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Peru - pushing its economy to the edge

ON the most recent of many trips to Peru, I was struck as never before by the seemingly insurmountable obstacles facing that poverty-stricken and violence-ridden nation. Now, with the recently reactivated economy doing so poorly and the loss of coherence and consensus on the part of a government that had provided the nation with a spark of hope as it emerged from the worst economic crisis in its modern history, it is hard to imagine what will happen. Peru faces the same daunting obstacles as most other heavily indebted Latin countries: an excessive debt burden; exorbitant unemployment rates; triple-digit inflation; and rising social unrest. In that atmosphere Peru must test its fledgling democratic system. The nation also has many unique problems: the worst per capita gross national product trend in South America over the last decade and the most fanatical and dangerous terrorist group on the continent. Some 10,000 victims have been killed since 1980 in the ``dirty war'' between the military and Sendero Luminoso (Shining Path), a group whose tactics resemble those of the Khmer Rouge.

In 1985 Peru found a salvation of sorts in a young and charismatic President, Alan Garc'ia P'erez, who was supported in his party, the American Popular Revolutionary Alliance, by a team of innovative technocrats. Demonstrating a boldness and enthusiasm long overdue in Peruvian policymaking, Mr. Garc'ia and his team tried to reactivate the economy by lowering costs for manufacturers and stimulating internal demand through price freezes and minimum wage increases. They limited debt payments to 10 percent of export earnings. Major emphasis was placed on cooperation with the private sector. As a result, Peru's overall economic performance in 1986 was remarkable. Inflation was held at 64 percent, and growth was 8.5 percent. Peru's entrepreneurial sector, long known for its dependence on foreign capital and unwillingness to invest, was an active and crucial participant in the recovery.

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By early 1987, however, bottlenecks began to appear in the economy and rifts in the Cabinet. The more responsible members of the team recognized that price controls had exhausted their effectiveness and that greater investment and a reduced government deficit were necessary to continue growth and curb inflation.

Garc'ia, meanwhile, surrounded himself with a new team of advisers, known as los audaces, or the ``bold ones,'' who wanted to increase state involvement in the economy. Many had served on the planning staff of the leftist military dictatorship of the 1970s. They were determined to work an economic ``coup'' if inflation continued and investment did not increase by midsummer. Garc'ia needed a dramatic move.

The team came up with a plan: The expropriation of all private banks, insurance, and finance companies was announced on July 28. The move came as a surprise even to the highest-ranking members of the ruling party; it contradicted Garc'ia's past promises to respect private property and his goal to reduce state bureaucracy. It was vehemently opposed by the business community.

The reasoning behind the move is baffling. Garc'ia said that the main motive was to force businesses to invest. As the banks were hardly responsible for the nation's capital flight, and the expropriations would obviously undermine business confidence, it is hard to see how an investment increase would result.

Ironically, Garc'ia had earlier christened 1987 ``the Year of Investment.'' The other professed goal, the ``democratization'' of credit, was also questionable; the record of loans by state banks to small-scale entrepreneurs was far worse than that of the private sector. The expropriations caused a major political reaction: an independent front composed primarily of the political center, led by Mario Vargas Llosa, the nation's best-known writer. The front protested the threat that state monopoly of credit in the country posed to individual liberties. The movement drew strong crowds at some of its demonstrations, and political opinion had shifted to 60-40 against Garc'ia.

Garc'ia hoped to use the expropriations measure to forge an alliance with the left; but the United Left front was hardly willing to cooperate with its main political rival and tried to sabotage the proposal in the Senate.

The question remains what Garc'ia gained by expropriating the 20 percent of the nation's banks that remained in private hands. He alienated private industry, destroying the motor for his economic model. He created rifts within his own party and subsumed its prestige to the blackmail of its main political rival. Finally, he aroused a massive political opposition, substantially eroding his support among the middle classes.

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The measure clearly indicated a shift toward increased state planning and control of the economy, a current that runs counter to the worldwide trend toward privatization occurring in such nations as Ghana, Mexico, and France. Peru now faces the specter of hyperinflation, dwindling reserves, and capital flight: in short, an impending economic collapse that is largely a product of the government's own folly.

In the context of Peru's volatile socioeconomic situation, widespread frustration, squandered human resources, and spiraling violence are likely to result.

Peru's case is clearly a sad one. The Garc'ia government has created one more obstacle to Peru's political and economic development when it already had a plethora of challenges facing it; now, thanks to the decision of ``Caballo Loco'' - ``Crazy Horse,'' as the opposition calls Garc'ia - to shoot his own economic model in the foot, Peru is likely to take a giant step backward while it reconfirms the oft-proved flaws of statism.

Carol L. Graham, formerly of the Brookings Institution, is a doctoral candidate at Oxford University.

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