In Hernando De Soto’s book, The Other Path, he argues that a leading cause of Peru’s economic and terrorist problems stem from the difficulty of joining the formal market for things like transportation, forming a business, and even acquiring housing. According to De Soto, Peru’s economic system is similar to mercantilism, a system where the government bureaucracy creates a dense wall of regulations that facilitates the creation of a small section of society forming monopolies. As De Soto notes, mercantilism was the dominant economic system before the industrial revolution, but still exists in Latin America. Under this system, there is a perception that the economy must be managed from above, and cannot be left to the population or the markets.
During the time that De Soto wrote his book, most markets in Peru were dominated by the informal sector, as much as 70% or more. This is inefficient. Since the informals lack direct recognition, they have no easy route to communicate their needs and desires to the government. Because of this, they have to rely on disruptive strategies to have their needs met, such as invading private or government land to establish settlements, or organizing large protests to get a voice in society. Another way that informals make up for a lack of official recognition is through bribery, but this is a poor use of money that only enriches corrupt officials, and delegitimizes the state. In terms of scales of efficiencies, the informal market does not succeed. Since informals have to hide their activity, they cannot establish effective means of production, such as building bigger factories, so they limit production based on how much they can hide rather than how much the market demands. Also, since they don’t have a guarantee of recognition or permanence, there is little incentive for long term planning and improvement of business plans and activities.
If a population doesn’t have a sense of ownership in society, and are barred from joining in markets or even having a title to their land, then violent tactics like terrorism become more appealing. De Soto argues that by giving the population ownership and formal recognition they will turn their energies to productive rather than destructive ends. Also, by lowering the entry into the formal market in a reasonable manner, it would allow Peru’s economy to take advantage of its greatest asset, its labor market. At the time of De Soto’s book, formal companies focused more on capital intensive output instead of labor intensive output, but this is due to market distortion from regulations as Peru has a greater abundance labor than capital. The lack of an official labor market also distorts the tax base, causing formal business to cover a skewed percentage of tax money to make up for the large percentage of informals.
De Soto proposes a set of policies that will allow for greater participation in society through creation of good laws and elimination of bad laws. According to De Soto good laws should create property rights and contracts. The security of having property rights will allow for greater stability, and through that more long term planning and a possibility of making investments to increase productivity. The creation of a legal basis for contracts will allow for more trust between suppliers and distributors, and do away with the practice of having to rely on more than one supplier or the risk of non-fulfillment. De Soto’s category of bad laws includes anything that impedes or disrupts economic efficiency.
There is a lot to be said for De Soto’s theories, but it is unlikely that they are a magic bullet that can cure poverty and terrorism on their own. Laws provide a skeleton structure to society, if that basic structure is flawed it is unlikely that society will be successful, but even with a good structure there needs to be an interior building that comes through things like experience and culture. This was something that was demonstrated during the liberalization of Russia after the collapse of the Soviet Union. During this time period a less regulated, freer, structure was established, but since the fundamentals of society hadn’t changed it was initially unsuccessful. Those who already had power were better able to take advantage of the new freedoms, and since society was unused to the new laws, the police and courts were not able to enforce them effectively. The reforms that De Soto argues for are important, but need to be carried out in a way that considers the underlying system and implements the transition in a careful methodological manner that focuses on strengthening the underlying institutions responsible for enacting the new laws.