What to do after Fallujah? There is a general feeling that last week's atrocity marks a new low in the Iraq story. The mob that killed, burned and mutilated four US security contractors seemed to be rejecting not only the occupation but also the possibility of the end of conflict.

No wonder that the trade fair that was supposed to open in Baghdad today has been postponed. The likelihood of it - or any other trade fair - taking place now looks remote.

Or maybe it does not. At least not according to Hernando de Soto, the Peruvian economist. Next month Mr de Soto will be awarded the Cato Institute's Milton Friedman Prize for a decades-long effort to challenge the fatalistic view that the developing world is always poor and angry and therefore always tends towards extremism, dictatorship and terror.

Mr de Soto foresees instead a future for the developing world of shaded afternoons trading at the electronic souk. This optimism might seem naive. Still, the thoughts that underlie it are worth review. Last week Mr de Soto explained to me how his argument works.

Citizens in most developing regions do not think of themselves as belonging to the private sector, even if they do have a chicken farm or CD-player repair business on the side. The phrase "private sector", to such people, describes a distant plutocratic elite, and that elite is presumed to be allied with imperialists from abroad.

The only source of pride for such people is their tribe (Sunni Fallujah) or their national sovereignty (loyalty to Saddam Hussein). That pride is easily offended. The sight of a US tank rolling by or a Coca-Cola banner unfurling infuriates. Citizens feel that such insults "poke at their sovereignty", as Mr de Soto puts it.

This is a familiar attitude - one often identified by Marxist theorists, in fact. But Mr de Soto next explains how he would change it. For starters, it is important to recognise that the stereotype of the impoverished developing world is wrong. The developing world is not poor. It is, in many cases, rich. A good share of people in Mexico City or even Baghdad actually do have assets - that repair shop, the family chicken farm.

The trouble is that citizens do not always have formal legal claim to those assets; nor do they, in many cases, live under governments that would honour such claims if they could make them. As Mr de Soto wrote in the first of two books on property, The Other Path, many Latin Americans, Asians and Arabs are trapped in black and grey economies. "They have houses but not titles, crops but not deeds; businesses but not statutes of incorporation."

Such "frozen" capital is - needless to say - illiquid: sales are hardly possible without documents. Leveraging such capital or using it as collateral is also a challenge. Securitisation proceeds at a glacial pace; debt and equity markets fail to develop.

Converting a black market to a legal one, or making it possible to open a legal business, would be huge improvements in such circumstances. But the political effect of Mr de Soto's ideas could be even greater. For once the small businessman sees that his work is respected and bankable, he will be less inclined to view outsiders as threats and more inclined to view them as potential business partners.

An angry local will become a friendly stakeholder. Now recognising himself as part of that once-distant private sector, he will no longer feel "poked", to use Mr de Soto's term again. What is interesting here is that change starts with nomenclature and law. "Instead of viewing people as unemployed proletarians," says Mr de Soto, "we should view them as oppressed entrepreneurs."

Mr de Soto established his bona fides in Peru from a base at the Institute for Liberty and Democracy two decades ago. Now, however, he is busy plying his theories elsewhere. He recently estimated there was about $245bn of frozen or "dead" capital in Egypt; nine out of 10 enterprises, by the ILD estimate, operate outside the law. Change in that part of the world he views as entirely possible.

"The majority of Egyptians, ergo the majority of Arabs, are actually a budding entrepreneurial class," he says. He has also discussed his ideas with Hamid Karzai, president of Afghanistan, and Vladimir Putin, Russia's president.

Sceptics will call Mr de Soto's approach dangerous. For what to you may look like justifiable legalisation of your informal claim may to me look like frank expropriation. A lot depends on which government and which claimant we are talking about. After all, every morning at breakfast Robert Mugabe probably tells himself that his resettlement actions were just honest legalisations of ancient Zimbabwean claims.

Then there is the possibility that dithering around with Mr de Soto and the other reformer-consultants of this world may give heads of corrupt, resource-rich states an excuse to postpone other important actions: privatising the national oil company, for example.

Yet another danger lies in assuming that property rights reform alone can transform places such as Libya, Iraq or North Korea. In all such places, political change has to come first.

But once it has - as in Iraq and, one can begin to hope, Libya - Mr de Soto's agenda may bring a new and shared prosperity to the most unpromising places. And with that a more reasoned view of the world - even after Fallujah.

© Copyright 2004 Financial Times