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Poor Underground Economy Thriving - 2002-04-24

A leading Latin American economist says the poor are the most valuable and underused resource of developing nations. Peruvian economist Hernando de Soto has been a consultant to governments from Mexico to Egypt.

The economist notes his pro-business ideas have drawn the anger of Peru's Shining Path guerillas, who call him and his colleagues "bourgeois reformists." The offices of his Institute for Liberty and Democracy in Lima have been machine-gunned and bombed. The opposition started when Mr. de Soto published a book that challenged the theories of the Marxist movement. He called the book "The Other Path."

Mr. de Soto says in many developing countries, a thriving underground economy bypasses government regulations and annoyances like taxes. This unregulated market can be huge, and much of it is in the hands of the poor. In Mexico, for example, he estimates the poor own assets worth $315 billion, and in Egypt nearly $250 billion. He says that is 50 times the total foreign investment made in Egypt in the last 150 years.

Mr. de Soto says the case is similar in Peru, where the poor control assets 12 times the value of the Lima stock exchange. "The poor have accumulated in Peru so far about $90 billion worth of assets. So they have a lot of capital. The problem is that it's not liquid," he says. "You even see it, when you drive through a shantytown in Peru, you see the buildings, which means instead of saving in money, they're saving in hard assets. So their problem is the liquidity."

The economist says that in the United States, the deed for a house can be used as collateral for a bank loan to start a business, but complex regulations make it hard to get a loan and start a business in his country. The Peruvian government has instituted some of his ideas to make it easier.

Mr. de Soto says in much of the developing world, informal associations, some of them criminal, emerge to impose order on community economics. "These small fragmented organizations basically are there as alternatives to the lack of government," he says. "When government produces good law that is more efficient than what the neighborhood mafia or the neighborhood organization can do, everybody goes of course toward the larger organization. It's a problem of cost efficiency of the law."

Mr. de Soto says wherever you find a large underground economy, the government loses because it cannot collect taxes. Entrepreneurs in an informal economy instead pay bribes to local officials.

The economist says the problem stems in part from excessive regulation, and partly form an undeveloped legal system. "You need property rights, you need the capacity to enforce agreements and enforce contracts. Basically it's property rights law," says Mr. de Soto.

He says informal economies once dominated the United States and the countries of Western Europe, which now have efficient and stable systems of property law.

Too often, says Peruvian economist Hernando de Soto, the systems of the developing world benefit a ruling elite, which alone is able to navigate the complex regulations. But he says development requires that economic systems be open to the poor and to the entrepreneurial spirit that thrives in developing countries.