HOPE, GROWTH AND OPPORTUNITY:

Between 1980 and 1993, Peru won the only victory against a terrorist movement since the fall of communism without the intervention of foreign troops or significant outside financial support for its military. Over the next two decades, Peru's gross national product per capita grew twice as fast as the average in the rest of Latin America, with its middle class growing four times faster.

Today we hear the same economic and cultural pessimism about the Arab world that we did about Peru in the 1980s. But we know better. Just as Shining Path was beaten in Peru, so can terrorists be defeated by reforms that create an unstoppable constituency for rising living standards in the Middle East and North Africa.

To make this agenda a reality, the only requirements are a little imagination, a hefty dose of capital (injected from the bottom up) and government leadership to build, streamline and fortify the laws and structures that let capitalism flourish. As anyone who's walked the streets of Lima, Tunis and Cairo knows, capital isn't the problem--it is the solution.

Here's the Peru story in brief: Shining Path, led by a former professor named Abimael Guzmán, attempted to overthrow the Peruvian government in the 1980s. The group initially appealed to some desperately poor farmers in the countryside, who shared their profound distrust of Peru's elites. Mr. Guzmán cast himself as the savior of proletarians who had languished for too long under Peru's abusive capitalists.

What changed the debate, and ultimately the government's response, was proof that the poor in Peru weren't unemployed or underemployed laborers or farmers, as the conventional wisdom held at the time. Instead, most of them were small entrepreneurs, operating off the books in Peru's "informal" economy. They accounted for 62% of Peru's population and generated 34% of its gross domestic product--and they had accumulated some $70 billion worth of real-estate assets.

This new way of seeing economic reality led to major constitutional and legal reforms. Peru reduced by 75% the red tape blocking access to economic activity, provided ombudsmen and mechanisms for filing complaints against government agencies and recognized the property rights of the majority. One legislative package alone gave official recognition to 380,000 informal businesses, thus bringing above board, from 1990 to 1994, some 500,000 jobs and $8 billion in tax revenue.

These steps left Peru's terrorists without a solid constituency in the cities. In the countryside, however, they were relentless: By 1990, they had killed 30,000 farmers who had resisted being herded into mass communes. According to a Rand Corp. report, Shining Path controlled 60% of Peru and was poised to take over the country within two years.

Peru's army knew that the farmers could help them to identify and defeat the enemy. But the government resisted making an alliance with the informal defense organizations that the farmers set up to fight back. We got a lucky break in 1991 when then-U.S. Vice President Dan Quayle, who had been following our efforts, arranged a meeting with President George H.W. Bush at the White House. "What you're telling me," the president said, "is that these little guys are really on our side." He got it.

This led to a treaty with the U.S. that encouraged Peru to mount a popular armed defense against Shining Path while also committing the U.S. to support economic reform as an alternative to the terrorist group's agenda. Peru rapidly fielded a much larger, mixed-class volunteer army--four times the army's previous size--and won the war in short order. As Mr. Guzmán wrote at the time in a document published by Peru's Communist Party, "We have been displaced by a plan designed and implemented by de Soto and Yankee imperialism."

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