Development problems in an export economy

Peru is one of the leading examples of a primary-product export economy which has failed to achieve a high level of economic development. In this study, two alternative explanatory models of such development failure are tested against evidence drawn from Peru's experience in the 1920's (the culminating decade of a cycle of export growth which began in the 1880's and was brought to a close by the world depression of 1930).
The first of the models is drawn from the mainstream of orthodox writing on development. Integration of an economy into international commodity and capital markets is viewed as a positive step towards development, and failure to achieve development is therefore explained by appeal to special obstacles which prevent the working-out of market forces. A variety of such obstacles may be proposed, of which three possibilities are particularly relevant: the absence of a dynamic, responsive elite to initiate and guide a development process; a binding scarcity of capital; and an inability of the local economy to adjust to the technological requirements of development. Because of the existence of such obstacles, the argument runs, the impulse towards growth and modernisation given by integration into the international economic system fails to spread much beyond the export enclaves. Foreign factors of production (particularly capital and technological skills) supplement scarce local factors and thereby increase the strength of the forces working towards development; but in the final analysis development can proceed only as fast as the obstacles are overcome.
The second, opposed, model of development failure suggests that market forces themselves work in such a way as to erode the local economy's capacity for development. Integration into the international economy, it is suggested, leads to economic retrogression rather than development, and may destroy a viable pre-existing capacity to generate development. Foreign capital enters the local economy not to fill gaps in its resource endowment, but because of market imperfections. Local enterprises are destroyed and local factors displaced by the process of investment by international firms. As a growing proportion of capital formation takes place in foreign-controlled, rather than locally-controlled, enterprises, the domestic economy's capacity to mobilise and allocate capital falls, and under-employment of local factors increases. Opening the local economy to international market forces also opens for the domestic elite the option of abandoning an entrepreneurial function, and converting themselves into client allies of foreign interests - a 'comprador' class, without commitment to the development of the broader national economy. The State participates also in this process of decay.
The thesis of this study is that Peru's experience in the 1920's fails to correspond to the first of these two models, but yields some evidence favouring the second. In Chapter 1, four central issues in the debate are identified, and hypotheses derived from them are then tested in the six subsequent chapters. The four areas selected for investigation are the following:
(i) Were there binding factor constraints which ruled out a self-sustaining development process? Attention focusses here particularly on the question whether there existed a 'savings gap', and whether the native elite may have been incapable of meeting the organisational, technological and psychological requirements of a development model.
(ii) What is the effect upon income levels and development prospects of the process of foreign direct investment in primary-product export sectors? In particular, does foreign direct investment supplement the local economy's supply of scarce factors, or displace native factors of production from efficient employment?
(iii) Does the Government perform satisfactorily as a regulating and bargaining agent, seeking to capture for the host economy the maximum possible gains from export growth in a context of foreign direct investment? The debate here hinges upon the question whether apparent failures of the Government in this role should be attributed to 'softness' or to deliberate policy.
(iv) What is the effect upon native enterprises of a process of denationalisation of leading export sectors? The key question here is whether local capital and entrepreneurs displaced from activity in one sector by the arrival of foreign capital were subsequently reallocated towards productive employment in other sectors of the economy, or instead withdrew from active employment or were allocated into activities whose contribution to development was relatively slight.
Chapter 2 describes the historical background to the Peruvian economy of the 1920's, indicating that the period since the 1880's had been anything but stagnant. Peru was able, using only local factors of production, to initiate a successful export-led growth process in the late nineteenth century, with important spread effects to other sectors. The country's integration into the international economy, however, quickly opened it to the entry of large international firms, which were welcomed by much of the local capitalist group, and which dominated the economy by the 1920's.
Chapter 3 looks more closely at the capability of the native elite, and establishes that the entry of foreign capital was not dictated by any inability of the local economy to mobilise capital or to apply and develop technology, but occurred rather because of differences between foreign and local firms in the perception of risk and calculation of future earnings; of these, the first appears more important. Development along the lines already begun in the 1890's, the chapter concludes, could have been sustained under the control of domestic firms, given the application of appropriate government policy, and continued expansion of export opportunities abroad.
Chapters 4 and 5 are devoted to a more detailed evaluation of the contribution to Peru's development made by the two leading foreign firms, which between them accounted for over half of the country's total export earnings by 1929. The methodology used is adapted from the recent UNCTAD studies of foreign direct investment in manufacturing, and hinges upon the comparison between the actual income effects generated by the foreign firms in practice, and the effects which could reasonably have been expected in the case of local control of those sectors in the absence of foreign capital. In both cases, the conclusion reached is that the net contribution of foreign capital was negligible or negative.
Chapter 6 takes up the issue of government policy formation, asking why, if Peru was deriving so little advantage from the presence of foreign capital, the Government did not regulate the foreign firms more stringently. The enquiry takes the form of a detailed case study of the relations between the Government and the largest foreign firm, the International Petroleum Company. The main conclusion is that the Government was an effective and generally skilled regulator and bargainer within the goals which it set itself; but that those policy goals were certainly not optimal from the standpoint of national development. Rather, the Government tended to embody narrow group interests - particularly the interests of Government itself.
Since the entry of large amounts of foreign capital in the early twentieth century displaced local entrepreneurs and capital from several export sectors, Chapter 7 considers the possibility that these factors of production might have been reallocated towards other sectors of the national economy, initiating dynamic growth there. The conclusion reached is that, on the contrary, the transfer of much of the export economy to foreign control coincided with the end of dynamic development of Peruvian manufacturing and the beginning of a swing towards capital flight, conspicuous consumption, and property speculation as the main activities of the domestic elite. Exports in the 1920's ceased to function as an engine of growth, and only a partial substitute was provided by the huge programme of Government foreign borrowing during the decade. The Peruvian development process which had begun in the 1880's had come to a full stop by the mid-1920's - five years before the onset of world depression.
The argument is not, however, that this conspicuous development failure should be blamed solely on the operations of international firms. Two other elements in the situation emerge as significant. The first is the failure of the host-country government to assert the national interest (if national interest is defined as a maximum Peruvian share in the gains of export industries) against the international firms - a failure which must be understood not as a manifestation of incompetence, but as a deliberate policy decision.
The second point is that, although the presence of international firms in Peru had negative net effects, it cannot be said with certainty that the country's evolution would have differed fundamentally in the absence of foreign capital. The level of national income at the end of the 1920's would have been somewhat higher, and the national economy would have been better-integrated, but in the absence of effective regulation by government, it is not necessarily true that the native elite would have carried the country into a development process of sufficient magnitude to raise it out of its underdeveloped status. The fact of operating in an open economy, exposed to the influences and opportunities of the international system, might instead have led the Peruvian elite down the path followed in fact by Bolivia, Peru's neighbour, rather than along the road of national capitalist development. The study concludes, thus, on a note of scepticism concerning the long-run viability of export-led growth models in the absence of a strong State genuinely committed to national economic development.