Peru

OUTSTANDING ISSUES

At a bus stop in downtown Lima
Courtesy Inter-American Development Bank

Unavailable

Figure 11. Employment by Sector, 1990

Children in La Molina, a town south of Lima
Courtesy Inter-American Development Bank

Harvesting hay near Huancayo, Junín Department
CourtesyHarvesting hay near Huancayo, Junín Department

Miner about to enter the 4,000-meter-high Mina Proaño multimineral mine
CourtesyMiner about to enter the 4,000-meter-high Mina Proaño multimineral mine

Miners drill dynamite holes at the Mina Raúl open-pit copper mine near Arequipa
Courtesy Inter-American Development Bank

For many Peruvians, the frustrations of prolonged economic deterioration in the face of such varied attempts to do something about it mean that something fundamental has gone wrong, perhaps so wrong that mere changes of public policy can do little to help. Such fears are certainly understandable and also costly. They encourage support for violent reaction, and they also foster great pressure on each new government to act quickly, in dramatic new ways, without sufficient attention to the likely costs of their actions. Such pressure may be a key part of the problem. Issues of current policy orientation need to be considered in the perspective of Peru's extremely dislocated society, but that context argues for great caution, as well as for change. The specific issues center on familiar conflicts: between the appeal of trying to return to the open economy and liberal economic system preceding the 1960s, and the contrary appeal of a more directive use of public policy to correct basic structural problems.

Convictions that something fundamental has gone wrong with the country can lead to violence, to emigration as an escape, or possibly instead to new consensus on the need to change particular constraints of public policy. The SL has advocated an extreme answer: traditional society has failed and needs to be swept away. For many others who reject violence, the answer has not seemed to be much more positive: emigration has become an increasingly popular way out for many, including professional people and businesspeople who take their capital with them. Although it is truly difficult to be certain that a reasonably peaceful recovery remains possible, two alternative answers, in different ways, suggest somewhat more hope for the future.

One interpretation of the deterioration since the mid-1960s is that it has been caused by stubbornly misdirected economic policies, specifically excessive protection for import substitution, a proliferation of internal controls adverse to efficiency and free markets, government deficits, and wildly exaggerated monetary expansion. That position gains solid support from the results of the governments of Velasco and García, plus much of the administration under Belaúnde. In that light, the Fujimori government's return of national policy to an open economy with greatly reduced protection and controls and more attention to budget balance is genuinely hopeful. The redirection initially offered the promise of renewed external help from international financial and development agencies, although that possibility was set back at least temporarily in April 1992 when the Fujimori government suspended democracy in Peru.

A second nonviolent alternative goes against attempts to return to the kind of economic system Peru had prior to the 1960s. The old system was neither an equitable system that served to integrate the society nor one that favored learning and technical progress. The depth of Peru's problems in 1991 seemed to call for more directive economic strategies to lessen poverty, pull the industrial sector into export competition, and establish a stronger tax base to provide noninflationary financing for an active government. Such redirection would be fully consistent with reduced protection, although it would gain from adding on strong incentives for industrial exports. It would need much the same kind of effort to maintain fiscal balance as the first alternative, although more through higher public revenue and less through cutback of public-sector functions.

Both of these two alternative orientations raise serious questions about what is possible. Such questions might be considered on three levels: first, can economic growth be revived without making inflation accelerate again; second, can the spread and deepening of poverty be reversed; and third, can the Peruvian people regain enough confidence in their society to induce renewed investment, productive effort, and acceptance of the constraints necessary to rebuild?

To the question on the first level, it is certainly no easy matter to revive economic growth without provoking inflation again, given all the special handicaps of political uncertainty, growing violence, and intense public awareness of past failures to curb inflation. Still, nearly all the purely economic conditions for revival without inflation are present: the industrial sector has a great deal of underutilized capacity, both skilled and unskilled labor is available in abundance, and the country is in the unusual position of having abundant supplies of foreign exchange to finance increased imports of supplies needed for rising production. If investment and exports can be encouraged, it should be possible to raise production quickly, without running into any near-term limitations on the supply side.

The experience of the first two years of the García government, from 1985 to 1987, suggests both the scope for raising output in such conditions and the danger of doing too much, too rapidly. That experience does not point to any necessary relapse back into inflation: it simply underlines the need for methods that are more consistent and more careful. The García government's revival was crippled quickly because of particular choices that could have been avoided. The exchange- rate policy was wholly and unnecessarily misdirected. More fundamentally, the degree of stimulus lacked any clear relationship to the constraints on how much it was possible to do, how fast, and with what financing. The need for adequate tax revenue and the need for prices of government services adequate to cover costs were never faced. To pay more attention to internal and external macroeconomic balance would have required a slower pace of expansion, but it might then have been possible to keep going without explosion. The experience does not demonstrate that sustained recovery is practically impossible in Peru, only that it has to be done with extreme care because of the damage of past misjudgment.

To the question on the second level--the possibility of seriously reducing poverty--the experience under García again suggests both grounds for hope and reasons for doubt. That government's combination of measures was initially favorable for both the rural poor and those in the informal urban sector. These measures made a notable dent in the degree of extreme poverty in the first two years. If the overall expansion had been more moderate, the gains would have been less but still positive. Redirection of public investment and of credit toward the rural sector must have played a helpful role in that brief experience of reducing poverty and inequality, as they would under any government if placed within a framework of overall balance.

Promotion of a more labor-intensive structure of production, with more rapidly growing employment opportunities for any given level of investment, could do a great deal to lessen poverty and inequality in the longer run. A necessary condition to move in this direction is to avoid overvaluation of the exchange rate. Overvaluation hurts the poor by making imported capital equipment and supplies artificially inexpensive, and thereby encouraging the replacement of workers with machinery. This situation took place under García, Velasco, and Belaúnde. Overvaluation is not beyond correction by a government concerned with the problem, although it may require intervention to offset perverse market forces like those operating in the first year of the Fujimori government. The price of foreign exchange needs to be kept high enough to encourage growth of industrial exports, or else more specific measures have to be taken to keep them growing, even if this means intervening to change the way that market forces are operating.

Beyond such questions of differential incentives and employment opportunities, and of investment and credit for the rural area, serious action to alleviate poverty clearly requires a strong public commitment to provide more nearly equal access to education, to public health programs directed to the poor, and to social action to alleviate conditions of mass hunger. The problem with the alternative of going back to an open economy with much less of a role for government is that it could leave the extent of poverty as great as ever, or even discourage public action to do more about it. Velasco and García went wrong in many ways, but their efforts to change the society were attempts to respond to a real need. To go back to the pre-1960s kind of economic regime might well be less costly than to repeat the nightmares of 1988- 90, but it would leave the human problems of Peru unresolved.

To the question on the third level--the possibility of restored confidence in the society--the answer cannot be in terms of economic analysis. It may be that the shocks of the 1980s and those of 1990, combined with the worsening of violence and deterioration of the capability of the government to act, will make it difficult for a long time to generate rising investment, whether by Peruvians or foreign investors. It may be that fear of inflation will paralyze promotional action by the government or, alternatively, that long delay will generate overwhelming pressures for violent change. Such possibilities are all too real. But the surge of hope in 1985-86 (and the surge of investment and of production that immediately came with it) made fatalism about Peru seem misplaced. Even through the confusions of economic policy at that time, including a great many costly kinds of interference adverse to efficiency, and even in the face of destructive violence, Peru was able to respond positively to the temporary turn in a more promising direction. Production went up, poverty went down, and the reign of terror in the Sierra temporarily lessened. Both poverty and violence were worse in 1991, but the background of economic policy distortions had in part been corrected.

It is probably true that Peru has a fundamental problem that underlies the long downward trend of its economic performance. It is not just the misdirection of excessive protection, government intervention, and excess spending. It is the severity of poverty and inequality. Too many people have serious grounds to reject the society because it has done so little to provide them any hope. The governments since the mid-1960s all tried to find some new way to deal with this basic weakness. Their methods were terribly damaging. It is fairly easy to see what went wrong in each case, if not so easy to see how to work out the interlocking problems at the beginning of the 1990s. Recovery of production is surely possible with better designed economic policies, but to keep society intact requires that the government go beyond reactivation of the economy to include more effective ways to reduce poverty on a sustained basis.

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The Peruvian Experiment, edited by Abraham F. Lowenthal, and The Peruvian Experiment Reconsidered, edited by Cynthia McClintock and Lowenthal, cover the Velasco period and its consequences. Rosemary Thorp and Geoffrey Bertram's Peru 1890-1977 is a comprehensive economic history. Paul E. Gootenberg's Between Silver and Guano examines the roles of nationalism and liberalism in shaping the country's development.

On agrarian problems, consult Tom Alberts's Agrarian Reform and Rural Poverty and Adolfo Figueroa's Capitalist Development and the Peasant Economy in Peru. On the informal sector, the classic book is Hernando de Soto's The Other Path.

The García government's economic program from 1985 to 1990 is analyzed in Eva Paus, "Adjustment and Development in Latin America," and in Manuel Pastor, Jr. and Carol Wise, "Peruvian Economic Policy in the 1980s." Thorp's Economic Management and Economic Development in Peru and Colombia examines this period through a comparison of the ways the two countries have managed their long-term problems of development. Peru's Path to Recovery, edited by Carlos E. Paredes and Jeffrey D. Sachs, is a thorough survey of Peru's problems at the start of the Fujimori government in 1990, with many proposals for corrective action. Particularly useful monthly Peruvian publications include The Andean Report and Perú Económico. (For further information and complete citations, see Bibliography.)

Data as of September 1992

Peru - TABLE OF CONTENTS