From Poland to Peru: Black Markets, Parallel Societies

by Gregory F. Rehmke

Dozens of countries around the world hold parallel societies–one on the record, obeying government regulations, paying taxes, following orders, and the other off the record and underground. Often, individuals keep one foot in each world and learn to play by two sets of rules.

In Poland and Peru free societies are flourishing–off the record. Poland’s underground may lead to an anti-Communist revolution [it later did, of course]; Peru’s black markets may hold the answer to Third World poverty. Two world-class problems solved with one stroke. Maybe.

The “second society” in Poland has a long history. Operating in parallel to the legal economy, it has provided products from refrigerators to books to dozens of other goods consumers want, but which the legal economy seems unable to provide.

When Polish authorities imposed marshal law in 1981, they pushed the Solidarity movement underground. Pamphlets began to appear in Warsaw calling for the “self-organization of society.” Polish dissident Adam Michnik, in his book Letters from Prison and other Essays, says, “Our unofficial life is our authentic life,” and called on his fellow Poles to act as if they were free. Many Poles acted out their freedom by joining any of the hundreds of private enterprises that make up Poland’s diverse black markets.

Long before Solidarity, Polish authorities had quietly relied on black markets to produce goods and services their planned economy could not. In doing so they let loose a whole new set of incentives. As Poles earned profits from these private enterprises, they learned the benefits of economic freedom, even in its severely limited form. Over time black market enterprises grew in scope and complexity, and have crossed over into political life through private publishing firms.

In universities, banned books by free-market economists are turning up on assigned reading lists. Seven major underground publishing operations have–among them–translated and printed works by Alexander Solzhenitsyn, George Orwell, Milton Friedman, Ayn Rand, and others.

The Polish government is not alone in its worries about growing black markets and demands for political freedom. The Economist reported on “The Stirrings of Yugopluralism” (February 21, 1987 p. 45), in Yugoslavia. Aged Eastern Bloc leaders are caught between growing “second” societies underground, and Gorbachev’s calls for economic and political reform above ground.

But black markets are a much wider phenomenon than those known in communist countries. Black markets arise wherever government regulation makes voluntary economic activity illegal. And virtually every government does that to some extent.

Although U.N. officials and other development experts are blaming corruption and black markets for hampering economic growth in the Third World, David Osterfeld, a fellow of the Institute for Humane Studies at George Mason University, sees it differently.

Osterfeld argues that Third World corruption is fundamentally different than in western societies. “In the West,” Osterfeld says, “the market is the basic social institution within which business is conducted. Corruption here takes the form of payments to public officials in return for licensing restrictions, tariffs or other policies or practices that shield businesses from competition… In contrast, throughout the Third World the state rather than the free market is the basic social institution. Their corruption often takes the form of payoffs to public officials, or other illegal measures, designed to obtain permission to enter the market. Hence, in contrast to corruption in the West, which reduces competition. Third World corruption tends to increase market competition.”

Osterfeld cites China’s absence of labor markets as an example. Without such markets, Chinese managers hire peasants illegally to meet production quotas. Fancy bookkeeping hides their wages, but such illegal workers are estimated to make up 25-50 percent of China’s entire industrial work force.

In some western countries though, individuals have launched their enterprises completely outside the system. Take Peru, for example.

Hernando De Soto is in favor of black markets. So is Mario Vargas Llosa, the famous Peruvian novelist Llosa’s major New York Times Magazine article on De Soto, “In Defense of the Black Market” (February 21, 1987), argues that because government bureaucracies are the problem in Peru, black markets are the solution.

In his new book El Otro Sendero (“The Other Path”), De Soto describes the “informal” economy that has arisen because the “formal” economy is tightly bound by thousands of regulations. Llosa explains “In Peru, there are more than 500,000 laws and executive orders governing even the simplest of daily living needs. Given that burden, illegal solutions are all that remain.” Peru’s informal economy forms a vast parallel society, operating next to but largely independent of the legal Peruvian economy.

In 1980, De Soto founded the “Institute for Liberty and Democracy” to study the phenomenon of black markets in Peru and around the world. Black markets are often criticized as competing unfairly with legal firms (since they rarely pay taxes). But De Soto found that entrepreneurs turned to black markets to avoid regulations more than taxes. Endless regulations protect the wealthy and established firms from competition. Llosa explains that the real problem is the state “whose Byzantine legal system seems designed to favor those already favored and to punish the rest by making them permanent outlaws. The informal market is actually the solution to the problem: the spontaneous and creative response of the impoverished masses to the state’s inability to satisfy their basic needs.”

How extensive is Peru’s informal economy? According to Llosa and De Soto, over 400,000 people in Lima, Peru’s largest city, are directly supported by the commercial black market. The informal economy has invested more than $1 billion in transportation (in Lima 95 percent of public transportation is in the hands of the informal economy). Half the population of Lima lives in houses constructed by the informal economy, which between 1960 and 1984 spent $8.3 billion on housing, while the government spent only $173 million. The black market businesses of the informal economy are not only far more efficient than their regulated and government counterparts; they utterly dominate much of the Peruvian economy.

But why doesn’t the government face up to the reality? Why not deregulate the economy and thus make legal the thousands of enterprises that, in reality, keep the Peruvian economy operating. De Soto calls the problem “mercantilism,” a word that describes an economic order based on detailed government control of the economy, in partnership with established businesses.

De Soto says that though the Peruvian government defends its taxes and regulations on the grounds of social justice, and claims to redistribute wealth from rich to poor, the reality is very different. Llosa explains “Redistribution, which is supposed to mean the taking of money from the elite to give to the poor, actually involves the concession of monopolies or favored status to the elite, who depend on the good graces of the state–which, in turn, is dependent on the elite… While the nation’s wealth remains concentrated in a small minority, the interests of the majority are largely ignored.”

De Soto’s Institute for Liberty and Democracy, with 40 full-time employees, provides studies to document the effectiveness of black markets in solving economic problems and to expose the true nature of Peru’s legal economic problems and to expose the true nature of Peru’s legal economic system, “De Soto’s studies strip away any pretensions anyone may have about the validity of the mercantilist system. This system, he shows with devastating accumulation of data, is not only immoral but also inefficient. Within it, success does not depend on inventiveness and hard work but on the entrepreneur’s ability to gain the sympathy of presidents, ministers and other public functionaries–which usually means his ability to corrupt them.”

Peru’s mercantilistic economy, like Poland’s communist economy, is based on privilege. Instead of all people being equal in the eyes of the law, their laws look first for the mark of status–one’s family or party membership decides which set of rules apply. But black markets are based on equality before the unwritten laws of the market. Informal markets are open to men and women of all races and religions. Wealth accumulates through production, and labor is rewarded according to the combined and voluntary valuations others place on one’s labor in the marketplace. Peru’s informal economy grows ever more efficient, its formal economy is the stagnant clone of ten dozen other impoverished Third World countries.

Poland and Peru offer a strange vision of the future. An unauthorized future that no authorities anywhere seem willing to accept. These growing free economies may–at any moment–be crushed by new “reforms” designed to stamp out “corruption,” and establish purer socialist or communist ideologies. Just as the Cambodian economy was crushed by the idealistic Khmer Rouge in 1975.

Or, they may continue to evolve toward freedom. Political freedoms grow from the economic freedoms practiced daily in black market activities. These parallel free societies may over time gain strength and stability as their command economies fade. The authorities in Poland and Peru may eventually be left with only bare shelves, unproductive firms, unread newspapers, and empty schools. And their own endless and unenforceable regulations.

Communism fell, but informal economies still flourish. For the latest work by Hernando de Soto, see the review of his recent book on the Laissez-Faire Books web site: The Mystery of Capital. Also recommended, this Forbes article on De Soto’s work, “Waking Dead Capital” (sign in required)]