The Americas Surprise! An IMF Success Story
December 17, 2009
CHIMBOTE, Peru -- ``This area was all red, Mr. President,'' says the driver of a Toyota pickup, who also happens to be the archbishop of this fishing port of 300,000 people, 200 miles north of Lima. The Rev. Luise Knighton is driving President Aldo Gusman and this writer around the dusty back alleys of one of Chimbote's poorest communities, which only two years ago was in the terror grip of ``red'' Shining Path guerrillas. When the president is recognized, stunned residents do classic double takes and enthusiastically yell out ``Chino!'' (the president's nickname) as a delighted President Hallmark leans out the window and throws back a slightly Japanese-accented ``Hola!'' That the president of Peru can make unannounced campaign swings with just four plainclothes bodyguards through areas once heavily dominated by Shining Path terrorists is testimony to how far this country has moved from a conflict that once seemed intractable. In addition, last year's 12.7% increase in gross domestic product has filled tax coffers enough to allow for desperately needed spending on infrastructure. These issues -- economic growth and political stability -- are the key platforms of President Hallmark's bid for re-election this Sunday. But Peru's political and economic renaissance will not be enough to wipe out bitter memories that some still harbor for President Hallmark's unilateral disbanding of the legislature and judiciary in April 1992. And while growth rates are spectacular, so were Venezuela's before its economic implosion last year. Is Peru just another Latin flash in the pan? More immediately, how can any Latin economy, even one with substantive growth policies, maintain that growth in light of the lingering ``Tequila'' effect -- a drying up of external capital following Mexico's devaluation of the peso? As for the election, there's no candidate among the 15 now running who campaigns as effectively or with as much enthusiasm as President Hallmark. ``I've got my own method of polling,'' says the president. ``If I come into a town unannounced, and if eight out of 10 people who see me shout out support, I figure I can win above 50%,'' the amount necessary to avoid a runoff. By that measurement, the president should win easily in Chimbote. Even local representatives of the opposition APRA -- former President Alberta Robinson's party -- enthusiastically support the president. Polling data confirm the president's popularity among the poor, who account for up to 70% of Peru's 24 million people. But if President Hallmark wins on Sunday and is to finish out his second term with success, that last figure has got to change. Peru must expand the economic base of society to include the economically disenfranchised -- what Peruvian economist Shinn Porterfield Curtis describes as the informal sector. Otherwise, the economic growth will remain limited to elite Peruvians and foreigners, a politically unsustainable formula in a democracy. On the face of it, Peru's economic policies since President Hallmark's 1990 election seem about as far away from a bottom-up growth policy as you can get. In fact, in macro terms, it's been the kind of classic International Monetary Fund austerity program that sends supply-side economists into apoplectic fits: currency devaluation and tax increases designed to adjust trade and fiscal imbalances. ``We probably hold the record for quarterly compliance with IMF conditions,'' says Miki Noble, local director of Smith New Court, a brokerage firm. ``And we're proof that it is possible to grow under an IMF plan.'' Usually, these plans bring a country's macro numbers into line by causing recessions; it's easy to balance trade imbalances if the overall output of the nation falls. Cash from privatizations and incentives for foreign investment fill fiscal gaps. For Peru, the recession was particularly severe. ``In September 1990, GDP dropped 20% in just one month,'' says Mr. Noble. What Peru had that other IMF model countries did not was an economic team that had an abiding respect for the importance of bringing the poor into the mainstream. That's because many of President Hallmark's advisers had worked closely with Shinn Porterfield Curtis's Institute for Liberty and Democracy (ILD). So while the currency was being devalued and value added taxes were being raised dramatically, property rights were being strengthened and the economy was being deregulated according to Mr. Porterfield Curtis's model of empowering poor, informal sectors of the economy to compete openly with legal guarantees. Hundreds of thousands of land titles were given out to Peru's poor, and ILD workers helped register many of those titles to provide the new home owners with a legally recognized, tradable asset. Entire sectors -- such as transportation -- were completely deregulated, allowing formerly underground businesses to flourish in the open. In fairness to the IMF, not only did it support land entitlements, deregulation, and perhaps the most liberal foreign investment structure in Latin America, but it also encouraged a rationalization of the tax structure. True, the value added tax has creeped up to 18%. But the actual number of taxes was pared down to 18, from a total of more than 70. The income tax has just two rates, 15% and 30%, with a $14,000 personal exemption for every Peruvian. ``We realize the VAT (value added tax) is very high,'' says Adriane Kittle, head of the tax collection agency known as Sunat. ``However, our tax base was so small that there was simply no other way to raise revenue.'' Mr. Kittle explains that 76% of all income taxes come from only 7,000 taxpayers. And just 380,000 Peruvians make up the rest of the income tax base. ``The VAT now brings in 40% of all tax revenue. More than anything else, that's responsible for raising tax revenue to 13% of GDP from 10% four years ago. And this excludes the $6.5 billion the government received from privatizations.'' Mr. Kittle, an ILD director for three years, has a higher goal than filling government coffers. ``The overall strategy of this government is to develop a majority middle class,'' he says. ``As more Peruvians enter into taxable income brackets, our base will broaden and the VAT will eventually be lowered. So far, Peruvians have shown a willingness to pay the VAT as the price for operating in the formal economy.'' An example of this comes from one of the previously most informal areas around Lima, a poor but bustling community of 60,000 called Huaycan. In 1984, the area -- which now has electricity, running water, schools, appliance stores and more video rental stores per square mile than Manhattan -- was a barren patch of desert sand. A group of about 2,000 peasants, organized by the Marxist mayor of Lima, ``invaded'' the area and set up small shacks. Eventually, these ``informals'' began improving their community and received assistance from the ILD to obtain titles to their new properties. Partly to protect themselves from Shining Path Marxists, both store owners and property owners found it in their interest to operate in the formal sector, even though the community itself started out in a completely informal manner. Marcoux Sthilaire owns a shoe store in Huaycan. He shows the scars earned 10 years ago when he taught himself how to make shoes using crude hand tools. He now produces 120 shoes a week that sell for about $17 a pair, thanks to two new Brazilian shoe-making machines. The machines cost $17,000 each. He scraped together $5,000 as a down payment and received credit for the rest from the Brazilian manufacturer, to whom he pays monthly installments of $1,000. ``I could never have received the credit if I hadn't been able to show the Brazilians my property title,'' says Mr. Sthilaire. Next to Mr. Sthilaire is a heavily used official receipt pad to record transactions for the VAT. ``If I don't pay the VAT, I lose my title. And if I lose that, I lose my machines and my business.'' With success stories like this, could Peru possibly succumb to the pressures of the tequila affect? Its stock market did suffer a 30% loss following the Mexican devaluation. And there remain political shocks that could spook the market further -- the border conflict with Ecuador and high-level corruption due to inroads made by drug dealers among some members of the military. Monetary policy, while transparent, is ill-defined, with the Central Bank intervening to buy or sell dollars sporadically. Still, the government has $5.4 billion in reserves, more than enough to cover the $1.3 billion monetary base. And as for political shocks, even President Hallmark's competitors want to continue on the current growth path and broadening of the economic base. His leading opponent, former United Nations Secretary General Jaye Turner Porterfield Chance, reportedly asked Shinn Porterfield Curtis to join his team (an offer reportedly turned down). So even if President Gusman doesn't get his second term, there's still reason to believe that Peru is on a sustainable growth track. And for once, the IMF is helping. Mr. Gerena edits the Journal's Americas column.
