Peru - History of the Economy

Orientation Toward Primary Product Exports

Peru's most famous exports have been gold, silver, and guano. Its gold was taken out on a large scale by the Spanish for many years following the conquest and is of little significance now, but silver remains an important export. Guano served as Europe's most important fertilizer in the mid-nineteenth century and made Peru for a time the largest Latin American exporter to Europe. The guano boom ran out about 1870, after generating a long period of exceptional economic growth. When the guano boom ended, the economy retreated temporarily but then recovered with two new directions for expansion. One was a new set of primary product exports and the other a turn toward more industrial production for the domestic market.

The alternative primary exports that initially replaced guano included silver, cotton, rubber, sugar, and lead. As of 1890, silver provided 33 percent of all export earnings, sugar 28 percent, and cotton, rubber, and wool collectively 37 percent. Copper became important at the beginning of the twentieth century, followed on a smaller scale by petroleum after 1915. Then, in the post-World War II period, fish meal from anchovies caught off the Peruvian coast became yet another highly valuable primary product export. Industrial products remained notably absent from Peru's list of exports until the 1970s. As late as 1960, manufactured goods were only 1 percent of total exports.

Manufacturing for the home market has had many ups and downs. The first major downturn came with the guano boom of the mid- nineteenth century. Foreign-exchange earnings from guano exports became so abundant and, therefore, imported goods so cheap that much of Peru's small-scale local industry went out of production. The end of the guano boom relieved this pressure, and in the 1890s a new factor, a prolonged depreciation of the currency, came into play to stimulate manufacturing. The currency was at that time based on silver, and falling world market prices for silver in this period acted to raise both import prices and export values (of products other than silver), relative to Peruvian costs of production. Without any overt change in national policies, Peru began a process of import-substitution industrialization combined with stronger incentives for exports. Domestic entrepreneurs responded successfully, and the economy began to show promising signs of more diversified and autonomous growth.

This redirection of Peruvian development was in turn sidetracked in the 1900-1930 period, in part by a decision to abandon the silver-based currency and adopt the gold standard instead. The change was intended to make the currency more stable and, in particular, to remove the inflationary effect of depreciation. The change succeeded in making the currency more stable and to some degree in holding down inflation, but Peruvian costs and prices nevertheless rose gradually relative to external prices. That trend hurt exports and the trade balance, especially in the 1920s, but instead of devaluing the currency to correct the country's weakening competitive position, the government chose to borrow abroad to keep up its value.

As has been noted, many Latin American countries reacted to the Great Depression by imposing extensive import restrictions and by adopting more activist government policies to promote industrialization. But at that point, Peru departed from the common pattern by rejecting the trend toward protection and intervention. After a brief experience with populist-style controls from 1945 to 1948, Peru returned to the open economy model and a basically conservative style of internal economic management, in sharp contrast to the growing emphasis on import substitution and government control in Argentina, Brazil, Chile, and Colombia.

Aided by the early recovery of some of its main exports in the 1930s, and then by development of new primary exports in the early post-World War II period, Peru had in many respects the most successful economy in Latin America up to the mid-1960s. But increasing pressure on the land from a rapidly growing population, accompanied by rising costs and limited supplies of some of the country's natural resources, began to intensify demands for change. One of the worst blows for continued reliance on growth of primary exports was a sudden drop in the fish catch that provided supplies for Peru's important fish meal exports; over-fishing plus adverse changes in the ocean currents off Peru cut supplies drastically in the early 1970s. That reversal coincided with supply problems in copper mining. Costs had begun to rise steeply in the older mines, and development of new projects required such large- scale investment that the foreign companies dominant in copper hesitated to go ahead with them. Further, population pressure and increasing difficulties in raising output of food converted Peru into an importer for a rising share of its food supply and began to work against use of land for agricultural exports. Although new investment and better agricultural techniques could presumably have helped a great deal, it began to seem likely that the only way to maintain high rates of growth would be to shift the structure of the economy more toward the industrial sector. Evolution of Foreign Investment

During its long period of attachment to an open economic system, Peru welcomed foreign investment and in some periods adopted tax laws specifically designed to encourage it. That is to say, until the 1960s the small fraction of Peruvians in a position to determine the country's economic policies welcomed foreign investment without paying much attention to growing signs of popular opposition. In the 1960s, many things changed. The major change for foreign investors was that growing criticism of their role in the economy led to nationalization of several of the largest firms and to much more restrictive legislation.

Foreign investment played a relatively minor role in the nineteenth century, although it included railroads, British interests in banking and oil, and United States participation in sugar production and exports. Its role grew rapidly in the twentieth century, concentrated especially in export fields. In 1901, just as Peruvian copper began to gain importance, United States firms entered and began buying up all but the smallest of the country's copper mines. The International Petroleum Company (IPC), a Canadian subsidiary of Standard Oil of New Jersey, established domination of oil production by 1914 through purchase of the restricted rights needed to work the main oil fields. The trend to foreign entry in manufacturing as well as finance and mining was stimulated by promotional legislation under the eleven-year government of Augusto B. Legu�a y Salcedo (1908-12, 1919-30), an initially elected president turned dictator who regarded foreign investment as the key to modernization of Peru. That much-publicized partnership between a repressive government and foreign investors was to play an important role for the future of Peru, by feeding convictions that foreign investment was inescapably linked to control of the country by the few at the expense of the public.

By the end of the 1920s, foreign firms accounted for over 60 percent of Peru's exports. The Great Depression of the 1930s changed that by bringing new foreign investment to a halt and by driving down the prices of the products of foreign firms (chiefly copper) much further than those exported by Peruvian firms. That double effect brought the share of exports by foreign firms down to about 30 percent by the end of the 1940s. Foreign investment remained low in the first postwar years, both because investors in the industrialized countries were preoccupied at home and because it was not encouraged by the populist government in Peru from 1945 to 1948. After a military coup installed a conservative dictator in 1948, the government offered a renewed welcome to foreign investors, made particularly effective by the Mining Code of 1950. This law offered very favorable tax provisions and quickly led to an upsurge of new investment. History repeated itself: as in the 1920s, a repressive government turned to foreign investors for economic growth and for its own support, adding fuel to widespread public distrust of foreign firms.

Public opposition to foreign ownership focused particularly on the largest firms owning and exporting natural resources, above all in copper and petroleum. The IPC became the center of increasing conflict over the terms of its operating rights and its financial support of conservative governments. When Bela�nde (1963-68, 1980-85) took office as president in 1963, he promised to reopen negotiations over the contract with IPC, but he then delayed the question for years and finally backed away from this promise in 1968. His failure to act provoked the military coup led by General Velasco, this time from the left wing. The Velasco government promptly nationalized IPC and started a determined campaign to restrict foreign investment. Although the government subsequently moderated its hostility to foreign firms, continuing disputes and then the deterioration of the economy led some companies to withdraw and held foreign investment down to very low levels through the 1980s.

The redirection of economic strategy under the Fujimori government in 1990-91 included a return to welcoming conditions for foreign investment, providing a much more favorable legal context, and disavowing completely the control-oriented policies of the governments of Velasco and Garc�a. Several foreign oil companies responded immediately, although the disorganized state of the economy and the context of political violence discouraged any general inflow of new foreign investment.

History of the economy

Through the nineteenth century and into the mid-twentieth century, the great majority of the Peruvian population depended on agriculture and lived in the countryside. By 1876 Lima was the only Peruvian city with over 100,000 people--only 4 percent of the population. Much of the impetus for economic growth came from primary exports. In common with the rest of Latin America up to the 1930s, Peru maintained an open economic system with little government intervention and few restrictions on either imports or foreign investment. Such investment became highly important in the twentieth century, especially in the extraction of raw materials for export.

For many Latin American countries, the impact of falling export prices and curtailed external credit in the Great Depression of the 1930s led to fundamental changes in economic policies. Many governments began to raise protection against imports in order to stimulate domestic industry and to take more active roles in shaping economic change. But Peru held back from this common move and kept on with a relatively open economy. That put it behind many other countries in post-World War II industrialization and led to increasing pressures for change. Significant protection started in the 1960s, accompanied by both new restrictions on foreign investment and a more active role of government in the economy.

One of the country's basic problems has been that the growth of population in the twentieth century outran the capability to use labor productively. The ratio of arable land to population-- much lower than the average for Latin America--continued decreasing through the 1970s. Employment in the modern manufacturing sector did not grow fast enough to keep up with the growth of the labor force, let alone provide enough opportunities for people moving out of rural poverty to seek urban employment. The manufacturing sector's employment as a share of the labor force fell from 13 percent in 1950 to 10 percent in 1990.

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