The formally legalized side of the service sector includes both government and private services. Government services, measured by payments for inputs in the absence of any recognized standard of output, have grown remarkably fast. As evaluated in current prices, government services increased from 4 percent of GDP in the decade of the 1950s to 9 percent in 1990.

Among the private service-sector activities, retail and wholesale trade has been the most important, accounting for 13.7 percent of GDP in 1988. Financial and business services were next most important at 8.5 percent of GDP, followed by transport and communications at 7.4 percent. Electricity and water constituted a small share of output in 1988, at 1.3 percent of GDP, but they increased at a very high rate from 1970 to 1988: their output in 1988 was 3.4 times as high as in 1970. Although these formal service-sector activities have, for the most part, shown significant growth even during the difficult 1980s, national accounts indicated that the largest of them--retail and wholesale trade--did not grow at all between 1980 and 1988. But that official measure was not readily credible, given the country's population growth and especially the rapid growth of the urban population. The official measure apparently reflected the fact that a growing share of trade was being carried out by unregistered individuals and firms.

Official statistics on production and employment are always subject to many reservations in Peru, as in all developing countries, but especially so for the service sector. Much of what is going on among these activities is outside the formal framework of the economy and very difficult to measure. In 1990- 91 many service activities were legally registered, reported sales and profits for tax purposes, and were in all respects within the formal accounting system of the economy. But many others were unregistered and might not even be known to exist as far as the government's statistics were concerned. That is true in any country for some activities, particularly those that operate against the law. It is also true on a massive scale in Peru for people who are just repairing shoes, making small items in their homes to sell in the streets, or in general trying to survive by activities that are perfectly normal and productive but not registered with the government. Peru has a massive informal sector, which includes more than half the total urban labor force. This sector accounts for a high proportion of personal services and retail sales activities, as well as considerable industrial production.

Exactly when and why these informal sector activities moved from a marginal to a large share of the economy are open questions. One strongly argued view, associated particularly with the work of Hernando de Soto, author of El otro sendero (The Other Path), is that regulatory activities of government proliferated from the 1960s onward, imposing intolerable costs on private business activities. A slightly different but consistent view is that the rapid growth of the informal sector coincided with increased business taxation, beginning at the end of the 1960s. The two interpretations fit each other, but the former lends itself more to a general argument against government regulation of business, without paying much attention to the fact that the growth of the informal sector means a shrinking tax base for the society.

Both of these analyses surely capture much of the causation behind the growth of the informal sector in Peru, but they may deflect attention from two other explanations that could be more important. One of them concerns the generalized deterioration of the economy and the consequent weak growth of job opportunities in formal-sector employment. With the rapid growth of the labor force, and a high rate of migration to the cities, the number of people looking for work far outpaced the number of formal job openings. The answer for those without regular employment in the formal sector has been to create self-employment activities of their own or to work for relatives in small-scale operations, often on a basis of family sharing rather than regular wage employment. These people do everything from selling coat hangers on sidewalks in the center of the city to putting together computers from discarded spare parts. In this view, the problem is not so much government regulation or excess taxation as it is one of macroeconomic failure of the economy as a whole. The informal sector may be in part a way to avoid regulation, but more fundamentally it is a necessary means of survival, a constructive answer on the individual level to lack of success at the level of the macroeconomy.

Still another interpretation that must be considered centers on the background of the migrants to the cities. They have been native Americans and mestizos from rural communities in which ways of earning a living are bound within traditional family and community relationships. Production is carried out on a self-employed or very small-scale basis with a minimum of the kinds of accounting, financial, and legal complications of modern society. The new migrants to the cities look for work and guidance from former migrants and especially relatives from the same communities who are carrying on much the same kinds of activities as they knew at home. They recreate in Lima the kinds of informal activities they have always known. In this view, the informal sector is largely a cultural phenomenon, by no means explicable in purely economic terms.

Succeeding governments have gone back and forth in their treatment of the informal sector, at times trying to crack down on unregistered vendors and their sources of supply, and at other times trying to provide them with information and technical help. The formal business sector might be expected to press for regulation of these activities because the legally registered firms must pay the higher costs of following regulations and paying taxes: competition is not even. But then the formal sector is itself divided. Because some of these firms cut their own costs by subcontracting activities to the informal sector, to some degree they share in the same profit from being outside the law. Everyone recognizes that the informal sector is the source of livelihood for a great many people without alternative opportunities and that helping to make them more productive could yield important gains for them and for Peru. The other side of the coin is that those in this sector pay no attention to the legal system, to health and safety regulations, or to the society's need for a tax base to support necessary public functions.

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Source: U.S. Library of Congress