets are from the National Endowment for Democracy. I don't know in what proportions. All right. So, it may very well be. But let me explain to you how it works in Peru.

If I, in Peru, get money from the wealthy class, I would be getting money from the privileged. If I were getting money from the poor, I would be exploitive of the poor—apart from the fact that the poor aren't going to have much money to give. If I get money from the wealthy in the United States, I would have all the leftists telling me that I am being financed by multinationals with interests in Peruvian politics. If I get money from my government, I would be dependent on the political power. If I get money from your government or anyone related to your government…there is no place that I can get money that isn't going to taint us. The only way to be absolutely clean would be if I did not get money from anybody. And that is impossible, you cannot do that.

So, the important thing is to make very sure that whoever you solicit funds from or whatever funds you get, they do not influence your program. We have stated very clearly, from the beginning, what it is we were going to do and what our points of view were going to be and how we were going to fight the wrong type of government, whether it be left or right—Peruvian left or right, which is very different from your left or right. So, in 1979 we organized a symposium during the socialist military dictatorship, called Democracy and the Market Economy. We also criticized government during 1980–85, when it was the right. And we continued with the Garcia government.

Reason: You are still a fairly young man, and I'm sure you will be in the thick of it for many years. Are you pessimistic or optimistic about trends in Latin America?

De Soto: Mario Vargas Llosa has always tried to discredit me by saying that I am constitutionally optimistic! And I am. I am optimistic, because I see trends changing. When I see something like what occurred in Peru now, that you can get 100,000 people together and six million people watching on television, it indicates that there is space.

So I would say that I am optimistic in the medium and long term, but I am probably rather pessimistic in the short term. I don't think progress will come quickly. I think that before you can change hearts and minds, as they need to be changed in Latin America, we will probably go through a lot of suffering. We will probably go through a lot of economic crisis. And there might even be death in the process before we get there. We have a terrorist movement in Peru, and that just won't disappear overnight. So, in the short term I have no reason to be optimistic. But over the long term I see a constituency for ideas, for freedom, building.