INTELLIGENCE MEMORANDUM PERU: PROGRESS AND IMPACT OF THE ECONOMIC REFORMS

• Document Type: CREST
• Collection: General CIA Records
• Document Number (FOIA) /ESDN (CREST): CIA-RDP85T00875R001600030109-8
• Release Decision: RIPPUB
• Original Classification: S
• Document Page Count: 18
• Document Creation Date: December 22, 2016
• Document Release Date: October 27, 2011
• Sequence Number: 109
• Publication Date: August 1, 1970
• Content Type: IM

 Declassified in Part - Sanitized Copy Approved for Release 2011/10/31 CIA-RDP85T00875R001600030109-8
DIRECTORATE OF
INTELLIGENCE
Intelligence Memorandum
Peru: Progress And Impact Of The Economic Reforms
ER IM 70-109
August 1970
Copy-No. 45
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WARNING
This document contains infonnation affecting the national
defense of the United States, within tha meaning o[ Title
18, sections 793 and 794, of the US Code, as amended.
Its transmission or revelation of its contents to or re-
ceipt by an unauthorized person is prohibited by law.
GROUP 1
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CENTRAL INTELLIGENCE AGENCY
Directorate of Intelligence
August 1970
INTELLIGENCE MEMORANDUM
Peru: Pr ogress And Impact Of The Economic Reforms
Introduction
In the nearly two years since the Belaunde
government was ousted, the long-term goals of Peru's
military government have come into focus. The
military cabinet headed by President Juan Velasco
Alvarado has promulgated a series of "reforms"
consistently expressing the themes of nationalism,
accelerated long-term development, and greater eco-
nomic and social equality. Although the reforms
have enjoyed wide popularity, they also have in-
hibited general economic advance by alarming both
foreign and domestic investors. So far, the self-
styled revolutionary government has been able to
concentrate on reform and financial stabilization
without much concern for immediate economic growth.
But continued stagnation would make it increasingly
difficult to carry out reforms and might bring
major changes in economic policy. This memorandum
describes the nature and progress of the reforms and
assesses short-term economic prospects.
Background
1. Although the scandal surrounding the Belaunde
government's settlement of a dispute with the Inter-
national Petroleum Company (IPC) provided the pretext
Note:" This memorandum was produced solely by CIA.
It was prepared by the Office of Economic Research
and was coordinated with the Office of Current
Intelligence.
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for the military's takeover on 3 October 1968,* the
new regime clearly had the primary objective of
instituting sweeping economic and social reforms.
Peru had lagged behind comparably developed Latin
American countries in instituting economic changes
and reducing income inequalities because the politi-
cal system continued to be dominated by parties
responsive to the oligarchy.
2. Largely because a favorable foreign invest-
mentclimate contributed to rapidly expanding mineral
and fishmeal exports, Peru's economic growth rate
for some time surpassed that of most other Latin
American countries. During 1951-67, growth averaged
6% annually, compared with 5% for the region as a
whole. However, growth was concentrated in the Lima
area and a few export-oriented enclaves and brought
little benefit to most Peruvians, especially those in
the rural areas. As a result, Peru became notorious
for the sharp contrast between the oligarchy's wealth
and privileges and the extent of the slums that sprang
up around many cities.
* The International Petroleum Company -- a sub-
sidiary of Standard Oil Company of New Jersey --
produced, refined, and distributed about 70% of the
petroleum products consumed in Peru. The company's
title to its main producing field, La Brea y Parinas,
had been disputed since the company acquired the
property in 1924, and the government had asserted a
claim for back taxes. When BeZaunde reached a
settlement with the company, which was to cede its
claim to the oilfield in exchange for a dropping of
the tax claims, the military overthrew him, charging
that the settlement (the Act of Talara) was a sell-
out. The military then seized the company's oil-
field and refinery and refused compensation on the
grounds that the company had illegally enriched
itself and owed Peru some $690 million,
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3. Because the oligarchy for the most part was
satisfied with the profits from its traditional
agricultural, banking, and commercial enterprises,
manufacturing and mining development was left mainly
to US and other foreign investors. Foreign-owned
businesses operated with few restrictions as long
as they did not threaten the oligarchy's privileged
economic position and access to political spoils.
In this laissez-faire environment, foreign companies
eventually emerged as highly visible owners of most
of Peru's modern industry.
4. A military junta intervened in 1962 to pre-
vent APRA from coming to power after winning the
election and then engineered the election in 196'
of a new reformist coalition headed by Belaunde.
The Belaunde government seriously tried to insti-
tute certain economic and social reforms but was
blocked by vested interests and the opposition
parties. Rapid economic growth continued during
1963-66, but Belaunde's inability to get Congres-
sional approval of rt:'enue measures needed to
finance his public investment program caused large
budget deficits. These, in turn, led to rapidly
increasing short-term foreign debt, mounting in-
flation, and -- in 1967-68 -- to devaluation of
the sol, loss of business confidence, and sharply
reduced economic growth. Another factor contribut-
ing to the loss of business confidence was a
smuggling scandal that involved various high govern-
ment officials, including several cabinet ministers.
5. Impatient with the Belaunde government's
shortcomings, the military decided it was the only
force capable of undertaking measures necessary
for the basic long-term reforms required to achieve
greater social justice and stave off an eventual
violent revolution. The military's self-confidence
was reinforced by the success of the Argentine and
Brazilian military governments in dealing with
economic problems that had defeated civilian regimes.
The Reforms' Goals and Progress
6. The Velasco regime has two primary long-
range goals. The first is to decisively increase
Peruvian ownership and control of the economy's
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modern sector at the expense of foreign influence,
and the second is to alter income distribution
substantially by neutralizing the economic power of
the oligarchy and integrating the large Indian popu-
lation into society.* In turn, the regime expects
more equal income distribution to accelerate in-
dustrial development by broadening the market. The
regime has indicated that several years will be
needed to achieve these goals and that it intends
to remain in power for at least five years and per-
haps as long as 20.
7. The government already has gone far in
assuming control over export industries, petroleum
refining, banking, and foreign exchange transactions
and recently announced plans for far-reaching partici-
pation in manufacturing. Expropriation of the IPC in
October 1968 was followed two months later by a
measure reducing foreign influence in banking. in
June 1969, Velasco introduced a land reform that
turned over all the large sugar estates to govern-
ment-controlled worker cooperatives and provided
for redistribution of all other large holdings.
During the past 12 months the government has
nationalized the principal telephone company and
the marketing of major exports products and has
reserved development of additional key economic
activities to the state. The decree on manufacturing
enterprises, issued on 28 July 1970, provides for
gradually increasing worker participation in the owner-
ship, management, and profits of all private establish-
ments.
8. Although these reforms represent an enormous
change for Peru, they are not unprecedented or even
radical by Latin American stands except in the
case of the new manufacturinS decree. Peru's seizure
of the IPC was strikingly similar to Mexico's seizure
of foreign oil company properties in 1937, which
marked the course of the nationalistic Lazaro Cardenas
administration and its successors. In several Latin
American countries, the government has long dominated
it About 5 million of Peru's 13 miZZion people are
Indians. Most Indians Zive in emaZZ, isolated
mountain communities, speak little if any Spanish,
and participate only marginaZZy in the money economy.
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certain important industries and guided private
investment. The planned gradual acquisition of
majority control of foreign firms by domestic inter-
ests also has precedents in several other Latin
American countries. Mexico, the best known example,
requires a minimum of 51% domestic public or private
ownership of all firms. Peru's move to gradually
transfer ownership of private manufacturing firm, to
their employees has no precedent in Latin America,
however.
Position of Foreign-Owned Enterprises
9. The Velasco government has substantially
reduced the scope of foreign-owned business in Peru.
Expropriating IPC's properties placed almost all
petroleum refining and marketing under government
ownership, and the banking decree that soon followed
restricted foreign ownership of domestic banks to a
maximum 25% interest. During 1969 the regime nego-
tiated the nationalization of the Peruvian Telephone
Company, an International Telephone and Telegraph
(ITT) subsidiary serving Lima, and announced plans
to eventually nationalize all remaining privately
owned communications and electric power facilities.
Subsequent decrees provided for government control
of mineral exports by nationalizing marketing
facilities and building state-owned refineries.
Marketing of all fish products including fishmeal,
a leading export, also has been placed in government
hands. The industrial decree specifies eventual
government ownership of all basic manufacturing in-
dustry. Future investments in such industries as
steel, chemicals, paper, and cement would be carried
out by the government, which already owns Peru's only
steel mill, and ownership of existing private firms
would be acquired gradually.
10. Because Peru needs capital for resource
development, the Velasco government from the begin-
ning has tried to combine economic nationalism with
continuing opportunities for private foreign in-
vestment. This policy was first manifested shortly
after the IPC expropriation, when Peru signed a
contract allowing Delco Petroleum -- a US-owned
firm to expand its oil extraction facilities
under favorable terms. In the copper industry, the
regime has pressured the large foreign-owned mining
companies to initiate expansion programs or risk
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losing their concessions. Foreign-owned fishmeal
enterprises not only are keeping their properties --
at least for the present -- but are being urged to
build plants to process fish for human consumption.
The nationalization agreement negotiated with ITT
also committed the company to build a tourist hotel
in Lima and enter a joint venture with the govern-
ment to produce communications equipment for the
Andean market.
11. The regime apparently expects the state or
Peruvian nationals to share in the ownership of
nearly all future mining ventures by foreign firms.
Although not prohibiting full ownership by foreign
firms, it offers them financial incentives to form
enterprises with at least 25% government ownership.
In negotiations with Anaconda on a $50 million to
$75 million project to develop the Cerro Verde
copper deposits, the government has inuicated that
it will insist on a minimum of 51% state ownership.
In the case of other more costly or technically
difficult projects, however, such as developing the
Cerro Corporation's capper concession, the govern-
ment is expected to be satisfied with a smaller
share, at least in the short run.
Scheduled Institutional Changes in Manufacturing
12. If fully implemented, the recent industrial
reform would radically change the present pattern
of ownership and control in manufacturing. Foreign-
owned firms are required to.conclude contracts with
the government setting up timetables for partial
nationalization. Once it has recouped its original
investment and a "reasonable profit," a foreign
company is to retain a maximum ownership interest of
only 33%,-with the balance to be acquired by the state
or, perhaps in some cases, private Peruvians. The
new decree, however, provides for exceptions to
these provisions "when in the national interest or
necessary for economic development." The decree
directs both domestic and foreign firms to institute
immediately a profit sharing system for distribution
of 10% of pre-tax profits to workers. In addition,
all manufacturing firms are required to contribute
15% of pre-tax profits to a state-controlled "in-
dustrial community fund" and to set aside 2% of pro-
fits for research and development. In basic industries,
the "industrial community" will buy bonds and dis-
tribute the interest received among the workers. In
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other industries, it will use its profit share to
buy stock in the firm; if the enterprise needs funds
for expansion, the "industrial community" will re-
ceive newly authorized rather than existing shares.
When the "industrial community" has obtained 50% of
the stock outstanding, it will transfer the shares
to the firm's employees. Other, more complicated
measures enable the employees to acquire a progres-
sively larger part of the firm's equity and allow
new employees to share some of the benefits. Workers
are to participate in management to the extent that
they or the "industrial community" have equity in
the enterprise.
Control of New Investment
13. The decree governing manufacturing also
outlines an incentive system aimed at stimulating
and shaping the composition of private investment.
The decree provides for substantial revisions in
import duties on capital goods and industrial inputs,
lowering those applicable mainly to high-priority
industries and raising those for low-priority
industries. Import duties on capital goods are set
c,t only 10% for first-priority industries (basic
industry and other fields reserved for state de-
velopment), at 30% for second-priority fields
(primarily export industries), and 60% for third-
priority industries, mainly those producing non-
essential goods. Producers of luxury goods gen-
erally will have to pay still higher duties. Im-
ports of raw materials and components would be
subject to duties ranging from 20% to 80%, depend-
ing on the industry's priority. In addition, the
law indicates that development banks will provide
subsidized credit to industries according to their
priority. Higher priority industries are allowed
tax-free reinvestment of profits, and tax advantages
are granted to companies locating outside of Lima.
To spur a rapid increase in investment, the decree
provides special tax benefits for firms investing
during 1970-72.
14. The Velasco administration also plans to
guide development by allocating bank credit. To
stimulate inflows of foreign capital, domestic
bank credit for foreign-owned firms has been
limited to the amount outstanding at the beginning
of 1969. To stimulate agricultural, development
and support the agrarian reform, commercial banks
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must allocate to agriculture 25% of the increase
in credit since January 1969. Credit allocation
will be facilitated by the recent entry into
commercial banking of the government-owned Banco
de Za Naoion -- formerly the holder of government,
accounts only. In addition, the government's
takeover in June 1970 of the bankrupt Banco Popular
(Peru's second largest commercial bank) provides
a national network of branch banks for direct
credit allocations to favored ventures.
Measures to Improve Income Distribution
15. The regime has announced several measures
to improve the welfare of lower income groups,
but except for land reform their implementation
has been restricted, partly for financial reasons.
in addition to land redistribution, the measures
call for the following:
-- Establishment of self-help organi-
zations to provide public services in
the Pueblos Jovenes (Young Towns), the
official name for the slum settlements
surrounding Lima and other cities.
-- Tax incentives to stimulate loca-
tion of new enterprises outside the
few coastal cities where they are now
concentrated.
-- Educational reform aimed at greatly
expanding basic literacy and job skills
in low income groups while de-emphasiz-
ing the more traditional preparation for
higher education.
16. Land redistribution has been carried out
rapidly.* With almost no external financial or
technical assistance, the government has organized
15,000-20,000 families into cooperatives on ex-
propriated sugar estates and has settled more than
20,000 families on other expropriated land during
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the past year. This progress compares very favorably
with that in Chile, where only 20,000 families have
been settled in the past five years despite large
expenditures aided by external financial assistance.
The land reform has not yet significantly burdened
government finances, because most expropriated land
is being paid for with long-term government bonds
and few expenditures have been made to provide needed
but costly rural infrastructure and technical and
marketing services. Among other reasons, the regime
moved rapidly in order to slow migration of un-
skilled, illiterate peasants from the highlands to
the rapidly growing urban slums, which it views as
a serious threat to internal order. Lima already
has 3 million of Peru's 13 million people, and per-
haps half of them rive in vast slum areas,
17. The land reform represents a drastic and
seemingly irreversible change in an agrarian
structure that had changed little since the early
1800s. Although it may reduce marketed output for
a time, land redistribution should help in the
long run to bring the Indians into the money economy
and broaden the national market. Land reform also
should generate political support for large, con-
tinuing public investments needed in agricultural
infrastructure if food production is to be expanded
appreciably. In both Mexico and Venezuela, for
example, the rural interest groups required to sup-
port-successful long-term agricultural programs were
created by widespread land reforms.
Repercussions and Problems of the Reforms
18. The economic reforms -- together with the
government's financial stabilization program,
drought, prolonged strikes at major copper mines,
and a shortage of an-hovies for the important
fishmeal industry -- have resulted in very sluggish.
economic growth in recent years. Growth averaged
only l/% in 1968-69, well below the rate of increase
in population, and apparently has changed little so
far in 1970. This slow growth has made it difficult
for the regime to finance some investments that its
programs call for. The May earthquake helped to
unify the regime and rallied public support, but
these improvements could prove fleeting if no eco-
nomic progress is made.
g
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19. The government's expropriation of IPC and its
strident nationalism caused capital inflows to largely
dry up. The reluctance of the US government and many
US enterprises to provide funds came as no surprise,
but the cutback in capital inflows from international
institutions and other sources probably exceeded the
regime's expectations. Until the 31 May earthquake,
the regime had obtained only two small loans from the
Inter--American Development Bank and none from the
World Bank. Peruvian leaders also have been disap-
pointed by the response of Japanese and West European
businesses to their overtures. The Japanese refused
even to consider committing resources to develop
several large US-held copper mining concessions that
might be relinquished. The USSR's failure to offer
substantial assistance likewise has deflated the
regime's hopes of obtaining non-US financing for these
copper concessions, as well as funds for several large
agricultural development projects.
forced them to convert their dollar holdings in
domestic banks -- perhaps as much as $100 million-
20. Even more vexing to the regime has been the
failure of domestic business interests to invest.
Because many members of the oligarchy had supported
the military coup and the expropriation of IPC, the
regime has been surprised by their.continuing
failure to proceed with planned investments. It
seems clear that many Peruvian businessmen are
passively resisting the Velasco government and its
reformist programs.
21. In response, the regime has attempted to
force.several foreign firms as weil.as Peruvian
businessmen generally to invest. The first step
was an effort beginning in 1969 to force the
foreign-owned mining companies to start developing
their concessions or give them up. A second step,
aimed at Peruvian enterprises and moneyed interests
generally, was an exchange control decree issued
in May 1970. Among other things, the decree
ordered Peruvians to repatriate funds held abroad
or risk criminal prosecution, sharply restricted
their freedom to send funds out of the country, and
funds available for public investment.
weeks by a currency reform requiring individual
holdings in excess of $20,000 to be invested directly
or exchanged for government bonds, thus making more
this decree will be supplemented in the next few
$150 million -- to soles.
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22. In successfully carrying forward the financial.
stabilization program initiated under Belaunde, the
Velasco administration clearly has circumscribed its
reform efforts. By the end of 1969 the government
had balanced the budget by imposing new taxes and
slashing public investment, liquidated a large back-
log of unpaid government bills, sharply reduced
the inflation rate, and restored foreign reserves to
normal levels by imposing an import surcharge and
prohibiting luxury imports (see the chart). The
program had a harsh impact on output and employment
in late 1968 and early 1969, however. Per capita
output has dropped slightly since 1967 and would
have dropped more if high prices for minerals and
fishmeal had not boosted export earnings. The
number of people without regular full-time jobs
rose sharply as construction and other economic
activities slowed and has probably increased by
almost 10% of the labor force since 1967, to perhaps
15%-20% of the total. Although the regime relaxed
the stabilization program in mid-1969, the economy
has not responded very strongly, mainly because
of the continuing depression of both public and
private investment.
Prospects
23. The Velasco regime seems likely in the next
several months to move steadily ahead in implementing
recent changes and to institute others in such
areas as taxation, retail trade, and international
commerce. How far the program will go over the next
two years is less certain. Program implementation
will depend both on political developments and on
the general course of economic activity; the latter
will be strongly influenced by the trend in private
investment and export prices. If economic growth
does not recover substantially and the rise in un-
emplo,'ment is not curbed, Peru's leaders will be under
increasing pressures either to take more authoritarian
and rep,-essive actions to force investment and eco-
nomic growth or to alter their economic aims.
24. Although some short-run improvement in eco-
nomic growth is probable, prospects for a return to
the 6% annual gains of 1951-67 are poor. Recovery
of sugar and fishmeal production, the opening of
several small new mines, and the absence of pro-
longed strikes should give the economy a lift in
1970. If substantial foreign aid is forthcoming
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because of the devastating earthquake suffered in
May -- as now seems likely -- the government should
be able to boost output and employment further by
means of increased public outlays. Stagnation of
private inveo tment seems likely to persist, and
this is expected to hold the annual growth rate
below 4%.
25. Public investment probably will rise-ap-
preciably in 1971. Sizable foreign-financed re-
construction expenditures should continue through-
out the year. Work may start on state-owned in-
dustrial facilities, especially if forced private
purchases of government bonds are large, as seems
likely. Littli private investment is in prospect
for 1971, howevu:, unless the government moderates
',ts stand toward the private sector. if drastic
government-imposed economic changes continue to be
implemented, the US copper companies probably will
invest only the minimum amounts necessary to retain
their concessions. Mining investments in 1970-71
are not likely to exceed $30 million annually -- an
amount that will scarcely induce much other private
investment. By 1971, Peru faces a possible weaken-
ing of prices for its main exports, which could
offset the stimulative effects of increased public
investment. Prices for copper and other minerals
already have dropped somewhat from their 1969-70
highs and may drop further.
26. Even if the Velasco government should succeed
in bringing about an economic upsurge, it faces
serious problems. The revolutionary rhetoric and
sweeping promises of a better life for the lower
classes may have already awakened unsatisfiable ex-
pectal;ions. Continued financial constraints on the
expansion of rural infrastructure may prevent the
land reform from holding the peasants on the land,
thus causing it to fail to halt the migration to the
cities. Moreover, massive investments would be re-
quired to improve the lot of urban slum dwellers.
If these people eventually become disenchanted with
the slow pace of economic improvement, they could
offer fertile ground for demagogic appeals by ex-
tremist groups or radical members of the Velasco
regime.
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PERU: SELECTED ECONOMIC INDICATORS
Estimated
30 Juno 1970
1965 1966 1967 1968 1969
Government Expenditures and Revenues
1965 1966
78771 8.70 CIA
Rise in Cost of Living Index
1969 1970
Estimated from
6 months' data 25X1
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Conclusions
27. The Vplaaco regime's economic reform program
is intended to achieve a sharp reduction in the
economic and political power of foreign investors
and Peru's traditional elite and correspondingly to
expand the government's role in economic development.
The reforms introduced so far are transferring con-
trol over Peru's natural resource and export in-
dustries to the government, forcing increased domes-
tic ownership of banking and manufacturing, and
redistributing large estates among the peasants.
Although most of the reforms are not particularly
radical compared with policies followed by several
other Latin American countries, they represent a
drastic change from Peru's traditional laissez-faire
approach to domestic and foreign investment. In
many respects, the Velasco regime is following
courses previously taken by Mexico, Chile, and, to
a lesser extent, by Brazil, Argentina, and Venezuela.
28. The major repercussion ox the reform program
has been continuing economic stagnation. Growth has
been depressed largely because the rapid pace of the
reforms and the strident nationalism with which t%ey
have been introduced have greatly reduced foreign
aid receipts and sharply d-pressed private investment
by both domestic and foreign firms. In addition,
public investment has been held down to promote finan-
cial stabilization. Because the economic growth rate
averaged only 1/% during 1968-69 compared with 6%
during 1951-67, unemployment increased rapidly and per
capita income declined. These economic shortcomings
contributed to dissension within the regime over the
pace and scope of the reforms which in turn delayed
additional reforms and added to business uncertainty.
29. The regime is likely to push ahead with re-
form during the next several months, but its course
and pace over the longer term will depend on political
circumstances and success in spurring economic
growth. Partly because of prospective foreign aid
of more than $100 million for earthquake relief and
rehabilitation, improved growth is possible over the
next two years or so. If the reforms continue at
their present pace, however, private foreign and domes-
tic investment seems unlikely to recover substantially
in the next year or so, thus preventing a resumption
of rapid economic growth. Moreover, growth could be
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hold down if the weakening of export prices continuos.
In any case, the regime faces difficult problems be-
cause the reform program may have awakened expocta-
tions among the urban and rural poor that cannot be
fulfilled. Thus, although the Veleeco regime has begun
to alter Peru's economic and social structure irravorei-
bly, the program's future remains uncertain and its
path difficult.
SECRET
Declassified in Part - Sanitized Copy Approved for Release 2011/10/31: CIA-RDP85T00875R001600030109-8