Peru: Private Sector Assesment

This report examines the environment for doing business in Perú following the far-reaching reform program instituted in 1990. It has never been easy to do business in Perú. This is a powerful reason why, amid such potential, Perú remains a poor and divided country. For business to flourish a country must enjoy conditions of continuity, stability, and evenhanded policy in which business trust and habits of competition can grow. Historical forces in Perú have done little to create these conditions. Since independence, periods of prolonged political stability have been rare. Unable to manage its public finances, Perú had to repudiate its foreign debt four times. Not unsurprisingly foreigners came to take much of the blame for recurrent crises, and, as a result, a tradition of hostility to foreign investment grew up. The recurrent crisis of public finance has also meant a poor quality of public services and public administration. Successive governments did little to bridge the large social and economic gaps between rich and poor. As a response to this unfortunate history, the last 30 years have been dominated by misguided government attempts to help the poor through direct public action and through controls on the private sector. The most productive land was confiscated and major sectors of the economy were nationalized. Government attempts to direct private investment for social purposes resulted in a significant interference in the ability of firms to contract freely. Populist economics reached its apogee in the second half of the 1980s. By the time the Fujimori Government came to office in 1990, Perú was, by every measure, near collapse. There was hyperinflation. Incomes and productivity had regressed to the levels of the 1950s. Government intervention had greatly distorted economic incentives. Tax collection had fallen to some six per cent of GDP, and public services were in disarray. The country was in the grip of a murderous terrorist movement which appeared able to operate at will. The shape of Perú's economy remains marked by its history. There is a very large informal sector. It is characterized by competition without capital, and most of its workers are locked in a cycle of low productivity, low earnings, and poverty. Most of the modern, or formal, sector is inefficient and inward-oriented. Raised on privileges handed out by government, it has had capital without competition. Agrarian reform and terrorism have led to a continuing decline in agriculture. In 1990, the Fujimori Government embarked on one of the most far- reaching economic reform programs in Latin American history. It touched every area of the economy. The economy was opened to domestic and foreign competition: import barriers were slashed and foreign exchange made freely available; all capital account restrictions were lifted; price controls were eliminated; financial markets were liberalized; labor restrictions were reduced. The financial health of the public sector was reestablished; the tax regime was overhauled and many surplus workers were dismissed. The government embarked on a radical program of privatization. The government set about rehabilitating the market for land. The reform program has borne its first fruits, though most of the changes in the structure of the economy still lie ahead. Inflation has sharply declined. After stagnating initially, output began a rapid recovery in 1993. Firm interviews, most of them carried out in early 1993, show large improvements in the business environment since 1990. In particular, difficulties with trade regulation, foreign exchange, and labor laws declined markedly. But the business community still perceives many obstacles to doing business. Given political uncertainties, the business community is not yet confident that the new policy regime will endure. Complex tax regulations are costly for firms. Moreover, regulations and taxes distort incentives in the domestic financial system. In addition, the lack of a Brady-type debt deal raises the cost of domestic finance and hinders foreign investment. Public infrastructure services remain poor. It costs as much to transport a truckload of produce from the Selva to Lima as it does to ship it from Lima to its destination in the United States. The telephone system works poorly. Many producers have their own power generators because of the unreliability of public power supplies. Bank loans are very expensive. Security is still a concern (though there has been a significant breakthrough in the fight against terrorism since the survey was conducted). The kind of business trust necessary for modern market economies to function is still largely lacking in Perú, and the business community's continuing mistrust of the court system helps explain this. Incentives to become formal are weak and barriers to entry remain. Overall, the government has made enormous progress in reforming the economy. The environment for business is incomparably more promising than it was in 1990. How far does the reform process still need to go? It is possible to identify many areas where action is needed to create stable business conditions and further improve the way markets work, but there is no doubt that the Government is aware of what needs to be done. What is most important is to create the conditions that will allow the momentum of reform to continue. This involves two issues, political credibility and the rebuilding of government.