Chapter 1. Overview: Charting Peru’s way to a high-income economy with better well-being for all citizens

Many factors play into Peru becoming a high-income country with an expanded and a consolidated middle-class. The changing external landscape – particularly the economic evolution of one of Peru’s largest export markets, China – has significant consequences for Peru’s traditional economy and for more inclusive development going forward. This chapter also summarises the value of the multi-dimensional review (MDCR) approach and methodology, leading to an overview of the three topics reviewed in this report, their results and the policy implications for more inclusive development in the country: productivity and economic diversification, transport connectivity, and informality. The chapter concludes with three future-state scenarios developed to consider the recommendations in light of major global trends that may affect development prospects for Peru.

  

After years of impressive economic growth that lifted scores of its people out of poverty and led to a burgeoning middle class, Peru must undergo structural reform to embark on the next chapter of its development. Transitioning from a middle-income to a high-income country will require economic diversification and higher productivity to avoid getting caught in the so-called middle-income trap (MIT).1 It will also require public policies that improve citizen well-being by providing quality formal jobs and public services.

The model that fuelled Peru’s impressive economic growth rates has depended on a global economic landscape that is now shifting. Global demand for natural resources has decreased, driven by a slowdown in China, and is already having an adverse effect on the Peruvian economy, with reduced commodity exports and foreign direct investment. Transitioning to high-income status with a consolidated middle class will entail crafting new development strategies that foster new engines of growth for the Peruvian economy and ensure growth is inclusive and sustainable in the long term.

Peru aspires to be a high-income country with an expanded and a consolidated middle class, where citizens enjoy high living standards. This vision sees an economy that provides quality formal jobs for citizens with the purchasing power to enjoy consumer goods and generates fiscal revenues to provide high-quality public services. In this vision, Peru is a highly connected, inclusive and sustainable society, where educated and healthy citizens trust institutions and actively engage in political and civil life. Peru would be well integrated in the region, with a vibrant business environment that fosters innovation and entrepreneurship. It would have a modern agro-industrial sector and well-managed natural resources. Efforts to improve sustainability will have reaped rewards such that citizens enjoy their country’s well-preserved and rich natural heritage and diverse vibrant culture.2

To realise this vision for its citizens and to meet their expectations, Peru requires ambitious reforms for the long term. Such reforms should diversify the Peruvian economy away from natural resource dependency and encourage formal job creation. This would enable Peru to consolidate its middle class, while reducing poverty and economic vulnerability. Reforms that improve Peru’s institutional framework and fiscal legitimacy should also deliver better public services in the areas of innovation, transport infrastructure and logistics, education and skills, and healthcare. Such an ambitious strategy to realise Peru’s high-income aspirations will also require significant financing and state capacity, with a detailed action plan and highly co-ordinated public administration for effective implementation.

This chapter presents an overview of how Peru can pursue development policies that support its vision of becoming an inclusive, high-income country. First, the chapter provides an overview of the major external challenges that Peru faces today in realising inclusive development, including major global trends that may affect future development prospects. Second, the chapter highlights some opportunities the multi-dimensional approach identified for Peru’s development, namely the importance of driving productivity and economic diversification, improving transport connectivity and incentivising the creation of formal employment. The three sections following summarise policy implications revealed by the multi-dimensional analysis of these topics. The final section presents three scenarios illustrating global trends that may affect future development prospects. These scenarios are used to test the resilience of recommendations to these structural shifts and changing environment.

Charting inclusive development in a changing global landscape

Favourable external conditions in the past decade were instrumental in the expansion of the Peruvian economy. As one of the largest producers of metals in the world, Peru benefited immensely from the upswing in commodity prices that started a decade ago. Record low international interest rates and sound macroeconomic policy attracted significant foreign capital and boosted economic growth to rates that surpassed those of Peru’s regional neighbours.

Today, Peru faces an uncertain global economic environment, with a sharp decline in global commodity prices and increasing volatility in global financial markets.3 The adverse consequences of some of these shifts are already visible: mining companies, for instance, have reduced their investment plans, leading to a decrease in foreign direct investment and commodity exports.

One important risk to Peru’s growth prospects is the shift in the economic model taking place in the People’s Republic of China (China), which has become an increasingly important destination for Peruvian exports (in 2015, 19% of Peruvian exports were destined for China, making this market Peru’s main export destination). The scale of the impact is significant. Estimates suggest that a decrease in China’s investment growth by 1 standard deviation is likely to reduce Peru’s terms of trade growth by about 2 percentage points and its gross domestic product (GDP) growth by about 0.2 percentage points (Han, 2014). Furthermore, China’s demand for commodities should continue contracting as the country rearranges its imports composition. China’s new normal imposes new challenges for Peru. Projections from the 2016 Latin American Economic Outlook foresee Peru’s exports slowing down from an impressive 16% annual growth in the period 2001-10 to less than 3% up to 2030 in the baseline scenario (OECD/Development Bank of Latin America [CAF]/Economic Commission for Latin America and the Caribbean [ECLAC], 2015; Chapter 2).4

Peru also will have to contend with other emerging global trends, which could have a significant impact on the success of its development strategies. These pertain to the structure and drivers of the global economy, but also to technological trends that could radically affect global production patterns, as well as domestic shifts that could shape the scope and form of Peru’s programme of reform. Three scenarios were developed to test the recommendations of this multi-dimensional review against identified global trends to ensure that strategies pursued both mitigate risks and seize opportunities in a shifting world.

Charting the way forward: The value of a multi-dimensional approach

To support Peru’s vision of becoming an inclusive, high-income economy, the OECD’s MDCR is part of the OECD’s Country Programme to support Peruvian authorities in identifying future reforms (Box 1.1).

Box 1.1. MDCR in the context of the OECD Country Programme with Peru

In 2014, the OECD and Peru agreed to set out a joint Country Programme to support Peru in its reform agenda and improve its public policies in priority areas. The programme will facilitate Peru’s adherence to OECD legal instruments, participation in OECD bodies and programmes, and effective implementation of OECD standards and best practices. Over two years (2015-16), the programme is and will be conducting a series of policy reviews and activities in five priority areas: removing barriers to growth, public governance, anti-corruption, human capital and the environment. The programme also includes workshops and capacity-building activities in areas such as tax policy, regulatory policy and statistics. In addition to the MDCR, other OECD reviews of the OECD Country Programme include a Skills Strategy Review, a Vocational Education and Training Review, an Environmental Performance Review, a Public Governance Review and a Territorial Review.

MDCR of Peru: Volume 1. Initial Assessment, launched in October 2015 by the OECD’s Secretary-General, was the first policy review of this Country Programme to be published. The current Volume 2 analyses and provides recommendations in three areas identified as key to boosting sustainable and inclusive development: economic diversification and productivity, transport connectivity and tackling informality.

The MDCR is composed of three distinct phases:

  • Volume 1 identified the main constraints to achieving sustainable and equitable objectives in well-being and economic growth.

  • This volume 2 analyses the identified areas to formulate policy recommendations that can be integrated into Peru’s development strategy.

  • Volume 3 will support implementing these recommendations. As in other Latin American economies, this final phase is particularly relevant in Peru, given the complexity of both the political economy and the policy-making process to make reform happen (Dayton-Johnson, Londoño and Nieto-Parra, 2011).

For each phase, a report is published and workshops are organised. The MDCR methodology is based on quantitative economic analysis, as well as qualitative approaches, including foresight and participatory workshops.

Quantitative methods include standard approaches and a comparative analysis with a selection of countries, referred to as the benchmark countries.

Benchmark countries identified in Volume 1 were selected according to criteria that included their high GDP per capita growth to tackle the MIT, the contribution of natural resources (particularly minerals) to GDP, and the degree to which their successful economic policies could be relevant to Peru. Eight are OECD member countries: Australia, Canada, Chile, Korea, Mexico, Norway, Portugal and Turkey. Australia, Canada and Norway are included because of their important natural resource sectors; Portugal and Turkey are included because of their development path; and Korea serves as an example of a highly successful, export-based economy. In addition to Chile and Mexico, five other Latin American and Caribbean countries are included: Brazil, Colombia, Costa Rica, Ecuador and Panama. Brazil and South Africa, both among the BRICS (Brazil, Russia, India, People’s Republic of China and South Africa), are included because of their growing economic power and their mineral resources.

The first volume of the MDCR of Peru described economic development in the country since the 1970s and provides an in-depth assessment of the Peruvian economy and state of well-being today. Since the beginning of the 21st century, Peru has experienced successful socio-economic progress. Coupled with strong economic growth compared to the region, considerable segments of Peru’s population were lifted out of poverty, swelling the ranks of the middle class. Peru’s success is attributed mainly to sound macroeconomic management, monetary and fiscal policies that reduced inflation and volatility, and a favourable external environment, attracting investment and driving a commodity boom. A stronger emphasis on social policies and redistributive programmes has been crucial for reducing poverty and income inequality to some extent (OECD, 2015a).

Volume 1 highlighted Peru’s good performance in improved ability of households to consume, social connection and life evaluation, along with its underperformance in areas of work, education, skills and health. Analysis of these outcomes drew attention to the issues of informality, inequality and productivity in Peru. These challenges reveal the dynamics underlying Peru’s development model, highlighting bottlenecks to inclusive development and identifying cross-cutting issues for further analysis.

A major challenge for Peru is to continue socio-economic progress in reducing poverty and inequality and to identify the new engines for economic growth that are needed to become a high-income country. The current drivers of growth in Peru, which is strongly reliant on labour, capital accumulation and the commodity export sector, seem insufficient to sustain such progress. Peru has a high level of labour utilisation, but low productivity. Structural factors are holding back performance of human capital and total factor productivity. Employment is highly concentrated in the least productive sectors of the Peruvian economy. The most productive sectors – mining, finance, energy, water and telecommunications – represent less than 4% of total employment, while more than half of Peruvian workers have jobs in Peru’s two most unproductive sectors: retail and restaurants, and agriculture.

Expanding the middle class has been among Peru’s great achievements, but it also created new vulnerabilities and an increasing demand for quality public services and better jobs. Between 2004 and 2014, the middle class jumped from 19% to 37.8% of the population (Figure 1.1). This places greater demands on policies as the middle class demands more and better public services, such as transport connectivity, education and skills. Another challenge is the growing number of vulnerable people in the population, which increased from 36.7% to 40.6% in the same period (World Bank, 2016a). Despite the socio-economic progress achieved in recent years, many people in Peru are in an unstable situation where they could easily slip back into poverty following any turbulence or slowdown in the economy. Most of the vulnerable population hold precarious jobs in the informal sector. Reforms aiming to boost economic diversification and productivity are fundamental to tackling informality.

Figure 1.1. Peru and Latin American population distribution by per capita income level (% of population), 2004-14
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Note: Poverty is defined as the percentage of the population living with less than USD (United States Dollar) 4 (2005) purchasing power parity (PPP) per day. The vulnerable class is defined as the percentage of the population living with USD 4 to 10 (2005) PPP per day. The middle class is defined as the percentage of the population living with USD 10 to 50 (2005) PPP per day. Latin America and the Caribbean (LAC) includes the following countries: Argentina, Bolivia, Brazil, Chile, Colombia, Costa Rica, Dominican Republic, Ecuador, El Salvador, Guatemala, Haiti, Honduras, Mexico, Nicaragua, Panama, Paraguay, Peru and Uruguay.

Source: OECD calculations based on World Bank (2016a), LAC Equity Lab (database), World Bank, Washington, D.C., www.worldbank.org/en/topic/poverty/lac-equity-lab1/overview (accessed on 1 July 2016).

 http://dx.doi.org/10.1787/888933411179

Thus, economic diversification and productivity, transport connectivity and formal jobs interact with and reinforce each other to achieve a brighter future for its citizens. As such, policies to address these bottlenecks for inclusive development must consider the possible synergies and trade-offs among them. For instance, policies to increase connectivity through infrastructure investment should increase economic diversification and productivity and could result in lower informality rates. However, high levels of informality give low levels of tax revenues, which in turn affect the necessary transport infrastructure investments to boost connectivity.

This Volume 2 of the MDCR presents in-depth analysis of and outlines recommendations for the three topics identified in Volume 1 as key constraints to inclusive development in Peru:

  • Promoting economic diversification and productivity (Chapter 2).

  • Improving transport connectivity to foster competitiveness and inclusiveness (Chapter 3).

  • Tackling informality in the labour market (Chapter 4).

Below is an overview of the main findings and recommendations for these three topics.

Promoting economic diversification and productivity

The shifting global economy and China’s new normal require a diversification strategy for the Peruvian economy. As described above, Peru’s growth model over the past decade has been heavily reliant on a commodity boom driven by Chinese demand. The shifting environment means Peru needs to diversify to drive new sources of growth.

Peru also needs to diversify its economy to avoid the MIT. MIT is defined as a period of prolonged slowdown once a country reaches a certain level of income (OECD/CAF/ECLAC, 2014; OECD, 2014). This phenomenon occurs when a country can no longer rely on its traditional drivers of growth (e.g. low labour costs or the accumulation of labour as a major source of growth) to make further progress. Peru’s recent period of high GDP growth helped it to achieve upper middle-income status in 2008, but this success is not without its challenges.

Overcoming the MIT will require higher productivity and greater diversification (OECD, 2015a). Peru’s labour productivity only represents close to 30% of the OECD’s labour productivity (Figure 1.2, Panel A), and the productivity gains required for Peru to reach high-income status are significant. Even were Peru to sustain the strong macroeconomic performance of recent years (4.6% of average per capita GDP growth rate in the past ten years), it would take Peru until 2029 to become a high-income country, supposing more than 80 years as a middle-income country.5 Compared to neighbouring Latin American economies, Peru is not an isolated case in the region (OECD/CAF/ECLAC, 2016). However, the performance of other countries indicates that a more rapid transition from a middle-income to a high-income economy is possible. For instance, it took Korea 27 years, Portugal 46 years and Chile 55 years (Figure 1.2, Panel B).

Figure 1.2. Moving from middle-income to high-income in Peru and selected benchmark economies
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Note: Panel A: Labour productivity per hour worked in USD 2015 (converted to 2015 price level with updated 2011 PPPs).

Source: Panel A: Conference Board (2016), Total Economy Database (database), The Conference Board, New York, www.conference-board.org/data/economydatabase/ (accessed on 1 August 2016). Panel B: OECD calculations based on methodology proposed by Felipe, Abdon and Kumar (2012), Data from International Monetary Fund (IMF) (2016), World Economic Outlook (database), International Monetary Fund, Washington, D.C., www.imf.org/external/pubs/ft/weo/2016/01/weodata/index.aspx (accessed on 1 July 2016); and Maddison Project (2016), Maddison Project Database (database), University of Groningen, Groningen, available at www.ggdc.net/maddison/maddison-project/home.htm, 2013 version (accessed on 1 July 2016).

 http://dx.doi.org/10.1787/888933411187

To design and implement a development agenda for productivity for all Peruvians, certain policy actions should be taken into account:

  • Further regional integration and policies to tackle barriers to entrepreneurship should attract foreign capital in productive sectors, expand access to international trade and improve the business environment.

  • Micro-analysis of potential sectors (as identified in this report) and pre-conditions in the development of these sectors are fundamental in the strategy to make Peru more productive and diversified. Experiences in agro-industry, tourism, metal-mechanics and forestry are useful for that purpose.

  • Higher investment in research and development and more effective interactions with the private sector, for instance through the Centros de innovación y Tecnología (CITEs), are needed to promote innovation.

  • To boost productivity and reduce regional inequalities, the allocation of commodity-based transfers should target all regions in Peru according to their socio-economic challenges. Sub-national authorities need to be supported with further technical capacity to manage these resources and interact with civil society, academics and the private sector to improve the allocation of these resources.

  • To finance broad-based policies affecting productivity and to make a more fair and efficient taxation system, Peru should move towards a comprehensive tax reform, increasing the share of direct taxes (thanks to personal income taxes).

  • Peru needs to move towards more strategic and implementation-oriented public planning for development at national and sub-national levels. Currently, many planning frameworks overlap and are not necessarily co-ordinated. Greater integration between planning agendas and the budgeting process must be a key element of such reform.

Improving transport connectivity to foster competitiveness and inclusiveness

Good transport connectivity can make Peru more efficient and ensure sustainable and more inclusive development (OECD, 2015a). Improving connectivity requires going beyond transport infrastructure provisions, recognising the need for policies and strategies that focus on increasing efficiency and reducing time and financial transport costs for businesses and the population. This is particularly relevant in Peru, where the ratio of transport costs to tariffs is 20 times higher than in OECD economies (Chapter 3). To take advantage of recent trade agreements, a better use of logistics for the transport sector and the adoption of a multi-modal approach beyond the current focus on roads (e.g. developing railways, ports and waterways) are fundamental.

Despite some recent improvements, logistics and transport infrastructure performance remains below those of benchmark countries. Peru’s gap with respect to Germany, the best-performing OECD member country, is 35% larger than that of the region’s leading country, Chile, and more than 2.5 times the average gap for OECD member countries.6 Since Peru has traditionally concentrated on road transportation, the use of other transport modes is low. Furthermore, the quality of ports, rails and roads remains below that in most of the benchmark countries.

A key objective is to define transport strategies to pursue outcomes for the economy and the population rather than exclusively for infrastructure development. Increasing connectivity in Peru means developing a policy framework focused on the reduction of time and financial transport costs and on the promotion of multi-modality. Going beyond transport infrastructure alone involves four key actions:

  • Design a national transport plan, which is fundamental to defining transport policy priorities. This should be aligned to wider priorities set for the economy and for improving quality of life for the population.

  • Create a logistics observatory to improve assessments on logistics, which is key to including more efficiently “soft” solutions, reducing transport costs.

  • Define a national urban transport policy and a lead agency for that purpose. Developing specific objectives, targets and guidelines for urban transport that translate sustainable and inclusive mobility into operational goals, and developing national programmes for enlarging the capacity of urban authorities to fund mobility projects, should be central strategies of the national urban transport policy developed.

  • Focus policies implemented at the local level, in particular in Lima-Callao, on unlocking the benefits of walking, cycling and public transport. This requires aligning investment and road space allocation priorities to these modes and setting pricing frameworks that reflect the social costs generated by private vehicles. The limitations created by the lack of coherent policies and investment decisions across administrative boundaries in Lima-Callao highlight the value of creating a single mobility authority for the metropolitan area. The unique authority will have to define key priority areas, while ensuring delivery of public value.

Tackling informal employment and informal economic activities

Informality is both a cause and a consequence of low levels of development in Peru. Despite a decrease in the past years, informal employment remains high at more than 70% of total workers, representing one of the highest ratios in the region. Reducing informality should be a key policy objective and its many manifestations suggest that it should be approached from different policy angles linked not only to productivity but social inclusion. In that sense, a large share of informality is a by-product of certain structural characteristics and will not disappear until those are removed, while other parts of informality can be dealt with from a shorter-term perspective. In addition, policies to promote formalisation of both firms and workers should be accompanied by measures to mitigate the negative impact of informality on working conditions and the functioning of the economy.

The informal sector in Peru is characterised by a vulnerable population. Close to 80% of informal workers belong to a vulnerable class (incomes between USD 4 and 10 per day) and work in low productivity sectors, such as retail and agriculture. Close to 50% of the middle class (incomes between USD 10 and 50 per day) also belong to the informal sector. Access to formal jobs is particularly difficult for younger workers, women, those with low education and workers from rural areas.

To promote formal jobs and deal with current high levels of informality while mitigating its pervasive impact on workers and the economy, four policy interventions stand out as most relevant:

  • Mitigate the pervasive impact of informality on working conditions without reinforcing the incentives to remain informal. This entails initiatives such as integrating existing health regimes into a single one and progressively expanding it to all citizens, as well as extending non-contributive pensions to gradually move towards universal coverage.

  • Promote the formalisation of jobs through three principle means. One, strengthen inspection and supervision systems, particularly for informal workers in the formal sector. Two, reduce the costs of formal hiring: 1) subsidise the social contributions for low- and low-middle-income workers; 2) provide alternatives to incorporate independent workers in the pension system; and 3) establish a clearly defined mechanism to determine minimum wages and make them less discretionary, allowing for the possibility of a differentiated evolution of minimum wages across regions. Three, improve communication and financial knowledge about the benefits of formalisation.

  • Promote the formalisation of firms by reducing incentives to remain small. For instance, simplify existing taxation regimes and decrease incentives to remain in the simplest one, and reduce some recurrent, administrative and fixed costs of being formal.

  • Create conditions and opportunities for formal job creation. To close the skills gap, increase skills levels in the country, strengthen and promote technical education and provide training opportunities for informal workers. To better match the skills supply with formal job requirements, certify skills acquired in the informal sector and progress towards the creation of a national qualifications framework. A broader productivity diversification strategy aimed at creating more opportunities for formal and better-quality jobs is also required.

Anticipating global trends: Three scenarios to test recommendations

To ensure that the recommendations in this report not only address current challenges but can withstand shifts in the global economy and global trends, future-state scenarios were developed to test the recommendations.

These scenarios are used to anticipate how these global trends might shape recommendations and, more specifically, how different contexts could affect the incentives and/or prioritisation of policy reform or even create new policy trade-offs.7 They are also used to ensure that policy recommendations are applicable in each scenario. The end of each chapter discusses the recommendations in light of each scenario and prioritises certain policy actions, depending on the risks and opportunities the scenario presents.

The scenarios for the future of Peru presented in this report were developed using inclusive participatory approaches. Two workshops hosted by the Ministry of the Economy and Finance (MEF) and the Ministry of Foreign Affairs in Lima in February and December 2015 brought together stakeholders from a broad set of backgrounds to identify global trends that could affect Peru’s future development. On the basis of these trends, stakeholders developed and elaborated three short scenarios with a time horizon of 2030. Their purpose is to help analysts and policy makers think through the potential consequences of decisions and identify both the risks and opportunities of public policy actions.

The scenarios bring together economic, political and technological trends in changing constellations.

  • Scenario 1 describes a revived commodity super cycle, driven by growing demand from India. While providing for a positive growth outlook, this scenario highlights the difficulty of dealing with prolonged resource dependency.

  • Scenario 2 assumes a rapid increase in the pace of change and use of technology and the impact on global production patterns. This scenario highlights the importance of education and skills, as well the link between skills, education and inequality.

  • Scenario 3 describes an increase in protests throughout Latin America in the 2020s and the successful mobilisation of the middle class to garner better public service provision. This scenario highlights the trade-off between higher social spending to meet increasing expectations and balancing budgets and remaining competitive.

Scenario 1: A new commodity super cycle

After an initial global slowdown, the pace of growth in India accelerates, prompting a new global commodity super cycle with important consequences to global demand on natural resources. In parallel, China’s economy continues to grow, albeit at a slower rate, generating an expanding middle class with new habits, diets and appetites for new commodities and consumer goods. The mining sector attracts significant foreign investment, and financial and human resources flow to the natural resource sector.

This scenario presents opportunities for Peru to take advantage of a favourable external environment and improve management and export of natural resource-based commodities. As in the past, growth would drive government revenue, and Peru could seize the opportunity to invest in public services and infrastructure, expand its middle class and reduce poverty rates. Investment in public services, especially health and education, could help to further reduce inequalities and deliver improvements in citizen well-being. This scenario also presents an opportunity to pursue a diversification strategy aimed at supplying the emerging Chinese middle class with new consumer goods and services.

This scenario also presents a number of risks. Renewed global demand for natural resources could create symptoms of Dutch Disease for the larger economy if strong revenues from natural resources removed incentives to pursue a diversification strategy. Investment could flow to the profitable extractive industries and away from the sectors that produce other tradable goods and services, such as agro-business or manufacturing. These sectors could suffer from reduced competitiveness regionally and in other export markets as the exchange rate appreciates with increased investment export inflows. While living standards would increase, in this scenario, Peru remains vulnerable to shocks in global commodity prices.

Scenario 2: Increasing technology and mechanisation

Investment in research and development and agreements for technology sharing between high-income and emerging economies deliver important innovations. The most significant of these are advances in mechanisation and robotics that surpass human capacity and enable the quicker production of higher-quality, cheaper goods. Ability to disseminate this technology radically affects global production patterns, as production costs and labour needs are greatly diminished. A number of service-based industries develop around these technologies. Countries increasingly need to invest in mechanisation and new technologies to ensure their production continues to be competitive. Countries also need to attract high-skilled labour.

This scenario presents an opportunity for Peru to thrive in a future technological revolution. By anticipating this global trend and investing in both research and development and necessary skills, Peru could take advantage of this global shift to position itself as a leading regional player and destination for investment. With a flexible regulatory framework, good business environment and skilled labour force, Peru could both attract firms to set up production in Peru and incubate Peruvian start-ups to supply services around these technologies. Improving intellectual and technical co-operation with other states and actors, such as the private sector, could have a positive effect on other sectors of the economy.

This scenario presents the risk of exacerbating inequality, as demand for highly skilled labour appreciates salaries while low-skill manufacturing, no longer competitive, subsides. Low-skill labour is drawn into the informal sector in low-productivity jobs, and income further depreciates. In this scenario, inequality risks becoming further entrenched between those with high- or low-skilled incomes, with or without skills relevant to new technology, and in formal or informal jobs.

Scenario 3: Rising expectations of the middle class

Popular protest and middle class dissatisfaction intensifies throughout Latin America in the 2020s. By 2030, the region is well integrated economically and politically. Mass demonstrations, marches and strikes have developed into an organised and mobilised social movement across the region. Driven by economic vulnerability and distrust in government and public institutions, the middle class is highly organised and able to represent their interests and extract concessions from governments. Governments respond to these demands by heavily investing in public services, notably improving the quality of education and healthcare, as well as public infrastructure and leisure facilities, to meet citizen expectations.

This scenario presents an opportunity for Peru to improve public governance, increase participation and improve citizen well-being through higher-quality service delivery. Increasing trust in government and public institutions improves the state’s fiscal legitimacy, which drives a slow and gradual formalisation of the economy as norms around fiscal participation and civic duty shift. Improved governance also drives high participation rates in political life, with higher turnout at elections and burgeoning connected, local-level institutions.

The scenario also presents risks. The private consumption/public expenditure model presents trade-offs between higher social spending to meet increasing expectations and the difficulty of balancing budgets and remaining competitive. Government financing of expensive public services risks reducing investment in the domestic economy, and strong social policies could drive lower competitive wages. As a result, job creation would dwindle and the Peruvian economy would struggle to integrate into regional value chains. This scenario also presents the risk of increasing regional disparities. As the government strives to respond to constituency expectations, investment in infrastructure is concentrated in unconnected urban centres at the expense of sparsely populated suburban and rural areas.

The following chapters use these three scenarios to consider recommendations against the risks and opportunities each scenario present. This scenario-based reflection is a simple tool to instigate reflection on policy options for different possible futures.8

References

Conference Board (2016), Total Economy Database (database), The Conference Board, New York, www.conference-board.org/data/economydatabase (accessed on 1 August 2016).

Dayton-Johnson J., J. Londoño and S. Nieto-Parra (2011), “The Process of Reform in Latin America: A Review Essay”, OECD Development Centre Working Papers, No. 304, OECD Publishing, Paris, available at http://dx.doi.org/10.1787/5kg3mkvfcjxv-en.

Felipe, J., A. Abdon and U. Kumar (2012), “Tracking the middle-income trap: What is it, who is in It, and why?”, Working Paper, No. 175, Levy Economics Institute of Bard College, Annandale-On-Hudson, www.levyinstitute.org/pubs/wp_715.pdf.

Han, F. (2014), “Measuring external risks for Peru: Insights from a macroeconomic model for a small open and partially dollarized economy”, IMF Working Paper, No. WP/14/161, International Monetary Fund, Washington, D.C., www.imf.org/external/pubs/ft/wp/2014/wp14161.pdf.

IMF (2016), World Economic Outlook (database), International Monetary Fund, Washington, D.C., www.imf.org/external/pubs/ft/weo/2016/01/weodata/index.aspx (accessed on 1 July 2016).

ITF (2015), ITF Transport Outlook 2015, OECD Publishing, Paris, available at http://dx.doi.org/10.1787/9789282107782-en.

Maddison Project (2016), Maddison Project Database (database), University of Groningen, Groningen, available at www.ggdc.net/maddison/maddison-project/home.htm, 2013 version (accessed on 1 July 2016).

OECD (2015a), Multi-dimensional Review of Peru: Volume 1. Initial Assessment, OECD Publishing, Paris, http://dx.doi.org/10.1787/9789264243279-en.

OECD (2015b), The Future of Productivity, OECD Publishing, Paris, available at www.oecd.org/eco/growth/OECD-2015-The-future-of-productivity-book.pdf (preliminary version).

OECD (2014), Perspectives on Global Development 2014: Boosting Productivity to Meet the Middle-Income Challenge, OECD Publishing, Paris, http://dx.doi.org/10.1787/persp_glob_dev-2014-en.

OECD/CAF/ECLAC (2016), Latin American Economic Outlook 2017: Youth, Skills and Entrepreneurship, OECD Publishing, Paris (forthcoming).

OECD/CAF/ECLAC (2015), Latin American Economic Outlook 2016: Towards a New Partnership with China, OECD Publishing, Paris, http://dx.doi.org/10.1787/9789264246218-en.

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Scarpetta S. (2016), “What future for work?”, OECD Observer, No. 305, OECD Publishing, Paris, available at www.oecdobserver.org/news/fullstory.php/aid/5433/What_future_for_work_.html.

World Bank (2016a), LAC Equity Lab (database), World Bank, Washington, D.C., www.worldbank.org/en/topic/poverty/lac-equity-lab1/overview (accessed on 1 July 2016).

World Bank (2016b), Logistics Performance Index (dataset), World Bank, Washington, D.C., available at http://lpi.worldbank.org/ (accessed on 1 July 2016).

World Bank-DRC (2013), China 2030: Building a Modern, Harmonious, and Creative Society, World Bank/Development Research Centre of the State Council, People’s Republic of China, Washington, D.C., www.worldbank.org/content/dam/Worldbank/document/China-2030-complete.pdf.

Notes

← 1. MIT is defined as a period of prolonged slowdown once a country reaches a certain level of income (OECD/Development Bank of Latin America [CAF]/Economic Commission for Latin America and the Caribbean [ECLAC], 2014; OECD, 2014). This phenomenon occurs when a country can no longer rely on its traditional drivers of growth to make further progress.

← 2. Two workshops hosted by the Ministry of the Economy and Finance (MEF) and the Ministry of Foreign Affairs brought together stakeholders from a broad set of backgrounds in Lima in February and December 2015 to discuss and develop narratives from the citizens’ perspective of Peru’s vision for the future.

← 3. High volatility in international capital markets, particularly in the exchange rate market, is a source of external vulnerability to the stability of Peru’s financial markets in a highly dollarised economy. Despite macro-prudential tools to contain financial vulnerabilities and a reduction in the exposure to foreign currency, close to 40% of Peru’s bank credit to the private sector remains denominated in foreign currency.

← 4. Two scenarios for China’s economy up to 2030 were modelled based on the projections analysis for China 2030 in investment and GDP growth (World Bank-DRC, 2013): a normal-pace transition (baseline scenario) and a high-pace transition (low-investment scenario). The high-pace transition scenario shows a lower GDP growth, especially evident in the period 2021-30. None of these scenarios assume specific external or internal shocks to China’s economy, only different trajectories for China’s transition from a middle-income and an investment-driven economy towards a high-income and a consumption-based one (OECD/CAF/ECLAC, 2015).

← 5. To define the lower and upper bounds of the middle-income group, the thresholds are defined as USD 2 000 and USD 11 750, measured in 1990 constant levels and adjusted for PPP (Felipe, Abdon and Kumar, 2012).

← 6. Based on World Bank (2016b), Logistics Performance Index (dataset), http://lpi.worldbank.org/ (accessed on 1 July 2016) (see Chapter 3 for more details).

← 7. This approach is consistent with the OECD’s focus on and approach to thinking about the future, including the implications of long-term trends. See, for example, the OECD New Approaches to Economic Challenges (NAEC) initiative (www.oecd.org/naec/); the use of scenario-based policy discussion at the 2015 Ministerial Council Meeting (www.oecd.org/mcm/documents/ministerial-meeting-2015-scenario-based-policy-discussion.htm), and selected publications, such as OECD (2015b), Scarpetta (2016) and the International Transport Forum (ITF) (2015).

← 8. Many policy recommendations suffer from a static view of time. Even forecasts and projections based on statistical models that portray a dynamic view of the future suffer from the basic flaw that they only can be produced on the basis of past knowledge. Most analysis necessarily assumes the future to be largely similar to the present, as we cannot know what type of changes will occur in the future.