Peru’s Silent Revolution

Despite Government Regulation, Entrepreneurs Are Rolling Back a Feudal Economic Order

There are times when economists tell better stories than novelists. The story told by Hernando de Soto in El Otro Sendero: La Revolucion Informal (The Other Shining Path: The Informal Revolution) is one of these occasions. Although based in the reality of Peru, the story reveals a dimension of third world life traditionally obscured by ideological prejudice.

Good literature does not come with an obvious moral. It often teaches indirectly. El Otro Sendero, on the other hand, contains an explicit lesson, one grounded in the reality of today but that projects into the future. As distinct from other economic and social treatises on Latin America, whose abstraction distances them from the real world, El Otro Sendero is rooted in reality. Focusing on a phenomena that until now was poorly studied and even less well understood — the informal economy — it proposes a solution to the problems of the less developed countries that is the complete opposite of the one taken by the majority of governments and political elites of these countries, be they progressive or conservative. But it is — and this is the central thesis of the book — the path taken intuitively and of necessity by the underprivileged.

El Otro Sendero is an exhaustive study of the Peruvian informal economy — that which is called, in other places, the black, hidden, or marginal economy. In this sense, it is notable for the breadth of its findings and revelations. But, in reality, the book is much more than this. After describing the magnitude and complexity of economic activities carried on outside of, or in contravention of, the law in Peru. Hernando de Soto — who has had the collaboration of dozens of researchers and interviewers from the Institute for Liberty and Democracy, which he founded in Lima six years ago — offers a novel and controversial interpretation of the causes of the misery, social injustice and low productivity of third world countries. This book, because it puts the problem of underdevelopment in a different perspective, undercuts many of the myths about poor countries that have passed as scientific truths.

The Informal Economy

The informal economy is usually thought of as a problem. Consider the clandestine entrepreneurs and street vendors, whose industries and businesses are not registered and who do not pay taxes or operate under the existing rules and regulations. Are they not disloyal competitors of the companies and stores that operate legally, paying their taxes on time? On evading their obligations do they not deprive the state of the resources necessary to attend to social problems and strengthen the structure of society?

This kind of thinking, as El Otro Sendero demonstrates, is completely erroneous. In countries like Peru, the problem is not the informal economy but the state itself. The informal sector is a spontaneous and creative popular response to the inability of the state to satisfy the most elemental aspirations of its people. It is, of course, paradoxical that this book, written by a defender of economic freedom, constitutes an indictment against the ineptitude and discriminatory nature of the state in the third world which is unrivaled in its severity and force. It reduces most radical or Marxist critiques of underdevelopment to mere rhetorical posturing.

When legality is a privilege of those with economic and political power, no alternative but illegality remains for the popular classes. This is the origin of the informal economy which Hernando de Soto documents with incontrovertible proof. In order to learn in practical terms what the “cost of illegality” is in Peru, the Institute established a small, fictitious garment company and went through all of the steps — the bureaucratic maze — to establish it legally. It was decided not to pay any bribes except in those instances in which approval could be obtained in no other way. Of the ten instances in which bribes were solicited, two had to be paid. To register the fictitious company took 289 days and required almost the full time of those assigned the task. It also required the sum of $1,231 (counting both direct costs and lost earnings) which is thirty-two times the minimum wage. To “legalize” a small industry, under these conditions, is beyond the means of the common man, who constitutes most of the “informals” of Peru.

If it is so costly for a poor man to incorporate a small company, it is even more difficult to obtain legal housing. Hernando de Soto’s Institute proved that if a group of humble families petition the state for a piece of vacant land on which to build, they would have to pass through six years and eleven months of bureaucratic red tape in the ministries and municipalities and pay a sum of approximately $2,156 per person (which is equivalent to fifty-six times the present minimum wage). Even to obtain a license to open a small store front shop requires Kafkaesque contortions: forty-three days of red tape at a cost of $590.56 (fifteen times the minimum wage).

The statistics accompanying Hernando de Soto’s study, such as the three I have cited, are devastating. They clearly and logically strengthen the Institute’s analysis. The image of the country portrayed by these statistics is tragic and absurd. It is tragic because in this society the legal system seems conceived exclusively to favor those already favored and to punish those who are not, assigning them to a permanent status outside of the law. And it is absurd because a system of this type condemns itself to underdevelopment, slowly drowning in its own inefficiency and corruption.

But although El Otro Sendero is relentless in its description of the sources and extent of injustice in a third world country, it does not leave us demoralized and skeptical about the solution to this state of affairs. The informal economy — a parallel society and, in many cases, a more authentic, industrious and creative one than that which calls itself legitimate — appears in its pages as a way out of underdevelopment. Many of the victims of underdevelopment have begun to take advantage of it and, in the process, are revolutionizing the nation’s economy. They are doing so without, curiously enough, catching the attention of the great majority of those who write and theorize about the backwardness and social injustices of the third world.

When the poor who came down to the cities, expelled from their lands by drought, floods, over-population and the decline of agriculture, they found the existing system closed to them. They did the only thing they could in order to survive: create sources of employment and go to work on the margin of the law. Lacking capital and technical training, they could not hope to obtain credit or insurance, nor could they hope for protection by the police force or the judicial system. They knew their businesses would always be threatened from all sides. They had only their will, their desire to work and their imagination to count on.

To judge by the four sectors researched by the Institute for Liberty and Democracy — commerce, industry, housing, and transport — they have not done badly. In every case they have shown themselves to be incredibly more productive than the state. The statistics in El Otro Sendero are shocking. In Lima alone, informal commerce (excluding manufacturing) provides work for some 445,000 people. Of the 331 markets in the city, 274 (83 percent) have been constructed by informals. With regard to transport, it is no exaggeration to say that the inhabitants of Lima can move around the city thanks to the informals since, according to the findings of the Institute, 95 percent of the public transportation system of Lima belongs to them. Informals have invested more than $1 billion in the vehicles and maintenance facilities. In housing, the figures are equally impressive. Half of the population of Lima lives in homes constructed by informals. Between 1960 and 1984 the state built low income housing at a cost of $173.6 million. In the same period, the informals built homes for the incredible sum of $8.2 billion (forty-seven times more than the state).

These numbers speak eloquently of the productive energy restrictive legality has pushed into the informal economy. But they also say much about the true nature of that which is called, in the countries of the third world, the state but is almost always a caricature of what it should be. In this arena, Hernando de Soto offers demystifying evidence.

Underdevelopment and Mercantilism         

One of the most widespread myths in Latin America is that her backwardness is a consequence of the erroneous philosophy of economic liberalism adopted in the constitutions of almost all of the republics on independence from Spain and Portugal. This opening of their economies to the forces of the market is viewed as making them easy prey for voracious imperialism and as responsible for the abysmal internal inequalities between rich and poor. Our societies are seen as having become dependent and unjust as a result of having chosen “laissez faire” as a guiding economic principle.

Hernando de Soto brings this fallacy to the fore and proves that it cannot withstand a serious study of our economic history. His thesis that Peru never had a market economy and only now, thanks to informality, is beginning to develop one — although in an untamed and limited way — is applicable to all of the Latin American countries and probably to all of the third world. Economic freedom was a principle engraved in the constitutions but it did not have any more reality than the other principle so engraved — political liberty — to which our rulers, particularly the dictators, have always offered lipservice. The regime that, in reality, prevailed in our economies, masquerading as a “market economy” is defined by de Soto as “mercantilist.”

This term can be confusing because it defines a historic stage, a school of economics, and a moral attitude. The sense in which it is used in El Otro Sendero is that of a bureaucratized, regulating state that puts the principle of redistribution of wealth over the creation of wealth. By redistribution is meant the concession of privileges and monopolies to small, private-elites that depend on the state and on which it, in turn, is dependent. The state was never, in our countries, an expression of the people. It was whatever government happened to be in power, liberal or conservative, democratic or tyrannical, and it generally acted in the economic arena in accord with the mercantilist pattern. This is to say that it legislated and regulated in favor of small pressure groups — what de Soto calls “redistributive coalitions” — and discriminates against the interests of the large majorities whom this system pushed to the side or allowed to enjoy but a few, token crumbs of legality. The names of the privileged individuals and groups changed as governments did but the system was maintained. Not only does it concentrate wealth in a small minority but it also concedes to that majority the right to wealth.

Economic freedom existed only on paper until, by the force of circumstances, the poor of our countries, overwhelmed by the discrimination of which they were victims, began to put it into practice. By the system, in this sense, is meant not only this hybrid anomaly — the state, government — but, in addition, the businessmen who work within the law. El Otro Sendero does not mince words about these businessmen who, instead of favoring a system of justice and opportunity in which the laws guarantee free competition and promote creativity, have accommodated to a mercantilist system and dedicated their best efforts to obtaining official favor for monopolies. And even today, when the comfortable house in which they have been living is crumbling about them, they continue to look on industrial activity as a sinecure instead of a means of creating wealth.

A system of this nature is not only immoral, it is, above all, corrupt and inefficient. In it success does not depend on incentives and effort but on one’s aptitude for winning the sympathy of presidents, ministers, and other public functionaries (which often means simply the ability to corrupt them). In the chapters on “The Cost of Legality,” Hernando de Soto reveals that for the majority of formal firms, the most important expenditure, in terms of time and money, is bureaucratic red tape. This clearly indicates that economic life is corrupt from its very roots. Instead of promoting the creation of new wealth, the system, confined to a small circle of beneficiaries, discourages whatever effort might be made toward that end. It is dedicated to the distribution of an ever diminishing amount of capital. In a similar context, what proliferates are non-productive, purely parasitic activities. The proof of this is the elephant-sized bureaucracy that, in order to justify its existence, requires, for example, that to register a small company a citizen must contend with eleven different ministries and municiple offices over a period of ten months and, in at least two occasions, must make recourse to bribery in order to achieve this goal. It is no wonder that, operating under these conditions, the firms of the third world lag behind in their technological development and have difficulties competing in international markets.

At the same time that a mercantilist system condemns a society to economic impotence, it fetters it with a strait jacket that prevents it from prospering, establishing conditions of life, relations between individuals, and between them and the state, that inevitably reduce or annul the possibilities for democracy to function. “Mercantilism,” as described by Hernando de Soto, relies on a method of producing laws and regulations that mocks the most elemental democratic practices.

The Legal Web

It is said that in Peru the number of laws and dispositions with the force of law — decrees, ministerial resolutions, regulations — exceed half a million. This is an approximation as there is no way to know the exact number; one is dealing with a juridical labyrinth in which even the most cautious researcher loses his way. This cancerous proliferation of laws reflects the bizarre ethical conditions that prevail in our legislative process. Laws serve special interests, not the general interest. A logical consequence of this uncontrolled growth is that for every law there is a counter-law that amends, attenuates or is at odds with it. In other words, anyone involved in this legal morass, whether he likes it or not, is at some time or other breaking the law. Even more demoralizing is the fact that anyone breaking the law can find a law that will justify his actions.

Who produces these laws and decrees? Hernando de Soto’s study shows that only an infinitesimal percentage, one percent, of the legal norms come from the institution created to pass them, Parliament. And that the vast majority of them, 99 percent, are dictated by the executive branch. This is to say, that, 99 percent are dictated by the ministers and public entities where the bureaucrats can conceive them, draft them, even without the knowledge of those affected. Laws proposed in Parliament are publicly discussed, and the possibility always exists that the media will bring them to public attention. As a result, their beneficiaries or victims may be able to influence the law’s final form. But nothing like this occurs with the majority of our laws. They are cooked up in bureaucratic kitchens of the ministries (or in the private studios of certain lawyers) in accord with the persuasive power of the “redistributive coalitions” whose interests they will serve. And they are promulgated at such a rate that, not only does the average citizen not know about them, but even the lawyers — to say nothing of those most affected by them — are not able to keep abreast of them and react accordingly.

When a third world country regains or establishes a democracy, it means that more or less genuine elections have been held and that there is freedom of the press and of political life. But, behind this facade and, particularly in the organization of its economic and legal life, democratic practices are conspicuous by their absence. And what prevails is, in reality, a discriminatory and elitist system run by minorities to their own advantage.

“Informality” is the response of the majority against this system that has traditionally made them victims of a kind of economic and legal apartheid. In this system, the laws seemed designed to deny them access to things as elemental as a job and a roof over their heads. Should they give up these aspirations basic to survival in the name of a legality that is, in many ways, unreal and unjust? Rather, they have renounced legality and taken to the streets, selling whatever they could, setting up their little shops, and building their homes on the hills and sand dunes. Where there was no work, they created it, learning as they went what they did not already know. They made a virtue out of their shortcomings, and turned their ignorance into wisdom. In politics, they acted with infallibly pragmatic criteria. They turned their backs without scruple on fallen idols and opportunistically moved toward the ascending star. They were Odristas with Odria, Pradistas with Prado, Belaundistas with Belaunde, Velasquistas with Velasco. Now, they are, simultaneously, Marxists with Barrantes and Apristas with Alan Garcia.

But what they are, in reality and very profoundly, underneath these transitory tactical alliances, Hernando de Soto’s book admirably illustrates. They are men and women who through will power and, at times, super-human effort, without the least assistance from the formal sector of the country (better said, with its overt hostility), have been able to create more employment and more wealth in the areas in which they could function than the all powerful state. They have often demonstrated more boldness, determination, imagination and profound commitment to the country than their formal competitors. Thanks to them there are not more robbers and vagabonds than those that do infest the streets. Thanks to them there are not more hungry and unemployed than the many we do have. If the social problem of Peru is enormous, without them it would be infinitely worse.

But what we should thank them for most is that they have shown us a practical and effective way to fight against misfortune which is totally contrary to the prescriptions of third world ideologues, whose perseverance in error is one of the most notable enigmas of our time. The adoption of the “informals” — that of the poor — is not the strengthening and aggrandizement of the state but its radical diminution. They do not want collectivism, planned and regimented by monolithic governments, but rather a return of responsibility for directing the battle against backwardness and poverty to the individual, to initiative, and to private industry.

Who would have said it? If we listen to what these poor slum dwellers, these hordes of street vendors, are telling us through their actions, they do not speak of that for which so many third world ideologues call in their name — violent revolution, state control of the economy — but, instead, of genuine democracy and authentic liberty.

This is the thesis that Hernando de Soto convincingly defends in El Otro Sendero. The option of liberty, with all it implies, has never been seriously applied in our countries. Only now, in a most unforeseen way, through spontaneous action by the poor in their fight to survive, is it beginning to gain ground, showing itself to be a more sensible and efficient option than those applied traditionally by our conservatives and progressives to conquer underdevelopment. Both, in spite of their apparent ideological differences, agree on strengthening the state and its interventionist practices, which are the source of this culture of corruption, incompetence and favoritism that appears, like a nightmare, the length and breadth of the third world.

It will greatly surprise many that, in El Otro Sendero, the alternative of freedom appears as a choice of the poor against the elites. This is so because one of the most widespread beliefs concerning Latin America in the last few years is that liberal economic ideas are a characteristic trait of military dictatorships. Didn’t the “Chicago Boys” put them into practice with Pinochet in Chile and Martinez de Hoz in Argentina with catastrophic and well known results? Didn’t these politicians make the rich richer and the poor poorer in both countries and didn’t they precipitate unprecedented crises from which they have not yet recovered?

Liberty is indivisible and it is obviously incompatible with authoritarian or totalitarian regimes. The liberal economic measures that such regimes can take — or better said, impose from above — will always be relative and will be weighed down, as in Chile and Argentina, by the lack of complementary political freedom. It is such freedom that permits evaluation, perfection, and rectification of measures that do not work. Economic freedom is the counterpart of political freedom and only when the two are united, like the two sides of a coin, can they function effectively. Never can a dictatorship be really “liberal” in economic matters because the basic principle of a liberal philosophy is that it is not the politically powerful, but the independent and sovereign citizens, who have the right to take the initiative, to work and to sacrifice in order to decide the type of society in which they will live. The function of political power is to guarantee that the rules of the game are followed so that initiatives can be taken in an equitable and free way. And this requires, a priori, a consensus of the majority as to these principles, which can only take place in a democratic system.

Within liberalism there exist extreme and dogmatic attitudes. They are usually expressed by those who refuse to change when their ideas do not meet the critical test for any political program: that of reality. It is natural that in a third world country with the economic inequalities, the lack of cultural integration and the social problems, as in the majority of Latin American countries, the state has a redistributive function to fulfill. It is only when these gaping differences have been reduced to reasonable proportions that one can speak of rules of the game that are really impartial and identical for all. With the current inequalities that exist between rich and poor, urban and rural, Quecha speakers and Spanish speakers, the best conceived and purest means tend invincibly, in practice, to favor the few and hurt the many.

It is crucial that the state remember that wealth, to be redistributed, must first be produced. And that in order to achieve this, it is indispensible that actions of the state obstruct as little as possible the activities of the citizens since it is they who know, better than anyone, what they want and what they need to do. The state must restore to its citizens the right to undertake those tasks, a right it has been usurping and obstructing. It must limit itself to functioning in those areas necessary to the nation in which private enterprise cannot function. This does not mean that the state will wither away. A large state is not synonymous with a strong one. In fact, in the majority of Latin America, it is the opposite. These immense entities that, in our countries, drain the productive energies of the society in order to maintain their sterile existence are, in truth, giants with feet of clay. Their very gigantism makes them slow and clumsy and their inefficiency and immorality deprives them of all respect and authority without which no institution can function well.

El Otro Sendero does not idealize informality. On the contrary, after demonstrating its successes, it describes for us the limitations that living on the margin of the law impose on informal companies. They are impeded from growing and planning their future, they are vulnerable to robbery and other crises. The book also shows us something about the desire for legality revealed by many actions of the informals: the street vender’s desire to move from the streets to a market stall or the neighborhood group that improves sanitary facilities and street appearance to gain legal title. But, although it doesn’t embellish or overrate the informal economy, this study does give us a glimpse into the spirit and imagination displayed by the informals. And it suggests what one could expect if all of this productive energy were channeled into an authentic market economy in which the people were protected and stimulated instead of harassed by the state.

El Otro Sendero champions a program for a transformation of society no less profound than that desired by the most radical ideological sectors. It calls for pulling an ancient tradition out by the roots, a tradition that, because of the inertia, greed, and blindness of the political elites, has blended in with the institutions, customs, and traditions of the official nation. But the revolution analyzed by this study is in no way utopian. It is underway, made a reality by an army of victims of the existing system who, on rebelling against it in the name of the right to work and to live, have discovered the benefits of freedom.

Mario Vargas Llosa


Jorge Mario Pedro Vargas Llosa, 1st Marquis of Vargas Llosa (born March 28, 1936) is a Peruvian-Spanish writer, politician, journalist, essayist, and recipient of the 2010 Nobel Prize in Literature.

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