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Financial scenarios 07 Jun 2016

Peru: The Importance of Economic Growth

Between 2002 and 2013, the Peruvian economy underwent a stage of fast and strong growth. During this period, the average annual growth rate was 6.1%. As a result, in a relatively short period of time, the per capita purchasing power of Peruvians nearly doubled and poverty declined by approximately 30 percentage points.

Picture of economic growth peru bbva continental

We also witnessed the emergence of a new middle class that supported the real-estate boom (after all, who bought the homes and apartments in the new buildings that are now part of the landscape of several cities in Peru?), durable good consumption (like cars, whose traffic we now have to put up with in cities like Lima), the demand for services such as healthcare and education, and the development of a modern retail sector that operates in shopping centers built around the country.

Unfortunately, the situation today is different and the economy is growing by just over 3%. Why has this slowdown occurred? Part of the explanation can be found in the reversal of the favorable external conditions (decline in the prices of the commodities that Peru exports, lower capital inflows and, in general, tighter financial conditions). But most worrying is that there are also structural factors behind this trend, such as lower accumulation of physical capital and a marked moderation of the increases in productivity.

Growing slightly above 3% is too low for Peru. According to new estimates, at this pace of GDP expansion not enough jobs would be created to absorb the new entrants in the labor force. Moreover, with weak growth it will be much more difficult to continue reducing poverty. Thus, Peru should recover greater economic dynamism so its income indicators continue to improve.

The importance of maintaining high growth rates over extended periods of time can be seen when analyzing the successful experiences in other countries. In the early 1960s, South Korea had average revenue significantly lower than Peru (equivalent to 40%). But during that decade the Asian country began an impressive phase of economic upturn and for 35 years managed to sustain growth rates in per capita income of nearly 7% a year.

At this pace, per capita GDP doubles every 10 years approximately, so by the mid-1990s, in just one generation, the average income of Koreans had increased by more than… nine times! Although South Korea started far below the purchasing power of the average Peruvian, today its GDP exceeds Peru's by 3.5 times.

And what should Peru do now that the commodities super cycle has come to an end and the international environment will not be so favorable? The key is obviously to invigorate what gave sustainability to the Peruvian process of fast growth: capital accumulation (i.e. more investment) and encourage gains in productivity. The next administration, which will come into power next July, should quickly implement reforms to prop up these variables. Otherwise, Peru will end up like one of those unfinished experiences, that could be but never were.