Peru - Establishing a competitive market environment

Report No. 11446-PE Peru Establishing a Competitive Market Environment July 22, 1993 Energy and Industry Division Country Department I Latin America and the Caribbean Region FOR OFFICIAL USE ONLY Au t1~eW ijdBank Vf- i*sdocum6riiii airtstricted distrilxtion and may be used by recipients ~ ~yin t pre'fmriac othroficial duties. Its contents may not otherwise ~t,e d.scIos~d withont Wo tred of r n ,.dscoe ._su Worl Ban autorzaton  CURRENCY BOUIVALZNTS (As of June 30, 1993) Currency Unit- Nuevo Sol (S/.)1 US$1.00 - S/2.03 S/.1.00 - US$0.4938 FISCAL January 1 to December 31 ABBREVIATIONS AND ACRONYMS Centromin Central Peru Mining Company (Empresa Minera del Centro del Peru) Cerper Fisheries Certification Public Enterprise (Empresa Publica de Certificacion Pesqueras) COPRI Commission for Promotion of Private Investment (Comision de Promocion de la Inversion Privada) CTS Compensation for Time of Service DGM General Directorate of Mines (Direccion General de Minas) Epuep Peruvian Company of Fishery Services (Empresa Peruana de Servicios Pesqueros) Flopeuca Peruvian State Fishing Fleet Company (Empresa Estatal Flota Pesquera Peruana) FMS Fisheries Management System FONAVI National Housing Fund (Fondo Nacional de Vivienda) FRMR Fisheries Resources Management Regime Hierro Peru Peru Iron Ore Mining Company (Empresa Minera de Hierro del Peru) IMARPE Peruvian Sea institute (Instituto del Mar del Peru) INDECOPI National Institute for the Defense of Competition and Protection of Intellectual Property INGEMMET Geologic and Metalurgic Mining Institute (Instituto Minero Geologico y Metalurgico) IPSS Peruvian Institute of Social Security (Instituto Peruano de Seguridad Social) ITQ Individual Transferable Quota Minero Peru Mining Company of Peru (Empresa Minera del Peru) Pescaperu National Fishery Company (Empresa Nacional Pesquera) Petroperu Peru National Petroleum Company RPM Mining Public Registry (Registro Publico de Minera) SENATI National Training Service Program (Servicio Nacional de Adiestramiento en Trabajo Industrial) SOB State-owned Enterprise Solgae Peru Gas Company (Compania Peruana de Gas) TAC Total Allowable Catch 1 On July 1, 1991, a new monetary unit, the Nuevo Sot (S/.), was introduced at a conversion rate of SI.1.00 * I/n.1.00. The so called Inti Milton (1/r.) --equivalent to one million [ntis (1/.1,000,000)-- was introduced on December 16, 1990 to simplify accounting and as a mans of transition between the Inti and the Nuevo Sol. Exchange rates were unified in August 1990 and, since then, have been allowed to float.  FOR OFFICIAL USE ONLY PERU ESTABLISHING A COMPETITIVE MARKET ENVIRONMENT TABLE OF CONTENTS SUMMARY AND CONCLUSIONS. I CHAPTER I INTRODUCTION .1 A. Objctive and Scope of the Study .1 B. The Current Reform Program. 2 C. Need for Additional Measures .4 CHAPTER 11 REMAINING ECONOMY-WIDE BARRIERS TO DOMESTIC COMPETITION. 7 A. Labor Market Constraints. 7 1. Legal Environment and Labor Stability. 7 2. Non-Wage Labor Costs .9 3. Impact of Rigid Labor Laws .10 4. Recent Reform Measures and Recommendations for Further Reforms .12 a. Labor Stability .12 b. Compensation for Time of Services (CTS .14 c. Social Security and Other Contributfions .14 d. Profit Sharing .16 B. Entry, Exit, Antitrust Policies, and Institutfonal Aspects .17 1. Entry ....... 17 2. Exit ....... 20 3. Antitrust ....... 22 4. Institutional Aspects .28 This report is based on the findings of a team that assessed economy-wide and sectoral competition and resource mobility issues in Peru, using the work done at Headquarters nd results of the field work carried out during the May and June/July 1992 Privatizatfon Adjustment Loan and Privatizatlon TA Loan preparation missions and of a June 1993 mission undertaken to discuss the findings/reconmnndatlons of the Green Cover Report nd to update the Infornution on new policy changes. For the *sction on NL bor Market Constraints", the report also utilized the White Cover report entitled: The Decline of the Value of Labor in Peru: Causes and Remedles, the World Bank (June 1992). The team consisted of Tercan Baysan, task manager, and Luis Guasch (LATTP). This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.  CHAPTER IA ISSUES IN THE MINING, FISHERY AND HYDROCARBON SECTORS ........ 31 A. The Miing Sector ....................................... 31 1. Background ........................................ 31 2. Rocent Reo t .......f............................... 32 3. Recommn dat/ons .................................... 36 BA The fishries Swtor ...................................... 39 1. Background ........................................ 39 2. Recent Reforms ..................................... 40 3. Recommendations .................................... 42 C. The Hydrocabons Sector .................................. 44 1. Background ........................................ 44 2. Recent Reforms ..................................... 46 3. Recommendations .................................... 46 ANNEX TO CHAPTER III EVOLUTION OF FISHERY RESOURCES MANA GEMENT REGMES.. 60  SURIARY AND CONCLUSIONS A. OVERVIEW i. There is ample evidence that competition is crucial in inducing/ foutering sustained improvements in productivity, quality, cost reduction, and resource allocation efficiency. It stimulates firms to modernize technologies, improve competitiveness, introduce new production lines, and search for new markets. In this respect, Peru's comprehensive economic reform program has taken major steps through its emphasis on markets, market-based polices and regulations, trade liberalization, and private sector initiative and development. As a major component of its structural reform effort, Peru is currently implementing a comprehensive privatization program, which should enhance the extent of competition and production efficiency gains. ii. However, to respond to and realize the efficiency gains expected from these reforms, firms must be able to adjust their labor force, move their resources into relatively more profitable areas, and exit activities that appear no longer profitable. To facilitate such adjustments, the Government needs to eliminate the existing policy-generated barriers to domestic competition and factor mobility. iii. This report examines the existing generic barriers to labor mobility, business entry, exit, and then discusses the key sectoral policy issues related to competition in mining, fisheries, and hydrocarbons sectors --the key sectors for production of tradables in Peru. B. GOP'S CURRRNT REFORM PROGRAM iv. The Government, after taking office at end-June 1990, initiated a comprehensive stabilization and structural adjustment program. While the short-term objective of the program was to halt hyperinflation and lower the rate of inflation to acceptable levels, its longer term objectives are to restore macroeconomic balances and increase efficiency in resource allocation and use. v. Major structural reforms have been introduced in the key policy areas, with a view to removing market distortions and establishing a competitive environment. Trade policy reforms included the elimination of non-tariff barriers and tariff exemptions, and Peru's tariff rate structure was simplified to a two-rate system of 15% and 25%. Other important reform measures included the elimination of monopoly rights of state-owned enterprises (SOEs), of most price controls, and of restrictions on foreign investment. Also, land property rights were strengthened, while, in labor markets, provisions for layoffs and temporary employment have been broadened, and positive changes have been introduced in labor legislation. Given its scope and speed, Peru's privatization effort is also a significant undertaking. vi. In mid-1991, the Government expanded its structural reform program in a major way, by starting a comprehensive privatization oroaram. Since May 1992, thirteen privatizations have been completed, yielding about US$235  - ii - million in cash proceeds. The Government's objective is to privatize all SONs by mid-1995 when its term expires. vii. The Government is also showing a serious effort in reforming the policy/legal and regulatory environment in all the key sectors before (or in parallel with) privatizations, to ensure that a pro-competitive environment is created and that inefficient state monopolies are not replaced by inefficient private monopolies. viii. Peru's reform program is being supported by the International Monetary Fund (IMF), the Inter-America Development Bank (IDB), and the World Bank. In the area of privatization, Bank support is being provided through technical assistance, financed by a Japanese privatization grant, the recently approved Privatization Technical Assistance Loan (PTAL) and the Energy and Mining Technical Assistance Loan (EMTAL). And, the implementation of s*ctoral privatization programs will continue to be supported by the already approved Privatization Adjustment Loan (PAL), the Financial Sector Adjustment Loan (FSAL), and the proposed Electricity Privatization Adjustment Loan (EPAL). C. NEED FOR ADDITIONAL MEASURES ix. The economy's capacity to respond to these reforms rapidly will depend on how quickly firms in Peru adjust and show supply response to changing market conditions, increased import competition and export opportunities. A strong response would, of course, help contain the short- term adjustment costs and ensure the sustainability of the structural reforms. While factors such as domestic and foreign firms' perceptions about political and economic stability and their ability to finance desired adjustments will be important determinants of the economy's adjustment to the liberalized policy environment, absence of any policy-generated barriers to competition and factor mobility will also contribute strongly. In this respect, there are several areas at the economy and sectoral levels, where further reforms are needed to facilitate firms' adjustments to Peru's structural reforms, strengthen the conditions for domestic competition and factor mobility, prevent monopolistic tendencies, and ensure efficient exploitation of natural resources. D. REKAINING ECONOMY-WIDE BARRIERS TO COMPETITION 1. Labor Market Constraints x. Leaal environment and labor stability. A key feature of Peru's labor legislation is the protection of workers' "labor stability". This principle was first introduced in 1970 in the Labor Stability Law, as part of the nationalist and populist policies of the military government. The law established that after a trial period of three months, a worker would obtain job "stability" and that dismissals would take place only when "grave faults" were committed. A dismissed worker, following a favorable decision on a legal action taken against the dismissal, could ask for reinstatement or compensation amounting to three months' salary in addition to accrued salaries since the dismissal. The Stability Law also established administrative procedures for closing of plants, reduction of shifts and days and hours of work, and for "massive" personnel reductions. In addition, the General Law of Industries, also issued in 1970, entitled workers, through the newly instituted "industrial communities", to a portion of the firm's profits in the  - iii - form of shares, thereby giving workers participation rights in the ownership (up to 50%) and management of the firm. xi. The Stability Law was modified several times during the last two decades in order to introduce some flexibility in dismissals, hiring, and temporary employment conditions. In each case, to afford one positive action, another aspect of the law was made more stringent, as in the case of compensation for unjustified dismissals, which was increased to 12 monthly salaries. Notwithstanding these modifications, however, the principle of protecting employment stability has remained intact, and is also guaranteed by Article 48 of the (1979) Constitution. Also, in practice, it has been very difficult to prove "fair causes" for dismissals in the labor courts, because of the law's very narrow definition of fair causes. As a consequence, firms' ability to dismiss workers has remained severely limited, thus making labor costs a part of fixed costs. Firms have also chosen not to use the provisions of the law for massive dismissals under exceptional economic situations, because of the very lengthy and elaborate procedures. Indeed, paying workers for their voluntary retirement has remained the preferred alternative for firms in Peru, with the severance packages averaging US$6,500 per worker in 1991-92 for SOEs and higher for private sector firms. xii. Non-waae labor costs. A large number of forced savings schemes financed through high statutory payroll taxes have also significantly increased labor costs for employers. Under the so called "Compensation for Time of Service" (CTS), employers are required to contribute one monthly salary for each year of service to a savings scheme, whereby accumulated savings are paid to employers as a lump-sum "severance payment" at the time of layoffs, resignation or retirement. The scheme is costly and has major weaknesses as a substitute for unemployment insurance, as a forced savings program, and as a way of mobilizing financial savings. xiii. Regarding social security (SS) programs financed by payroll taxes, employers' contributions to pension/health plans and the accident insurance system managed by IPSS (Instituto Peruano de Seguridad) had exceeded 16% of wages until the reform measures of November 1991 (see below). In addition, employers had been required to contribute to the National Housing Fund (FONAVI) and the National Training Service (SENATI), at rates of 5% and 1.5% of wages, respectively. Also, in mining, labor costs are increased further since firms are required to provide housing, hospital and school services if mines are located more than one hour from urban centers. xiv. Impact of rigid labor laws. Since the early 1970s, job opportunities and real wages in the formal sector have shown falling trends -- average real wages have fallen by almost 60%. The high total cost of labor has constrained employment generation in the formal sector and led to shifts into the informal sector. Moreover, efforts of firms to contain the growth of total labor costs, when downward adjustments in the level of employment could not be made, appear to have led to wage compression and declines in the ratio of skilled workers/total employment. The resulting compromise from the desirable skill-mix must have had adverse effects on productivity of firms in Peru, as reflected in rising labor/output ratios. It seems that firms have ended up substituting capital for skilled labor, despite the high degree of complementarity between the two.  - iv - xv. These trends are harmful for labor, employers, and for the economy. Benefits of Peru's structural reforms will depend on firms' ability to vary employment levels, skill-mix and, if necessary, exit certain activities without incurring significant costs. xvi. Recent corrective measures and recommendations for further reforms The new Government has attempted to address some of the labor market ,issues, first through changes introduced in a new labor stability law enacted in November 1991. The most important change is that economic, technical, and restructuring reasons can now be considered valid causes to initiate collective dismissals. Also, the provisions of "fair cause" for individual dismissals was expanded to include, for example, low productivity. More recently, the Arbitration Law and the Law of Collective Agreements, Strikes and Unions were promulgated, providing a framework to resolve disputes between management and labor. xvii. Perhaps the most important recent positive development regarding the Peruvian labor stability law, however, is the elimination of the stability clause in the draft new Constitution, abolishing the guarantee of the worker's right to employment stability. The current draft of the new Constitution simply states that the law should provide "adequate protection" to the worker. It also eliminates the right of workers' participation in ownership and management, while retaining mandatory profit sharing (the former change had already been made effective in late 1991 through a legislative decree). xviii. Notwithstanding the recent changes in labor legislation, however, until the draft new Constitution is approved, the main issue of labor stability and the key restrictive stability conditions will remain, hindering labor mobility. xix. With respect to payroll taxes/deductions, the Government also introduced changes in the CTS system in July 1991, requiring the employer to deposit every six months the CTS payments into a bank account owned by the employee. This change has removed one major problem facing the employer in managing CTS payments, the uncertainty of the real value of CTS liabilities during high inflationary periods. This was because the base for calculating CTS was the last monthly earnings. However, despite the improvements effected in its implementation --such as the removal of uncertainty regarding the real value of CTS balances, and the creation of a new source of long-term savings for the financial sector-- the CTS scheme still remains an economically costly way of achieving the intended objectives. xx. Other important reform measures include the changes in Peru's SS system, introduced in November 1991. First, the incidence of SS taxes has been altered, with the employer's share falling from 12% to 2% and that of workers increasing from 6% to 16%. Second, workers can now choose some private pension and health service coverage beyond a basic coverage that is to be provided by IPSS. Thus, the new law opens the way for competitive provision of SS services, providing more options for workers and competitive pressure on IPSS to be more efficient. Also, the employer's contribution to the housing fund, FONAVI, has been reduced, while the employer's contribution to the industrial training fund, SENATI, has been eliminated, effective from January 1994.  xxi. RBclM At