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Backgrounder #555 on Latin America

January 6, 1987

January 6, 1987 | Backgrounder on Latin America

Ecuador and Peru: Competing Strategies of Economic Growth

(Archived document, may contain errors)

555 r.2 1'1 b 1 i January 6, 1987 4 .I COMPET1N.G STRATEGIES OF Paul R. Wisgerhof Senior Fellow GROWTH INTRO DUCTION Both are located on South Americals west coast and boeh 'share much in terms of resources and history are veering increasingly apart as they pursue different strategies of economic growth. In Ecuador, two years ago, Leon Febres Corder0 Rivadeneyra was elected president on a free enterprise platform calling for reduced tariffs, more foreign investment, and improved competition for Ecuador's exports. By contrast, about a year later in Peru, Alan Garcia Perez was elected president on a platform callin g for increased state intervention in the economy, rigid wage.and price controls, higher tariffs, limited servicing of the foreign debt import substitution, cooperative agriculture, and nationalization and state control of primary industries Yet today Ecua d or and Peru Both strategies face obstacles. Ecuador's vested political and economic interests oppose Febres Corderols stratagems. Peru meanwhile, is having trouble borrowing money abroad because it has scared off lenders by its reluctance to pay all the i nterest due on its existing foreign debt.and for having nationalized a foreign oil company.

The jury is still out on which strategy will succeed in. the long run So far, however, Ecuador's free market effort is winning.

Ecuador has successfully renegotiat ed its foreign debt with both commercial bankers and governments, reduced agricultural subsidies restructured its monetary affairs, and is promoting foreign direct investment. Peru, in contrast, has refused to honor its'foreign debt obligations to commerc i al. banks, has increased its auricultural subsidies through price controls is discouraging f oseign direct investment, and has made no effort to restructure its monetary affairs. What makes matters worse is that Garcia I s flirtations ,with the radical po litics of the Group of 77 nations and with the Non-Aligned Movement give little hope to those who believe he can be convinced to stop or slow his leftward drift.

In.its attempt to construct a market economy, Ecuador deserves full United States support. Non-military assistance should be increased 25 percent from the $48 million which Ecuador received in 19

86. The new funds should be used for private enterprise projects in the agricultural, industrial, and fishing sectors. U.S. military aid meanwhile, shoul d be doubled to $10 million, the bulk of it for anti-narcotics efforts I As for Peru, Washington should not try to impede sanctions if they'are imposed on Peru by the commercial banks to which Peru owes money. Washington should encourage Garcia and his ad m inistration to return to the international monetary system. Should Peru decide not to make reasonable efforts to come to an agreement with private banks it may find it very difficult to win necessary new funding. Because Peru cooperates with the U.S. in t h e fight against narcotics, Peru should continue receiving the $80 million in non-military U.S. aid appropriated in 1986 Other Third World states should pay close attention to the strategies adopted by Pen and Ecuador. Ecuador could provide a valuable exam p le of how to promote economic development through free enterprise while Peru almost surely will demonstrate those policies which ought not be followed in economic development. Ecuador is dynamic, while Peru has entered a period of stagflation. The U.S sho uld support those Third World leaders sensible enough to give a free market strategy a chance.

PERU AND ECUADOR: SIMILARITIES AND DIFFERENCES Located on the west coast of South America.with an area of 496,224 square miles, Peru is about three times the siz e of California and ranks behind onlv Brazil and Arcrentha as South America's third largest Chile nation. It Gorders Ecuador; Colombia, Brazil, Bolivia, and The population in 1985 was estimated at 19.6 million, with an 2annual average growth rate of 2.6 p ercent. Gross domestic product for 1985 yas about $17.5 billion, amounting to a per capita GDP of 8

70. For Latin America, average population qrowth rate is 2.3 percent and average per capita GDP is $1,760 second smallest Spanish speaking nation, equal in area to Colorado.

Ecuador's neighbors are Colombiaj Brazil;-and Peru. -The nation's population in 1985 was about 9.6 million, with an annual average growth rate of 2.8 percent. Gross domestic product for 1985 was $12.1 billion with f growth rate of 3.8 pe rcent. Per capita income was about $1,300 Ecuador, with an area of 104,506 square miles, is the continent's Ecuador and Peru share much history. The Spanish conquered what are now the two countries in 1531-15

32. Ecuador and Peru were part of the Royal Audiencia of Lima from 15

63. Ecuador was made part of the Vice Royalty of New Granada in the late 1600s. Both nations participated in.the War of Independence (1810-1822) which saw Peru become an independent nation in 1822 while Ecuador became part of the R epublic of Greater ColoNia. In 1830 Ecuador formed its own government.

Both nations have gone through periodic political upheaval, with a succession of democratically elected presidents, military juntas and both civilian and military dictators. Each recently saw military governments (Peru-01968 to 1980: Ecuador-1962 to 1979) succeeded by democratically elected presidents whose successors also were democratically elected. The military'regimes of the 1960s and 1970s in both nations imposed agricultural reforms which destroyed the large land owners, nationalized some or all of t h e major minerals industries, and either nationalized or imposed heavy controls on primary industries strategy to promote industrial growth, imposing high tariffs ostensibly to allow local industry to produce .products which lotherwise would be imported. T h e strategy of "import.substitution" was fashionable among influential international economists in the 1960s I Each military regime also adopted an It import substitution i. "Foreign Economic Trends, Peru," April 1986, U.S. Department of Commerce. Statisti c s on Peru's GDP/GNP probably understate actual production since there is no way to account for the contribution made by the "underground" economy. Estimates by the respected Institute of Liberty and Democracy in Lima put the "underground" economy at as mu c h as one-third of GNP 2. "World Development Reports," International Bank for Reconstruction and Development Washington, D.C., July 1986, p. 154 3 Background Notes: Ecuador U.S. Department of State, September 1986 3and most of the 1970s and was tacitly enc o uraged by the World Bank and International Monetary Fund. Generally, however, "import substj.tutionl has retarded rather than spurred economic development because the locally produced goods are usually more expensive than the imported product.would be, an d may not be of equal quality. The result: the nations l'protected'm by tariffs become ever less capable of competing internationally.

Peru's President, Alan Garcia' Perez, took office in July 1985 with three primary goals: to control inflation and reorgan ize the economy; to place his party firmly in command of the bureaucracy; and to make an impact on the world political stage, primarily in the Non-Aligned Movement (NAM) and with the Third World nations collectively known as the Group of 77 His efforts to achieve these goals have moved Peru away from the private enterprise and free trade policies of his predecessor toward the statist, anti-business era of earlier repressive military regimes includes limiting foreign debt payment to about 10 percent of the v alue of Peru's exports. Meanwhile, Garcia faces a significant internal threat from two growing communist guerrilla movements, and a burgeoning group of narcotics traffickers I I Part of his economic package Ecuador's new President, Leon Febres Cordero Riv a deneyra, entered office in August 1984 determined to right some of the economic wrongs of his predecessor. So far he as renegotiated Ecuador's foreign debt with governments and private bankers: promoted foreign direct investment; overturned some of the re s trictions of the Andean Pact, a common market organization composed of Venezuela, Colombia, Ecuador Peru, and Bolivia, which required majority local ownership of new business and industrial enterprises; reduced agricultural subsidies and restructured Ecua d or's monetary affairs. As in Peru, Ecuador faces a communist guerrilla movement, and has ever increasing problems with narcotics production and trafficking. Febres Cordero also faced an attempted military coup last January THE PERUVIAN CASE Garcia took of f ice with the Peruvian economy in shambles inflation was running about 250 percent annually. To check this, he froze most wages and prices, devalued the currency 25 percent: raised tariffs; banned imports of some 500 items; and imposed controls on foreign e xchange and foreign currency denominated bank deposits. In his inaugural address, Garcia declared that:Peru would only pay a portion of its foreign debt, not to exceed 10 percent of the value of exports in any given year 4- .I Foreicrn Debt Situation At l east in facto.terms, Peru has defaulted on its foreign debt payments.

Of Peru's $14 billion foreign debt, $2 billion is owed to the International Monetary Fund (IMF) and World Bank; about $6 billion is owed to private banks; and about $6 billion is owed to governments and other organizations. I Arrearages .to the,.IMF.and World Bank are over $300 million; arrearages to governments and other organizations are over $500 million; and arrearages to private banks as of mid-1986 were over $500 million and were e xpected to double by mid-19

87. Payment of all arrearages, plus debt falling due in 1986 would cost Peru about $3 billion value of Peru's exports this year followed immediately by failure to pay the commercial banks, caused great concern in world banking circles.

Inter-agency Country Exposure Risk Committee (ICERC which regulates foreign lending practices by U.S. commercial banks, declared Peruvian loans "value impaired" in November 19

85. As a result, U.S. banks were ordered to set aside reserves equal t o 15 percent of their outstanding loans to Peru This about equals the estimated Garcia's proclamation of the ceiling on Peru's debt payments The United States As.a group, meanwhile, foreign commercial banks cut Peru's trade Most of those lines are offered by European and Japanese Banking sources believe that Peru's available credit dipped credit lines from $880 million in March 1984 to about.,$150 million today banks below $100 million by mid-1986.

The IMF Problem Peru owes the IMF $700 million The governm ent of Peru signed Last April, the Fund warned Peru a restructuring agreement with the IMF in early 1984, but found itself unable to comply with the terms that failure to pay its arrearages by August' 15 would result in Peru's being declared ineligible fo r-further drawings. Peru paid only $35 million of its then current arrearages of $196 million on August 12 and hence was declared ineligible on August'l

5. In response, Garcia blasted the IMF as #'The great overseer and guardian of imperialist economy and international capitalism.1fi He added We cannot accept that the economy of the nation be strangled to satisfy foreign demands, which may be supported by lfgal documents but which historically have no moral upp port 4. International Financial Sta tistics I n ternational Monetary Fund, July 1986, p. 391 5. FBIS, Volume VI, August 18, 1986, page J1 5 Foreian Reserves Peruls refusal to repay its debt predictably has boosted Peru's net foreign reserves. They have grown from $1.46 billion in June 1985 to $1.65 bil lion in July 19

86. Gold holdings have climbed from $483 million to $8f7 million over the same period, using constant valuation for the gold.. Peru1" tactics"hiivQ'produced somQ short-t'e'km'gains but the long-run costs will be expensive I New Economic Pro crram Garcia imposed wage and price controls on all sectors of the economy soon after taking office somewhat, dislocations still exist. The strict exchange controls froze foreign currency-denominated deposits in the Peruvian banking system, which amounted to about 60 percent of all deposits at that time. On August 27, 1985, Garcia rescinded the operating contracts of U.S.-owned Belco Petroleum.Corporation, Occidental Petroleum, and the Argentine Oxy/Bridas consortium. Following heated negotiations, new con t racts were written with Occidental and Oxy/Bridas while Belco's operation was nationalized.' Belco is negotiating a claim for $400 million with the Peruvians. In the middle of this year, Garcia prohibited the repatriation of,profits, dividends, and licens i ng and royalty fees by all companies. Coupled with his tight import controls and the debt situation, he has effectively ended further foreign investment in Peru I While these since have been relaxed The military regime which took power in Peru in 1968 alr eady had nationalized most of the mining sector, petroleum, fishing and fish meal manufacturing, and restructured agriculture, breaking-up large holdings and,distributing.land to the poor and to small farmers.

That, coupled with Garcia's measure, means tha t all traditional export sectors are either state-owned or the sale of their end product must be handled through state-'owned enterprises. The results: in 1965 Peru was a net exporter of sugar, in 1985 it was a net importer; in 1965 it was the worldls thi rd largest producer of fish products; in 1984 its production was only slightly larger than Panama's shrimp catch.

Guerrillas and the Druu Problem I Peruvians raise coca plants on more than 200,000 acres (less than 20,000 acres are licensed legally most of it in the high jungle of the Eastern Andes. The crop, the raw material from which cocaine is refined, produces at least $700 million for the economy, about 10 6. International Financial Stat istics 9~ cit p. 49 7. FBIS, Volume VI, August 11, 1986, p. J1.

I 6I percent of the value of the finished drugs threat illegal drugs pose to his society and government. He has ordered police and military forces to fight,narcotics and is cooperating with the U.S Colombia, and Ecuador in the campaign against drugs Garci a recognizes the Peru is also home to two guerrilla factions: the nihilist, Pol Pot-style group. called. Wendero Luminoso SL or "Shining Path, and the Moviemento Revolucionario Tupac Amaru (MRTA a communist, Moscow oriented and backed, urban terrorist band . While there is no solid proof that either group is working with the narcotics traffickers, a symbiotic relationship probably will develop. The SL now controls significant portions-of Peruvian territory in the South central part of the nation extended fur t her north, toward Lima, with serious'destabilixing potential for the government. It is unlikely that SL could incite a successful revolution at this time, but it..remains a serious threat to life and property There is a possibility that such control will be THE ECUADORIAN CASE Leon Febres Cordero, a Social Christian, was inaugurated President of Ecuador on August 10, 19

84. Though he has faced a Congress controlled by his opposition, he built a working maj,ority between 1984 and 19

86. Last year's election gains by the opposition however, might have destroyed his ability to forge a coalition in the Congress.

The Economv a nd the Foreian Debt When he entered office, Febres Cordero found the Ecuadorian economy in sharp decline. During the petroleum boom of the 1970s Ecuador's oil wells were a windfall for the nation of oil began to fall, Ecuador's economy stagnated. Real GDP.growth for 1982 was only l.Q.percent, and the following year, the GDP actually fell 3.3 percent 48 percent in 1 9 83, and 31 percent in 1984 The main causes were 1) the effects of the world recession; 2) thq sharp drop in oil prices; 3) rapid growth in the external debt: 4) declining world market prices for raw materials and agricultural products; and, 5) an erosion in private sector confidence in the system, prompting capital flight.

Cordero and his team place renegotiation of Ecuador's $7.3 billion But as the price Consumer prices8rose 16 percent in 1982 In marked contrast to Peru's Garcia administration, Febres 8. International Financial Statistics OD. cit, p. 191 7foreign debt at the top of their agenda.

Ecuadorian government completed a multi-year rescheduling agreement MYRA) with its commercial bank creditors. the first such with any government and covered some $4.4 billion in debt falling due between January 1985 and December 1989 followed in April 1985 by a similar agreement with the ItParis Club,II composed of the U.S Japan, and nine European nations, who are the most important, government.-lenders to Ecuador rescheduled $400 million of government-to-government credits due between January 1985 and December 1987 As part of this, Ecuador agreed to International Monetary Fund conditions for a $105 million stand-by accord in March 1985, and syccessfully complied w i th the terms of that agreement last spring In December 1984 the This private bank MYRA was This was The Paris 'Club agreement Economic Reform Linked' to movement on the debt was Febres Corderols decision to push for major economic structural reforms. In N ovember 1984, Ecuador signed an agreement with the Overseas Private Investment Corporation OPIC a U.S. government agency, to promote and guarantee investment in Ecuador by U.S. f~nns. A potential obstacle to such investment was Andean Pact Decision

24. By 'this, the Pact (composed of Venezuela Colombia, Ecuador, Peru, and Bo1ivl.a) requires domestic participation in any new business and restricts foreign ownership to 49 percent or Febres Corder0 has avoided the potential obstacle of Decision 24 by interpre t ing it in a way that expands the opportunity for foreign participation and repatriation of profits. At the same time, Ecuador reduced subsidies on agricultural and industrial items, cut tariff protection, and limited or erased price controls. In September 1984 a facto devaluation of the Sucre, Ecuadorls currency, began with the transfer of many transactions from the official rate of exchange to the market rate foreign debt arrearages, and has remained current with all creditors.

While the nation had t $25 million balance of payments surplus in 1985, falling oil prices will probably lead to a 1986 deficit of about 20 million less after a relatively short period.

In 1985 the government of Ecuador repaid some $283 million in Ecuador continues to liberalize it s economy. Last August it deregulated interest rates on domestic savings. and loans, allowing them to find their market levels. Companies earning foreign exchange were able to sell those funds on the free market, rather than to the Central Bank at the off i cial rate of exchange. All private importers now buy their foreign exchange on the free market 9. "Background Notes: Ecuador OD. cit 8- Guerrill as and the Drua Th reat As in Colombia and Peru, Ecuador is challenged by a communist guerrilla movement and g r owing involvement in international drug trafficking. The IIAlfaro Vive, Carajo!lI (AVC) guerrilla movement is typical of the communist urban terrorist groups that have popped up in Latin America. in the past two decades Whi1.e I their numbers remain relat ively small, the guerrillas have kidnapped prominent businessmen and bombed government offices. More than a dozen AVC troops went to Colombia for training with the M-19 communist revolutionaries.

Ecuadorls armed forces are ill-equipped to combat such activ ity, and look to the U.S. for training and improved equipment U.S. government sources believe that about 20,000 acres ;of Ecuador's high jungle are being used to grow coca plants. Although a small amount, the area is increasing. Most of Ecuadorls coca'pas t e is exported to Colombia for processing into cocaine. Ecuador is not yet willing to participate. in cooperative action. against drugs similar to that recently taken by Bolivia. Nonetheless, Ecuador needs U.S assistance in combating its emerging drug prob l em 0 RECOMMENDATIONS FOR U.S. POLICY Ecuador Ecuadorls new government has gone far to liberalize its economy and reduce government intervention. Coupled with compliance with an International Monetary Fund restructuring program and the clearing of debt arr e arages with its creditors, Ecuador was granted a $150 million I1bridge1l loan by Washington in 1986 I Because of his efforts and successes, Febres Corder0 merits continued U.S. support. A pillar of Ronald Reagan's foreign policy is its backing for free.ma r ket economies. Ecuador clearly qualifies. In addition to the $150 million bridge loan, the U.S. thus should boost its developmental, economic, and military assistance to Ecuador in the next two to five years. Non-military economic assistance has been $48 m illion for each of the past three fiscal years. This should be increased to about $60 million-consisting of at least $30 million in Economic Support Funds and the rest in direct assistance and Food for Peace programs. Economic Support Funds are provided b y the U.S government to foreign nations for use in balancing their budget. The funds are not spent on specific projects, but generally are used either to pay bills or re$ire debt assistance should be changed from sales to outright grants should be at least $10 million annually (compared to 5 million To spare Ecuador future burdensome debts, U.S. military These g c currently in'military sales). The bulk of these funds should be earmarkea for Ecuador s efforts in fighting narcotics traffickers and guerrillas. Additional funds, probably in the $2 million. per, annum range, should be made available-for .anti-narcotics work Peru Peru poses a difdicult problem, Sor Washington.d-.Foreign commercial banks have a clear legal right to take appropriate steps to effect p ayment of monies owed them by Peru embargoes on further loans to Peru and attempts to seize Peruvian assets abroad. Both the International Monetary Fund and the Morld Bank find themselves forced to forgo new loans to Peru and may be required to stop disbu rsement of loans already agreed to the result of Garcia's failure to honor his nation's prior commitments.

For the U.S however, the case is not as clear-cut as it is for the banks. Although Peru for a time in 1986 was in arrears on repaying its military an d,economic assistance loans to the U.S., the repayments are now up to date. Peru, therefore, remains eligible for continued U.S. economic and military assistance programs economic aid for.Peru--$37 million for Economic Support 20 million for Development A s sistance 17.7 million for Food for Peace, and $5.7 million for anti-narcotics work. Military assistance for fiscal 1987 is $25.9 million. These levels are adequate These actions may include These are The fiscal 1987 U.S. budget targets more than $80 milli o n in What is not adequate is Peru's economic strategy. Statism cannot solve Peru's economic problems. Washington should thus encourage Peru to reduce barriers to business expansion and formation, re-privatize agriculture, improve tax collection, and shrin k the bureaucracy.

Although Garcia's stance on the international debt question has been extremely confrontational, efforts should be made by the U.S. and other governments, multi-lateral institutions, and commercial banks to get Peru back into the world ec onomic system should not allow Peru's intransigency on the debt issue to interfere with Garcia's obviously strong interest in controlling drug trafficking and halting the spread of communism. Garcia has ordered his armed forces and police to interdict the drug traffickers and eradicate the coca production The U.S., moreover CONCLUSION Febres Corder0 faces a difficult task in trying to free Ecuador from the burdens of statism and give market dynamics the chance to ignite economic growth interests have attem pted to thwart his efforts.

Deeply vested political and economic It will take time to 10 convince Ecuadorians that these policies provide their best hope for stable, long-term growth and therefore the best opportunity for more jobs and higher income for al l. In part, the success of his reforms rests on external factors: the Price of oil and raw materials including agricultural products; and Ecuador s ability to judiciously manage its foreign debt. In part it.also depends on his ability to deliver on. his e iectoral promises, such as constructing 120,000 housing units by 1988 What. Febres .Corder0 needs is time--something I that the U.S with appropriate aid, can help him buy.

Ecuador's free,market sains should be teachins a lesson to Peru.

That country cannot expect io enjoy economic growti; so long as state control and import substitution remain the basis..of its economic strategy.

Peruvian leaders may be willing to reassess the disastrous Garcia policies. At the same time, Garcia's efforts to fight the drug mafia must be encouraged and supported by the U.S While it may be difficult to convince Garcia of this, other I Paul R. Wisger h of is a State Department officer on special leave to The Heritage Foundation. Mr. Wisgerhof has served in Lima as Counselor .of Embassy for Economic Affairs in Venezeula, Mexico, Germany, Ecuador, and Japan. The views expressed in this study are his own a nd should in no way be attributed to or necessarily reflect the views of the Department of State or the U.S. government 1.1

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