The Other Path
Field measurement of Lima's informal economy and the cost of legality; the founding text.
Summary
De Soto and his Institute for Liberty and Democracy studied the informal economy of Lima, and this book reports what they found. It was written during Peru's conflict with the Shining Path, and the title contrasts the informal economy with that movement's armed alternative.
The empirical work is the book's foundation. De Soto's researchers measured the extent of informality: the share of housing built outside the legal system, the proportion of transport provided by unlicensed operators, the size of informal retail markets, and the value of assets held without title. They then measured the cost of legality directly by attempting to register a small garment business, following every required step, which took two hundred and eighty-nine days of full-time effort and payments equivalent to many months of the minimum wage, with bribes solicited repeatedly.
The argument follows from the measurement. Informality is not a cultural characteristic or a preference for evasion but a rational response to a legal system whose costs exceed its benefits for most people. The informal sector develops its own institutions, including extralegal property conventions, contract enforcement and organisations, which function well enough to sustain large-scale economic activity. De Soto argues that these institutions are the basis on which a functioning legal system should be built, and that the state's mercantilist regulation, which he traces to colonial administration, exists to protect established interests rather than to serve any public purpose.
The book influenced Peruvian policy substantially and de Soto's institute worked on simplification of business registration.
The titling and formalisation agenda that developed from this work has had disappointing results in later evaluations, particularly on credit access. Critics also argue that de Soto understates the informal sector's own exploitation and that formalisation can dispossess as easily as it enfranchises.
Key takeaways 7
- Informality is a rational response to legal costs that exceed legal benefits, not a cultural preference or a form of evasion.
- Registering a small business in Lima required two hundred and eighty-nine days of full-time effort, which the researchers measured directly.
- The informal sector develops its own property conventions and contract enforcement, which function well enough to sustain large-scale activity.
- Extralegal institutions should be the basis on which formal law is built rather than something formal law replaces.
- Regulation in this setting protects established interests rather than serving any stated public purpose.
- Informal operators supply housing, transport and retail at scale where the formal sector does not.
- The mercantilist legal structure of Latin American states descends from colonial administration and has not been redesigned since.
Who should read it
Investors and operators in emerging markets who want measured evidence of what informality costs and why it persists.
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Where it sits in the reference 3
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