Peru's Debt Crisis and Subsequent Shock Economy

A political and economic overview of a developing nation.

By Carlos Alberto Gomez

 Living standards for Peruvian people were unbearable in the late 1980s due to an unmanageable debt and hyper-inflation. The two administrations prior to the crisis of the 80's dealt lethal blows to the Peruvian economy: General Alvarado and his staff applied a realist form of policy-making which emphasized protectionism and questioned foreign assistance. Belaunde succeed General Alvarado in 1980 and began to implement a liberal model of economy by eliminating tariffs and getting Peru to re-join the international economic field. The latter administration resulted in a collection of weakened industries that were softened by government protections, which the former then opened to the world market. From timber to agriculture, no Peruvian industry withstood the shock of entering a highly competitive world market. Only Fujimori's stringent shock economy in the early 1990's managed to get Peru of out the downward spiral.

During the 1960s an export-led economy was designed by the administration of Fernando Belaunde. The Belaunde administration aimed to liberalize the major industries of Peru in an effort to get the country out of poverty. Unfortunately his efforts were cut short when a military coup led by General Alvarado removed Belaunde from office. Alvarado Velasco reformed the economy of Peru through substantially different policies than anything Peru had seen before. Initially Alvarado created land reforms that removed land from the few landowners and redistributed the plots among the peasantry.  Eventually his administration de-privatized many aspects of the economy. His reforms resulted in both the weakening of the wealthy ruling class and in making those same elites enemies of his government. His military regime then initiated import substitute industrialization, which aimed to protect local markets by raising tariffs on foreign imported goods. The reforms were relatively successful, but due to the heavy borrowing Velasco undertook to initiate such drastic changes to Government policy Peru became even more in debt than before. The oil crisis of 1973 topped off the economic problems, and inflation began to surge in Peru. By the time democracy was reinstituted in the 1980s, the economy had suffered immensely.

Alvarado's economic policies of removing land from elite landowners made conditions worse for the masses. The wealthy ruling class had the technology to develop agriculture to a western standard. Smaller plots divided among more people were much less productive and the agriculture industry almost collapsed. Increased government spending resulted in the debt growing to an unmanageable level. The same people who Alvarado aimed to protect and benefit were the people that opted to remove him from power in a bloodless coup.

After the military ruler was ousted Belaunde was reelected and democracy returned to Peru in 1980. Belaunde quickly began to liberalize the economy. This led to the privatization of over two thirds of the economic sectors in Peru. Foreign based companies controlled the major export businesses of mining and fishing. Wealth began flowing in but it was only reaching the elite ruling class that advocated laissez-fair economic policies. For the large poor masses distribution of wealth was not improved once again. Belaunde promised that the tough economic times would eventually end and the growth of Peru would be significant enough to improve living standards for all Peruvians. Unfortunately his effort to liberalize the economy failed once again, but this time it wasn't due to factors within Peru.

Belaunde's policies were beginning to work when a series of national natural disasters and international events devastated improvements and set the economy back once again. Beginning with a strong earthquake in 1983 and continuing with a series of strong storms, the infrastructure and agriculture of Peru was devastated. Furthermore the international price for the major products Peru exported dropped: the United States, Europe and Australia subsidized their agricultural industries. As a result two of Peru's major exports, potatoes and sugar, were devastated when the price for their world price dropped.

 The World Bank provides some statistics that explain what the situation in Peru was beginning in 1980. The Per Capita GDP was $2,569, but note that the large disparity between the rich and the poor makes this figure appear to be higher for the average Peruvian. The population was becoming increasingly urbanized with 62% of everyone living in a large city (namely the capital Lima where 30% of the entire population resides). The amount of borrowing amounted to more than 473 million dollars, yet the infrastructure was still weak. The problem was that most of the money being borrowed was used to alleviate existing and failing institutions, not to build new institutions that would eventually free the country from poverty. For example the police force had to be funded with borrowed money because inflation was beginning to cause instability within the poorest of the poor.

 There are some unintended side effects that come from borrowing from the IMF. Because the IMF has become known as the ‘lender of last resort' whenever a country borrows from the IMF automatically it is labeled too ‘risky' for regular investors. Conditions are at their worse so no one is willing to risk loaning or investing in Peru. In any case the infrastructure was only being repaired, but not improved by the loans from the IMF. There were only 17 phone lines for every 1,000 people in 1980! The infrastructure was weak enough to cause 126 deaths for every 1000 infants born due to inadequate medical facilities.

 In 1983 because of the natural disasters and international events real wages dropped, per capita GDP was now at $2,244, down from $2,686 just two years prior. Inflation for consumer products increased 52% from 1981-1983. Naturally these two figures show a decline in living conditions that continued until about 1987 when slowly the economy began to recover. In 1987 inflation decreased by 25%. The only option Belaunde's government had been to borrow once again, just like Velasco. The Peruvian people opted for Belaunde to be reinstated because of his harsh criticism of Velasco's heavy borrowing, but once again forces outside of Peru's control lead to a period of intense borrowing from the IMF. National debt increased from just fewer than 10 billion in 1980 to more than 13 billion.

 Instability under Belaunde's administration began to rise as living conditions decreased. A professor in the University of Humanga founded the group “Sendero Luminso” which opened a campaign of terror against Belaunde. Many young males in remote and tropical areas of Peru were attracted by the prospect of change for the better that the SL promised so recruiting was highly successful. Belaunde's administration was incapable of dealing with the guerilla group at least for the first couple of years. The organization was successful in disrupting the daily procession of government functions, so successful in fact that their results prompted Belaunde to assign the military to counter-insurgency. Their tactics were heavily criticized in the international community due to perceived human rights violations: military personnel were not careful in distinguishing between true guerilla fighters and ordinary citizens. The result for Peru was staggering: more than 5,000 people died in the fighting and over a billion dollars in collateral damage was done to an already ailing infrastructure.

 The increasing popularity of the SL combined with a deteriorating economy and bad government policies led to skyrocketing inflation in the early 1990s. By 1991 inflation had increased more than 7,000% and per capita GDP decreased to 1,908 (down from 2,643 in 1987!). The populist administration of Alan Garcia Perez disappointed the 48% of the population that voted for him due to a lackluster performance and inability to curb the rising inflation and declining living conditions. Possibly among the few good elements of the Belaunde and Garcia administration is the increased use of democracy to enact changes in government policy. While the SL became more popular, the majority of Peruvians opted to vote rather than support the insurgent group.

 Garcia's term ended with the economy running in the same direction of hyper-inflation that had began with Belaunde's administration. The two main candidates were Fujimori and Llosa. Interestingly, Fujimori won the election not so much because he was the more appealing candidate, but because people didn't want Llosa in power. The reason was that Llosa proposed a severe and difficult program to end hyperinflation by raising consumer product prices, lower interest rates, opening the economy to trade, and increasing the privatization of industries in Peru. Yet once Fujimori was in power he enacted the same finance program to end hyperinflation that Llosa was advocating. Fujimori's administration saw this as the only viable option in order to change the economic deterioration of Peru. For the duration of the ‘shock' economy living conditions were made worse, but civil instability declined. Fujimori's stern rule and policies did in fact slow down inflation and began to recover the economy. Between 1990 and 1992 inflation decreased by an incredible 7,408%, but per capita GDP decreased to $1,863. With inflation curbed however, slowly per capita GDP began to painfully increase; in fact by 1996 it climbed back to $2,263 (just $306 less than the rate in 1980 or the rate before the beginning of economic decline).

 Fujimori's economic reforms, gradual civil unrest decline due to a decrease of hyper-inflation, and scarce natural disasters allowed the economy to recover to levels just under those of 1980. The per capita GDP was $2,344 and inflation for consumer products was reduced to a mere 4%. The recovery allowed Peru to re-enter the international economic field and investors slowly began to return. Even the national debt was reduced: Peru used $350,000,000 less in IMF loans from 1998 to 2000. In addition, new medicines imported from the west allowed for a significant increase in living conditions, even without the per capita GDP of 1980. For example infant mortality rate in 1980 was 89 deaths per 1,000 babies. Yet by 2000 the number was reduced by over 50% to a mere 40 deaths per 1,000 babies. Even the literacy rate increased from 79% of all adults over the age of 15 in 1980 to 90% in 2000. The technologies imported from the Western nations allowed for a increase in living conditions, even while real wages were not much better off than in 1980.

 Fujimori's liberalist economy was more successful than Belaunde's attempt because his measures were much more drastic. Belaunde attempted to end inflation and debt, but was careful not to eliminate all protections of the industry. In essence he was thinking like a politician. Fujimori almost immediately eliminated all protections (tariffs and subsidies). This eventually led to growth, but initially Peruvian people were forced to pay as much as 500% more for consumer products that suddenly cost as much as they did in the world market. Fujimori also temporarily shut down the Congress in order to pass legislation allowing security forces to increase the fight against the insurgent groups. While his tactics were less risk-averse they proved successful both in reforming the economy and curbing the crime and instability that limited growth.

Fujimori's economic reform is considered liberalist because it was based on the integration of Peru to a world economic forum. Due to previous inflation, instability, protectionism, and debt Peru became a very uninviting place for foreign investment. Fujimori took Belaunde's vision further and established policies that successfully placed Peru on the world market. This is not to say that Bealunde's attempts at reform were not liberalist: when Belaunde privatized agriculture he did not intend to hurt the poor, he intended to make the agriculture more productive in Peru so that in the long run the poor could be benefited more in a wealthier economy. The problem with Belaunde's liberalist attempt was that privatization and deregulation were not taken far enough, so the result was that the poor were made worse off and the economy didn't recover. Natural disasters were partly to blame; the agricultural collapse due climate conditions could neither be predicted nor averted. 

General Alvarado's reform was a realist response to worsening conditions for the poor. Alvarado's administration saw the world market as a rival, in a sense it was ‘every man for himself'. Thus import substitute industrialization was initiated and the trade borders of Peru were closed. Protectionist subsidies and tariffs were placed to protect local industries. In addition to all this the government redistributed land among the peasants. The result was significant increase in government spending while making the economic backbone of Peru weaker. Not only were the trade barriers resulting in foreign retaliatory moves (other countries closed their trade with Peru to retaliate) but also the agriculture became much less manageable and productive.

The different economic policies that different administrations undertook display the difficulty a government faces when addressing economic deficits. For example the realist movement of General Alvarado served to increase the debt and move the country to hyper-inflation when the intention of the government was to ‘protect' its people and industry from the instability of the world. Seeing the world as an enemy proved worse than trying to ally with it, at least in the long run. In the short run Belaunde attempted to make Peru a viable option for investors by initiation liberal policies, but due to economic and world market failures his attempts were futile: the economy was worse off than we he came in.

Not until Fujimori initiation his shock economic policy did Peru begin to rise out of debt and see controlled growth. The intention of the government could be one in good faith, but there are many aspects that ultimately dictate how the economy of a country will wind up: in the case of Peru, conditions were not ready for a liberalist policy until the early 1990s. Had Fujimori attempted his shock economic policy before, it may not have been as successful. Peru began a steady growth of out its debt crisis thanks to the shock economy being implemented at the right time and under the right conditions.

 Peru's tragic history over the last two decades appears to be coming to an end with increase economic, and political stability. Natural epidemics like an outbreak of cholera have been reduced to a minimum thanks to medical technologies imported from the Western nations. All this goes to show that government policies can do a lot to alleviate the living standards of the masses when applied correctly and with a little luck from mother nature.