Peru's Peaceful Revolution

The Other Path, by Hernando de Soto, New York: Harper & Row, 272 pages, $22.95

Few books by free-market authors have achieved the goal of selling, in only one year, more than 100,000 copies. It is even harder to find Spanish publications that have had any noticeable impact in the United States. The Other Path, by a Peruvian businessman-turned-intellectual, Hernando de Soto, accomplished both goals even before the release of its English edition. The success of the book lies not only in the quality of its in-depth analysis but also in de Soto's unique style, which brings together sound economic analysis and a constant concern for the poor and oppressed.

The main virtue of The Other Path is its demolition of some widely held myths about Latin American development:

Myth 1: Latin Americans lack an entrepreneurial spirit.

Myth 2: The United States is the region's main oppressor.

Myth 3: The current economic system in most Latin American countries is predominantly capitalist.

To take just the first myth, in detailed field studies de Soto found that Peru does not lack entrepreneurs, but most of them have been driven out of "the formal sector" by state oppression—for example, a plethora of regulations, taxes, permits, and licensing laws. During a simulated registration process, in which bribes were requested 10 times and had to be paid twice, de Soto demonstrated that it takes 289 days to register a small factory in Peru. And the total cost of registering was eight times the Peruvian GNP per capita. The result? The poor cannot afford to obey the government.

Consequently, some 60 percent of the work force operates in the informal sector, without the required licenses and permits. De Soto and his researchers calculate that this work force accounts for nearly 40 percent of Peru's gross domestic product.

In publicizing these findings, de Soto dispels the myth that the Latin American population "is different" and incapable of taking advantage of market opportunities. What stifles entrepreneurship is not a lack of risk-taking individuals but extensive and repressive economic regulations.

De Soto defends those who have been displaced from the legal sector and condemns entrepreneurs who "feel more comfortable collaborating with an interventionist power, with whom they can make deals, than advocating a market economy which has no omnipotent ruler who can come to their rescue." The underground entrepreneurial class, he maintains, constitutes valuable, even indispensable, human capital. This group has given hope and an income to a growing number of people and provided an avenue for social mobility and productive opportunity.

Hernando de Soto is not an orthodox classical liberal. For example, he defends the right and duty of the state to redistribute wealth to the poor. Nonetheless, both his analysis and his policy recommendations suggest that the best way to help the poor is to allow the evolution of a system of private property.

At times, de Soto seems to regret that the underground, or informal, economy serves as a barrier to implementing government economic policy. Yet, far from being a liability, as he implies, this barrier to social engineering has actually prevented establishment of a complete technocratic dictatorship. If government attempts to manipulate economies miss their targets in the broad daylight of the formal Western economies, imagine their ineffectiveness when they shoot in the dark of an economy dominated by black markets.

In spite of these drawbacks, The Other Path is mandatory reading for anyone concerned with Latin American problems. Reaching back to the Spanish colonial era, it provides a brilliant history of Peru's economic, social, and political institutions. His analysis provides a better understanding of the causes of underdevelopment than the explanations favored by American intellectuals either of the left, who blame the capitalist system, or of the right, who frequently fault "backward cultures." De Soto does not deny that cultural differences play a role in economic development, but he proves that the legal system, which poorly defines and protects property rights, is the main explanation for the difference in development of industrialized Western nations and Third World nations like Peru.

A question deserving lengthier study is what accounts for the adoption of these different legal systems. It is not enough to blame, as de Soto does, the Hispanic mecantilist heritage or the role of special interests. Most of the failed policies implemented in Peru and the rest of Latin America received intellectual or financial support from U.S. bureaucrats and scholars. These people have little knowledge and biased perceptions of Latin American realities. For example, in the '60s, U.S. policymakers ushered in with much fanfare the Alliance for Progress, an aid program that recommended a variety of interventionist economic reforms. Likewise in the '70s, the United States made land reform and other anti-market policies a precondition for aid to El Salvador.

In their reinforcement of myths about Latin America, U.S. Latin American scholars and policymakers, mostly social engineers or emigres who distrust markets and private property, have been aided by a lack of empirical studies with sound theoretical foundations. The Other Path will make it more difficult for such analysts to ignore the conditions of human prosperity. De Soto incorporates into his analysis the latest contributions to social science from scholars such as F.A. Hayek, James Buchanan, Gordon Tullock, and Douglass North and provides empirical corroboration for their theories. Drawing from Hayek, de Soto shows the importance of a spontaneous ordering of human activity, rather than an imposed order. He utilizes Buchanan and Tullock's public choice theory to show how many commercial regulations result from interest groups pursuing economic advantage in the political arena. From North's work, de Soto builds the case for private property as essential to economic development.

This Peruvian intellectual is at his best in the uncompromising words of the conclusion: "We are convinced that, the more we treasure the importance of the Rule of Law, the more we will realize that the true problems lie not in the informal sector but in the formal sector." De Soto tags the rebellion against the state that takes place in the form of the underground economy "the other path," playing off the name adopted by Peru's Maoist guerrillas, The Shining Path. As long as government intervention in the economy by leftist and rightist regimes continues, the peaceful revolution of the underground economy may well be "the only path" for the survival of the private sector. As Arturo Fontaine, another leading Latin American, said, "A new path has been opened, and the people are treading on it."

Alejandro Chafuen is director of Latin American Affairs at the Atlas Economic Research Foundation in Fairfax, Virginia.