PERU AMONG WORLD'S MOST INFORMAL ECONOMIES

UNCLAS SECTION 01 OF 02 LIMA 004139

SIPDIS

DEPT FOR WHA/AND, EB/EPSC
LABOR FOR ILAB, TMCCARTER, LBUFFO, CROMERO

E.O. 12958: N/A
TAGS: ELAB ECON PGOV ETRD PE
SUBJECT: PERU AMONG WORLD'S MOST INFORMAL ECONOMIES

REF: LIMA 3778


1. Summary: The World Bank ranks Peru as the world's fifth
most informal economy. In urban Peru, nearly 70 percent of
workers (62 percent in Lima) are employed informally, the
third highest rate in Latin America. Bureaucratic barriers
largely account for Peru's informality, generating problems
such as tax evasion, low productivity, and poor working
conditions. The GOP sought to reduce informality through
legislation approved in July 2003, but it has achieved
little progress. The GOP views the U.S.-Andean FTA as a
tool to reduce informality and generate more export-oriented
employment. End Summary.

High Informality in Urban Centers
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2. The Ministry of Labor's most recent report on national
labor market informality reveals that Peru possesses the
third highest rate in Latin America, behind Bolivia and
Panama. In its 2002 National Household Survey, the Labor
Ministry reports 69 percent of all workers in urban Peru are
employed informally. The Ministry defines informal workers
as: employees of unregistered businesses, workers without
remuneration, untrained independent workers, and domestic
employees. In 2003, the World Bank listed Peru as one of
the leaders in informal employment worldwide, ranking it
fifth, with 60 percent informality (no definition for
informality was provided).


3. In Metropolitan Lima, 62 percent of all employment
qualifies as informal, according to INEI, Peru's Statistical
Organization. The 1.3 million independent workers (domestic
workers, taxi drivers, and food vendors, among others)
account for 57 percent of the informal workforce, 279,000 of
whom are street vendors. Enterprises employing between two
and four workers account for another 39 percent of the
informal workforce. Nearly all informal workers are
employed by microenterprises, which employ less than ten
workers. The young bear the burden of informality. Those
between 11 and 24 years old make up 26 percent of the
economically active persons, yet account for about half of
informal workers.


4. An even higher incidence exists in the urban areas
outside of Lima, where informality accounts for 74 percent
of the workforce. Single worker enterprises occupy 50
percent of the 3.2 million informal jobs existing in these
areas. Another 44 percent work for enterprises employing
between two and four people. Just as in Lima, micro
enterprises account for nearly all informality.

Costly to Join Formal Economy
--------------


5. Despite Peru's positive macroeconomic growth, formal job
creation has lagged. Bureaucratic barriers are largely
responsible for the long delays and high costs in
establishing a formal business. In Peru it takes a minimum
of 98 days and costs $778 (36 percent of per capita income)
to start a business, according to the World Bank. Business
leaders often complain that Peru's labor laws are too
burdensome and costly, creating incentives for small
enterprises not to join the formal economy. Employers that
adhere to the high-standard labor legislation find that 64
percent of their labor expenses are non-salary related.



6. The Labor Ministry indicates that 41 percent of workers
participate in the informal sector because they could not
find other work, whereas 50 percent participate by choice.
The most prominent reason why people choose to work
informally is the opportunity to make more money, followed
by the desire to work independently. Given the option,
informal one-worker enterprises and microenterprises prefer
not to pay taxes and cover the relatively high costs of
being formal. Many business leaders argue that by
implementing a more flexible labor code and streamlining
registration bureaucracy, Peru would attract more private
investment and increase the size of the formal economy.

Legislative Fix Fails to Reduce Informality
--------------


7. Congress passed Law 28015 in July 2003, with the
objective of reducing barriers to the formal economy and
simplifying the registration process for microenterprises.
Unfortunately, then-Labor Minister Fernando Villaran, the
main promoter of the law, left his office just as it passed
congress, and the four subsequent Ministers have not made
its implementation a priority.


8. The negative effects of informality are extensive,
reaching both the demand and supply side of the labor
market. The visible effects of Peru's high informality
include: the inability to collect income taxes from nearly
70 percent of workers, no tax revenue from informal
businesses, low workforce productivity (down 40 percent from
1975),and unregulated and poor working conditions. Without
job security, workers in the informal sector often receive
less than minimum wages and no benefits.

Comment: FTA Promotes Formality
--------------


9. A recent proposal by Labor Minister Juan Sheput to
reduce labor market rigidity has met stiff opposition from
labor unions and some political parties (Reftel). While
many in the GOP understand the problems affecting Peru's
labor market, forward action is unlikely during an election
year. Nevertheless, the GOP views the U.S.-Andean Free
Trade Agreement (FTA) as a tool to stimulate reform and
create new export-related employment -- a key element for
moving Peru's workforce into the formal economy.

POWERS