The Peruvian government recently proposed reforms to deregulate its extractive industries. The proposed deregulatory framework shows Peru’s desperation to sustain high levels of foreign investment.
Since 2000, Peru’s economy has grown the most of any country in Latin America. It has liberalized trade and finance, attracting significant levels of foreign investment in the primary sector.
But the commodity boom is coming to an end for the Andean nation. As commodity prices continue their gradual descent, Peru’s central government is in a difficult position of dependence.
The government recently announced a proposal to further deregulate the country’s extractive sector to lure foreign investment and keep the economy growing above 5% annually in 2014. Unfortunately, what Peru needs to maintain high levels of foreign investment is not deregulation but, rather, bureaucratic effectiveness and stronger enforcement of the rule of law. Deregulating legally fragile extractive industries could be economically damaging.
Deregulating an already broken system
A country’s business environment is not always improved by deregulating entire sectors. Multinational corporations want to know their assets are safe in host countries and that the courts will rule fairly. In other words, foreign investment prefers effective governance and increased state capacity to protect its interests.
If the recently reshuffled cabinet wants to increase foreign investment as world commodity prices decrease, it needs to prove that it can make business fair and transparent for foreign corporations. In a country such as Peru with a weak rule of law, low government effectiveness and high violence, deregulation does not protect corporations. Rather, it exposes their business to violence, corruption and informal domestic competition mired in illegality.
The proposed framework may have a negative effect on investment, as Peruvian government has not taken note of the biggest threat to foreign extractive companies operating in Peru: the informal sector.
A non-containable informal sector is arguably the largest threat to corporate interests as well as Peru’s international economic legitimacy. Increased gold and copper extraction during the 2000s paralleled an alarming growth in unprotected and extralegal mineral extraction.
The Peruvian government’s inability to tackle the informal sector in the past decade stems from its lack of state capacity and mediocre governance. By simply proposing this reform, President Ollanta Humala’s government is sending a message to investors that it is incapable of integrating the informal sector into Peru’s economy and enforcing the rule of law.
The government recently concluded negotiations with unlicensed miners (ironically, the informal sector has the capacity to organize and bargain with the central government). The miners pledged to respect environmental law and pay taxes, and in turn, the government will promote small-scale, non-corporate mining.
But this agreement could be broken by either party at any time. The negotiations failed to bring forth a long-term solution to informal mining, and more importantly they do not integrate informal interests. Unlicensed workers can continue to mine as they have in the past, beyond the scope of the central government’s regulation.
The negotiations also failed to reach a compromise with every informal mining group, a shortcoming which limits its long-term sustainability.
Deregulating where the state cannot enforce the rule of law
The government’s proposal to deregulate extractive industries will only augment the informality problem that Peru now faces. The extractive sector is already highly unregulated; deregulating it would be counterproductive because the state is already unable to enforce the rule of law in certain parts of the country (e.g., the south-western region).
Peru’s president is attempting to develop Peru’s economy as a resource-rich and liberalized hub, but it may come at the cost of alienating corporations and excluding them from legal protection.
Peru is now participating in the race to the bottom, which will make it increasingly difficult to attract long-term investment and fix its informality problem.
