To Recover From Corona-Contraction, Peru Needs Markets
Next year marks the bicentennial of Peru’s independence. But rather than preparing to celebrate this milestone, the country is being forced to hunker down to meet a perfect storm of challenges. From April through June this year, the economy contracted 30 percent – more than any economy in the world during that period. Today, it also has the world’s highest per capita Covid-19 death rate. And allegations of corruption and a coverup against Peru’s president, Martín Vizcarra, recently prompted the country’s Congress to vote on impeaching him.
These developments mark a sharp turnaround for Peru. For the past few decades, it has been an economic standout, allowing free-market forces to flourish, which fostered high growth rates that boosted incomes and dramatically reduced poverty. A fundamental question now, amid the enormous Covid-19 challenges, is whether Peru’s political class will adhere to the market-based policies that underpinned the country’s past progress.
That progress would have been unthinkable 30 years ago. In 1990, Peru’s annual inflation rate exceeded 7,600 percent. From 1987-90, the economy contracted 25 percent, leaving it the same size it had been in 1975. More than 60 percent of the population was estimated to be living in poverty.
But the economic crisis created an opportunity for policymakers to take a different path. Sweeping economic reforms were implemented in the 1990s. The country abolished price controls and capital controls. It liberalized labor and financial markets. It also privatized several industries, including telecom, energy, rail, and airports. And the government exercised fiscal discipline, which reduced (and eventually eliminated) federal budget deficits.
Starting in the early 1990s, Peru’s presidents also recognized the need to deepen the country’s integration with the global economy. Rules on inbound foreign direct investment were liberalized, import quotas and several other trade restrictions were ended, and tariff rates were slashed (falling from an average of 66 percent in 1990 to 6 percent in 2013). The welcoming approach to trade enabled Peru to strike free trade agreements with some of the world’s largest and most successful economies, including the United States, China, the European Union, Japan, Canada, Mexico, and Singapore.
Today, Peru is ranked 29th (out of 162) in the most recent Cato Institute/Fraser InstituteEconomic Freedom of the World rankings. The rankings reward smaller government, private property rights protections, monetary discipline, trade liberalization, and limited regulatory restraints. This is a stark change from the 1980s, when Peru had some of the lowest levels of economic freedom anywhere in the world.
The payoff from Peru’s policy reforms? Economic growth rates have been strong for most of the past 25 years and have averaged more than 5 percent since 2005. That’s enabled remarkable gains in gross national income, tripling in just the past two decades and exceeding $6,700 last year.
Rising national income has led to a sharp reduction in poverty. The poverty rate has fallen from 55 percent in 2001 to 21 percent today, which has meant higher living standards for more than six million people. Peru’s progress has been recognized in Oxford University’s Multidimensional Poverty Index. From 2007-18, Peru was one of three countries (along with India and Ethiopia) to achieve “significant” progress in all 10 of the index’s categories, such as nutrition, child mortality, years of schooling, and access to drinking water.
Research by Javier Herrera, a Peruvian economist, shows that the lion’s share of the poverty reduction from 2004-15 was a direct byproduct of Peru’s economic growth, reflecting the creation of jobs and opportunities that contributed to higher incomes.
The public policy challenge now facing Peru is not to turn its back on the principles that enabled such dramatic progress in recent decades. Covid-19 has underscored the need to further reduce poverty, as it’s the poor who have been disproportionately affected by the virus. A return to robust economic growth would provide the employment and income that raises living standards and improves health. Economic growth will also provide the government with revenue that can be allocated to improving the country’s health care infrastructure.
There have been some encouraging signs. The government has not resorted to protectionism, which is often the first step that many countries take in times of economic crisis. And in July, the finance ministry announced plans to deregulate the development of mining projects – an important step given the outsized presence of the mining sector in the national economy. More recently, the medium-term budget released in late August emphasized turning to debt reduction once the economic crisis has ended.
Less encouraging has been the government’s talk of raising taxes on anyone earning more than the equivalent of $2,900 per month. These so-called “solidarity” taxes rarely raise the revenue they project, which is why the number of OECD members maintaining them fellfrom 12 in 1990 to 4 in 2017.
Peru faces steep challenges, but the key will be to learn from what worked in the recent past. During her tenure as head of the International Monetary Fund, Christine Lagardecited “Peru’s success” in structurally reforming its economy, which she said had “many lessons” for other countries.
The lessons from Peru are that by liberalizing the economy, allowing free markets to function, and joining the international trading community, a country can become more prosperous and significantly reduce poverty. These principles will help guide Peru through its crisis with Covid-19 and provide the groundwork for expanded opportunity and higher economic growth – both of which would make the country’s tricentennial, in 2121, something to celebrate.
