Informal Economy and Entrepreneurship in Latin America and the Caribbean

Hernando do Soto, source:

In the podcast “Empowering Latin America entrepreneurs”, Hernando De Soto joins CIPE Executive Director Andrew Wilson to discuss the importance of the informal economy, the central role of property rights, and the early successes of the ILD-CIPE partnership. In this opportunity, they discusses about the informal economy and entrepreneurship in Latin America and the Caribbean.

Latin America and the Caribbean region faces significant challenges related to mistrust, which profoundly impacts such as social cohesion, economic growth, and governance. This mistrust can be manifests in several forms and in specific scenarios more typical the regions with lack of confidence in institutions, interpersonal distrust, and skepticism toward economic and political systems.

There are some key factors and challenges in Latin America and the Caribbean relation with trust issues. One is the informal economy and entrepreneurship. Hernando De Soto highlights the prevalence of the informal economy in the region, where up to 70% of economic activity may be informal. This sector often includes entrepreneurs who operate outside formal legal frameworks due to complex and inaccessible regulations.

De Soto declares: “As a matter of fact, most of the poor of Peru are not labor. They’re entrepreneurs”. The informal economy is a double-edged sword: it allows for entrepreneurial activity and economic survival, yet it also perpetuates insecurity and instability due to the lack of formal property rights and protections.

Another key factor is the impact of historical events, such as terrorism and authoritarian regimes, have left deep scars, leading to systemic mistrust in government and institutions. De Soto mentions the Maoist insurgency in Peru as an example of how terrorism can devastate social trust. The region has experienced significant socio-economic inequalities, with the wealthiest segments capturing disproportionate shares of national income, exacerbating feelings of injustice and mistrust.

The percentage of individuals who believe that most people can be trusted (generalised or “interpersonal” trust) decreased from 38% in the period 1981-85 to 26% in 2016-20, according to data from the Integrated Securities Survey. In Latin America and the Caribbean, the reduction has been even more drastic, with a drop in confidence levels from 22% to 11%. Only one in 10 people believes that it can be trusted. 

Asymmetries in information and power also led to make things more difficult for individuals to assess government performance independently. Citizens are often coerced into compliance with government regulations without adequate mechanisms for accountability, increasing opportunities for political opportunism and corruption. 

This erosion of trust affects all aspects of life, reducing the willingness of individuals to engage in collective action or invest in public goods. Mistrust undermines economic activity by discouraging investment and innovation. Businesses are less likely to respond positively to government policies if they distrust the government’s intentions or capabilities.

The trust deficit in Latin America and the Caribbean is rooted in historical, economic, and social contexts. The pathways to rebuilding trust requires more than time. Strengthening judicial and administrative processes to ensure predictability and fairness can help rebuild trust in institutions, government and citizens. 

“Relationship between trust and informality”. The countries of Latin America and the Caribbean appear mostly in the lower right quadrant, where those nations with the lowest level of trust and the greatest informality are located (graph 4).

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