Peru - A private sector assessment

Report No. 12096-PE Peru A Private Sector Assessment March 31, 1994 Latin America and the Caribbean Region Country Department I Country Operations Division FOR OFFICIAL USE ONLY MICROGRAPHICS Report No: 12096 PE Type: SEC Document of the World Bank This document has as 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  CURRENCY EQUIVALENTS (As of December, 1993) Currency Unit = Nuevo Sol (S/) US$1.00 = S/2.16 S/1.00 = US$0.46 FISCAL YEAR July 1 - June 30  FOR OFFICIAL USE ONLY Foreword This report was written by Paul Holden LATAD, (task manager) and Geoffrey Shepherd, LAICO. They visited Peru in October 1992 on a preliminary mission with Xenia Kazoli (consultant) and Rosa Moreira (consultant). In Feb, ry 1993, the team returned to Peru in connection with three surveys of Peruvian entrepreneurs and industrialists th . are discussed in the report. While on this mission, Rosa Moreira conducted extensive interviews in the informal sector which pros ided information that is contained in Chapter 3. In May 1993, Paul Holden, Geoffrey Shepherd and Xenia Kazoli visited Peru on the main mission. Firms in the garment and construction industries were surveyed to analyze the costs of transacting in the business environment in Peru. A broader survey on the constraints to growth was conducted over a cross section of firms. The surveys were performed by Charles Thomas (consultant) with the assistance of Lucia Burga (local consultant). Andrew Stone (PSD) and Charles Thomas analyzed the data. The survey resuhl3 are used extensively in the report. Chapter 4 makes extensive use of the paper on the survey results prepared by Andrew Stone. As part of the background to the PSA, Xenia Kazoli has prepared a paper, 7he .,egal Frameworkfor Doing Business in Peru, which is available upon request. In February 1993, an IFC team consisting of Manuel Nuffez and Woldai Futur undertook a mission to interview entrepreneurs and industrialists in Peru. They prepared a paper on the results, Constraints to Private Secto. * Devdlop- ment, the conclusions of which are reflected in the private sector assessment. Mateen Thobani provided help in the issue of water rights. Hemant Shah prepared a policy matrix on financial sector issues, many conclusions of which are reflected in the section on capital markets. The authors of this assessment are grateful for the cooperation of many people interviewed in the private sector, industry associations, universities and the government m Peru. They are also grateful to the many people who pro- vide I comments on earlier drafts. The statistics underlying the charts that appear in the report are available upon request. Elena Pandritis (consultant) provided research assistance and helped in the administration of the surveys. Jennifer Sobotka (consultant) prepared the graphics and the report. Design and layout of the report was provided by the DA Art Studio. Contents Page i Summary 1 Chapter 1: Introduction 2 Chapter 2: The Historical Perspective S Chapter 3: The Structure of the Economy 13 Chapter 4: Transactions without Trust: Doing Business in Peru 19 Chapter 5: The Institutional Framework 20 Chapter 6: Conclusions and Recommendations 25 Appendix 26 Bibliography 28 Statistical Appendix 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.  As a response to this unfortunate history, 2) Structure of the Labor Sum m ary the last 30 years have been dominated Force, 1950-89 by misguided government attempts to This report examines the environment for help the poor through direct public ac- D Self-mloyp doing business in Peru following the far- tion and through controls on the private reaching reform program instituted in sector. 4 1990. * The most productive land was con- 3D o ,,,._ It has never been easy to do business in fiscated and major sectors of the Peru. This is a powerful reason why, economy were nationalized. amid such potential, Peru remains a poor and divided country. For business to * Government attempts to direct pri- >k.*,.,,.**44 *4iit flourish a country must enjoy conditions vate investment for social purposes | o , of continuity, stability, and evenhanded resulted in a significant interference SD M RI) R s Vs ER t policy in which business trust and hab- in dhe ability of firms to contract X its of competition can grow. Historical freely. derousterroristmovementwhichap- forces in Peru have done little to create peared able to operate at will. these conditions. Populist economics reached its apogee in the sewond half of the 1980s. By the The shape of Peru's economy remains * Since independence, periods of pro- tima the Fujimori Government came to marked by its history. longed political stability have been office in 1990, Peru was, by every mea- rare. sure, near collapse. * There is a very large informal sec- tare.__sure,__near_collapse._ tor. It is characterized by competi- * Unable to manage its public fi- tion without capital, and most of its nances, Per had to repudiate its for- Monthly Inflation 197693 workers are locked in a cycle of low eign debt four times. productivity, low earnings, and pov- * Not unsurprisingly foreigners came Iety. to take much ofthe blame for recur- I . l +~~~~~~~~~ Most of the modern, or formal, sec- rent crises, and, as a result, a tradi- tor is inefficient and inward-ori- tion ofhostility to foreign investnent ented. Raised on privileges handed grew up. S 11&1 out by government, it has had sapi- * The recurent crisis of public finance tal without competition. has also meant a poor quality of and terrorism have public services and public adminis- Agrrian reform tration. Successive govenmments did led to a continuing decline in agri- little to bridge the large social and culture. economic gaps between rich and i 2 In 1990, the Fujimori Governnent em- poor. barked on one of the most far-reaching Annual GDP Growth, 1951-93 economic reform programs in Latin * There was hyperinflation. American history. It touched every area of the economy. * Incomes and productivity had re- 1V L u.Ihb gressedtothe levels ofthe l950s. * The economy was openedto domes- tic and foreig competition: import _ M ~ EI . * n * Government intervention had barriers were slashed and foreign EI U EI _ _ ^ greatly distorted economic incen- exchange made freely available; all tives. capital account restrictions were lifted; price controls were elimi- * Tax collection had fallen to some six nated, financial markets were liber- per cent ofGDP, and public services alized; labor restrictions were re- were in disarray. duced. i5 ,,,,,,,,,,,,,,,,,,,,,,, j,,,,,,,,,,, * Thecoywasinthegipofamur- * The financial health of the public i  will endure. Pofliy Recommendations s Monthly Inflation, 1992-93 wi endure. 16 14 Complex tax regulations are costly The government must maintain cred- ut for firms. Moreover, regulations Ibili with both the business commu- and taxes distort incentives in the nity and the electorate. To do this: 6 domestic financial system. In addi- 4 _^ _ tion, the lack of a Brady-type debt * The timetable for completing the 2 , _ deal raises the cost of domestic fi- privatization process must be 0. nance and hinders foreign invest- adhered to, especially in infra- j ,j 3 X b j ment. structure services which hav. deteriorated to the point where * Public infrastructure services re- they constitutesevere bottlenecks sector was reestablished; the tax re- main poor. It costs as much to trans- to economic recovery. gime was overhauled and many sur- port atruckload of produce from the plus workers were dismissed. selva to Lima as it does to ship it * Thegovermnentmustcontinueto from Lima to its destination in the make a priority of containing in- + The governmernt embarked on a United States. The telephone system flation. radical program of privatization. works poorly. Many producers have I their own pcwer generators because * The need for a Brady-type deal * The government set about rehabili- ofthe unreliability of public power with foreign banks is urgent. tating the market for land. supplies. * Rapid progres in the tltinp and The reform program has borne its first * Bank loans are very expensive. registration of real property will fruits, thtough most ofthe changes in the help extend the benefits of reform structure of the economy still lie ahead. * Security is still a concern (though to the poorer parts of Peruvian I there has been a significant break- society. * Inflation has sharply declined. through in the fight against terror- ism since the survey was con- * New poicies to encourage com- * After stagnating imtially, output be- ducted). petition and protect consumers, gan a rapid recovery in 1993. I if judiciously applied, will help * Thekind of business trust necessary promote business trust and con- Finn interviews, most ofthem carried out for modem market economies to sumer confidence; if used with in early 1993, show large improvements function is still largely lacking in excessivezeal, they could under- in the business environment since 1990. Peru, and the business community's mine business confidence. In particular, difficulties with trade continuing mistust ofthe court sys- regulation, foreign exchange, and labor tem helps explain this. Incentives * Publicizing the new economic laws declined markedly. But the busi- to become fonnal are weak and bar- rules and maintaining a high and ness community still perceives many ob- riers to entry remainL public level of government com- stacles to doing business. mitment to the new market or- Overall, the government has made enor- der will cement the reforms. * Given political uncerainties, the mousprogressinrefomiingtheeconomy. business community is not yet con- The environment for business is incom- Rebuilding the machinery of govern- fident that the new policy regime parabiy more promising than it was in mentis essential ifthe reform process 1990. How far does the reform process is to continue. The Issue is not only to thlOutp 1992-93 still need to go? It is possible to identify improve the quality of the central Monthl On utpu 992-9 many areas where action is needed to governmentadministration. Itis also create stable business conditions and fur- to remove from central government therimprove the way markets work, but (to the private sector, local govern- there is no doubt that the Government is ment, or to autonomous agencies) L I | l aware of what needs to be done. What those services that can better be sup- is most important is to create the condi- plied In a decentralized fashilon. tions that will allow the momentum of 4 reform to continue. This involves two If these measures are pursued by a issues, political credibility and the re- committed government, much of the imJ .ki.9z jat u 'building of govemment rest ofthe reform agenda can fall into place. ii  _ 1 _ gains. Most obviously, this means in part PERU: PRIVATE SECTOR that governments must be "neutral", re- ASSESSMENT 3. Historically, the state has not been a fraining from policies that favor one type reliable provider of public goods in Peru, of activity over another or one firm over forcing private firms to provide for them- another. Less obvious perhaps are the ef- selves many services with public good fects and policy implications of the insti- 1 Introduction characteristics that can be most efficiently tutional framework on the organizational 1. IntroductiOn supplied by the state. Stable prices, a well processes that foster efficiency. The way functioning legal system, a sound infra- that economic activity is organized, structure, and security have usually been whether through markets or through fins, 1. A private sector assessment for mostnotablebytheirabsence. Atthe same has significant implications forproductiv- Peru provides a particularly interest- time the government has frequently inter- ity. Ing opportunity to evaluate the private fered extensively in property rights and sector business environment going contracting with the result that incentives through a process of transition and have been unstable and have changed radi- adjustnent. A new govement in 1990, cally through time. 5. The process of development or mod- inheriting an economy in chaos and a eitionis in many respects synonymous bankruptand powerless administrative with an increasing division of labor, the machine, carried out a thoroughgoing The reform program has to polar extremes of which are transactions proam of stablization and market- reverse the breakdown thatoccurimarketsandthosethatoccur oriented reforn. It r