David Levy - Vice President
Published December 1, 1989 | December 1989 issue
By Hernando de Soto
Harper & Row
Photographs, 271 pages
These days, nearly any discussion on developing countries will eventually turn to the ideas of Hernando de Soto contained in his book, The Other Path. Universities teaching international economics or development will most likely list de Soto's book as required reading; directors of international development agencies have begun to universalize the book's concepts; and heads of state quote de Soto in their speeches.
President Bush, in his remarks to the World Bank/IMF annual meeting this year, was no exception. He summarized the essence of the book well by saying:
The Peruvian economist, Hernando de Soto, has helped us understand a worldwide economic phenomenon. By walking the streets of Lima not analyzing official statistics, he found the poor of Latin Americawho have never read Jefferson or Adam Smithran their affairs democratically, outside the formal economy, organizing their private, parallel economy in a free and unregulated manner.
De Soto's great contribution has been to point out what, in retrospect, may seem obvious: People everywhere want the same things. And when left alone by government, people everywhere organize their lives in remarkably similar ways.
De Soto's prescription offers a clear and promising alternative to economic stagnation in Latin America and other parts of the world. Governments must bring "informal" workers into the regular economyand then get out of the way and let individual enterprise flourish.
The book and its ideas have gained currency in a remarkably short time. It was only in 1986 that de Soto published his book El Otro Sendero in Spanish, and the first English translation appeared in early 1989. It quickly went on the best seller lists wherever sold and now is translated in languages ranging from Swedish to Swahili.
Why so popular? The story begins with de Soto, a mid-40s Peruvian entrepreneur who earlier worked as an economist for GATT, as a managing director of an engineering corporation in Europe and as director of Peru's Central Reserve Bank. De Soto decided to find an answer to the simple and direct question that had continuously plagued him: What's wrong with Peru's economy? He began to seriously explore the question and to open his mind to explanations that went beyond the normal conjecture of "class-blaming-class" or "industrialized-exploiting-underdeveloped." De Soto didn't have a predetermined answer in mind; he wasn't looking for an informal economy.
But that's what he found. Side by side with the highly socialized formal economy was an exceptionally healthy and reasonably efficient market economy. It was the country's black market, but he chose to call it the informal economy, a label with less negative connotations.
Since the end of World War II the major cities of Peru experienced an in-migration of poor, mostly illiterate peasants. They came to the cities with few or no skills and found practically no government safety nets. Systematically, they were excluded from participation in the formal economy by what de Soto calls the redistributive tradition. That is, the established order held little interest in creating new wealth and was content to reflexively serve pieces of the existing economic pie to each other. An impenetrable bureaucracy bounded the formal economy.
To better help his readers understand what these peasants encountered, de Soto compares the governments and politics of Peru to that of the mercantilists of 15th-19th century Europe. Historically, the mercantilists sought economic welfare through state control of monopoly rights. In the context of his book, de Soto means more specifically a "bureaucratized and law-ridden state that regards the redistribution of national wealth as more important than the production of wealth."
So, those who arrived late to the cities couldn't gain favored status in the economynor any status. Worse yet, they found no jobs, transportation, housing or even food and water.
The informals responded by spontaneously creating a market to support themselves. It's this point that so many find fascinating. Left alone with a pressing need for efficiency and precious few resources, how did these people organize themselves? What was their "natural" inclination? Without question they picked Adam Smith over Karl Marx. They chose the market economy.
And the market economy has served them well (which also fascinates the development professionals). Through invasion and illegal purchase the informals acquired land, opened businesses and initiated bus routes. By organizing themselves and voluntarily obeying their own extralegal norms, they provided virtually adequate public services, policed their communities and administered a system of justice designed for the emerging subculture.
The Instituto Libertad y Democracia, the think tank de Soto heads, offers remarkable statistics quantifying the informal sector's economic progress and showing its contribution to the national wealth:
These numbers, along with others that de Soto tracks clearly show that the poor of Peru are finding an independent way to bootstrap themselves. By conscious choice they pick private initiative and enterprise to conquer their own underdevelopment and poverty.
De Soto would argue that Peru is not unlike most of Latin America and a large portion of Third World countries; they all have informal economies. But they are stuck with variations of long-ago inherited mercantilist systems. Development possibilities are slim until market economies are legitimized rather than seen as problems themselves. This notion stands traditional development thinking on its head.
De Soto calls The Other Path a political book. I'd say political economy, written not as an abstract economist-to-economist treatise that only recommends further study, but rather as an insightful investigation that may well, as one reader put it, serve as a "virtual manifesto for laissez faire capitalism in the Third World."
Of importance is that de Soto is himself an activist. That sets his work apart from the standard fare of development studies. He takes a personal stand in the government and politics of Peru and has been called upon to advise other countries of the region. He's not content to slap another set of ideas on the table and see if anyone's interestedand then move on. No, he's working for constructive change as he sees it. It's much more than a book-length speculation; it's serious business for de Soto.
In the last chapter of his book, de Soto lays out his conclusions and an outline for a course of action. They're somewhat predictable, but left unsaid for those who plan to read the book. How are the lingering remnants of mercantilism handled? Who supports or opposes a populist-based market economythe left, the right, neither or both? What are the chances of a violent outcome if formal and informal can't synthesize?
At an historic time when Communist countries worldwide are rethinking their political philosophy and economic orientations, de Soto's book seems to be on the top of the stack for consideration.
The Other Path's many lessons deal mostly with developing countries, but it is only natural to relate them to one's own local economy. Tracking the Ninth Federal Reserve District's regional economy as we do, it's obvious to see that informal economies exist here also. Our Midwestern versions are substantially different, of course, because of the size, the welfare system altering incentives and the national capitalist (not socialist) orientation. But nonetheless we have economically disenfranchised groups who struggle to improve themselves. Where ethnically identifiable, they are, among others, recent Southeast Asian immigrants and Native Americans.
For these local informals, the book's ideas could be important if only to highlight the economic potential of finding market-based solutions; and expanding the circle, it's a safe bet that its pages could inform (in some small way) those who work on the larger problems of America's inner cities.