New strategy helps Peru's workers move into the formal economy under state regulation

Economists have various ways of defining and measuring informality. According to the government think tank National Centre of Strategic Planning (Centro Nacional de Planeamiento Estratégico, CEPLAN), the informal economy includes any economic activity conducted outside of the reach of state regulation. The informal sector is also described as all economically productive units that are not registered with the tax agency, the National Superintendency of Customs and Tax Administration (Superintendencia Nacional de Aduanas y Administración Tributaria, SUNAT).

Economic Mainstay

A large number of primary production units in the agricultural, fishing and mining sectors are considered to be part of the informal sector. Informal employment also includes that which neither pays taxes nor receives formal benefits, such as social security. Most self-employed workers are considered to be part of this category. According to CEPLAN, a positive aspect of the informal economy is that it provides employment for people who would otherwise have no financial support. However, it also has negative implications for tax revenue and the funding of social services.

According to a March 2016 CEPLAN study, in 2013 almost one-fifth of total GDP, or 19%, originated in the informal sector. Over a decade-long period, non-agricultural informal employment fell from 75% of the total workforce in 2004 to 64% in 2013. Despite this reduction, Peru remained among the Latin American and Caribbean countries with the highest proportion of informal employment. A separate academic study conducted at the Pontifical Catholic University of Peru in 2014 suggested that 73.8% of the total workforce, had worked informally. CEPLAN projected that based on current trends 6% of GDP would originate in the informal sector by 2050, and informal employment in the non-agricultural sector would total nearly 30%. A typical informal worker might be female, young and self-employed. Informal working is most prevalent in certain industries such as agriculture, transport, construction and commerce. Most informal work is undertaken by individuals with a lower income work, although it is not uncommon among high-income individuals.

Out Of The Shadows

After taking office in July 2016, the government of President Pedro Pablo Kuczynski made clear that a key part of its strategy for growth would be reducing informal economic activity. A presentation by the Ministry of Economy and Finance (Ministerio de Economía y Finanzas, MEF) at a business forum in Lima in August 2016 laid out the rationale for the new strategy. The ministry noted that despite a recovery in mining GDP, which had begun to accelerate after the second quarter of 2014, and in overall GDP, which bottomed out shortly before the second quarter of 2015, Peru still had a “two-speed economy”. The slower speed was aggregate private sector demand, which had not recovered as strongly and had remained comparatively weak through 2015 and 2016. Private sector investment had also been weak since mid-2014.

The economy’s growth potential had therefore dropped from 6.4% per annum during the 2004-10 period to an estimated 4% per year for 2016-21. Total factor productivity – which is defined as the contribution of technology and innovation to increasing outputs from capital and labour – had turned from positive in the 2001-15 period to negative in 2016 and was expected to remain at zero throughout the 2017-21 period. There was, therefore, a need to kick-start a new process of structural economic reforms to once more raise the country’s long-term growth rate.

The MEF noted that according to international studies, countries with higher GDP per capita tend to have a lower proportion of self-employment or informality in their workforces. While the World Economic Forum ranked Peru 12th globally in terms of macroeconomic stability in 2015, it was ranked 43rd in terms of reliance on self-employment. The countries least reliant on self-employment, ranking first and second globally, were Estonia and the US. They also had the lowest proportions of self-employment in the world. The MEF estimates that no less than 73% of the Peruvian workforce is informal, a proportion that has decreased only marginally from 80% in 2007. The vast majority of Peruvian companies, or over 90%, remain small, with less than five members of staff, low productivity and a low capacity to create employment.

Plan In Place

To change this situation, the MEF has proposed a three-pronged strategy for 2016-21 that focuses on reducing barriers to formalisation, improving access to and quality of public services, and building a pro-formalisation regulatory framework. In discussing the first of these, the ministry acknowledged that the existing tax structure disincentives formalisation. According to the MEF, value-added tax (VAT) and income tax evasion are running at 31% and nearly 50% of total tax liability, respectively, which are among the highest tax evasion rates in Latin America.

Making taxes simpler and easier to pay is expected to encourage formalisation. Under the second pillar of the strategy, the MEF argued that the advantages of formalisation needed to be increased by making the benefits side of the equation more attractive. This would involve greater health care and education provisions and raising investment in infrastructure. Finally, under the third focus of the state’s formalisation priorities is a series of institutional measures to strengthen the rule of law, increase financial inclusion, deepen financial markets, develop business training and generally promote good governance.

Wider Net

In early 2017 the debate on how to reduce informality was ongoing, and further government measures were under consideration. One analyst, Jaime Dupuy, economic research manager and business consultant at the private sector Association of Foreign Trade of Peru, told local press that there was a kind of “valley of death” that small and medium-sized firms faced when making the difficult transition to paying taxes, becoming formal and eventually evolving into larger enterprises. The current government has also suggested a solution known as 10 for 10: allowing smaller companies that start paying taxes to pay a reduced 10% VAT rate for their first 10 years of operation. At present there is an option for a reduced 10% VAT rate, but it is linked to revenue levels, rather than specifically to formalisation. In any case, Dupuy also said, “One single measure is not going to formalise all economic activity in this country.”

In 2016 the government was expected to launch further initiatives to tackle informality in the labour market. In February 2017 Alfonso Grados Carraro, minister of labour, told local press that preliminary discussions had begun with employers and trade unions and would be expanded to include political parties, with a view to presenting draft legislation to Congress in July 2017. The aim was to facilitate and reduce costs at each stage of what the minister called the employment cycle, meaning the process of hiring, developing and training staff, and eventually terminating employment contracts. Grados also said there were no less than seven sets of regulations affecting the employment cycle, each adding a layer of extra costs and none encouraging formalisation. The aim of the legislation would be to cut costs without reducing employee benefits.

Sector Specific

Officials are also focusing on the need to reduce informal employment in mining specifically. A large number of people, estimated to be as high as 100,000, earn a living from illegal, small-scale mining ventures. Starting in January 2017, the government is offering a three-year period for miners to obtain land titles and meet legal requirements, such as registering with SUNAT and paying taxes. As with other areas of informality, analysts said the task of persuading small miners to register is complex and will require a number of additional initiatives. One idea mentioned during the 2016 election campaign was the creation of a mining bank, a financial institution dedicated to offering credit and financial services to small-scale miners.

The government also indicated that it was preparing incentives to encourage the formal employment of young people. The issue is politically sensitive given that the previous government’s attempt to introduce the youth employment law, Ley de Régimen Laboral Juvenil del Perú, also known as the Ley Pulpín, was a high-profile failure. Although approved by Congress in December 2014, after a wave of protests it was repealed in January 2015. That law was heavily criticised for reducing young peoples’ employment rights. According to officials, a new attempt to legislate will offer employers incentives to encourage formalisation without reducing employment rights for those between 18 and 29 years of age. Germán Lora, an adviser at the Ministry of Labour and Employment Promotion, said the proposed law would cover first-time employees and those who had been unemployed for six months. One incentive under consideration was to exempt firms who employ young workers from having to pay the 9% tax for the public health fund. The proposed law would also have safeguards in place to prevent companies firing older workers to replace them with younger staff.