The Genesis of the ILD

In 1979, Hernando de Soto was running a group of small Peruvian mining companies headquartered in Lima and spending too much of his time grappling with red tape and climbing over regulatory barriers. Having been educated in Europe and begun his business career in Switzerland, he knew that doing business need not be so burdensome. And he refused to accept the explanation that Peruvians were just not culturally cut out for business; after all, he himself was Peruvian, and he knew scores of compatriots who were as brilliant and innovative as anyone he had met in Europe. De Soto also discovered that many of his fellow businessmen in Lima were just as frustrated as he was with the legal obstacles to doing business, and several were eager to join him in his effort to find out precisely what the root of the problem was.

They began with an investigation of Peruvian business law, hiring two recent law graduates to count the number of laws and regulations related to how citizens produced and distributed wealth that had been enacted in Peru since World War II. The results were astonishing: Peruvian governments were passing about 28,000 such laws and regulations per year —more than 100 laws each working day. Even more disconcerting was that further research indicated that this huge and ever-growing legal morass did not seem to address even remotely the needs of most of the nation’s people.

A Legal System Divorced from Reality

To confirm this disconnection between the law and the poor, the team set up a two-sewing-machine garment factory in a Lima shantytown, and attempted to get it licensed. With the help of five university students who spent several hours a day wending their way through Peruvian bureaucracy, De Soto discovered that to obtain a legal license to operate even such a small business took 289 days and cost 31 times the average monthly minimum wage. Here was incontrovertible evidence that the nation’s laws were divorced from reality, generating more costs than benefits. Laws were difficult to understand and expensive to follow. Not surprisingly, Peru’s majority opted for extralegality.

Peru, in fact, had become two nations, one where the legal system bestowed privileges on a select few, and another where the majority of the Peruvian people lived and worked outside the law, according to their own local arrangements. How large was this extralegal sector? No one in the government seemed to have a precise idea. In 1981, De Soto and his colleagues decided to form a not-for-profit organization —they called it, uncontroversially, the “Institute for Liberty and Democracy” (ILD)— to investigate Peru’s “shadow economy”.