How capitalism can liberate the world

How capitalism can liberate the world's poor

By Robert J. Caldwell
Caldwell is editor of Insight. He can be reached at robert.caldwell@uniontrib.com

November 24, 2002

LIMA, Peru – Tucked away behind a wall on a quiet residential street here is a think tank dedicated to a breathtakingly revolutionary idea. The Institute of Liberty and Democracy and its founding economist, the brilliant Hernando de Soto, are ardent apostles of liberating and empowering the Third World's poor.

How?

By giving them access to the fundamentals of capitalism that have made the West rich – property rights, the rule of law, credit, capital and free markets.

If these capitalist components seem unconnected to the plight of, say, poor and uneducated Peruvian peasants, think again.

De Soto and his researchers at the Institute for Liberty and Democracy (www.ild.org) spent several years investigating and documenting what kept Lima's slum dwellers poor. Their findings pointed unerringly to the systematic exclusion of the poor from Peru's formal, legalized economy. For marginalized and dispossessed people, that exclusion translated to few and unsecured property rights, an absence of law, little or no credit or capital, and unfree formal markets controlled by government fiat, favoritism and corruption.

Thus, for example, a Peruvian family living in one of the illegally constructed shantytowns ringing Lima faced huge obstacles to even the small-scale entrepreneurship that could end its poverty. Starting a simple business – a sewing shop, for example – would require overcoming a veritable obstacle course of barriers.

The celebrated test case run by ILD researchers posing as business applicants found that obtaining all the necessary government permits and licenses required 289 days. Eleven government agencies had to approve and process the applications. Along the way, the ILD simulators posing as peasant poor were solicited for 10 bribes they were told were necessary to speed up the paperwork process.

The net cost for licenses, permits and the two bribes that couldn't be evaded by the hypothetical peasant applicants came to $194.40. The nearly 10-month wait entailed a further cost in net profits lost of $1,036.60. The total cost, then, was $1,231, a sum equal to 32 times Peru's monthly minimum wage. Such sums, obviously, were far beyond the resources of impoverished applicants.

ILD teams documented comparable horror stories of bureaucracy, corruption and deliberate exclusion of Peru's poor in housing, land acquisition and ownership, retail trade and in providing informal transportation (mini-buses) in transport-deficient Lima.

Faced with such odds against access to the formal economy, millions of marginalized Peruvians operate instead in the informal economy, otherwise known as the black market. De Soto estimates that almost 40 percent of Peru's entire economy, 48 percent of the work force and 61 percent of all work hours are in the informal, extralegal sector.

The lost opportunities, inefficiencies and sheer injustice in all this are huge.

Housing and land for which no formal titles can be obtained deny their owners the collateral essential for borrowing capital. Without access to capital, entrepreneurship is crippled. Without secured and recognized property rights, the creation of wealth and the reduction of poverty are severely constrained.

Informal sectors proliferate throughout Latin America, the Third World and now in most of the formerly communist countries.

De Soto writes that the black market constitutes 50 percent of the economy for Russia and Ukraine, 62 percent for the formerly Soviet Republic of Georgia and up to 90 percent in the African nation of Zambia. He cites International Labor Organization reports stating that 85 percent of all new jobs created in Latin America and the Caribbean since 1990 were in the extra legal sector.

In all, perhaps 4 billion people around the world are effectively denied access to the formal economy, and thus to the global economy.

The culprit here isn't too much free-market capitalism (as the muddle-headed anti-globalist protesters imagine) but rather not enough.

De Soto's work shows compellingly how Peru, and much of Latin America, built economies that were mercantilist, not free-market capitalist. The differences were decisive. Mercantilism, developed in Europe centuries ago, featured state-controlled, monopoly economies; the antithesis of democratic market capitalism.

Yet, for all the inefficiencies of informal sectors, de Soto and his institute calculate that the world's extra legal economies have nonetheless created more than $10 trillion in wealth over the past 40 years. As de Soto notes, that is a value 90 times greater than all bilateral foreign aid and 40 times larger than all international development loans received by poor countries.

Imagine, just imagine, how much poverty could have been eradicated and wealth created by liberating the creative power of this vast underclass. Surely $10 trillion could have become $100 trillion or more. The potential for raising living standards and improving the lives of many hundreds of millions, if not billions, of people was, and remains, staggering.

De Soto put all this in his global best seller, "The Other Path," first published in 1987. A sequel, "The Mystery of Capital: Why Capitalism Triumphs in the West and Fails Everywhere Else," is an impassioned plea for institutional reform, notably including establishing full property rights and the rule of law in developing countries.

De Soto is now an international consultant explaining his ideas to interested governments and showing how they can be implemented.

A better antidote to the dead-end futures that prompt violence and terrorism could hardly be imagined. Nor a better formula for creating both wealth and justice while opening the global economy to the world's poor and disenfranchised.