Commentary Magazine

The Only Hope for Latin America

As the 20th century nears its final decade, the forces which have shaped the entire postwar era appear at long last to be in definitive decline. At any rate, it seems virtually certain that in the coming years various regions and powers will play roles very different from the ones they have played for nearly half a century. The United States—somewhat recovered from Vietnam but apparently lacking the political will to continue as a great power—debates what role its resources will allow it to play. Within three years, the countries of the European community will open their borders to one another, creating what may well be the world’s largest and most powerful economic unit. The imminent end of the cold war has been announced, and major trends in West German opinion suggest the revival of an idea at least as old as Bismarck, namely, that Germany’s interests lie to the East, not the West. Japan, defeated and humiliated by the United States in 1945, now holds the key to New York’s financial markets, and therefore the entire economic well-being of its erstwhile conqueror. Korea, once a ward of American charity, has become a major industrial power in its own right, expanding its hold on some of the most competitive (and lucrative) Western markets.

In the so-called Third World, the picture is radically different. There, at least to judge by reports in the press, the characteristic motifs are internecine conflict, social regression, and sharp economic decline. This is most dramatically evident in Latin America, whose real per-capita Gross Domestic Product (GDP) has declined by at least 1.5 percent since 1980. In every rubric used by international agencies or development organizations to measure well-being—consumer price levels, investment, exports, imports, or the proportion of external debt to exports—the region as a whole has moved backward, in some cases precipitously so. It is perhaps the only Westernized region of the world with good reason to fear the 21st century.

This is a fairly astounding development when one reflects upon the fact that these figures subsume not merely backward tropical republics like Honduras or Paraguay but sophisticated urban societies like Brazil, Argentina, Colombia, and Venezuela—nations which ranked in the second tier of powers after World War II; which registered fairly respectable rates of growth for the first six or seven decades of the 20th century; and which still produce large numbers of talented and energetic scientists, engineers, physicians, technocrats, intellectuals, and skilled workers, many of whom have quit their places of origin for Western Europe or the United States, or are in the process of doing so.

The loss of international status has been both relative and absolute, and over the years a new rhetoric has come into existence to explain the current state of affairs, as well as to make certain that the blame is placed as far from home as possible. During the 1960′s, the dominant themes of public discourse in Latin America were the allegedly “unequal terms of exchange” of goods and services or the supposed machinations of the “transnational corporations”; in the 1970′s, all ills, economic and otherwise, were attributed to the lack of democratic government, due, supposedly, to the export of militarism and “McCarthyism” by the United States; in the 1980′s, the new explanation has become the burden of Latin America’s huge public and private debt. This is certainly not negligible; in 1988 it was estimated at somewhat in excess of $400 billion, the service on which represented slightly more than 42 percent of the value of exports. “The status quo is intolerable,” states one report by a multinational commission. “As long as Latin America must pay out substantially more in interest than it obtains in new loans, the region will remain stuck on a treadmill of austerity, stagnation, and rising debt,” the report continues, and concludes that the weakest performing economies of the region “require outright relief from a significant share of their obligations.”1

Some Latin American political leaders have gone considerably further than this, demanding not merely debt relief or debt forgiveness, but the massive transfer of new resources, such as those which the Soviet Union and the United States will presumably possess as a result of the INF treaty and the general disarmament process. As Bolivian Vice President Julio Garrett Ayllón—by no means a man of the Left—recently stated, it would be terrible if funds excised from Western military budgets ended up being utilized by the industrialized countries to “improve and increase their technological development, thus postponing the aspirations of the underdeveloped countries which are greater in number and have the highest mortality, unemployment, and illiteracy rates.”

Thus in a mere twenty years the political agenda in Latin America has gone from the need to liberate oneself from foreign economic influence and U. S. “imperialism” to asserting the obligation of the quondam imperialists to rescue societies on the verge of economic collapse. In times past, even quite irrational economic demands could be made more palatable by invoking the larger security imperative; in the post-cold-war world, the Latin Americans may find it significantly more difficult to get Washington to return their calls, much less to earmark for them larger portions of its dwindling budget for overseas assistance.



In no country is this dilemma placed in sharper relief than Peru, where the rate of inflation in 1988 reached 1,722 percent, more than ten times its previous record (158.3 percent) just three years ago. Personal income has declined steadily over the last ten years, and is now at the level of 1968. Massive strikes, often degenerating into violence, have become a commonplace, and only the sure conviction that a coup would lead to international isolation and sanctions by the U.S. Congress has prevented the armed forces, which gave up power to civilians in 1979, from seizing it once again. As if this were not enough, Peru is afflicted with a peculiar guerrilla movement, the so-called “Shining Path” (Sendero Luminoso5), which probably constitutes no more than 3,000 persons, but is capable of blacking out Lima, the capital, or other Peruvian cities at will, and posing a serious security threat in many areas of the countryside.

As in most Latin American countries, in Peru the contrast between rich and poor, between haves and have nots, is enormous, though not for lack of attempts at a radical solution. In fact, Peru has already had its revolution, complete with land reform, self-governing “industrial communities,” expropriation of foreign oil companies, expulsion of the U.S. military mission, and the purchase of arms from the Soviet Union—all under a leftist military junta which was in power from 1968 to 1975. These policies bore a remarkable resemblance to those of Marxist Salvador Allende in neighboring Chile (1970-73). Indeed, the results were much the same—the only difference being that, having a military government to start with, the experiment ended not in a coup but in the surrender of authority to hapless civilians.

As far as Peru has gone, this would appear to some to be not far enough. The current president, Alan García Pérez, is a firebrand of the Latin American populist Left who took office in 1985 determined to square accounts with the United States and the International Monetary Fund, both of whom he held responsible for his country’s problems. During the first two years of Garcia’s term, Peru reduced payments on its foreign debt (then estimated at $14 billion) to 10 percent of its export revenues; for a brief period the country enjoyed a modest consumer boom before it became apparent that debt service was only a small part of its economic problems. García’s popularity, which was 67 percent at the beginning of his term, now hovers in the low teens, and sophisticated observers have reason to think that he has been actively conniving at a coup of his own as the only way of assuring his political future six or seven years hence. At this juncture, the Marxist mayor of Lima, José Barrantes, appears the most likely successor to Garcia in next year’s elections, though Barrantes may not successfully turn aside a mounting challenge from the novelist Mario Vargas Llosa, a political newcomer who is perhaps the most famous living Peruvian. If Barrantes does win, it will be interesting to see if an explicitly Marxist president can go farther than his predecessor in hurling the country backward toward the 16th century.



Peru would seem, then, to be a case study in the apparently limitless capacity of Latin American societies for self-mutilation. However, this may be true only at the level of public (that is, explicitly political) life. Beneath the surface there is another reality which holds out some hope for Peru’s future and that of societies like it. Such, at any rate, is the import of Hernando de Soto’s new book, The Other Path, which has already captured the imagination of readers in nearly two dozen Spanish-speaking countries, and is now available in English.2 On one level, The Other Path is a study of how the Peruvian economic system actually works, to whose benefit, and at what cost. But on another level, De Soto’s book amounts to a counter-manifesto to what passes for “development economics” in Latin America (as well as the United States and Western Europe), and an alternative theory of economic history. This is a great deal to ask of a single volume, yet De Soto carries it off with surprising success. At any rate, the study, which was conducted by the Institute for Liberty and Democracy (ILD) in Lima, a think-tank which De Soto heads, raises questions that will be difficult to ignore, and presents data that must either be refuted3 or provoke some radical rethinking at places like the U.S. Agency for International Development and other bodies charged with the allocation of assistance to Third World countries.

The Other Path shows that there are two ways of looking at societies like Peru—either by measuring their economic performance in terms of the amount of wealth generated by enterprises licensed by the government (the “formal sector”), or by looking at their underground economies (the “informal sector”). In the case of Peru, it is De Soto’s contention that in recent years fully 48 percent of the economically active population, representing 61.2 percent of all hours worked, has been engaged in informal activities which have contributed 38.9 percent of the GDP recorded in the country’s national accounts. Without this informal sector, Lima today would have almost no housing and virtually no public transportation.

Like most Third World capitals, Lima has mushroomed into a sprawling metropolis over the last forty years, largely as the result of migration from rural areas. On paper, this growth has been strictly controlled by laws governing zoning and licensing. In fact, virtually the totality of the postwar city has been created in defiance of the law, successive portions having been gradually incorporated into the existing system through a succession of amnesties and recognitions purchased by pledges of political support to a succession of governments of the most varied ideological complexions.

Like most Latin American governments, one regime after another in Peru has come to power committed to “affordable housing.” According to ILD calculations, between 1960 and 1984, the state invested $173.6 million4 in housing, much of it presumably from foreign assistance. Yet this amounts to a mere 2.1 percent of the resources put into housing by the informal sector. In 1984 the total value of informal housing—that is, housing built without a permit—in Lima was in excess of $8 billion, and what is perhaps more to the point, equivalent to 69 percent of the country’s long-term external debt in the same year.

Clearly, there is still a housing shortage in Lima, but not from lack of energy, capital, or commitment on the part of Peruvians, who have managed to circumvent the state and outperform it—spectacularly so.

The story is the same in public transportation. De Soto’s group discovered that in 1984 fully 91 percent of the facilities in Lima were being operated informally, by a fleet of buses, minibuses, and taxis, representing 41.2 percent of all public investment in Peru. Again, the contrast with the state is instructive. In 1973 the “reformist” military junta attempted to create the Metropolitan Federation of Transport Cooperatives. Though by the end of 1982 the Federation had received $12.9 million in subsidies, its fleet had actually declined in size—from 285 to 189 vehicles. Were President García (or his successor) to decide to outlaw the vast pirate armada of vehicles which provides the capital with transportation, he would have to come up with $620 million in replacement costs, leaving aside an additional $400 million in infrastructure (gas pumps, repair shops, and so forth).

These figures point to a fact often missed by journalists, diplomats, international civil servants, and humanitarians, namely, that the structure and dimensions of employment in Peru (and, presumably, other countries like it) are very different from those set forth in official figures. Quite apart from the people engaged in construction and transport, De Soto’s group has found that fully 314,000 people in Lima are dependent upon street vending, which in 1985 represented $6.2 million worth of sales a week, $322.2 million a year. The net per-capita income from street vending was $58 a month, which may not seem like much to Americans, but is nearly four times the legal minimum wage. Technically, street vending is either illegal or subject to a welter of regulations tending to limit its extent, and various Peruvian governments have tried to circumscribe it by building markets where small-scale commercial transactions can take place. There are in fact some 57 of these markets in Lima, but the ILD has discovered that there are another 274 which officially do not exist—four out of five.



One might well ask why so large a part of the Peruvian economy is underground. The answer is that over the last two generations at least, every government, whether civilian or military, Left, Right, or Center, has enacted a welter of regulations whose effect is to stifle enterprise. In order to document the full dimensions of this problem, the Institute for Liberty and Democracy actually undertook to “walk through” a series of operations. Its researchers found that to get a building permit required 83 months of applications, litigation, and waiting. It took 26 months to obtain approval of a minibus route. To build a market, an average of seventeen years was required, De Soto reports, “from the formation of a minimarket until the market proper comes into operation.” If someone were foolhardy enough to stay the course until a small industrial firm were finally established legally, which would take quite literally years, he would discover that to remain formal would cost 347.7 percent of the firm’s after-tax profits and 11.3 percent of its production. “In other words,” De Soto notes, “for every $100 that a small industrial firm must pay in order to remain legal, $22 goes to taxes, $73 to other legal costs, and $5 to utilities. . . . The company’s prosperity depends less on how well it does its work than on the costs imposed on it by law.” Small wonder that so many people have deserted to informality.

An even more interesting question is why the Peruvian state would wish to stifle enterprise in the first place, particularly since the main effect of such a policy is to shrink its own tax base. The answer is that the organizing principle of all government activity in Peru (and indeed, in almost all Latin American countries) is to distribute income—and unearned income at that—rather than generate it. This, according to De Soto, has “transformed us into a democracy of pressure groups.” He goes on:

A legal system whose sole purpose is redistribution . . . benefits neither rich nor poor, but only those best organized to establish close ties with the people in power.

It ensures that the businesses that remain in the market are those that are most efficient politically, not economically. . . .

Thus, redistributive laws ultimately politicize all sectors of the population, which try to organize in order to live at the other’s expense. Consumers press for prices below competitive levels, wage earners press for wages above them, established businesspeople try to prevent or delay any innovation that might damage their position, and employees exert pressure to keep their jobs and avoid replacement by more efficient workers.

The system has forced all of us to become experts in obtaining protection or advantages from the state. . . . Some of the country’s best talent and . . . best hours are spent on waging redistributive wars instead of achieving real progress.

This point becomes clearer when one turns to the specifics. The reason Lima has almost no legal public transportation is that over the years the government has imposed a series of controls on fares which are, to put it mildly, economically irrational. After these regulations drove several companies out of business, the state took them over, pumped millions of dollars into subsidizing them, and the fleet still shrank in size. However, the larger political purposes of the government were served—it could prove it was “caring” because it refused to buckle under to pressures to raise fares. The dirty secret is that if all Peruvians had obeyed the law, the city of Lima would have come to a total standstill.

There are many ways in which the explosion of Peru’s informal sector can be regarded as a sign of the fundamental health of the society—its capacity to negotiate past irrational obstacles; the working energies of its people; the entrepreneurial skills which require no injection of “foreign aid” to blossom; the sheer power to create wealth by people who are, inevitably, very poor by Western standards. But as De Soto points out, two economic systems operating at cross purposes exact an unusually high price. The informals must disperse employees among a number of smaller and less visible workplaces, preventing the creation of critical mass or economies of scale. They cannot advertise their goods and services. They are fearful of entering certain markets. They are undercapitalized because they have no access to major sources of credit; even if they did, they would be hesitant to invest in certain major capital improvements lest they attract government attention.

There is also a point beyond which informal enterprises cannot expand. Because they are not legally recognized they cannot transfer their property easily; they cannot sell shares; they cannot convert debts into shares; they have great difficulty obtaining insurance; they must spend substantial amounts defending their possessions. In matters such as housing, there is a strong temptation to invest disproportionately in moveable objects (household electrical fixtures, for example) rather than in piping, drainage, and roofing. There is a tendency to rely upon word-of-mouth and personal recommendations rather than allow production, labor, and capital markets to remain wide open “and so achieve both economies of scale and increasingly efficient specialization.”

Even so, the informals are hardly irrelevant to the formal system. That is, though they do not pay direct taxes on operations, they transfer resources to the government and other formal institutions through indirect taxation, inflation, and differences in the interest rate which they must pay to private and small-scale lenders. In 1985, for example, the ILD estimates that $1.367 billion—or 9.5 percent of the GDP—was transferred to the state from the informals. As De Soto points out, “This would have more than covered the central government’s entire investments for that year, which came to $465 million.”



De Soto’s description of the Peruvian economy is redolent not of socialism but of the corporate state, with one major difference—successive governments have not succeeded in making the official structures coterminous with the system as a whole. Instead, there are really two Perus, one whose objective is to redistribute wealth, no matter how much this reduces the actual amount of wealth available (the formal sector), and another which operates according to the normal law of supply and demand, but given the legal context, must limit its scope and reach, lives in fear of discovery, and inevitably contributes less to society and to the state than it otherwise might do (the informals).

What De Soto suggests is that Peru is living in two historical times at once—officially, it inhabits a period similar to that of Western Europe during the reign of mercantilism; unofficially, it is battering down the walls that separate it from the modern world. In order to illustrate the metaphor, De Soto devotes an entire chapter to comparative history, reminding us that for a very long period countries like England and France were organized in ways not very different from contemporary Peru. They too “had to support a large number of unproductive bureaucrats and lawyers, who served only to wrap, unwrap, and rewrap [their] countries’ subjects in laws which controlled, distributed, redistributed, and assigned the privileges which strengthened the state and favored certain entrepreneurs.” This approach was perhaps understandable in a period when most societies were isolated from one another; when levels of technology were abysmally low; when life expectancy was short; and when the notion of a finite universe was a logical response to the perceived environment. No such excuses can be provided to any state in the contemporary world, least of all in Latin America.

De Soto goes even further, and provides an entirely new twist to Marx’s theory of historical development. He argues that the degree to which European societies have succeeded in making the transition to modernity and democracy depends directly upon their capacity to make the jump from mercantilism to capitalism. This provides him with a continuum, with England on one end, France in the center, and Russia on the far side. “The lesson to be learned from Europe,” he writes,

is that a declining mercantilist government which resists the necessary institutional changes is opening the door wide to violence and disorder. It may delay the final outcome at the cost of repression and considerable suffering, but sooner or later the contradictions will probably be solved either by a Communist dictatorship or by coexistence within a democratic system and a market economy.

Some may find this affirmation a bit too sweeping. Economic historians of Western Europe will no doubt quibble over some of his interpretations of British, French, or Russian history, but clearly De Soto is onto something very important, at least as far as Peru is concerned. One of the ways in which the issue has been confused in that country has been the tendency of beneficiaries of the official system (owners of large-scale businesses benefiting from government subsidies, direct or indirect)—in other words, the political Right—to adopt the language and ideological stance of their confrères in modern Western countries. This leads the traditional Left, not unnaturally, to confuse the two systems and conclude that “although private ownership of the means of production predominates, the development the country needs has not been achieved, proving that capitalism has failed and that a collectivist model is needed.” In short, in Peruvian politics both Left and Right are debating the merits of a system which exists only at the margins.

Actually, there is very little private property in Peru, in the sense that most people have no legal right to the wealth they have created. De Soto shows how some groups, particularly urban settlements, have used partisan politics to negotiate recognition of what they already enjoy in usufruct. Nonetheless, most people enjoy only what he calls the “expectative rights of property.” If the system were opened up, and the right to property made universal, this would have the effect of freeing vast productive forces currently either underground or not yet congealed into wealth, propelling Peru toward a capitalist revolution of a type not yet seen in Latin America.



De Soto has never made any claims that his book does anything more than describe what the Institute for Liberty and Democracy found in Peru. Yet since The Other Path was published, he has been flooded with mail, phone calls, and visits from people from Mexico, Ecuador, Colombia, Venezuela, and Argentina, all of whom have assured him that “if you change the names of the towns or the names of organizations, you have [my country].” These include industrialists, labor leaders, even the vice president of a South American country. If they are right, then important political choices lie ahead. Will the region be able to make them? It is a tall order—given, particularly, the continuing domination in every country of a political class trained only in the jurisprudence of the old system. This class lives in a parasitic fashion on the diminishing wealth created by the formal system, and is egged on by the vast infrastructures of development organizations favoring an international welfare state.

The truth is, however, that no vast international transfers of wealth are likely to take place in the 90′s: the only hope for the survival of democracy in the region is the diffusion of property and the enfranchisement of those who actually work and create wealth. The Latin American politicians are right about one thing: the current economic crisis is undermining the stability of the region, and raises the very real specter of a plunge into a full-dress collectivism. But the answer to this is more economic freedom, not less. “We have to call things by their real name,” Spanish President Felipe Gonzalez recently said. “Their economic system doesn’t work. The explanations their leaders give for the poor results are no longer convincing.” He was referring to the socialist states of Eastern Europe, but his remark might just as easily be addressed to his colleagues in Latin America. Hernando de Soto has given them a road map to the future; one can only hope they will prove capable of taking it.




1 The Americas in 1989: Consensus for Action, A Report of the Inter-American Dialogue (Washington, D. C, 1989).

2 Harper & Row, 271 pp., 122.95.

3 The econometric models are not reproduced in the book, but are available from the publisher.

4 All figures are based on the ILD's calculations and converted to U.S. dollars on the rate of exchange in 1984 or 1985.

About the Author

Mark Falcoff is resident scholar emeritus at the American Enterprise Institute in Washington.

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