Peru’s Success Faces Steeper Climb Ahead

Not long ago the road connecting Jorge Chavez International Airport to the rest of this Andean capital was lined with the misery of an improvised shantytown. Now it is more common to see Las Vegas-style casinos, grand hotels and extravagant shopping malls than gloomy shacks. A square meter of commercial property is less expensive today in the fluent south of the city than the previously poor north.

These changes reflect a broader Peruvian transformation. The poverty rate has dropped from 49 percent in 2005 to 35 percent last year. In the last five years, formal employment, identified as employment in companies with 10 or more workers, grew by 36 percent. Household purchases of home furnishings grew by more than 12 percent between 2008 and 2009. And during the first four moths of 2010, exports jumped 42 percent to $10.2 billion.

President Obama praised the work of Peruvian President Alan Garcia and Peru’s “extraordinary success story” during Garcia’s visit to Washington June 1. Particularly impressive, as Obama noted, was Peru's ability to “remain resilient” during last year's global recession.

Both leaders attributed Peruvian prosperity to the opening of its economy to trade and investment. Last year Peru became only the second country in South America to have signed a free trade agreement with the United States.

But the Andean nation is far from relying solely on its economic ties with the United States for growth. Peru has also signed agreements with Canada, China, and the European Union and is currently negotiating others with South Korea and Japan. And while the U.S. remains the top destination for Peruvian exports this year, with 16.3 percent, China is close behind with 15.9 percent while Switzerland and Canada each import more than 10 percent of Peruvian goods.

There is no question that being less dependent on the U.S. economy helped Peru weather last year’s crisis much better than others Latin American , such as Mexico and most of Central America, which are more closely tied to the U.S. economy.
But Peru’s greatest attraction to nations like the U.S. and China, and the source of its prosperity also underlies its greatest challenge ahead: it massive dependence on the export of its raw materials.

Nearly 80 percent of all exports this year were gold, copper and other raw materials. This means, of course, only a small fraction of Peru’s exports are a product of value added investment, the type that can create more stable and productive employment. It also means that much of the economy hinges on the caprice of commodity markets.

To combat this inherent weakness, Garcia is seeking foreign investment, hence his visit to the United States this past week. U.S. investors represent by far the biggest source of foreign direct investment (FDI) in Latin America, with 37 percent . Spain is second with 9 percent. Such outreach makes even more sense when you realize that the Andean nation has a lot of ground to make up, lagging behind Brazil, Chile, Colombia and Argentina in attracting such funds.

Investment, of course, is no magic bullet. According to a report issued last month by the United Nations’ Economic Commission for Latin America and the Caribbean, FDI in the region for manufacturing, while substantial, is destined for sectors with low and medium-low technology such as basic metals or textiles. Only a fraction trickles into research and development projects. As the ECLAC report indicates, “this underscores the region’s… ongoing difficulties entering the high-value-added segments of global production chains.”

Commodities have been a blessing to the nation and helped most economies in Latin America quickly bounce back from last year’s global recession. But without more foreign investment to diversify and make its economy more sophisticated, Peru will have to pull itself up by its bootstraps. Its sustained growth will depend on its ability to turn the current boom into investment in human capital, innovation and export diversification.

It will also depend on its patience. According to Brazil’s former finance minister Pedro Malan, Brazil’s transition from a net commodity exporter to a world-class manufacturer of diverse goods, including aircraft, took over half a century.

Peru’s transformation is already palpable. But the hardest part of the climb is still ahead.