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Peruvian Democracy under Economic Stress: An Account ofthe Belaunde Administration, 1963-1968

Peruvian Democracy under Economic Stress: An Account ofthe Belaunde Administration, 1963-1968

by Pedro-Pablo Kuczynski-Godard, P. Kuczynski

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As economic adviser and manager of the Central Reserve Bank of Peru, Pedro-Pablo Kuczynski observed at first hand the crisis that preceded the overthrow of the Belaúnde administration on October 3, 1968. His role in the economic policies of that era enables him to provide an insider's view and analysis of the financial and economic problems besetting a


As economic adviser and manager of the Central Reserve Bank of Peru, Pedro-Pablo Kuczynski observed at first hand the crisis that preceded the overthrow of the Belaúnde administration on October 3, 1968. His role in the economic policies of that era enables him to provide an insider's view and analysis of the financial and economic problems besetting a democratic regime in a developing country.

The author pays particular attention to the reasons for the difficulties of the administration after a promising beginning. He considers the main actors during the period 1966-1968, their central motives, the role of the opposition-controlled Congress, the government's efforts to cope with economic and financial problems, and the role of U.S. foreign policy. The initial successes of the administration in areas such as social participation depended on the initiative of a few key figures—a dependence that contributed to the crisis of 1966-1968.

Originally published in 1977.

The Princeton Legacy Library uses the latest print-on-demand technology to again make available previously out-of-print books from the distinguished backlist of Princeton University Press. These editions preserve the original texts of these important books while presenting them in durable paperback and hardcover editions. The goal of the Princeton Legacy Library is to vastly increase access to the rich scholarly heritage found in the thousands of books published by Princeton University Press since its founding in 1905.

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Peruvian Democracy under Economic Stress

An Account of the Belaúnde Administration, 1963-1968

By Pedro-Pablo Kuczynski


Copyright © 1977 Princeton University Press
All rights reserved.
ISBN: 978-0-691-04213-8


The Economic and Social Setting

Most descriptions of the poorer (or "developing") countries generally begin by listing a low rate of savings and investment, the disparity of income levels, the instability of the economy due to its heavy dependence on a few exports, the low level of skills in both the private and public sector, and the difficulty of internal communications. Generally, but not always, the climate is said to be inhospitable. In some ways, Peru fits the stereotype of the developing countries at least in its general lines. The physical and cultural setting of Peru is, however, rather unusual. The sharp physical distinction between the coast and the Sierra is paralleled by an equally sharp distinction between the five million or so Indians in the Sierra — who are only slowly being integrated with the Spanish-speaking culture — and the urban mass in Lima and Callao.

The lack of water on the coastal strip has been a major problem for Peruvian agriculture: except for the river valleys in their last few miles before the sea, after they have precipitously tumbled down the Western slope of the Andes, the whole length of the 1,200 miles of coast is a complete desert. Beyond the Andes, after an as yet largely unexploited set of valleys on the eastern side, lies the Amazonian plain, almost entirely covered by jungle and large meandering rivers. The main city, Iquitos, a somnolent port of 150,000 inhabitants on the northern bank of the Amazon, has had its ups and downs with the rubber boom, the export of live jungle animals to the United States, and now the development of oil in the Amazonic region.

Most foreign visitors to Peru, even if they venture outside the normal tourist areas, would even today not fail to be impressed by the extent of the foreign presence. Billboards near a slum will tell the shopper to go to Sears, the handicraft store advertises that it accepts cards from Diners' Club, and El Skyroom and El Sheraton overlook Lima at night. Although in this respect Peru is different only in degree from similar countries, there is no doubt about the large extent of foreign participation in the Peruvian economy in the sixties. Although developments in the sixties tended to alter the economic setting of Peru as described in this chapter, the changes were, with a few exceptions, alterations in emphasis rather than in basic character. Of the larger South American countries, Peru, in 1968, was still more of an export and private enterprise economy than most of the other countries of the continent.


Exports have in the past been the main dynamic force in the "modern sector" of the economy. Except for mining in the Sierra, export activity has left the interior largely untouched. The "modern sector" was and still is concentrated on the coast. The fortunes of Lima and the coast have depended heavily on one or two export products, although in the last twenty years the structure of exports has become somewhat more diversified than in most developing countries. Following the traditional pattern, export activity has tended to be liberal in its use of capital (land and equipment) and economical of employment. Whereas in the mid-sixties exports of goods and services accounted for 18-20 percent of Gross Domestic Output, direct employment was and still is much smaller: employment in mining, fish-meal, and major agricultural exports in the mid-sixties did not directly account for more than 7 percent of total employment.

The role of exports is not a mere historical accident. With almost half the population concentrated in the poor Sierra, domestic purchasing power has always been relatively low and has been concentrated on the coast, where most of the export agriculture has been within easy reach of seaports; even the mineral wealth of the Sierra has naturally enough had to go through the coast in order to reach export markets. In such a setting, foreign trade was bound to become a major activity. As in many of the poorer countries, the growth of foreign trade was in spurts, depending upon the exploitation of some new natural resource in high demand. Such was the case of guano — a natural fertilizer that accumulates on off-shore islands because of the large population of marine birds combined with the lack of rainfall — in the mid-nineteenth century; of the development of lead, zinc, copper, and silver mining in the twenties; of the rapid expansion of cotton and sugar production after the Second World War; and of the fishmeal boom in the early sixties.

In the period of rapid economic growth of the fifties and sixties, Peruvian exports increased in volume and value at an unprecedented rate. The expansion of exports provided the foreign exchange for the fairly rapid industrialization of the sixties and for the increasing demands of the "middle" class, in reality the economic group just below the very top fraction of income recipients. The growth of exports took place on a broad front, so that Peru acquired a diversified export base — fishmeal, copper, silver, lead, zinc, cotton, sugar, and coffee, but the main thrust came from two sources: the extraordinary development of the fishing industry and of large-scale copper mining. (See Table 1.)

The history of the Peruvian fishmeal industry is one of the better-known economic "miracles" of recent history. The cold Humboldt current that runs northward up the Peruvian coast has caused a desert coast interrupted only by occasional rivers and fertile valleys. Peru thus faces an agricultural supply problem unless farm development can take place in the thus far largely inaccessible areas east of the Andes. On the other hand, the Humboldt current permits a marine wealth not found at similar latitudes, and indeed nowhere else. The desert coast is therefore in a sense the price for the rich sea, a major factor in the decision of successive Peruvian governments to uphold territorial waters of up to 200 miles. The main resource of the sea is a tiny fish called the anchoveta — not an anchovy — which is ideal because of its tiny size and special texture for the making of fish flour or fishmeal, the animal feed with the highest protein content that can be made economically.

The development of large-scale fishing and of the fishmeal industry has been largely a domestic Peruvian phenomenon. From 1958 on, production grew by leaps and bounds, from 130,000 tons of fishmeal to 1.4 million tons in 1964 and close to 2 million tons in 1967. Production in 1970 was over 2 million tons, with a fish catch of more than 10 million tons. The fishmeal boom of the early sixties was a pell-mell affair, with many middle-class Peruvians, including such professionals as doctors, lawyers, and others with no business experience, getting into debt to buy a stake in a fishmeal factory or in fishing vessels. Little equity was put in, and with long-term financing scarcely available, most of the fishmeal industry was erected with short-term debt. The complicated nature of the fishing business (due to the vagaries of the availability of fish and to government-imposed fishing bans, needed for purposes of conservation), the financial pressure under which most of the fishmeal producers operated, the fairly frequent fluctuation in world prices (influenced by the production of competing proteins such as soybean meal), turned fishmeal operators into an aggressive and vocal group. With a limited reliance on imported inputs — which amounted to no more than 40 percent of total costs — and a large component of wage costs, the fishing and fishmeal industry was and still is particularly sensitive to the exchange rate, a fact explained by economics but little understood by the press or by the majority of politicians. This fact, and the aggressive private enterprise attitude of many fishmeal producers, explain why the industry was so concerned with government policies during the period covered by this book.

The mining industry stands in sharp contrast to the fishing industry. It was largely a foreign-owned and run operation, with a few large mines accounting for the bulk of the output. The spurt in mineral exports in the early sixties was the result of large well-planned investments, which contrasted sharply with the free-for-all growth of the fish-meal industry. The main investment, begun in 1955 and completed in 1959, was in the Toquepala copper mine in the south. Developed by the Southern Peru Copper Corporation — a combination of American Smelting and Refining, Phelps Dodge, Cerro Corporation, and Newmont Mining — as a result of the introduction of the Mining Code and of an agreement with the Odria government, the Toquepala mine is the largest in Peru. Somewhat earlier, in 1953, the Marcona Mining Company, a consortium of Utah Construction and Cyprus Mines, had opened a large iron-ore mine. These two investments, totaling about U.S. $300 million, financed in large part with loans from the U.S. government-owned Export-Import Bank, propelled Peru from a backseat in the mining establishment of the world to the status of a major copper producer and a growing iron-ore exporter.

Peru has undeniable natural advantages for mining. In the course of its seventy years in Peru, Cerro de Pasco Corporation, which was the largest and most diversified mining enterprise, either by itself or through others identified and measured copper deposits that form one of the largest single unexploited group of potential copper mines in the world. Although some of the deposits have a low ore content, the proximity of most of them to the sea, the development of advanced refining techniques, and the high cost of mining in the United States are making their exploitation progressively more feasible and financially attractive. On the basis of an agreement reached in 1969 with the military government, Southern Peru is at present developing the Cuajone deposit, the largest single unexploited mine waiting to be developed during the Belaunde administration.

The attitude of international mining companies is in general conditioned by the long-term nature of their investments. Their main needs have been long-term tax agreements and guarantees about the availability of foreign exchange to repay their debts abroad and to remit their profits, and, if necessary, depreciation and depletion allowances. More than other investors, mining companies are willing to wait and negotiate for long periods of time until they obtain the best possible treatment, since the investments affected can have a life of twenty-five years or more.

The relations between the major foreign mining companies and the Peruvian government during the Belaunde administration were somewhat distant but diplomatically maintained. The attitude of the companies was cautious, and they were generally scrupulous about paying their taxes.

At the time of the Belaunde administration, the mining companies held the key to Peru's future prosperity. Mining offered the only opportunity for the substantial growth in exports. The other export sectors, such as fishmeal and high-grade long-staple cotton, appeared to have limited possibilities because production depends on natural supply in the first case or on the availability of irrigated coastal lands in the latter; sugar and coffee faced limited markets. Although locally owned mining companies had shown drive and profits in the sixties, the major new investments required the presence of the foreign mining companies, whether alone or in conjunction with the Peruvian government. Since the Toquepala mine was opened in 1959, the companies had made only routine investments in Peru: opportunities elsewhere — as in Chile — were better from a tax point of view; a tax claim against Southern Peru Copper was pending until 1968, and it was not until then that Congress gave the executive authority to enter into the special agreements that the companies had continuously insisted upon. Mining output rose very slowly in the sixties, and it was only because the price of copper started a sharp rise in 1966 that the growth of export earnings kept up.

The export boom that began in 1959 made it possible for Peru to maintain a stable exchange rate, without any exchange controls, for a much longer period than the increase in domestic costs would normally have allowed. Although the rise in the cost of living was very moderate in comparison with that in Chile, Argentina, or Brazil, the consumer price index — which probably underestimated the rise in domestic costs — was already rising at an annual rate of 6 percent from 1960 to 1963, and accelerated to over 10 percent in the three years to 1966, an increase of 70 percent in six years.

With its image as an economy with a stable and free exchange, rapid aggregate economic growth, and a reasonably stable government, Peru managed to attract a growing inflow of foreign investment, particularly from the United States. Although Peru had by the end of the sixties only 6 percent of total United States investment in Latin America, the increase was at a faster rate than into other Latin American countries, Mexico excepted. A growing and increasingly protected domestic market encouraged investment into manufacturing. (See Table 2.)

Agriculture and Manufacturing

The export and foreign investment boom in the sixties continued the established export-induced pattern of development in Peru. At the same time, however, an accelerated shift from agriculture to manufacturing began taking place. Although Peru in the early sixties probably had a significantly lower level of protection than most other South American countries, protection increased sharply in the course of the decade as a result of two general import tariff increases and of the introduction in 1968 of various import prohibitions. Combined with higher purchasing power for consumer goods, protection inevitably provides a strong stimulus to manufacturing.

While manufacturing was thus more than shielded against the effects of a fixed exchange rate that increasingly encouraged imports, this was not the case with agriculture. The growing disadvantage of domestic agriculture in the face of food imports could have been offset through the aggressive use of existing tariff mechanisms, but this was not done, following the traditional policy of attempting to keep the price of basic foodstuffs down. This type of policy, practiced since the thirties in Peru, is a well-known feature of many Latin American and several Asian economies. The main element in the drop in total Peruvian agricultural output, however, was the decline in production for export, particularly of cotton. (See Table 3.)

The contrasting performance of manufacturing against that of agriculture is strikingly illustrated by the following estimates. The manufacturing sector was helped not only by a rising level of protection, but also by the increasingly liberal use of tax concessions, particularly on import duties for the import of raw materials and machinery, and on profits taxes through reinvestment allowances. Import duty and profits tax exemptions for industry rose very rapidly in the sixties in relation to total industrial output, as noted below in Chapter IV. The rapid increase in protection for consumer industries, together with the exemptions for component parts, stimulated the creation of assembly industries, notably cars, home appliances, paint, artificial textiles, and pharmaceuticals. All required a high level of protection. A few of these industries had a better chance than others of lowering their costs over a period of a decade, but some, such as the car assembly plants, had very little chance of becoming economic for a very long time.

The establishment of the car assembly plants in 1964 gradually generated a debate on whether such industries were in the national interest. The discussion was mostly in terms of whether the establishment of the plants, including the initial inflow of foreign capital, saved foreign exchange at all or not. Hardly any attention was paid to the cost of this saving, if indeed there was any saving of foreign exchange; the cost is not only the fiscal revenue lost, and the diversion of investment away from possibly more remunerative activities for the country, but also the substantial loss of flexibility in the import pattern. If Peru had faced a foreign exchange shortage fifteen or twenty years ago, temporary restrictions on certain luxury imports could conceivably have had a positive effect at little political cost; however, in the mid and late sixties, the cost was the unemployment of skilled assembly line workers, a much less acceptable result.


Excerpted from Peruvian Democracy under Economic Stress by Pedro-Pablo Kuczynski. Copyright © 1977 Princeton University Press. Excerpted by permission of PRINCETON UNIVERSITY PRESS.
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