2. Boosting long-term growth

Michael Koelle

Abstract

After two decades of strong economic performance driven mainly by commodity exports, growth has significantly decelerated. A fresh push for productivity and investment growth will need to be sustained by a broad-based, innovative, and competitive business economy. This requires structural reforms to make markets more competitive and innovative, strengthening the rule of law and the implementation capacity of the state. Strengthening competition enforcement, fighting corruption, modernising the civil service, and increasing judicial independence and efficiency are priority areas for improving the business environment and public infrastructure. Implementing these reforms would put Peru on a sustainable growth path to raise living standards for all.

Introduction: Peru’s long-term growth challenges

Peru has experienced significant economic growth over the past few decades and has been one of the fastest-growing economies in Latin America. Between 2002 and 2019, the economy grew around 5.1% each year, on average, and GDP per capita more than doubled. This facilitated a convergence of living standards towards regional and OECD averages. After a “lost decade” in the 1980s (Figure 2.1) – with hyperinflation, default on mounting foreign debt, a financial crisis and a deep recession – investment and productivity recovered thanks to economic stabilisation and structural reforms, and an increasing focus on institution-building with the return to democracy in 2001. Sound macroeconomic policies, openness to foreign investment and trade, and some of the richest mineral deposits in the world put Peru in a position to benefit greatly from the global commodities boom of the late 2000s. Growth was then driven largely by mining investment, but also spilled over to other sectors such as construction and services. Peru joined the group of upper-middle income countries in 2008 (OECD, 2015[1]).

Figure 2.1. Growth surged with the commodity boom, then decelerated

However, Peru’s growth decelerated after 2014 with the end of the commodities super-cycle. GDP growth dropped to about 2.5% per year, and growth of GDP per capita to 0.8%, below both the regional and the OECD average. This led to a gradual erosion of the earlier achievements in bringing standards of living closer to more advanced economies (as discussed in Chapter 1). Just before the pandemic, in 2019, per-capita GDP in Peru, adjusted for price differences (PPP), amounted to less than 30% of the average OECD country. The pandemic, which led to a larger drop in activity in Peru than in most other countries, caused a further setback in income convergence, and hit the poorest very hard (Chapter 3).

Boosting long-term growth in a sustainable way is essential to achieve lasting improvements in living standards and in reducing poverty and informality. This requires a revitalisation of productivity and investment growth under less favourable global economic conditions than in the 2000s. The prolonged low growth episode further shows that the previous drivers of growth – an expanding labour force, capital accumulation, and the commodity exporting sector – have become insufficient to sustain further socioeconomic progress (OECD, 2015[1]). Growing the economy towards high income levels will require boosting productivity through more competition, innovation, and a better allocation of resources; and restarting public and private investment in increasingly diversified and higher value-added sectors.

Peru’s dual economy, fuelled by high rates of informality, constitutes a drag on growth. Few large firms with high labour productivity coexist with a large low-productivity informal sector composed mostly of small firms that employ about 75% of all workers (see Chapter 3). Both the size of the informal sector, and the productivity differences between large and small firms, are particularly high in Peru, dampening aggregate productivity (World Bank, 2022[2]). At the same time the high cost of formality, which is caused by a mix of overly strict regulations and a lack of effective enforcement, incentivises informal firms to stay small and unproductive (Ulyssea, 2018[3]). This creates a vicious cycle in which pervasive informality becomes the norm.

Moving towards a high-income economy based on knowledge and innovation sustained by a broad base of productive and formal firms requires a new set of enabling conditions. Previous rounds of reforms largely focused on a small number of public institutions that became “islands of efficiency” (Guerra Garcia, 1999[4]) to guarantee favourable framework conditions – such as macroeconomic stability, access to capital, and regulatory predictability – to the relatively small formal economy especially in the commodity sector. However, a business environment that sustains the development and productivity growth of a much broader and diverse share of the economy requires significantly wider reforms.

The next section sets out priority areas for reform based on an analysis of Peru’s business environment. The remainder of the Chapter then discusses in turn these areas and presents detailed recommendations for reforms: promoting competitive and innovative markets, strengthening the rule of law, and improving state capacity for public investment and service delivery.

An analysis of Peru’s business environment

Peru is highly regarded internationally for its macroeconomic stability and trade openness (Figure 2.2). This reflects its solid economic institutions with their strong reputation for sustainable and prudent fiscal policy, an independent central bank, and a sound financial regulation framework and well-regarded financial supervision authority. These arrangements have kept debt low and have contributed to the accumulation of substantial foreign currency reserves which underpin the country’s commitment to free capital flows. Moreover, Peru has put in place strong protections for private investment, including regulatory and fiscal stability agreements with investors.

Figure 2.2. Peru stands out for macroeconomic stability and trade openness

Peru has pursued a policy of systematic economic opening including trade liberalisation. Tariffs are among the lowest in the region, similar to Chile. Peru is an integral member of various regional trade alliances such as the Pacific Alliance, the Andean Community, and APEC and a signatory to 24 bilateral and multilateral free trade agreements. Exports of goods and services have grown faster in Peru than in any other peer country in the region in the last two decades (Figure 2.3). This has brought trade penetration to 47% of GDP in 2019, which is about the LAC average, but above other South American countries including Argentina, Brazil and Colombia that are at similarly long distances from global economic centres. However, although expanding into non-traditional agricultural trade has met with success, exports are highly concentrated in commodities, mostly to China (see Chapter 1), calling for a gradual diversification of exports and an upgrading of Peru’s position in global value chains.

Figure 2.3. Goods and services export growth is highest in the region

Despite these clear strengths that have underpinned Peru’s strong growth until recently, the overall competitiveness of its economy lags behind OECD countries, including peer countries in the region such as Chile, Colombia, Costa Rica and Mexico (Figure 2.4, Panel A). Among the different factors that drag down the business environment, two areas stand out. First, burdensome regulations and low competition reduce market dynamism, discourage investment, and limit innovation and creative destruction, the bedrock of productivity growth (Figure 2.4, Panels B and C). Perceptions of a high burden of government regulation likely reflect a combination of factors: excessive regulatory complicance costs, poor regulatory quality, and weak and uneven enforcement. High market dominance reflects high concentration in many industries.

Figure 2.4. Restrictive regulations, limited competition, and weak institutions harm the business environment

Second, the weakness of the rule of law reduces the attractiveness of Peru’s business environment. A strong rule of law is supposed to not only protect private parties from arbitrary action and infringement of property rights by the state, but also to ensure a level playing field for economic interactions between private parties. It provides for security of property rights and contract enforcement (Acemoglu, Johnson and Robinson, 2001[6]; Johnson, McMillan and Woodruff, 2002[7]), necessary incentives for private sector investment and innovation. However, in Peru, high corruption and an unpredictable and inefficient judicial system result in weak de facto property rights, as perceived by the business community (Figure 2.4, Panel D). The poor efficiency of the legal framework in settling disputes (Figure 2.4, Panel E) limits businesses’ willingness to bear the risk of, for example, contracting with unknown business partners, or hiring formal workers given high legal uncertainty about the interpretation of strict employment protection regulations. Such risks arguably constitute a larger deterrent on potential market entrants due to their lack of information, experience, and contacts to navigate the Peruvian business environment, thus contributing to low market dynamism and competition. Evidence from the OECD long-term model shows that a stronger rule of law would have particularly large effects on boosting long-term growth (Chapter 1).

Finally, Peru’s competitiveness is set back by the poor quality of its infrastructure (Figure 2.5, Panel A). Despite significant investments and considerable progress in the past decade, which saw important roadbuilding and upgrading especially of national trunk roads, a sizeable infrastructure gap remains. Poor roads limit the access to domestic and international markets for producers in many regions, especially in the Andes and the Amazon. The few existing railways largely serve to transport mineral ore from highland mines to the sea. Congestion along main trade arteries and in the Lima metropolitan area – which hosts the most important air and sea ports for international trade – increases transport times and costs; as do inefficiencies and bottlenecks in the logistics chain. Poor quality of schools and hospitals, and limited coverage of mobile and fixed line broadband, hold back improvements in human capital. The main constraint to building more and better public infrastructure is the low implementation capacity of the state (Figure 2.5, Panel B). Policy implementation in Peru is hampered by limited coordination across institutions and levels of government, a fragmented civil service with weak human capital and high turnover, high corruption, and diffuse incentives and weak accountability of public officials. More generally, insufficient state capacity is a key constraint to creating a favourable institutional framework that promotes an innovative and diversified business economy (OECD, 2015[1]; World Bank, 2022[2]; IMF, 2022[8]).

Figure 2.5. Weak state capacity hampers implementation of projects to close the infrastructure gap

Based on this analysis of Peru’s business environment, this Chapter proposes recommendations for reforms to boost the economy’s growth potential; whenever possible informed by prior work of the OECD with Peru. The next section discusses how to make markets more competitive and innovative: through stronger competition policy, administrative simplification, better regulatory policy, financial inclusion, R&D policy; and by better harnessing Peru’s trade openness to foster greater innovation and diversification. The following section proposes two key ways to strengthen the rule of law and thereby create a more predictable legal and regulatory environment: reforming the judicial system and enhancing efforts to fight corruption. The final section deals with how to make the state a more efficient champion of public investment and high-quality public services. Implementing the civil service reform is key to this, complemented with reforms to strenghten public procurement, multi-level governance and coordination, and modern public sector project management and finance. Other factors that matter for growth including skills, education and training, and labour market reforms are discussed in Chapter 3.

Promoting competitive and innovative markets

Fostering competitive markets with effective competition policy

Peru has a thriving private sector, with many internationally competitive companies. Its competition regime is active and generally in line with internationally recognised standards and practices; The strong and established competition authority, Indecopi, is well-regarded both domestically and internationally (OECD, 2018[9]). Indecopi has the authority to enforce competition law in all economic sectors except telecommunications, which is under the competence of the sectoral regulator OSIPTEL.

The introduction of a general merger control scheme in 2021 was an important step forward for promoting competition. Merger control regimes are now in place in most Latin American jurisdictions (OECD, 2022[10]). Under the new regime in Peru, mergers and acquisitions of firms with combined turnover above about USD 130 million require an explicit ex-ante notification, examination, and authorisation by Indecopi. Previously, merger control existed only in the electricity sector. In 2022, Indecopi received 20 merger notifications in the regime’s first full year of operation.

However, many markets in Peru are dominated by a few large business groups, resulting in high concentration and low perceptions of competition (see Figure 2.4, Panel C above). High market concentration is prevalent especially in consumer-facing industries and products such as beverages and dairy products (Box 2.1). It is also reported from upstream products and industries such as steel and cement (Durand, 2017[11]). In addition, many companies with large shares in individual markets including pharmacies, retail chains, and banks are part of a conglomerate (Salazar Vega, 2017[12]). High concentration limits the number of competitors in a market and as such gives firms market power which can lead to higher prices and less innovation into product quality and differentiation. This has negative effects on the purchasing power and welfare of consumers. In addition, limited competition in upstream sectors can lead to distortions and productivity losses down the value chain (Bourlès et al., 2013[13]).

Market concentration is partly the result of consolidation and mergers that took place in the years before the only very recent introduction of the general merger control scheme. Indeed, some firms’ dominant market positions resulted from high-profile mergers just before the scheme entered in force. In one prominent example, the merger of the two largest pharmaceutical retail groups, with a combined market share of over 80%, occurred just two years after Indecopi sanctioned price-fixing of the same companies. Other factors, such as the relatively small market size in purchasing power terms, and the high level of informality, discourage the entry of new firms that could compete with large incumbents.

Box 2.1. Measuring the degree of competition in Peru

Evidence on the degree of competition in Peru is scarce, despite widespread perceptions and anecodotal accounts of high concentration. Available data is limited to perception surveys (e.g. by the World Economic Forum) or to empirical studies of individual industries, such as in Indecopi’s market studies. By contrast, comprehensive comparable empirical evidence on industry concentration is available for advanced ecomomies in Europe and North America (De Loecker, Eeckhout and Unger, 2020[14]; Gutiérrez and Philippon, 2018[15]; Bajgar et al., 2023[16]) as well as for other countries in Latin America (Eslava, Meléndez and Urdaneta, 2021[17]).

Results from empirical work for this Survey suggest a high degree of concentration in several Peruvian industries (Figure 2.6). Concentration is measured as the share of value added of the four largest firms in each industry, defined at the 2-digit level. The analysis is based on firm-level data from the 2019 Annual Economic Survey. Participation in the survey is compulsory for large companies, ensuring adequate representation of the largest firms in each industry. However, as coverage of small firms is limited, information on total industry value added from the survey is complemented with information from national accounts.

Figure 2.6. Concentration is high in several industries

Concentration is particularly high in industries that manufacture basic consumption products such as dairy, beverages, and cooking oil, or provide essential services such as telecommunications (Figure 2.6, Panel B). Such products have limited international competition and few domestic substitutes. Therefore, high concentration has a larger potential to limit competition, leading to higher prices for consumers. By contrast, industries such as construction, food and accomodation, and trade have low concentration, reflecting the presence of many competitors in these sectors.

Source: Garda, Koelle and Ugarte (forthcoming), “Industry Concentration in Peru”. Technical Background Paper.

Given the high legacy concentration in some markets, effective competition policy that enforces rules concerning cartels and abuse of dominance, as well as competition advocacy, are particularly important in Peru. Competition policy is the competency of Indecopi. The structure of Indecopi is unusual in that it combines both a competition branch (with about 50 staff) and a much larger branch dealing with consumer protection, unfair competition and trade practices, and intellectual property rights (with about 1,300 staff). Indecopi hosts the OECD Regional Centre for Competition in Latin America, which provides training and policy advice for competition experts, regulators and judges in the region.

While Indecopi has an independent legal status, an established institutional track recordpublic recognition, and enjoys high functional, technical, budgetary and administrative autonomy, the legal framework governing appointments to senior roles could be strengthened in order to safeguard the institution against the risk of political interference, given the significant economic interests at stake from its decisions. This has been previously recommended by the OECD (OECD, 2004[18]; OECD, 2018[9]). Specifically, formal procedures should ensure that senior recruitment processes are merit-based, open, staggered, and delegated from the government to a broad-based independent selection committee. The politically appointed board should have no authority over staff assignments.

The risk of price-fixing and other forms of cartel behaviour is higher in more concentrated markets, especially in oligopolies with a small number of similar-sized firms (World Bank, 2021[19]). Indecopi actively engages in enforcement against collusion (cartels) with several detected and sanctioned cases each year, but could be more active in other areas such as abuse of dominance. The fact that Indecopi has sanctioned multiple cases of abuse of dominance each year since 2021, after a 15 year break in imposing such sanctions, is a positive signal in this direction.

Many competition authorities have the power to impose remedies either as a condition for approving a merger or as a sanction of anti-competitive practices. Peruvian competition authorities can impose both behavioural remedies (e.g. compliance programmes), which are frequently used, and structural remedies, including structural separation or divesture orders. Indecopi has so far not imposed any structural remedies (such as divesture of certain assets or business lines) but is in principle in a position to do so. Several countries, including the United States and many European jurisdictions, have made strategic use of structural remedies to break up historically grown quasi-monopolies. However, it should be noted that the imposition of structural remedies outside of merger control (where they are applied regularly as a condition for merger authorisation) is rare and generally seen as a last resort, reflecting the substantial interference in private property rights that this would imply (OECD, 2022[20]).

Indecopi could consider increasing the number of market studies it conducts and publishes. Market studies are very valuable, especially in the Peruvian context of high legacy concentration, because they inform authorities on market functioning, competitive dynamics, regulations that facilitate anti-competitive behaviour or hinder market entry, and can even reveal indications of potentially anticompetitive behaviour (World Bank, 2021[19]). Several of Indecopi’s proceedings against anti-competitive behaviour were catalysed by the evidence and intelligence obtained from a market study. Market studies further signal vigilance and transparency to market participants, discouraging anti-competitive practices. They also contribute to fostering a competition culture among stakeholders and the general public (OECD, 2018[9]). According to Indecopi, 14 market studies were published between 2015 and 2022 – about 1.5 per year on average, compared to regional and OECD averages of 2-3 per year.

The resources dedicated to Indecopi’s competition branch seem insufficient to perform its required functions. With 46 staff, or about 1.4 per 1 million inhabitants, the competition division is significantly smaller than the average competition agency in the region (4 per million) and the OECD (9 per million) (OECD, 2022[10]). In addition, members of the commission that decides on cases elaborated by the technical secretariat only work part-time, which hampers specialisation and professionalisation of their role and also poses risks about their independence. While the competition branch’s budget increased by 60% to cover the additional responsibility of ex-ante merger review, its budget per staff member (around €50,000) is still only half of the Latin American and a third of the OECD average. Unlike other specialised economic institutions – such as the central bank and banking supervisor – Indecopi’s salaries are not detached from the general public sector pay scale. This creates difficulties for attracting and retaining highly qualified, specialised staff.

An adequate resource mix involves both own resources raised by Indecopi, and transfers from the central government. Between 2014 and 2022, Indecopi relied entirely on its own income for funding, about half of which is raised from fines, and the remainder from other user fees (especially in the non-competition branches). While directly raised income supports Indecopi’s independence, the high reliance on fines for its income potentially creates perverse incentives for Indecopi. In addition, such resources can be highly volatile, and driven by fines of a few large-scale infringement cases. In most OECD countries, competition agencies are funded from general public revenues. In countries where they are (partly) self-funded, agencies typically rely on a mix of sources, such as merger filing charges (e.g. Canada, United States), earmarked portions of corporate tax revenue (e.g. Italy, Türkiye) or transfers from sector regulators (e.g. Portugal). In 2023, the Ministry of Finance again agreed to a contribution from the general public budget. A recurrent annual transfer from the general budget, which provides Indecopi with a long-term stable and predictable income source, would help support a more strategic and long-term approach to its broad mandate, including competition enforcement and advocacy.

Reducing compliance costs with regulation

Product market regulations are more competition-friendly in Peru than in Latin America on average, but still more restrictive than in the OECD as a whole, suggesting room for improvement (Figure 2.7, Panel A). This is especially true with regards to the administrative burden on obtaining licenses and permits for start-ups (Figure 2.7, Panel B). These can constitute a barrier for setting up a formal firm, and push entrepreneurs either to the informal economy or prevent them from entering the market. Easing business licensing is therefore a key element for reducing compliance costs with regulation.

Figure 2.7. There is room to make regulations more competition friendly

Peru has enacted several reforms to streamline business licensing in recent years. Remaining barriers to starting a business are largely due to delays and complexities in obtaining municipal operating and construction licenses and permits, with significant differences in the process across municipalities (World Bank, 2022[2]). Recent legal changes that mandate the use of a standardised procedures for certain local administrative processes has been slow to implement (CPC, 2022[21]). The use of a pre-existing online platform for business registration (SID-SUNARP), which simplifies some but not all of the procedures to start a business, has seen a sharp spike during the early months of the Covid-19 pandemic, and has stayed high since. However, despite these improvements, currently there is no one-stop shop for starting a business, unlike for example in Chile or in Colombia. There are different models of one-stop shops, for example in Mexico, Spain and Sweden, that integrate national and sub-national procedures (Box 2.2) and which could provide useful examples for Peru.

Box 2.2. One-stop shops for starting a business

In Mexico, although a national one-stop shop for starting a business does not yet exist, some sub-national governments, including the capital district and the state of Yucatán, offer fully digital one-stop shops that integrate municipal, regional and national procedures. The one-stop shop in Yucatán further covers land transactions and building permits.

In Spain, CIRCE is a a one-stop shop run by the Ministry of Industry, Commerce and Tourism directed at small businesses, both for starting a business and for various administrative tasks of operating businesses. CIRCE offers a single online platform that interacts with other government agencies, such as social security. There is an integration with participating municipalities to apply for local licenses.

In Sweden, the one-stop shop verksamt is run jointly by the employment agency, companies registration office, tax agency, and agency for economic and regional growth. It integrates information and information on public support available for entrepreneurs, both on business operations such as finance and accounting and on personal matters such as pensions.

Source: Verksamt; CIRCE; and OECD (2021): “OECD and the Government of the State of Yucatan launch the Digital Window for investment": https://www.oecd.org/gov/regulatory-policy/oecd-and-yucatan-launch-the-digital-window-for-investment.htm.

Ill-designed regulations reduce incentives for firms to grow and become more productive. Two kinds of regulations, discussed elsewhere in this Survey, stand out. First, the design of the corporate tax system, with multiple corporate tax regimes for small businesses, provides incentives for firms to remain small (see Chapter 1). Firms subdivide into smaller units, a clearly less efficient form of organisation, to benefit from more favourable tax regimes. Unifying these corporate tax regimes, as recommended in Chapter 1, would improve incentives for successful businesses to grow, and to achieve higher productivity via corporate efficiency gains. Second, Peru’s high labour informality lowers productivity through weak incentives for human capital accumulation, for example via on-the-job training (Jaramillo and Escobar, 2022[22]) High informality also harms competition in Peru, as in other countries in Latin America (Eslava, Meléndez and Urdaneta, 2021[17]), since it reduces the number of formal (and relatively large) firms that operate in each market, as informal firms’ non-compliance with costly regulations and taxes constitutes unfair competition against formal firms. Strict labour legislation, in particular a regulation that mandates reinstatement of a worker following an unfair dismissal, as deemed by a labour court, reduces incentives to hire permanent, formal workers (see Chapter 3). Such a reinstatement regulation is uncommon in OECD countries, and given the shortcomings of the judicial system it heavily relies on (see below), might constitute an unnecessary barrier.

More generally, there is an established mechanism to review and eliminate excessive regulations, through a specialised commission for the elimination of administrative barriers in Indecopi’s non-competition branch. The commission can scrap requirements, fees, and restrictions codified in regulations or administrative practice that unlawfully or unreasonably hinder entry into or exercise of economic activity. Cases are brought to the commission either by interested parties and the general public, or are investigated ex officio by Indecopi, including through their regional offices. This is a powerful mechanism, and the commission successfully eliminates about 670 bureaucratic barriers per year; and in addition provides incentives for entities to voluntarily review and eliminate more administrative barriers before they are even brought to the commission (around 6,000 a year). The mechanism could be further strengthened by reforming the strict professional requirement on local government attorneys to appeal every case without due regard to merit. While a decision by Indecopi continues to be in force during the appeals process, such automatic appeals are costly and add to regulatory uncertainty. According to Indecopi, most of its decisions are upheld in the final instance. The introduction of systematic monitoring of decisions regarding the elimination of administrative barriers, a new permament consultive commission on regulatory quality, and a significant increase in training for public officials on administrative burdens are welcome recent improvements. However, the resources of the commission and its technical secretariat have been recently strained by a large increase in cases; an increase in resources should be considered. Public-private workshops of sectoral dialogue (mesas de trabajo) are another mechanism used in Peru to identify regulatory and administrative bottlenecks.

Authorities could go one step further and adopt to a larger degree strategic approaches to reviewing potential administrative barriers, with a view to positively fostering competition. For example, Colombia, with technical assistance of the OECD, undertook a systematic review of regulations in the beverages sector, which gave specific recommendations to eliminate or replace regulations (DNP, 2022[23]). Similarly, Chile, Australia, and Portugal carried out extensive mapping of licenses procedures in strategic industries and their effects on investment and firm expansion, which in each case led to regulatory simplication reforms (Cavassini et al., 2022[24]). In Peru, such regulatory sector reviews could be systematically integrated into Indecopi’s market studies, which already give recommendations on the market conduct of private firms and public entities. Indecopi currently receives technical assistance from the World Bank Group to review competition in selected sectors at the regional level. The ongoing development of a National Competition Policy, the planned review of “administrative chains”, as well as the future implementation of ex post regulatory impact assessments, provide additional opportunities to anchor such strategic approaches. It will be important to ensure these new developments are complementary to and interact with Indecopi’s commission. More broadly, the experience of some OECD countries with national productivity boards might be useful to consider for Peru. Such institutions monitor trends, assess policies, and make recommendations for improving productivity and competitiveness (Cavassini et al., 2021[25]). For example, the license mapping exercises in Australia and Chile were carried out by the countries’ national productivity boards, as part of their more general mandate.

Advancing the modernisation of regulatory policy

Peru has made significant progress in its regulatory policy framework in recent years. In line with recommendations of the OECD Review of Regulatory Policy (OECD, 2016[26]), a regulatory oversight body has been established in the Presidency of the Council of Ministers (PCM) and several instruments to improve regulatory quality through more transparency, predictability and evaluation were created in law. These include simplification of administrative procedures, ex-ante regulatory impact assessments, ex-post evaluation, and stakeholder engagement. This is in line with the key principles of the 2012 Council Recommendation on Regulatory Policy and Governance.

The first step towards improving the regulatory policy framework in Peru consisted in conducting a regulatory quality analysis of existing administrative procedures, with a focus on the most prevalent and economically impactful ones. This resulted in a simplification and standardization of many procedures. According to the PCM, the review process will be repeated automatically every three years. This will provide an important mechanism for improving the quality of the stock of existing regulations, especially while systematic ex-post evaluation is not yet actively implemented.

After a transition period, in which they were piloted in a few public entities (i.e., regulatory agencies) with OECD support, in 2022, ex-ante regulatory impact assessments (RIAs) were made mandatory. In the first phase, all primary legislation proposed by 55 public entities of the national government, including all ministries, needs to undergo an RIA. Other central government entities and subnational governments are scheduled to follow such an approach at a later stage. RIA require a comprehensive analysis of the policy problem, an evidence-based evaluation of potential alternative solutions with their economic, social and environmental costs and benefits, and the development of monitoring and evaluation criteria (PCM, 2021[27]). A Regulatory Quality Comission formed by the oversight body of the PCM, the finance and justice ministries provides quality control and evaluates and approves RIA submissions made by ministries. In line with best practices, the commission can return deficient RIAs for revision (OECD, 2021[28]). In May 2023, a new General Law of Regulatory Quality Improvement unified the different legal provisions.

Effective stakeholder engagement is an important component of good regulatory policy, as it establishes a feedback mechanism with those who bear the costs or reap the benefits of regulations (OECD, 2021[28]). Although some form of stakeholder engagements such as pre-publications of legislative proposals have existed before, the full implementation of RIA will make active stakeholder engagement by authorities compulsory. With the introduction of an annual regulatory agenda in 2023, stakeholders will have a better overview and more time to prepare for and engage meaningfully with regulatory proposals. This is a welcome development and should significantly increase stakeholder engagement in Peru.

After these important and positive changes to the policy framework, the challenge is now their implementation in line with best practices, starting with the key central government agencies that participated in the first phase. It is essential for authorities to monitor and reflect on the experiences with the current roll-out of RIA, using the lessons learned for continuous improvement of the process. Peru could also benefit from other countries’ experiences. Mexico, for example, has a well-established and systematic process of RIA and stakeholder engagement that is not only more advanced than other Latin American countries, but is also good practice relative to the OECD as a whole. Mexico’s central online register contains all draft regulations, the completed RIAs, and authorities’ responses (OECD, 2020[29]).

RIAs demand a high level of technical capacity of officials. While the regulatory oversight body has conducted extensive training with officials and offers technical assistance, additional training and capacity-building of entities beyond the centre of government (key ministries close to the executive power, e.g. PCM, Ministry of Finance), might be needed, especially in local governments,. RIAs further rely on extensive data to estimate costs and benefits to various economic actors and social groups, which could create a bottleneck. Given the significant resources and time that the elaboration of a RIA requires, authorities should ensure that their use is proportional to the scope and potential impact of the regulation examined. For example, Mexico and Korea have a requirement for RIA to be proportional to the expected impact of the regulation (see Box 2.3).

Managing such an ambitious reform requires strengthening the Regulatory Quality Comission and providing it with sufficient resources to maintain a high-quality technical secretariat. The secretariat should not only perform quality control but also provide training, technical assistance to implementing authorities, and monitoring and evaluation. While a major independent evaluation of the reform is foreseen after four years, it will be equally important to continuously monitor the rollout of RIA in order to inform any required adjustments and possible improvements, Moreover, the success of the planned evaluation hinges on the availability of adequate statistical data to measure the impact of RIA on firms, citizens, and other stakeholders.

One limitation of the new regulatory policy framework is that it is only mandatory for laws and regulations proposed by the Executive, not by Congress; a situation similar to many OECD countries (OECD, 2021[28]). Members of Congress are served by a secretariat that advises on legal and constitutional aspects of draft bills, but not on budgetary, economic, or social aspects. While each draft bill receives a formal opinion by the competent congressional committee, limited technical capacity reduces this in practice to a check of formal requirements (OECD, 2016[26]). For example, in a sample of draft laws discussed in Congress’ economic commission, 94% did not come with any cost-benefit analysis (CPC, 2022[21]). One option to strengthen technical and analytical capacity is the creation of a congressional economic and social research service. Such a service would be at the disposal of members of Congress, and could be called upon to provide technical expertise and advice. For example, in the United States, the Congressional Budget Office (CBO) – besides its role as an independent fiscal institution (IFI) – provides parliamentarians with independent, non-partisan costing and impact assessments of draft bills (OECD, 2016[30]). In the United Kingdom, the Scrutiny Unit supports parliamentary committees’ assessment of draft bills. It further coordinates selective ex-post assessment of legislation. In Sweden, a similar unit that works closely with parliamentary committees also can commission assessments from external experts.

Box 2.3. Regulatory impact assessments and stakeholder engagement in OECD countries

The practice of RIA in Mexico encompasses the use of threshold tests to perform analyses that are proportional to the expected impact of the regulation. Specialised assessments analyse effects on competition, risk management, trade, and consumer rights, among others. Policymakers have the obligation to respond in writing to comments received during public consultation of regulatory proposals. Responses to the comments are added to the publicly accessible regulatory proposal.

Korea’s 2018 reform of regulatory policy introduced a requirement for analysis to be proportionate to the significance of the regulation. Stakeholder consultation is carried out through different ways including virtual conferences, public meetings, email and letters. Two independent public research centres support cost-benefit analysis, provide guidance and training, and conduct evaluations of regulatory policy.

Source: OECD (2021) Indicators of Regulatory Policy and Governance 2021: Korea and Mexico.

Leveraging financial inclusion and promoting financial competition

Financial inclusion and digital payment technologies can contribute to more competition by improving consumer choice through better information and access to finance, and by bringing more market participants into formal markets and platforms. Cashless payment technologies have been found to improve the competitiveness of traditional retailers and tax compliance in Mexico (Higgins, forthcoming[31]), thus fostering competition and formalisation. Similarly, the rich information on economic transactions inherent in financial technology can shrink the informal economy and illicit financial flows (OECD, 2018[32]). Policy should steer these trends and to ensure that they are beneficial in fostering competition.

Financial inclusion in Peru is low (Figure 2.8). Few Peruvians have access to a bank account, a credit card, or a bank branch. To some degree, this reflects the underprovision of commercial banking services outside larger cities, with many provincial towns only served by the state-owned Banco de la Nación. Unlike other state-owned banks in Latin America, Banco de la Nación does not compete with private banks, but rather handles financial transactions of the state and carries out the implementation of financial inclusion policies by offering basic checking and savings accounts. A digital savings account for every citizen, accessible with only the national identify document (Cuenta DNI) is currently being rolled out, starting with people in poverty or extreme poverty, and has been integrated with new digital payment systems (see below). Low financial inclusion, however, is also a reflection of limited financial literacy, trust in financial institutions, and financial culture, as evidenced by the popularity of early pension fund withdrawals.

The private commercial banking system is relatively concentrated (Figure 2.8, Panel C). This does not necessarily imply that banks have price-setting power in all market segments, as regional credit and savings associations, cooperatives, microfinance institutions, and various non-bank consumer lenders compete in different market segments. The presence of such non-bank financial institutions is larger in Peru than elsewhere in the region (Figure 2.8, Panel B). However, evidence from the small business lending segment in Peru shows that higher concentration among lenders reduces access to finance especially for new potential entrants, leading in turn to higher concentration and lower competition in product markets (Burga and Céspedes, 2021[33]). More generally, banking competition is important for growth by fostering creative destruction (Bertrand, Schoar and Thesmar, 2007[34]).

Figure 2.8. Access to finance lags behind

Payment systems in Peru have traditionally been characterised by a lack of competition, resulting in high interest rates on credit cards and high merchant fees (INDECOPI, 2021[35]). The market was long characterised by vertically integrated acquirers that exclusively handled cards of a single issuer, with Visa (69% of cards) and its acquirer Niubiz (76% of card payments) having the largest market share. In 2020 acquirers switched to a multi-card model, but continue to be vertically integrated with card issuers, which reduces incentives to provide a level playing field. The exponential growth of digital currency wallets during the pandemic has disrupted payments systems in Peru, and increased the share of cashless transactions. The monetary authority, which had laid the regulatory ground for these developments well in advance of the pandemic (Vega and Vásquez, 2022[36]), took appropriate action and mandated the interoperability of digital wallets to foster competition and consolidate the adoption of cashless payments. The developments in this dynamic market should continue to be monitored to understand its competitive evolution and to determine whether further regulatory action is need; to this end the central bank and competition authority could establish a joint information system.

Most payment cards and digital wallet accounts are issued by banks that belong to one of the main Peruvian industrial conglomerates, which have strong footholds in consumer sectors such as insurance, supermarkets, non-food retail trade, pharmacies, and food product manufacturing. This provides conglomerate business groups with access to potentially large amounts of costumer data that can help them gain an advantage against competitors in many markets. Privileged access to data, especially by firms who are in a position of acting as gatekeepers to markets, is at the forefront of competition concerns relating to conglomerates (OECD, 2020[37]) and more generally in digital markets (Nicoletti, Vitale and Abate, 2023[38]; OECD, 2022[39]). These concerns extend to platforms such as delivery and ride-sharing apps, which are very active in Peru. It would be useful for authorities to monitor these markets – such as through Indecopi’s March 2023 market study of the Fintech sector – and to gather information on the extent of the role that proprietary data plays in them, in order to assess possible implications for competition.

Diversifying exports and moving up the value chain

Exports are heavily concentrated in primary goods and commodities (see Chapter 1). Mining, agriculture, and energy make up 85% of all exports. Peruvian soil is rich in mineral deposits, and the country is the world’s second largest copper producer and a leading exporter of gold, silver, zinc, lead and tin. This strong position is the result of both natural advantages and deliberate policies such as the pre-eminence of macroeconomic stability and strong constitutional guarantees for the security of foreign and domestic investment in the form of legal stability agreements that take precedence over legislative changes for an agreed time period. By contrast, free trade agreements play only a marginal role for mineral exports, for which unilateral import tariffs of major importers are already mostly very low.

Such a heavy specialisation in commodities limits the complexity and value added embedded in Peruvian exports. Peru ranks 105 of 130 worldwide in the Economic Complexity Index. It stands on the first rungs of global value chains (GVCs), meaning that a large share of Peruvian exports are processed in other countries into other export goods (i.e. high forward participation in GVCs). This and the fact that China is the largest trading partner means that Peru benefitted greatly from the Chinese export and construction boom (Arnold et al., 2023[5]). The flipside is that the Peruvian economy is also very vulnerable to economic fluctuations in China. This was felt again recently during the pandemic, but also after 2014 when the global commodity super-cycle came to an end (see Section 2.1.).

Gradual diversification of exports and upgrading of Peru’s position in global value chains is a major challenge. While there are some future opportunities especially in copper mining and lithium production, which will be essential for the global green transition, adding more diversified and complex products to the export mix would boost productivity and increase resilience of the economy. There are good experiences in agro-industry, tourism, metal-mechanics, and forestry in Peru that can serve as an example of successful diversification and upgrading of the production structure (OECD, 2016[40]). This would help to create higher-quality jobs and increase incomes, particularly in the manufacturing and services sectors, a major challenge for the Peruvian economy (see Chapter 3). There are succesfull experiences with diversification within the primary sector, where Peru has moved into higher value products in agriculture. The country has become a major global exporter of fresh horticulture products such as asparagus, grapes and blueberries (Box 2.4). In other commodities such as bananas or coffee, Peru moved into premium niches such as fair trade, organic, and single-origin. Peru also grew its services exports, notably in tourism, building on its rich cultural and archaeological heritage and increasing reputation as a culinary destination. However, service exports still account for only 5% of overall trade; a similar share as in other countries.

There is room to harness the openness to both trade and international capital flows to further diversify and upgrade Peruvian exports. Empirical evidence from agricultural export diversification points to the role of several interlinked enabling factors: free-trade agreements open up foreign markets to new products (Mincetur, 2015[41]); strong state institutions such as sanitary and phytosanitary control agencies help exporting firms meet the strict compliance and certification requirements of export markets (Vásquez, 2015[42]); complementary infrastructure such as large-scale irrigation projects lower production and trade costs (Monjarás Saldaña, 2014[43]); as do special tax and labour regimes targeted at the agricultural sector (Castellares and Martinez, 2023[44]); and export promotion agencies help firms establish a foothold in foreign markets (Volpe Martincus and Carballo, 2008[45]). In addition, factors discussed before in this Chapter such as improving transport infrastructure (ports, airports, and their congested feeder roads), strenghtening the business environment, and streamlining regulations would increase private sector incentives to invest in industries with high export potential.

Box 2.4. How Peru became the world’s largest blueberry exporter in a decade

Peru started producing blueberries for the first time in 2010. By 2020 it had become the world’s largest exporter and second-largest producer. In 2022, the industry exported USD 1.4bn (0.6% of GDP and 2% of exports) and employed 120,000 workers during the peak season. Blueberries were introduced from Chile by a Peruvian agro-entrepreneur who optimised them for local conditions in collaboration with Peruvian and foreign universities. Peru’s mild climate allows for year-round production with high yields.

Initially most production took place in Peru’s Northern coast, where large-scale irrigation projects had just recently transformed swaths of desert into productive agricultural lands. Blueberry production and exports were spareheaded by firms that had already gained experience and built supply chains as leading exporters of other fresh horticultural products such as grapes, asparagus, and avocado. Production has since spread to other coastal regions. The industry is very dynamic and attracts many new entrants, such that the largest firm’s market share reduced from 60% in 2013 to below 20% today.

Source: IABD (2022), Blueberries and the Promose of Agricultural Innovation in Latin America. https://blogs.iadb.org/ideas-matter/en/blueberries-and-the-promise-of-agricultural-innovation-in-latin-america/ and http://arandanosperu.pe.

The success of other countries such as Costa Rica (see Box 2.5) with export diversification, including through strategic attraction of foreign direct investment (FDI), points to the importance of paying greater attention to industrial clusters and domestic supply chains. Interactions between domestic firms and the multinationals they supply led to significant spillovers in terms of productivity and employment in Costa Rica (Alfaro-Ureña, Manelici and Vasquez, 2022[46]). In the Czech Republic, strategic attraction of FDI with a high innovation potential, and the creation of joint ventures between multinational and local enterprises, contributed to the country’s success with generating such spillovers (OECD, 2020[47]). Often such spillovers are local (Greenstone, Hornbeck and Moretti, 2010[48]), which is why countries such as Costa Rica and the Czech Republic put special emphasis on strategies that promote the clustering of enterprises. However, any export diversification strategy also needs to take into account the limiting role of the special geographic conditions of Peru, in particular its remoteness (Salinas, 2021[49]). Deepending regional integration, especially with the Pacific Alliance countries where port-to-port distances are much shorter, has a particularly large potential in Peru. Existing multinational FDI networks could constitute a promising starting point given the importance of multinational firms for international trade (Cadestin et al., 2018[50]).

Box 2.5. Costa Rica’s experience with harnessing FDI to build a modern diversified economy

Costa Rica’s productive transformation moved the country from being an economy based on agricultural commodity exports, first to a prime destination of ecotourism and an important producer of microchips, and lately to a leading exporter of medical instruments and ICT and other knowledge-intensive consulting services. A stable pipeline of FDI inflows, particularly in the manufacturing sector and from the United States, has underpinned this shift towards higher-value addex exports.

Costa Rica’s success with economic diversification is the result of favourable enabling conditions, many supported by deliberate policies. Macroeconomic stability and long-standing commitments to openness to trade and capital flows, a favourable geographic location close to major markets, and strong property rights protections make the country an attractive investment destination. Costa Rica used free trade zones (FTZ) to transparently target support to strategic high value-added sectors and to create economic clusters and enhance value chain linkages and spillovers, including to domestic firms. Strong and effective public institutions, especially investment and export promotion agencies, not only help foreign firms to establish themselves but also actively promote linkages between firms, especially with domestic companies. Evaluations suggest that these programmes were successful in creating spillovers (Rodriguez-Alvarez and Monge-González, 2013[51]). Costa Rica periodically evaluated such support policies and adapted them to changing circumstances. Finally, enabling conditions such as adequate infrastructure, political stability, universal access to health and education, and a strong commitment with sustainability played a role in attracting foreign investors.

Source: (OECD, 2023[52]; OECD, 2016[53]) OECD Economic Surveys: Costa Rica.

A well-functioning logistics chain that links export clusters with sea and air freight terminals matters for export performance. Evidence from Peru sheds light on, for example, the importance of roads that connect producing regions to ports (Volpe Martincus, Carballo and Cusolito, 2017[54]) and efficient important and export processing, including customs (Carballo et al., 2023[55]). Peru has made important progress in these areas, for example with the introduction of a single window for customs, and the introduction of online applications to estimate customs clearings delays in real time. Similarly, processing times for sanitary and phytosanitary controls of agricultural exports have been significanlty reduced, although further room for improvement remains. However, traffic congestion around ports, especially Callao which handles 50% of overall seaborne goods volume and 90% of all container volume, adds to logistics costs (CPC, 2022[21]). Initiatives such as the amplification of regional ports and the construction of bypass roads should be continued and prioritised. In addition, where geographical conditions allow, such as along the coast, railways such as the proposed combined passenger-freight line connecting Lima with neighbouring regions would contribute to decongestion and at the same time help advance decarbonisation (see Chapter 1). Intermodal connections with road freight, for example from agricultural areas in the mountains, could further enhance the usefulness of railways. More generally, development of export clusters and export logistics should be closely coordinated to avoid bottlenecks (see Box 2.6 for a case study from Arequipa).

Box 2.6. Regional economic diversification: the case of Arequipa

Arequipa, Peru’s second largest city with about one million inhabitants in its metropolitan area (10% the size of Lima) is the capital of a region about twice the area of Ireland. While mining contributes almost one quarter of the region’s GDP, sectors such as construction and ICT have grown particularly strongly in recent years. Arequipa host several renowned universities, including a public one well-endowed with mining royalties, which supply skilled graduates especially in STEM fields as well as research activities that contribute to the region’s innovation.

The regional government plans to foster high-tech service exports through the creation of a mining hub and the opening of a technology business park. A large-scale irrigation project would unlock new agricultural lands for export-oriented production, but it has been paralysed for years. Better infrastructure, especially interconnections to seaports, would lower trade costs as well as air pollution.

Improving innovation and R&D support

Innovation and the adoption of new technologies is key to improving productivity within sectors and firms. Public and private expenditure on research and development (R&D) is low (Figure 2.9). In 2019, Peru only spent 0.16% of GDP on R&D, less than any other country in the region and considerably less than the average in OECD countries, which is around 2%. However, this still represents an improvement over time: in 2012, only 0.06% of GDP was destined to R&D. The pandemic further brought to the fore the importance of public investment in science, technology, and innovation. Government scientific funding has since continued to increase (Bertelsmann Stiftung, 2022[56]). However, weak human capital especially in the regions, weak intellectual property rights, and a still emerging scientific culture that does not yet produce a critical mass of basic research all limit incentives to engage in R&D (CONCYTEC, 2020[57]).

Different instruments for R&D support are offered by the national science, technology and innovation council (CONCYTEC) and by the Ministry of Industry (PRODUCE) to various stakeholders including firms and research institutions. They include competitive grants for basic and applied research, R&D tax incentives, and business support centres, such as the regional Centres for Innovation and Technology Transfer (CITE). International support for Peru’s systems for science, technology and innovation and technology adoption by private sector firms is given by the World Bank and the Inter-American Development Bank.

R&D tax incentives are offered by almost all OECD countries to stimulate business R&D by private firms. International evidence has shown that this is an effective tool (Guceri and Liu, 2019[58]), especially in smaller firms which are typically subject to larger financial constraints (Dechezleprêtre et al., forthcoming[59]; OECD, 2020[60]). In Peru, R&D tax incentives in the form of enhanced deduction of R&D expenditure were introduced in 2016, in line with recommendations from the initial OECD Multidimensional Review (OECD, 2015[1]). However, take-up has been limited – only about 18% of the total available funding for R&D tax incentives was spent in 2019, even though most applications made by firms were approved (CONCYTEC, 2022[61]). Several adjustments were made over time, including an increase of the deduction rate up to 240% for small and medium enterprises in the latest iteration of the programme (2023-2025). Authorities should continue to evaluate the programme to generate evidence of its impact and to inform adjustments for future iterations. For example, one shortcoming is the limited transferability of tax deductions over time, which reduces incentives for participation by small firms and start-ups that might be loss-making or have otherwise limited tax liabilities for several years. To remedy this, Peru could follow countries such as Chile, Colombia and Mexico and convert at least a part of the enhanced R&D deduction into tax credit. An additional measure that goes one step further, and is used for example in Australia, Canada, Norway and the United Kingdom – and proposed in Chile – would be to make the tax credits refundable, at least for small firms (OECD, 2022[62]).

Research and innovation are still incipient in Peru. For example, articles in scientific journals or patent applications relative to population are below most OECD countries, and the vast majority (92%) of patent applications are filed by non-residents (CONCYTEC, 2023[63]). Peru is currently upgrading its STI support system. This includes the elaboration of a new national STI Policy, and an integrated project with World Bank support with three strategic axes: green economy and climate change resilience, health, and digital transformation. The challenge for Peru is to create a critical mass of high-quality research that is at the same time relevant for addressing the country’s structural challenges. Moreover, while a greater availability of scholarship programmes in the last decade contributed to increasing the number of Peruvian postgraduates trained at world-leading universities abroad, a challenge is to attract and integrate these potential scientists into Peruvian research institutions. Such researchers also typically have existing links to foreign institutions, which could be leveraged for increased international research collaboration. One example for Peru to consider is Mexico’s National System of Researchers SNI, which on a competitive basis awards academic recognition, financial incentives and better research conditions.

Peru could improve its link of R&D policies with other industrial policy objectives, such as improving diversification (see above), food security, or the transition to carbon-neutral energy production. All of these areas require high degrees of innovation and advanced technology adoption. To achieve such objetives, Peru needs to increase the knowledge capacity in environmental science and related fields – including through technical and scientified training (see Chapter 3) – and build innovation ecosystems in these areas. For example, as detailled in Chapter 1, Peru has a high potential in renewable energies such as solar and wind power, and in technologies of the future such as green hydrogen. Such a potential could be leveraged to increase participation in sustainable mining, given anticipated demand for the global green transition (e.g. of copper and lithium). Social conflicts in mining are also often framed around environmental issues (water security, air and water pollution), which could be mitigated with more advanced and environmentally clean production technologies. In doing so, Peru could take advantage of the increased availability of international funding for the development and adoption of clean technologies.

Strengthening the rule of law

Continuing the fight against corruption

Corruption stymies growth by affecting the provision and quality of public goods and services, diverting public resources, distorting capital and labour allocation in the economy, reducing the government’s ability to correct externalities, and lowering trust in public institutions (Olken and Pande, 2012[64]). Especially harmful forms of corruption emerge when public objectives are misaligned with private rents, since the latter can be shared with bureaucrats to pervert incentives via bribery (Banerjee, Mullainathan and Hanna, 2012[65]). Corruption creates an uneven playing field that is biased in favor of businesses that engage in corrupt practices, providing them with an unfair advantage over their competitors. It can also increase the costs of doing business by increasing red tape and imposing additional expenses on firms that are required to pay bribes to secure contracts, permits, or licenses. This can lead to reduced profitability, decreased investment, and ultimately, can affect negatively productivity and reduce economic growth. Corruption also undermines the government’s ability to implement policy, collect revenues, and enforce laws and regulations according to public interest criteria.

Peru has made some progress in implementing anti-corruption measures in recent years (Shack, Pérez and Lozada, 2022[66]). Based on the National Integrity and Anti-Corruption Policy and Plan, which are currently being updated, and in line with recommendations of the 2017 OECD Integrity Review (OECD, 2017[67]), authorities integrated the anti-corruption unit (the Public Integrity Secretariat) into the Presidency of the Council of Ministers, enacted an electoral reform to strengthen internal party accountability mechanisms, systematised public asset and interest declarations of politicians and public servants, and strengthened the national control system. The supreme audit institution, the Comptroller General’s Office (CGR) plays a key role in conceptualising, steering and implementing external control policies.

Corruption is still perceived to be high in Peru (Figure 2.10). Moreover, indicators suggest that control of corruption has eroded over time since its peak shortly after the return to democracy in 2001 – which was itself fuelled by the discovery of evidence of pervasive corruption cases involving senior politicians, judges, and businesspeople (McMillan and Zoido, 2004[68]). In opinion surveys, even during the COVID-19 pandemic, Peruvians consistently name corruption as the most important problem that the country faces. High-level bribery and influence-peddling scandals have involved all branches of government and may have contributed to the salience of corruption. Most former presidents of recent years have been facing criminal prosecution for alleged corruption. Public sector bribery and judicial corruption are the areas in which Peru is particularly vulnerable (Figure 2.10, Panel D).

About 3% of GDP is lost to corruption each year, according to the Peruvian Comptroller General (CGR, 2022[69]; Shack, Pérez and Portugal, 2020[70]). This represents about 14% of total government expenditure, with important variation across levels of government, sectors, and regions. Corruption leakages account for 22% of all expenditure in regional governments, 30% in the transport and communications sector, 20% in the education sector, and 15% in the health sector. These are precisely the sectors that are key to close gaps in infrastructure and provision of social services to all Peruvians (see below and Chapter 3). Corruption therefore deprives especially the most vulnerable of essential public services. Corruption leakages are generally higher in the largely poor and rural southern regions that also receive the highest share of mining royalties. Nevertheless, they are highest in Callao, part of Lima’s metropolitan area, where 40% of all public expenditure is lost to corruption.

Peru is in the middle of a major overhaul of its national control system, kicked off by a reform legislated in 2017. A key element of this reform is the gradual introduction by the CGR of concurrent audits (“control concurrente”), a mechanism for continuous monitoring along the project cycle. This approach was piloted in a few emblematic major infrastructure projects, including the works for the 2019 Panamerican Games held in Lima.

In Peru, few irregularities identified by audits lead to an application of sanctions for the public officials involved, even if the audit recommends judicial prosecution (Shack, 2020[71]). This reflects to a large degree the deficiencies of the judicial system (discussed in the next subsection). Being caught is not a sufficiently powerful incentive to deter corruption. Preventive mechanisms that aim to dissuade, detect and correct irregularities early along the project cycle are therefore especially important in Peru and in Latin America more generally. Countries in the region such as Colombia and Brazil have recently adopted similar mechanisms, and others such as Mexico are considering their adoption (OECD, 2021[72]). Moreoever, the introduction of a system based on prevention, early correction, and risk management represents an ongoing cultural shift away from a traditional, punitive control system (CGR, 2021[73]). However, such a system requires the collaboration of many institutions (CGR, Public Integrity Secretariat, national procurement and infrastructure authorities, and internal audit offices) to avoid either duplicating or undermining efforts, which has ocurred in the past (OECD, 2017[74]). Strengthening links and the smooth interplay between concurrent audits and anti-corruption policy more generally, on the one hand, and improvements to the public procurement framework (see below), on the other hand, would result in complementarities and ultimately higher effectiveness of efforts.

The external control mechanisms promoted by the Comptroller General’s Office would be much more effective if they went hand in hand with strengthening public entities’ internal control functions. More than half of Peruvian public entities have internal control systems that are either non-existent or very rudimentary (CGR, 2022[75]). A major factor seems to be the lack of accountability and alignment of internal control with the objectives and day-to-day functioning of entities (OECD, 2017[67]). Very few entities have internal audit offices that advise senior management on the adequacy of control processes and risk management. Most OECD countries use a three-tier system of internal control, with internal audit offices being complemented by corporate functions such as compliance, human resources and accounting, and managerial control over their areas of responsibility; the elements of each tier are defined by recognised international standards (see Box 2.7). Peru has made important advances in this direction with the preventive integrity model promoted by the Public Integrity Secretariat (SIP). One of its pillars are institutional integrity offices, corporate functions supporting line and senior management that, while receiving functional support by the SIP, report ultimately to the highest level within each entity. This is a step in the right direction as it strengthens oversight of and support for the entity’s risk management process and thus contributes to corruption prevention and the promotion of integrity. However, there should be a separation of responsibility from audit and control functions (OECD, 2019[76]). A next step would consist in the establishment of internal audit offices, high-level independent advisers that report directly to an entity’s governing body (i.e., the board of directors, or the ministry an entity depends on) that would provide an additional layer of assurance.

The government should further ensure the coordination of anti-corruption policy across all institutions of the state, with the ultimate goal of improving its efficiency and effectiveness. In particular, Peru could take the opportunity to analyse the current institutional setting of its integrity system and identify scope for improving its steering, co-ordination and coherence. Importantly, it is the government’s role to provide political leadership for the overall direction of such policies, and to ensure a consistent approach across all relevant public entities. This should be based on international best practices and evidence from pilot programmes. For example, evaluations of concurrent audit pilots suggest significant value for money, with 6 soles saved in project overcosts for every sol invested (Shack, Portugal and Quispe, 2021[77]). Despite the success of pilots, the limited take-up is due to a lack of assigned resources. To implement concurrent audits beyond flagship projects, it will be important to ensure that their scope is proportional to the corruption risk and the resources at stake in each project (OECD, 2020[78]).

Box 2.7. The three lines of defence model of internal control

The general international standard for internal control systems in public entities follows the “three lines of defence” model (OECD, 2017[67]; IIA, 2013[79]):

The first line corresponds to mid-level line management of operational units, who own and manage risks in their area of responsibility. This includes supervising and monitoring their staff.
The second line corresponds to corporate functions outside operational units but within each entity’s corporate hierarchy and chain of control that provide specialised tasks which support both line management and senior management. Such corporate functions include compliance, human resources, accounting, and others such as financial or quality control depending on each entity’s line of activity. The institutional integrity offices in Peru are situated here.
The third line corresponds to internal audit, a function that according to recognised international standards offers independent assessment and assurance of an entity’s procedures, governance, and risk management directly to the entity’s governing body (e.g., board of directors, responsible ministry). The key distinction from the second line is the level of independence from day-to-day activities and internal management and reporting structures of the entity. There are different arrangements, with some countries (such as the United Kingdom and Brazil) opting for a centralised model where a dedicated government agency incorporates all internal audit units, and others having internal auditors attached to each entity.

External auditors, attached to the supreme audit institution (CGR in Peru) complement these functions with external scrutiny and oversight. Importantly, supreme audit institutions should not be involved in internal audit; and in countries where internal audit functions are centralised, they are attached to other entities (e.g., the ministry of finance in the United Kingdom).

By contrast, in Peru, there exist institutional control offices (OCI) that are attached to the CGR, with a role more oriented towards compliance and oversight, rather than advising management on processes. Civil servants tend to view them as punitive. At the same time, the presence of these offices tends to create confusion, diffuse accountability, and limit management involvement in internal control, since they feel it is the OCI’s responsibility.

Source: (OECD, 2017[67]) OECD Integrity Review of Peru: Enhancing Public Sector Integrity for Inclusive Growth.

More generally, fighting corruption requires a comprehensive strategy in which preventive control measures are complemented by public sector reforms that reduce opportunities for engaging in corruption, provide full transparency to increase the likelihood of detection, and improve the alignment of the private incentives of politicians and civil servants with public policy objectives Progress in the fight against corruption is likely to be gradual, needs political will and perseverance to continuously upgrade institutions and policies over several years.. Measures include designing regulations, simplifying administrative procedures, reforming the civil service, public procurement, decentralisation, and ensuring effective and efficient enforcement by the judiciary (OECD, 2018[80]) – all topics that are discussed elsewhere in this Chapter. Similarly, reducing opportunities and incentives for corruption should also be considered in a reorganisation of subnational finances (see Chapter 1). In general, special efforts should be made to strengthen integrity systems of sub-national entities (OECD, 2021[81]). Moreover, a well-functioning framework requires a professional and ethical civil service as a key pillar and the heads of agencies, ministries and public enterprises must promote ethical behaviour by example. Finally, simplification and unification of administrative proceedings, for example in procurement, would reduce the number of irregularities detected due to simple errors, improving the effectiveness of control systems in deterring corruption.

Regulation and transparency of lobbying and political finance are important tools to ensure the inclusive and fair participation of different interests in public decicision-making process, and to avoid policy capture by special interests (OECD, 2021[82]; OECD, 2017[83]). In Peru, illicit political funds from illegal economic interests including narcotics, illegal mining, and illegal forestry are seen as especially important topics; as is the association of members of Congress with special interests, for example in private education. Peru was a pioneer in the region in establishing its lobbying law in 2003, and in recent years has made progress in several areas, including asset and conflict of interest declarations of political candidates, public vistor registries in all major entities, cool-down periods for public officials, and establishing criminal sanctions for recipients of ilicit or undeclared political finance. However, several provisions that have been already legislated, such as holding internal primary elections for party candidates, have not been implemented yet. Such provisions would be especially important in the context of chronically weak political parties in Peru, which are often highly personalised, short-lived, and lack broad-based membership (Levitsky and Cameron, 2003[84]; Vergara and Augusto, 2022[85]) and thus are particularly susceptible to capture by special interests.

Improving judicial performance

An independent and effective justice system is vital for fostering trust in governance and institutions and creating an attractive business environment (OECD, 2022[86]; World Bank, 2017[87]). Protection of property rights, appropriate application of regulations, and enforcement of private contracts all depend on an effective justice system (Palumbo et al., 2013[88]). Those institutions in turn protect the returns of investors, reduce transaction costs and dissuade opportunistic behaviour, thus incentivising savings, investment, and complex economic interchanges which are the basis for trade and specialisation. Evidence shows that slow courts significantly reduce economic growth, especially in industries where well-functioning contractual relationships with suppliers are particularly important (Amirapu, 2021[89]). Accessible, fair and efficient justice institutions also render growth more inclusive, reduce poverty and inequality, and improve opportunities (OECD, 2021[90]).

Performance of the Peruvian justice system lags behind both OECD countries and peer countries in the region (Figure 2.11). The justice system is perceived by businesses and citizens alike to be lacking in transparency and accessibility (Figure 2.11, Panels A and B), and ineffective and inefficient in settling disputes (Figure 2.11, Panel C). The latter reflects in part the large delays in bringing cases to a close and the high cost of judicial representation. Peruvian courts face a significant backlog of cases, which has increased during the COVID-19 pandemic (Poder Judicial, 2022[91]). However, low perceptions of justice not only reflect inefficiencies in its administration, but also a perceived lack of fairness. More than 80% of Peruvians do not feel that they are treated equally before the law (Latinobarómetro, 2021[92]). Control of judicial corruption is lower than in any OECD country (see Figure 2.10, Panel D above).

Peru is currently undergoing a challenging modernisation agenda of its complex and fragmented justice system (Box 2.8). After previous unsuccessful reform attempts, authorities seized the opportunity following a widely publicised high-level influence-peddling and corruption scandal in the judiciary (World Bank, 2019[93]). This led to the Wagner commission report with recommendations on justice reforms. These reccommendations are reflected in the current 2021-25 Public Policy for the Reform of the Justice System. Their implementation has been set back so far by political volatility and instability in the Ministry of Justice.

Figure 2.11. Performance of the justice system

Box 2.8. The Peruvian justice system

The Peruvian justice system consists of five constitutionally autonomous institutions:

The Judiciary (Poder Judicial) is the independent branch of the state that administers justice in all courts except the Constitutional Court, and employs all their judges.
The Constitutional Court (Tribunal Constitucional), with members elected by Congress, is the final instance in constitutional matters, including individual constitutional rights.
The Attorney General’s Office (Ministerio Público – Fiscalía de la Nación) investigates and prosecutes criminal cases, and employs all public prosecutors.
The National Justice Board (Junta Nacional de Justicia, JNJ) selects, appoints, evaluates and removes judges and prosecutors. It was created in 2020 after its predecessor institution was at the centre of a major corruption and influence-peddling scandal.
The Judicial Academy (Academia de la Magistratura) trains and accredits prospective and sitting judges and prosecutors, and cooperates with JNJ in performance evaluations.

In addition, the Ministry of Justice and Human Rights (MINJUSDH), a part of the Executive Branch, develops and oversees public policies in the justice sector, protects human rights, and ensures access to justice. It employs state attorneys (procuradores), which represent the state’s interest in court, and public defenders; and implements alternative dispute resolution mechanisms. The budget of all justice system institutions is proposed by the Ministry of Economy and Finance and voted on by Congress.

Source: (World Bank, 2019[93]).

A significant share of judges (61%) in Peru is employed on short-term contracts and can easily be removed from their position (Table 2.1). This share increased sharply by 5 percentage points during the COVID-19 pandemic (CPC, 2022[21]). On top of the regular merit-based selection of regular judges, two mechanisms exist for appointing temporary judges. First, regular judges (jueces titulares) can be hired in an acting capacity for a higher role than they were initially appointed to (so-called ‘provisional judges’). Second, supernumerary judges are temporary hires not selected through the merit-based process. For example, they might be chosen among the longlist of unsuccessful applicants. A similar system is used for public prosecutors. The appointment of temporary judges became widespread in the 1990s under the authoritarian regime in an attempt to curtail judicial independence (Lovatón Palacios, 2017[94]).

Table 2.1. Distribution of judges by appointment type
June 2022
	Regular	Temporary		Total
	Regular	Provisional	Supernumerary	Total
Supreme court judges (jueces supremos)	8 (14%)	48 (86%)	0	56
High court judges (jueces superiores)	399 (50%)	377 (48%)	15 (2%)	791
Specialised court judges (jueces especializados o mixtos)	801 (40%)	320 (16%)	905 (45%)	2026
Justices of the peace courts (juzgados de paz letrados)	162 (25%)	0	481 (75%)	643
Total	1370 (39%)	745 (21%)	1401 (40%)	3516
Note: Specialised courts have jurisdiction for one area of law (civil, criminal, commercial, labour, administrative, etc.). In rural areas, they might be of mixed jurisdiction. They are the first instance for many cases. Justices of the peace courts hear small claims civil cases up to specific monetary ceilings, and family matters.
Source: Poder Judicial, Boletín Estadístico Institucional No 02-2022, Anexo No 6.

This overreliance on temporary judges can impact the independence, quality and efficiency of the justice system. First, it results in high turnover of judges, as they are moved, removed, or seek more stable employment elsewhere. Replacement of a judge in the middle of a trial can significantly impact the speed, efficiency, consistency and predictability of the case’s resolution. Large turnover also limits the specialisation of judges in specific areas of the law or structural features of cases, and prevents accumulation of human capital, which is crucial for a justice system to develop expertise and build capacity. Second, temporary nominations lack competitive selection processes and can result in appointments of unequalified or inexperienced judges. Third, the precarious nature of temporary employment, and the untransparent and arbitrary power over judges that other stakeholders inside and outside the judicial system have impairs judicial independence and creates significant conflicts of interest. This is particularly true for judicial appointments given the large degree of professional autonomy that the role of a judge requires, and the binding and final nature of judicial decisions in applying and enforcing the law. The temporary status of judges can make them more susceptible to external influence, leading to biased or unjust decisions and possibly corruption.

Several elements risk undermining the independence of regular judges (Figueroa Gutarra, 2020[95]). The initial recruitment processes lack guarantees of due process, and the recruitment panel has large discretionary power. There is no established career path for judges, either through a seniority-based promotion system (typical in civil law countries) or participation in open professional competitions for higher courts (typical in common law countries). Sitting judges need to have their appointment re-ratified every 7 years (and performance appraisals take place every 3.5 years). The Inter-American Court of Human Rights has repeatedly ruled that this constitutes a violation of the principle of judicial independence enshrined in the Inter-American Convention of Human Rights.

To make the judiciary more independent, Peru could consider strengthening the independence of regular judges and reduce the high reliance on temporary judges. There are several interlinked elements to be considered to achieve these objectives. First, creating more permanent positions requires better strategic human resource planning. Although many temporary judges are assigned to nominally temporary courts tasked with reducing backlogs, the persistent nature of these arrangements suggests structural rather than one-off needs. Second, coordinated efforts between the judiciary and the Ministry of Finance could deliver a more predictable and adequate budget for the judiciary. This would require a better identification and justification of the judiciary’s funding needs. Third, a more clearly defined and transparent appointment process and career path for judges would increase their independence, create career incentives against corruption, and reduce the need to fill positions on an interim basis. Fourth, an overhaul of the performance appraisal process for judges could support effective human resource management. Fifth, as with civil servants (see below), salaries that better reflect the degree of responsibility, rather than the contract type, would help to delineate career paths and set desired incentives.

Modern case and court management systems using digital technology can improve accesibility and the efficiency of courts (World Bank, 2019[93]; OECD, 2020[96]). They also generate large amounts of detailed statistical data, which can be used to better identify bottlenecks and target resources, and which increase transparency. Digital case management systems have been introduced in many OECD countries, including in New Zealand, Portugal, and the United Kingdom, where in each case this was part of a wider modernisation programme to make justice systems more efficient and closer to citizens (OECD, 2020[96]), In Peru, a digital case management system (expediente judicial electrónico) has been piloted since 2017. Evaluation of these pilots points to significant time and cost savings (World Bank, 2019[93]). However, digital tools have mostly been introduced in isolation, through the initiative of individual institutions of the justice system, and sometimes also within specific courts. Moreover, this system is not yet interoperable, both within the judiciary across different IT systems and applications, and with other justice institutions that maintain separate electronic file management systems. Therefore, the current level of implementation does not always improve bottlenecks in a system that requires simultaneous inputs by many actors to advance cases and the need to maintain digital and analog systems in parallel may even increase workload.

Peru could consider advancing the implementation of the digital case mangement system, and make special efforts to ensure that it is interoperable across all relevant institutions in the justice system. Many countries, including Colombia and Spain, have created special inter-institutional commissions to coordinate the implementation of interoperable digital justice tools. In Peru, a bill to create a Permanent Inter-Institutional Technical Commission for Data Management and Interoperability of the Justice System was presented to Congress but was not passed by majority. The government should continue to promote the cooperation of justice institutions to achieve interoperability. At the same time, it should also promote the large-scale introduction of the digital system, taking into account the lessons learned with the pilot programmes. Sufficient resources, including hardware, software, and network infrastructure, should be devoted to this. The process could also be supported by the digitalisation unit of the Presidency of the Council of Ministers and integrated into a general digital strategy of the Peruvian state.

The forthcoming OECD Justice Review of Peru as well as the technical OECD accession assessment of the Peruvian justice system will provide an opportunity to identify good practices and concrete recommendations to support Peru in its reform efforts to develop a modern, independent and effective justice system.

Improving state capacity for public investment and service delivery

Closing infrastructure gaps requires significant public investment

Despite significant progress in some areas, a large infrastructure gap remains. This gap extends beyond modern digital infrastructure, such as broadband and high-speed mobile networks, or transport infrastructure such as roads and railways, to include basic services like safe water and sanitation (Figure 2.12). Although impressive progress was made especially in electrification and roadbuilding, with rural electrification increasing from 56% in 2010 to 97% in 2020 and paved road surface doubling in the same timeframe, investment needs are still high. Peru’s complex geography complicates implementation, but building resilience to climate change and natural hazards, such as seismic activity, will be critical as Peru is especially vulnerable, as discussed in Chapter 1.

Massive investments are needed to close infrastructure gaps. Investment of almost 50% of GDP (around PEN 360bn in 2019 values) would be required to bring Peru to OECD averages in most areas of infrastructure, and to regional averages in domestic transport infrastructure (MEF, 2019[97]). This massive volume of investments partly requires additional fiscal resources (see Chapter 1), but also increased involvement of the private sector in project financing (see below); as well as high-quality cost-benefit analysis to prioritise the projects with the greatest social value for money. The largest investment needs, more than 20% of GDP alone, are in transport infrastructure, especially roads and railroads (Figure 2.13). Around a third of this has been already allocated to 72 megaprojects, which are prioritised through triannual infrastructure plans. However, implementation even of already budgeted investment is slow: between 2019 and 2022, only about 12% (PEN 13.7bn) of the investment scheduled in the infrastructure plan for a five-year period was executed (MEF, 2022[98]). While the pandemic certainly played a role, the example demonstrates that Peru requires, on the one hand, more credible and realistic infrastructure plans and, on the other hand, significant improvements in implementation capacity and investment efficiency. Moreover, the increased vulnerabilities to natural disasters that global climate change implies for Peru, highlight the need for additional modern, resilient and sustainable infrastructure as acknowledged in the 2022-25 National Plan for Sustainable and Competitive Infrastructure. Currently, public investment amounts to about 6% of GDP annually, almost double the OECD average of 3.3%, but investment efficiency is low.

Figure 2.12. Many Peruvians still lack access to basic public services

Closing the infrastructure gap will not only happen through megaprojects, but just as importantly through a large number of small, local public works that are not always part of the national infrastructure plan. Water and wastewater networks, hospitals, and schools are mostly built and maintained by sub-national governments. Together these sectors make up half of the total investment gap (Figure 2.13, Panel B). At the same time, there is a large regional dispersion in the quality of physical infrastructure, such as schools (Figure 2.14). Many public works projects are abandoned or remain unfinished ("white elephants”). For example, in a national sewage programme this concerned 75% of all projects at some point in time (Bancalari, 2020[99]). Abandoned projects not only deprive citizens of essential services and signify a waste of scarce public resources (thus contributing to Peru’s overall low spending efficiency); they can also became a health hazard. Even completed projects take much longer than foreseen. A leading factor in project delay and abandonment are judicial processes revolving around project irregularities, either due to corruption or to poor project management, for example deficient technical specifications (OSCE, 2020[100]). Improving the coverage and quality of infrastructure therefore requires improving technical capacity especially in sub-national governments. Continued efforts to fight corruption and improve judicial effectiveness, and modern control mechanisms that try to correct deficiencies on the way would also help (see above).

Figure 2.13. Closing the infrastructure gaps requires significant investment

Figure 2.14. There are large regional differences in the quality of public infrastructure

Creating a modern and effective state capable of delivering high-quality services and investments to citizens and businesses throughout Peru requires ambitious reform packages in several key areas. These include the civil service, public procurement, multi-level governance and coordination, infrastructure long-term planning, public finance and project management, including PPP governance. The legal bases for many of these reforms have already been laid, and support units at the centre of government have been established. The ongoing creation of an Advisory Commission for the Development of National Infrastructure, inspired by the United Kingdom’s National Infrastructure Commission, is another positive step in this direction. The challenge now lies in fully implementing these reforms throughout the entire government and across the entire country. This will require bold leadership from the top of government to convince all stakeholders of the need to change established behaviours and embrace the best practices of modern public sector management.

Re-starting the civil service reform

In all countries, civil servants are at the forefront of delivering public investments and services (OECD, 2017[101]). Civil servants need to have the capabilities to formulate technical project specifications, manage project implementation by contractors, and ensure adequate maintenance and supplies. They need to conduct procurement processes in a way which maximises public value for money. Building experience and continuity enables them to manage projects with long horizons, plan strategically, and develop trust and coordination mechanisms with other institutions and stakeholders. Civil servants are also often driven by pro-social motives and are motivated by pride in providing public goods and services (Ashraf et al., 2020[102]). The absence of some or all of these elements in Peru are a main contributor to delays, cost overruns, and abandonment of public works and underprovision of public services.

The Peruvian civil service is fragmented and over-reliant on ad-hoc administrative service contracts - CAS (Figure 2.15). For a long time these contracts were temporary, resulting in high turnover and low career incentives, which has severerly hampered the accumulation of experience and long-term capacity for undertaking needed reforms and implementing public publicies, It has also provided insufficient deterrence against corruption. A contract could be as short as a few months, and hiring was extremely personalised to the degree that often entire teams were replaced with new hires when a manager changes (OECD, 2016[103]). All of this breeds a culture of personal loyalty to the immediate superior rather than to the law, institution, the civil service, or the general public interest. Service contracts are also frequently used for political appointments, which reach far below the actual political level of the administration, and are used to reward party members or other connected persons with a government job. Turnover of ministers (on average every 8 months), but also of directors-generals, the highest professional level (every 12 months) is high and increasing (CPC, 2022[21]). By contrast, in two thirds of OECD countries even the highest level civil servants remain in place with a change in administration (OECD, 2016[103]). A previous career civil service regime (green bar in the below figure) was “frozen” in 1992 and although positions under this regime can still be re-filled, no new ones can be created (see Box 2.9).

In 2021, this already complex civil service framework was further complicated by new legislation by Congress and a subsequent decision by the Constitutional Tribunal to convert all temporary service contracts that were in force on the day of the law’s enactment into permanent ones. All other contract elements – including remuneration, tasks, and other aspects of the job – remained valid, even though they had been individually negotiated outside the civil service’s pay scales and human resources frameworks, generally with a view to the temporary nature of the contract. For example, there is not even a defined retirement age for workers on such contracts. Workers have the right to remain indefinitely in the position they held in March 2021, with very limited mobility, possibility of reassignment, advancement, or separation. In late 2021, hiring on temporary contracts was made possible again, but only for new workers.

Figure 2.15. The civil service has become dominated by ad-hoc service contracts

Box 2.9. The Peruvian civil service

Prior to the civil service reform, three main contractual regimes existed in public administration:

The “old” career civil service regime (DL 276), established in 1984, was “frozen” in 1992. No new positions under DL 276 could be opened since, but existing positions are turned over and new replacements hired under the legacy contract type.
The “private sector” regime (DL 728), created in 1992, provided for hiring of civil servants on open-ended contracts under the same conditions as in the private sector. Due to budgetary considerations, growth of this regime has mostly stopped.
Administrative service contracts (CAS, DL 1057) allow to hire independent contractors for full-time work in a public institution. Workers enjoy some labour rights, including paid vacation, sick and maternity leave, annual bonuses, and health insurance.

In 2013, a civil service reform was passed (Ley 30057). The reform introduces a new professional civil service regime that was designed in consistence with OECD best practices. Its implementation was delegated to the National Civil Service Authority (SERVIR). The main elements of the reform are:

Professionalisation of the civil service through meritocratic approaches to recruitment, retention, and job progression.
Restriction of political appointments to 5% of all staff in each entity.
Standardisation the employment framework into job families and pay grades.
Consolidation and modernisation of human resource management (HRM) and training.
Mandatory performance management linked to career progression and termination decisions.

Sources: (OECD, 2016[103]), OECD Public Governance Reviews: Peru - Integrated Governance for Inclusive Growth; (OECD, 2023[104]) Gestión de las Finanzas Públicas en el Perú: Una revisión de pares de la OCDE.

This system significantly constrains building a professional, skilled and experienced civil service that embodies modern approaches to public management and a culture of integrity. There is consensus across the public administration that high turnover has prevented experience and other forms of job-specific human capital from being accumulated. The lack of standardised job descriptions, hiring criteria, pay grades, and competitive and meritocratic hiring and performance evaluation processes contributes to skills mismatch and stifles modern human resource management. It also makes assessing the adequacy of a hire’s skills and experience e.g. by an external auditor very difficult. The high personal dependence of hired contractors leaves the door open for nepotism and corruption. The virtual absence of defined career paths in the civil service removes a key performance incentive for civil servants (Bertrand et al., 2019[105]).

Implementation of the 2013 civil service reform (see Box 2.9) has been very weak. Ten years after the reform law was passed, only about 1,700 civil servants (0.2% of the target population) have transited to the new regime (depicted as narrow red bar segments in Figure 2.15). Only 14 institutions (of a total of more than 2,500) have been certified to hire under the new regime (OECD, 2023[104]); and only 8 have actually done so. One critical factor is the complex and burdensome certification process, which requires elaboration of several advanced human resource management planning instruments, including a complete mapping and classification of all roles in the organisation before the first civil servant under the new regime could be hired. Although this process has recently been simplified, according to the National Civil Service Authority it remains sufficiently complicated to disincentivise entities from following through with certification. In addition, the conversion of temporary contracts into permanent ones has changed the original logic of the civil service reform, which was meant to start with the transition of workers on temporary service contracts. Moreover, the absence of clear deadlines to complete the process, and the absence of earmarked funds for the transition, limits institutional incentives and results in implementation being perceived as voluntary rather than mandatory.

Another key constraint is the apparent lack of individual incentives for most civil servants to transit to the new contract. An important disincentive is related to differential tax treatment. Service contracts are taxed as self-employment income, which enjoys a much higher personal tax allowance than wage income and dispensation from mandatory pensions affiliation. Beyond the fact the service contract remuneration is negotiated outside any reference frame, compensation comparisons are complicated by the fact that for some civil servants, as little as 10% of their gross pay corresponds to nominal wages (which are often frozen at their early 1990s values), with the difference made up by various allowances and bonuses. This muddles pay comparisons and blurs career profiles and creates an informal sector among the government’s own employees. In most OECD countries the largest part of public sector remuneration consists of base salary. Allowances and other remuneration concepts play a more exceptional role to compensate specific working conditions, skills, or responsibilities (OECD, 2021[106]). Moreover, the pay scale of the new civil service contract was set in 2014 and has not been updated since. Many civil servants further express concerns about how mandatory performance evaluations under the new civil service regime would affect them.

A new impulse for implementing the civil service reform is necessary, with political support from the highest level and the backing of the whole of government. A more gradual and flexible approach to implementation that prioritises conversion of individual civil servants to the new scheme seems the most promising path. This could include offering one-time bonuses to civil servants for making the transition; linking conversion to career progression; providing greater budgetary leeway to individual entities for conversions; making pay grades more flexible and tailored to the requirements of different institutions; and non-economic incentives. This might require mobilising more resources than currently foreseen, especially in the short term as transitions might result in temporary duplicity of expenses, and because many of the parameters of the framework such as salaries were set a decade ago. Better individual incentives should be complemented by other measures, such as automatically re-assigning posts to the new contract type whenever they become vacant due to natural turnover.

Such renewed efforts should be accompanied by a systematic and independent assessment in order to measure progress and be able to take informed actions to adjust the implementation of this important reform. This could include evaluating the success of different contract parameterisations on conversions to fine tune the most effective combination of incentives. For example, a pilot initiative in Mexico used modern impact evaluation methods to assess the effects of different monetary and monetary incentives in attracting public sector workers (Dal Bó, Finan and Rossi, 2013[107]). Simulations of net and gross pay under the existing system and suitable reform options can also help assess the net fiscal cost of the reform.

Strengthening public procurement

Public procurement plays an outsized role in the activities of the Peruvian government. Half of all government expenditure is devoted to public procurement, more than in any OECD country (Figure 2.16). Public procurement is also a critical factor in the strategic government objectives of closing gaps in infrastructure and service provision. As the difficult experiences with procuring protective and medical equipment during the COVID-19 pandemic, and the failure to procure alternative fertiliser supplies following Russia’s large-scale invasion of Ukraine have underlined, effective, efficient and resilient public procurement is vital for supporting lives and livelihoods. At the same time, in most OECD countries public procurement is one of the highest-risk areas for corruption, underlining the need to create transparent procurement systems with solid risk management (OECD, 2016[108]).

Public procurement in Peru consists of a comparatively large number of actors, with sometimes competing roles: the central purchasing body (Perú Compras), the procurement supervisor (OSCE), contracting authorities, the Comptroller General, and the Ministry of Economy and Finance. OSCE and the ministry play a strong central supervision and approval role; they define very detailed budget lines and maintain mandatory electronic purchasing and public investment systems. At the same time, procurement is decentralised into over 3,000 entities, including more than 2,000 subnational governments. There is a strong and well-known freedom of information law, and a high degree of transparency through routine disclosures. For example, information both on individual contracts as well as aggregate statistics on procurement trends are made publicly available. These are widely used by the media and the general public to monitor integrity in contracting with the government.

Figure 2.16. Public procurement makes up a large share of government spending

Public procurement in Peru has historically focused more on ensuring compliance with procedures than on driving efficiency and ensuring value for money (OECD, 2017[74]). Around 1.2-1.9% of GDP each year is lost due to inefficiencies in public procurement in Peru (BCRP, 2023[109]). The World Bank estimated that more efficient procurement strategies would yield up to 0.4 percentage points of GDP in fiscal savings (World Bank, 2017[110]). A new procurement law in 2014, and subsequent legislative changes in 2018, shifted the focus towards efficiency and value for money and created the central purchasing body. The planned next steps are to amend the law to new contract types that have already been tried out in government-to-government projects under foreign law, and to put greater emphasis on using procurement strategically to improve sustainability, corporate social responsbility, and support innovative domestic firms. These measures represent further steps in the right direction. Other important areas for improvement are increasing the number of bidders in public tenders to make the public buyer benefit from competition, and to fight bid-rigging (OECD, 2021[111]).

Public procurement would benefit from strengthening the effective role of the policies defined in the public procurement law such as centralised purchasing. The main goal of central purchasing systems in the OECD is to increase efficiency in purchasing by leveraging the buyer power of a large purchaser to obtain lower prices and reduced transaction costs (OECD, 2017[74]). Counterintuitively, achieving this might require providing contracting authorities with more flexibility and reducing excessively strict and cumbersome regulatory processes. For example, unlike Peru, most OECD countries make the use of framework agreements mandatory only for contracting authorities at the central level, but voluntary at other levels (OECD, 2019[112]). Voluntary agreements have to be competitive to incentivise local authorities to use them. By contrast, in Peru, contracting authorities seem to find ways to get around notionally mandatory mechanisms that are seen as too rigid and bureaucratic. One third of the total procurement volume consists of small contracts below PEN 40 000, that fall outside the scope of the public procurement law, and this share has strongly increased over time (OSCE, 2022[113]; OSCE, 2018[114]). According to the Comptroller General, procurement contracts tend to be divided into smaller instalments so that they fall below the threshold (CGR, 2023[115]). This not only opens the door to corruption, but also cancels any potential benefits from bulk purchasing. At the same time as making centralised purchasing tools more attractive, authorities should detect and sanction divisions of contract volumes that evade the procurement law, monitor the efficiency of procurement at the entity level, and use the Ministry of Finance’s transaction databases to actively promote the use of centralised contracting. Greater use of centralised contracting mechanisms would also be facilitated by improving planning capacities and budget security of local governments (see below), as well as by avoiding the creation of new special purchasing regimes.

Greater professionalisation of the procurement function would enhance capacity, facilitate strategic workforce planning, and help disseminate the strategic vision of the national procurement system from the centre of government to contracting authorities. Many OECD countries are currently grappling with the development of a procurement professionalisation strategy. Procurement is recognised as a standalone administrative profession only in a third of OECD countries (OECD, 2023[116]). It requires a unique skills profile that mixes law, economics, public administration, and other fields (OECD, 2017[74]). Given the large number of entities in Peru’s procurement system, a recognised procurement professional career could lead to greater policy coherence, attraction of talent, and accumulation and diffusion of experience. An existing training and certification programme, run by OSCE, could serve as a basis for that purpose. A recent evaluation using the OECD MAPS methodology provides policy options to increase professionalisation (OSCE, 2019[117]). Advancing the implementation of the civil service reform would support the professionalisation efforts in public procurement.

Improving multi-level governance and coordination

Sub-national governments are responsible for 62% of public investment in Peru, more than in most OECD countries. Typically, only federations such as Mexico, Switzerland, Australia or Germany assign a higher expenditure share to sub-national entities. Most sub-national spending corresponds to local governments, of which there are more than 1,800 in Peru. These governments mostly have no resources on their own, but rather are allocated a quota of the national budget, often tied to specific income sources (OECD, 2023[104]).

The predictability of the committable annual budget for local authorities is weak. Although a multiannual financial framework exists at the national level, and budget lines for individual entities including subnational governments are determined at the beginning of each year in the budget approved by Congress, final funding allocations are only determined towards the end of the fiscal year. While small inter-annual adjustments occur in many OECD countries, in Peru such adjustments correspond to more than 50% of the approved budget, on average (CGR, 2022[118]). At the extreme, for local governments, such variation implies that the final budget can reach two to three times the initial amount (Figure 2.17). Since this difference is systematic, the initial budget is not credible and all actors expect it to be raised; but since local authorities can commit funds only when they are included in a formal budget, this greatly constrains their annual planning (OECD, 2023[104]). This is one factor behind the low budget implementation capacity of local governments, which in 2021 amounted to 65% of the (end-of-year) budget (Comex Perú, 2020[119]).

Greater predictability and ability to make realistic annual spending plans would help budget implementation of subnational governments. One key element seems to be closing the gap between initial and end-of-year budget lines. This likely requires complementary measures, such as de-linking individual expenditure and revenue items, improving initial revenue forecasts, and introducing effective budget control mechanisms (OECD, 2023[104]). Improving the technical quality of project appraisals, especially for larger and more complex projects, would result in more realistic cost estimates that could be reflected already in the initial budget. Other recommendations of this Chapter, such as improving internal control mechanisms in public institutions, deterring corruption and professionalising the civil service, would likely also contribute to the success of such measures by improving capabilities and accountability of local governments. This could also lay the ground for the assignation of own resources and rule-based transfers to subnational governments, managed under their own responsibility; as is the case in most OECD countries.

Figure 2.17. Initial budgets for subnational governments systematically understate available funds

Better coordination between national, regional and local goverments would increase efficiency in several areas, including investment planning and public procurement. First, there is a lack of mechanisms for coordination between regional governments and municipalities. Regional governments could take up such a coordinating role within their territory, and also undertake more sub-regional projects that benefit several municipalities but which are beyond the scale and capacity of individual local jurisdictions; as discussed in Chapter 1. The “micro-regions” program in Mexico, which bundled interventions by several ministries in a group of rural localities, with involvement of and accountability to local communities, might be another example to consider (OECD, 2003[120]). Second, investment projects by ministries or subnational governments are often not connected to strategic plans or holistic needs assessments; and neither are fiscal plans (OECD, 2016[121]). The national infrastructure plan, despite its strategic orientation and focus on closing infrastructure gaps, has a focus on megaprojects executed at the national level without involving subnational goverments (OECD, 2023[104]). Recent legislation that encourages subnational governments to align their local projects with the plan, is a step in the right direction. Colombia, for example, derives its prioritisation of transport infrastructure projects from a holistic transport masterplan based on high-quality data and empirical methods (OECD, 2023[104]). Subnational and sectoral development plans could also be more closely aligned with national priorities and policy objectives, such as the ones articulated in the National Infrastructure Plan, National Competitiveness and Productivity Plan and the Strategic National Development Plan. Public procurement could benefit from better coordination among buyers such as local governments to strategically aggregate demand and take advantage of better prices and conditions through framework agreements and corporate purchases (OECD, 2017[74]). Critically, this would again require public entities to make realistic annual plans of their procurement needs rather than engaging in small-scale, reactive purchases (OECD, 2021[111]).

Strenghtening the governance of public infrastructure investment

The private sector plays a significant role in infrastructure investment in Peru. Private sector involvement is usually done through Public-Private Partnerships (PPPs) and Works for Taxes, a mechanism through which public investment projects are financed and implemented by private firms. Together these mechanisms account for over 1% of GDP in infrastructure investment per year. Peru was an early adherent, in 2016, to the OECD Principles for Public Governance of Public-Private Partnerships. Foreign goverments also participate in infrastructure investment through Government-to-Government (G2G) agreements, which were prioneered in Peru for the implementation of the 2019 Pan-American Games and have since included other areas, for example with France for the delivery of equipped hospitals. PPPs and G2G agreements usually correspond to major infrastructure works, such as highways, ports, airports, large-scale irrigation projects, and urban transport networks while Works for Taxes projects have typically smaller volume, for example schools or urban roadworks. The government is currently creating a central project management office, the National Infrastructure Authority, to manage all major infrastructure projects and to ensure their resilience against natural disasters.

Given the size of investment needs in Peru and the importance of respecting fiscal rules, involving the private sector is of utmost importance. Furthermore, given the documented limitations of technical and project management capacities at national and subnational levels, burdensome procurement processes, corruption, and substantial cost overruns and delays, including through frequent judicial disputes between the state and construction companies, the private sector (and foreign governments) is perceived to be more efficient in delivering projects (IFC, 2018[122]). Other advantages are risk-sharing between private and public actors, and the fact that (under PPP and Works for Taxes) initial construction is pre-financed by the private counterpart, and only paid back over time by the state through transfers or foregone income. The Peruvian state, through its investment promotion agency ProInversión, actively encourages private participation in infrastructure projects. At the same time, implementation of private-public partnership projects might also come with potential drawbacks, including misaligned incentives, inadequate control over projects and their costs, and implicit fiscal contingencies (World Bank, 2017[123]). This requires strong and effective governance arrangements for public infrastructure projects.

Authorities should continue to strengthen governance of public-private and G2G projects, ensure an appropriate choice of project implementation mechanism, and build capacity in the public sector. This includes continuously evaluating and improving value for money metrics; including retrospectively when the true costs of projects become known. The new central project management office will help anchor project management expertise in the government, and contribute to stronger project governance. A remaining challenge is strengthening such expertise beyond megaprojects, especially in local and regional governments. The most common mechanism used there, Works for Taxes, has no built-in learning component, other than how to administer the programme itself (Backus, Proinversión & USAID, 2015[124]); and firms often implement projects that are far away from their core business competence (e.g. a brewery might deliver a school to a local government). Authorities should also evaluate the efficiency of Works for Taxes beyond completion times, since the full cost pass-through provides itself no incentives for cost-saving project implementation.

Knowledge transfer and capacity-building in sub-national governments to supervise and eventually implement projects should be enhanced. For example, local governments could be more systematically involved in centrally managed infrastructure projects in their territory, both direct works and those implemented using PPP, G2G and Works for Taxes. Colombia’s Contratos Plan might be a useful example for Peruvian authorities to consider. Those contracts are binding agreements between the national government and sub-national authorities to coordinate their investment agenda and jointly deliver a defined list of interventions (OECD, 2016[121]; OECD, 2014[125]). Within the contract framework, the sub-national government has certain autonomy to decide on how to allocate the given budget to achieve the plan’s objectives, while working together with national officials. This contributes to building implementation capacities at the subnational level.

Better monitoring of the physical advancement of infrastructure works would help advance projects. Currently, the government only monitors budget execution of public works, not physical execution. There is a system maintained by the Comptroller General’s Office (Infobras) that systematically publishes information on project execution, but it relies on self-reporting of the physical execution status, thus leading to a vast underreporting of physically paralysed projects. In addition, the Ministry of Economy of Finance also monitors publicly and privately implemented investment projects, including those prioritised in the national infrastructure plan. The new project management office could be responsible for monitoring project execution with a risk-based approach, and intervene with the contracting authority to provide support when possible interruption is detected in financial data. This requires coordination with the Comptroller General’s Office, which through new concurrent audit mechanism already provides such monitoring from an audit and control (and less from a project management) perspective, and other entities.

Table 2.2. Main findings and recommendations
FINDINGS	RECOMMENDATIONS (key recommendations in bold)
Promoting competitive and innovative markets
Many markets are dominated by a few large firms. Market concentration predates a recently introduced general merger control scheme.	Increase competition enforcement and improve detection of cartels and abuse of dominance. Improve incentives to better retain qualified competition experts.
Barriers to starting a business are largely due to delays and complexities in obtaining municipal operating and construction licenses and permits.	Introduce one-stop shops that integrate municipal and national procedures for starting a business.
New legislation for regulatory policy that includes stakeholder engagement, regulatory impact analysis, and ex-post evaluation has been adopted and is being slowly implemented.	Ensure effective gradual implementation of the new regulatory policy law, with a focus on training and capacitation of officials.
Financial inclusion is low and concentration in the banking and payment systems is high. The payment systems market underwent rapid change during the pandemic with the entrance of new digital payment systems.	Promote competition in the payment systems market, for example by reviewing and potentially revising financial regulations.
Openness to trade is high, but exports are dominated by commodities, with high dependence on specific goods and export markets.	Gradually diversify exports and upgrade the position in global value chains by improving logistics infrastructure and supporting industrial clusters.
Strengthening the rule of law
High corruption significantly affects the business environment, rule of law, and policy implementation capacity. Few detected irregularities lead to successful prosecution. Preventive anti-corruption measures have recently been introduced, but there is room for improvement.	Establish a comprehensive strategy for effective corruption deterrence by strengthening preventive anti-corruption measures and implementing complementary reforms in key areas of justice, civil service, public procurement, infrastructure governance, and regulatory transparency. Strengthen internal control mechanisms and concurrent audits, ensuring their complementarity in corruption prevention.
The justice system lacks in transparency, accessibility, efficacy, and fairness. Large case backlogs and long delays hamper the administration of justice. Judicial corruption is high. Overuse of temporary judge positions creates inefficiencies and conflicts of interest.	Reduce the share of temporary judges by replacing them with career positions. Define clear criteria for tenure and career advancement of career judges. Advance the introduction of a digital case management system that is interoperable across all institutions in the justice system.
Improving state capacity for public investment and service delivery
The civil service is fragmented and over-reliant on ad-hoc service contracts with high turnover and low career incentives. A civil service reform has failed to be implemented.	Improve individual and institutional incentives for civil servants to switch to the new regime. Perform progress and impact evaluations of this new implementation stage to inform any further adjustments that might be required.
Centralised purchasing tools are underutilised, and many small contracts fall below the threshold for application of the public procurement law.	Increase the attractiveness of centralised purchasing tools through administrative simplification and providing greater flexibility for contracting authorities. Sanction the undue division of contracts.
Infrastructure gaps require significant investment. Subnational governments bear the responsibility of implementing most infrastructure projects, but face budget execution challenges and local projects are disconnected from national plans.	Improve the technical quality of national infrastructure planning and coordination and consistency of national plans and local infrastructure project implementation. Improve the budget process and ensure a predictable and committable annual budgeting mechanism for subnational governments. Enhance formal co-ordination mechanisms between levels of governments and strengthen the role of regional governments in coordination and planning of regional development.
The private sector and foreign governments play a crucial role in infrastructure development, given high investment needs and fiscal constraints. Public sector implementation capacity is weak, especially in subnational governments. Governance and evaluation against value for money could be improved.	Provide the new National Infrastructure Authority with technical capacity and budget. Promote knowledge transfer and capacity generation especially in subnational governments.

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