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Volume 28, Number 2-3, Winter, Spring, 2010

The Power of the Poor

With Hernando de Soto

DVD, 57 minutes
Produced by Free to Choose Media
Reviewed by Jerry Jewett

Peruvian economist and reformer Hernando de Soto narrates this simple yet dramatic documentary about the challenges Peru suffered and how careful changes in the law transformed the country from a rural backwater into a growing economic powerhouse.

Peru had been under tyrannical central rule for most of its existence. Large landholders and a cultural and administrative elite, primarily those of European descent, ran the country, while rural people worked the land in conditions akin to serfdom, perpetuating a tradition of exploitation dating back to Pizarro himself. Though they might have lived on the land for generations, the indigenous people lacked legal title, nor had they any formal legal personal identification. As a result, obtaining credit was largely impossible. Subsistence agriculture was the norm.

Owing to historical misadventures, Peru was nearly bankrupt by 1929. Exchanges of power between civilian and military authority, and consistent domination of the economy and land holdings by the Eurocentric oligarchy, kept the country sharply divided into a minority of haves and a majority of have-nots. Widespread prosperity had never prevailed in Peru. Beginning in the 1970s, the Maoist guerrilla faction Sendero Luminoso (Shining Path) exploited these stresses as they fomented civil insurrection and terrorism. The insurrection threatened the stability and survival of Peru.

Hernando de Soto was born in Peru, but during one of the periods of military rule, his exiled family relocated to Switzerland. There, de Soto learned that Switzerland had once been a poorer country. In 19th Century Switzerland, the federation of cantons was loosely organized, with each canton retaining its traditional French, Italian or German character, folkways, and business and legal practices.

Though Switzerland had been “an island of prosperity” at the end of the Thirty Years War, succeeding centuries saw rule by oligarchy over the cantons. An economic depression following the Treaty of Paris in 1815 lasted about three decades. At the time, there was not a strong national economy. Among the reasons? Perhaps the oligarchy favored only its own members to the exclusion of others, but there were structural factors, as well. Title, instruments of credit and other incidents of commerce were ill-developed on a broad scale. Each canton had a patchwork of customs and practices that might be at variance with any other Swiss canton. As a result, Switzerland had glorious scenery but a largely agrarian economy, as it has done for centuries. Trade was mostly local. But legal reforms attributed to one man changed Switzerland’s laws and its economic situation.

Eugen Huber was born in Zurich in 1849. By 1872 he had a doctorate in jurisprudence from the University of Zurich. Circa 1888-1892, Huber conducted an elaborate field study of the private laws of the cantons, yielding four volumes of findings. In 1892, the Swiss government asked Huber to develop the Swiss Civil Code.

Rather than consult with university professors, economists, and lawyers as to the most desirable order of things, Huber went among the people to find the commonalities and shared values that held true most generally across Switzerland. As a result of his survey, he drafted a thousand-article Civil Code for Switzerland to adopt. When it was adopted, this put all cantons on an equal legal and business footing, creating the basis for a robust national economy well able to compete in international trade. Within generations, Switzerland changed from a lovely and mostly rural country a bit on the poor side, to one of the more affluent countries in the world.

While exiled to Switzerland, de Soto became a student at the University of Bern, and also a student of the development of Switzerland over its past century or so. He observed some similarities between Peru and Switzerland. Both countries in the 19th century had largely rural economies of mostly agricultural nature. However, Switzerland had since metamorphosed into a dynamic, prosperous, and growing economy. His studies in Bern persuaded de Soto that Eugen Huber had been the chief architect of the transformation of Switzerland into a powerful national economy. Huber may serve as a Swiss model for Karl Llewellyn and his work on the Uniform Commercial Code in the United States. As de Soto studied the work of Huber, he realized that the ideas, the principles and organizational plans which Huber developed, were not intrinsically Swiss in nature, but could be portable. Though the problems of Peru were not identical to what Switzerland had faced, there were parallels.

Creating a legal system that was not to the disadvantage of the poor was a key change for Peru. De Soto notes that to build a bridge enabling the structurally deprived to cross over into full economic participation, three things must be so. First, the bridge must anchor in the custom and practice of the people, with a solid foundation that will not crack. Second, it must be sufficiently well articulated and flexible that it won’t crack with the problems that develop over time. Third, it must be broad enough for everyone to cross.

Upon his return to Peru, de Soto studied the economic and legal situation in Peru. He observed the huge migration of people from rural areas to the outskirts of the cities, in desperate search for a life better than subsistence agriculture. He knew that the poor and the structurally disadvantaged were aware of the benefits of life in capitalist free societies, and wanted the benefits of such a life for themselves. He also notes that 2/3 of the world’s population lives in poverty in shanty towns or similarly undesirable circumstances. For those who make the migration from country to city, they typically were born without documentation of identification and have not acquired any.

The lack of any form of identification that reaches beyond the knowledge of fellow members of village and clan seriously hinders people of an entrepreneurial bent. Without a birth certificate or driver’s license or the like, one cannot get a formal loan in most cases. Without title to the property where one’s family may have lived for generations, one cannot get a loan secured by the land in order to improve the land or expand one’s production. The very right to contract or fully own property is abridged in such cases. Here are people who want to enter the capitalist system, but are shut out from within.

De Soto realized that these poor people are excluded from the purported benefits of globalization, as they are unable to market beyond their locale, or to perform contracts with foreign trading partners, for the lack of identity. Rich and poor all want the same things: homes, shops and businesses, roads and public works, schools, hospitals, and other infrastructure to support their lives. For more than forty years in Peru, throngs had left the land for the towns and cities, seeking education and prosperity, spontaneously forming markets where specialization of labor would benefit all. But all too often they were thwarted by legal systems that had been designed without regard for them.

When squatters settle on waste land that they do not own, their lack of title, lack of a specific address, and absence of personal identification rule out the provision of electric power and street lighting, water mains and sewer systems, improved streets, and other infrastructure so taken for granted by Westerners.

De Soto’s studies convinced him that major reform was needed. To counter The Shining Path, he laid out his vision in a book, The Other Path: The Economic Answer to Terrorism. De Soto was also instrumental in founding the Institute for Liberty and Democracy (ILD). This organization worked in Peru to ascertain causes of the plight of the structurally disadvantaged, and to seek solutions. One finding was that, even when fully financed by the Institute and guided by lawyers with knowledge of the system, getting a small sewing business registered as a legitimate enterprise took 289 days. Another discovery was that where a person without title, whether a rural farmer of many generations or a squatter just moved to the outskirts from the hinterlands, wanted to obtain title, the process took six years and 207 steps to secure title to their land.

It was obvious that the poor were systematically excluded. They were aware of their limitations, as well. The Shining Path guerrillas exploited the discontent of the poor and threatened to wreck Peruvian society in the process. Sendero offered protection to those who were left out of the system. Speaking of the poor, De Soto notes, ‘We will give them a stake in the game or they will bring down the game as many times as necessary until the game accommodates them,’ or much to that effect.

What de Soto found was that the poor who were excluded from the formal legal system were compensating by extralegal means. That is, they were working against the black-and-white letter of the law but with the support of the people The makeshift poor had learned how to hold property, to create and enforce contracts, and trade among themselves without recourse to the State and its legal system. One might call it a gray market; it worked well within its limitations. But growth was sharply limited and expansion almost impossible because of the constraints associated with lack of title and other legal documentation.

In 1969, apparent reforms took place. Redistribution of the land from big landlords occurred, but the recipients were collectives, ruled by directors appointed by bureaucrats from Lima. This change did not benefit the poor. Meanwhile, the Sendero activists excited the people with a Maoist vision of equality, which incited the discontented populace to support the terrorist insurrection. De Soto notes that to be poor is to be assaulted by impossibility. He also noted the extent to which such impossibility is man-made, and hence subject to change. And he reasoned that exclusion from possibility, rather than pure poverty, leads to violence and terrorism.

The law has to make sense, in order to integrate extralegals into the system. And getting them into the system has manifold benefits. First, the extralegals who enter the system develop the ability to obtain credit, have long-term contracts, expand their businesses, reach into larger and even global markets, and otherwise improve their own conditions very substantially. They are fully self-supporting and productive. Secondly, in so doing, they become employers and thus provide incomes and inspirations to ‘first-generation’ migrants to the cities. Thirdly, they very much stabilize society in the sense of investing in it, rather than attacking it for injustices experienced.

This is where de Soto’s learning of Huber’s work enters. Upon his return to Peru when it became safe to do so, de Soto founded ILD. He undertook research and education that led to entitling the poor. Setting up a secure property system created a foundation of order. By the end of the reforms pushed by the ILD, over 50% of Peruvians had title to their land. The time to register a business was shortened to one day, from 289 days. The amount of time required to formalize title to real property was cut to 45 days, from six years. By securing property to Peruvians of many walks of life, they were enabled to leverage their growth.

One example given was an LP gas supplier, Miguel Gutierez. He had started out with only a few LP gas canisters which he carried on a route he walked, then he got a wheel barrow to let him carry more canisters, and later used a bicycle to improve his productivity. He bought a small piece of property in a shanty town, taking full legal title. Then he used the title as security for a loan for $4,000 for a used station wagon. The increased prosperity led him to purchase a truck. He is now CEO of Multigas, a large LP gas distribution business with several dozen employees, all made possible because the background circumstances of ownership and commerce were so vastly improved. He always had the energy and talent but it took the reforms to permit him to establish his business at an enduring and prosperous level. Other examples were given, as well.

With secured property rights, access to capital, and opportunities to compete on a world market, substantial growth and prosperity followed. Hernando de Soto notes that brain power and research, economists and lawyers working together to improve the conditions for entrepreneurship, were what really defeated Sendero Luminoso. That the conflict was direct was proven when Sendero once bombed the headquarters of the ILD.

Of course, persuading an entrenched elite to surrender or diminish power for the benefit of the masses is a hard sell on purely philanthropic or altruistic grounds. But the ILD activists tried no such thing. Rather, they noted that, apart from the increased stability resulting from a vested populace with an interest in the economy, the domestic economy itself would grow. The ILD noted that this would benefit the elite in many ways, which the elite were able to understand, so they did not stand in the way of the reforms.

Since the successes in Peru, The Other Path has been translated into several other languages. The ILD activists and de Soto now consult with leaders in other societies in underdeveloped or post-Communist lands, to show how conditions may be made favorable for the growth of dormant or stagnant economies from within, by simple reform measures. Though there is far to go, the example has proven the workability of the concept. This documentary confirms in many respects what Butler Shaffer says in Boundaries of Order: Private Property as a Social System. As some may recall, that lesson is that respect for human rights to own property, specifically private property, is at the root of good social order and human prosperity, with only the most limited role for central government.

The author is a graduate of the University of Iowa College of Business Administration and the Juris Doctor program at Southwestern University School of Law. He has previously been published in Cult Movies, Mondo Cult, The Lamp-Post of the Southern California C.S. Lewis Society, and Prometheus.

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