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Peru The García Government, 1985-90
With the market-oriented choice of economic strategy
discredited by results under Belaúnde, Peruvians voted for
the
dynamic populist-reformist promise of García and responded
enthusiastically to his sweeping changes. García's program
worked
wonders for two years, but then everything began to go
wrong.
The main elements of the economic strategy proposed by
the
García government were full of promise. They recognized
the prior
neglect of the agricultural sector and called for
redirecting
public programs toward promotion of agricultural growth
and
reduction of rural poverty. Correspondingly, economic
activity
was to be decentralized to break down its high
concentration in
Lima, and within the cities resources were to be
redirected away
from the capital-intensive and import-intensive modern
sector to
the labor-intensive informal sector. A strategy of
concertación (national understanding) with private
business leaders on economic issues was to be used
systematically
to avoid disruptive conflict. Problems of external balance
were
to be answered both by restructuring production to lessen
dependence on imports and by reorienting toward higher
exports
over the long-term.
These goals for structural change could have improved
the
efficiency of resource allocation while doing a great deal
to
lessen poverty. But the goals clearly required both time
and the
ability to restore expansion without worsening inflation
and
external deficits. The government initially emphasized
such
macroeconomic objectives as necessary conditions for the
structural changes. The first step was to stop the
built-in
inflationary process, but to do it without adopting
orthodox
measures of monetary and fiscal restraint.
To stop inflation, the government opted for heterodox
policies of control within an expansionary program. Prices
and
wages in the modern sector were to be fixed, after an
initial
one-shot increase in wage rates. The increase in wages was
intended to raise living standards of workers and
stimulate
production by raising sales to consumers. To offset the
effects
of higher wages on costs of production, financial costs of
the
business sector were cut by intervention in order to
reduce and
control interest rates. After making one adjustment of the
exchange rate to minimize negative effects on exports, the
government stopped the process of continuing devaluation
in order
to help hold down inflation. Imports were rightly expected
to go
up as the economy revived; to help finance them, García
made his
controversial decision to stop paying external debt
service
beyond 10 percent of the value of exports. Unorthodox as
they
were, all the pieces seemed to fit. At least, they went
together
well at the start under conditions of widespread idle
capacity,
with an initially strong balance of payments position.
The macroeconomic measures worked wonders for
production. GDP
shot up 9.5 percent in 1986 and a further 7.7 percent in
1987.
Manufacturing output and construction both increased by
more than
one-fourth in these two years. An even greater surprise
was that
agricultural production per capita went up, running
counter to
its long downward trend. And the rate of inflation came
down from
163 percent in 1985 to 78 percent in 1986, although it
edged back
up to 86 percent in 1987. In response to stronger market
conditions and perhaps also to growing confidence that
Peru's
economic problems were at last being attacked
successfully,
private fixed investment went up by 24 percent in 1986,
and
capital flight went down.
The government avoided any spending spree of its own:
central
government spending was actually reduced in real terms
each year.
But because the government also reduced indirect taxes in
order
to encourage higher private consumption and to reduce
costs for
private business, its originally small deficit grew each
year.
The economic deficit of the nonfinancial public sector as
a whole
(excluding interest payments) went up from 2.4 percent of
GDP in
1985 to 6.5 percent by 1987.
Although the government reduced its total spending, it
managed to support a new public works program to provide
temporary employment and to direct more resources to rural
producers as intended in its program for structural
change. Three
lines of policy helped especially to raise rural incomes.
The
first was to use generous guaranteed prices for key food
products. The second was to provide greatly increased
agricultural credit, financed essentially by credit from
the
Central Bank. The third was to exempt most of the
non-guaranteed
agricultural prices from controls, allowing their prices
to rise
sharply relative to those of industrial products from the
modern
sector. From July 1985 to December 1986, prices of goods
and
services not under control increased more than three times
as
much as those under control. Wholesale prices in
manufacturing
increased 26 percent, but those for agricultural products
increased 142 percent.
Besides higher employment and living standards, the
first two
years of economic revival seemed to offer a break in the
cycle of
rising rural violence. The flow of displaced peasants from
the
Sierra eased, and a good many peasants began to return to
the
countryside. That reverse might be explained by García's
initial
efforts to reduce reliance on military force to combat the
guerrillas and thereby to lessen the degree of two-way
violence
driving people out of their villages. But the trend may
also have
been a response to the reality of better economic
conditions and
earning possibilities in the agricultural sector.
The first two years of the García government gave new
hope to
the people of Peru, with rising employment, production,
and wages
suggesting a clear turn for the better after so many years
of
increasing difficulties. It was hence doubly tragic to see
the
whole process unravel so quickly, once things started
going wrong
again. The first sign of trouble came, as it often had,
from the
balance of payments. The economic boom naturally raised
imports
swiftly, by 76 percent between 1985 and 1987. But the real
exchange rate was allowed to fall by 10 percent in 1986
and by a
further 9 percent in 1987. The boom pulled potential
export
supply into the domestic market, and the fall in the real
exchange rate reduced incentives to earn foreign exchange.
Exports fell slightly in 1985 and remained below that
level
through 1987. The external current account went from a
surplus of
US$127 million in 1985 to deficits of nearly US$1.1
billion in
1986 and nearly US$1.5 billion in 1987.
The García government reacted to the growing external
deficit
in exactly the same way as had the governments of Velasco
and of
Belaúnde--by postponing corrective action while the
problem
continued to worsen. As ever, a major fear was that
devaluation
would worsen inflation. Inflationary pressures were, in
fact,
beginning to worsen behind the façade of control. To some
degree,
they were growing in response to the high rate of growth
of
demand and output, reducing margins of previously
underutilized
productive capacity. But the more explosive pressures were
being
built up by relying on price controls that required a
dramatic
expansion of credit to keep the system in place. Prices of
public
sector services--gasoline above all, oil products in
general,
electricity, telephones, and postal services--were frozen
at
levels that soon became almost ridiculous in real terms.
The
restrictions on prices charged by state firms drove them
ever
deeper into deficits that had to be financed by borrowing.
The
borrowing came from wherever it could, but principally
from the
Central Bank. At the same time, Central Bank credit rose
steadily
to keep financing agricultural expansion. Still another
direction
of Central Bank credit creation was the financing used to
handle
the government's new structure of multiple exchange rates.
Differential rates were used to hold down the cost of
foreign
exchange for most imports, again with the dominant goal of
holding down inflation, while higher prices of foreign
exchange
were paid to exporters to protect their incentives to
export. The
Central Bank thus paid more for the foreign exchange it
bought
than it received for the exchange it sold.
The term used for these leakages--for extensions of
Central
Bank credit that did not count in the government's budget
deficit--is the "quasi-fiscal deficit." Its total
increased from
about 2 percent of GDP in 1985 to about 4 percent in 1987.
Meanwhile, the government's tax revenue fell steadily in
real
terms, partly because of tax reductions implemented to
hold down
business costs and partly because of the effect of
inflation in
cutting down the real value of tax payments. Added
together, the
fiscal deficit plus the quasi-fiscal deficit increased
from 5
percent of GDP in 1985 to 11 percent by 1987.
The two horsemen of this particular apocalypse--the
external
deficit and the swift rise of Central Bank credit--would
have
made 1988 a bad year no matter what else happened. But
President
García guaranteed financial disaster by his totally
unexpected
decision in July 1987 to nationalize the banks not already
under
government ownership. No one has yet been able to explain
why he
decided to do so. It would not seem to have been a move
necessary
for any component of his program, or needed for government
control in a banking sector in which it already had a
dominant
position. In any case, the action underlined the
unilateral
character of economic policy action under Peru's
presidential
system
(see
The García Government, 1985-90, ch. 4) and
wrecked
any possibilities of further cooperation with private
sector
leadership. Private investment began to fall, and the
whole
economy followed it down shortly thereafter.
The García government tried a series of major and minor
new
policy packages from early 1988 into 1990 to no avail. The
new
policies never succeeded in shutting off the rapid
infusion of
Central Bank credit that was feeding inflation, even when
they
did succeed in driving production down significantly in
1989.
Manufacturing production fell 18 percent in that year,
agricultural output 3 percent, and total GDP 11 percent.
Simultaneously, inflation increased from a record 666
percent in
1988 to a new record of 3,399 percent for 1989. The one
positive
change was the external current-account deficit: the fall
in
domestic production and income was so steep that the
current
account went from a deep deficit to a substantial surplus.
The
internal cost was perhaps clearest in terms of real wages:
the
minimum wage in real terms for urban labor fell 61 percent
between 1987 and 1989, and average real wages in
manufacturing
fell 59 percent.
Data as of September 1992
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