LBJ School of Public Affairs P.A.

693BAdvanced Political Economy: Economics of Urban and Regional Policy November 2013

TERM PAPER Denny S. Rivas Analysis of the evolution of urban economic structure using time series: the case of the cities of Huaraz, Ica, and Puno-Juliaca in Peru.

1. Introduction Unlike large urban cities in Peru, small scale cities (less than 250,000 inhabitants) are strongly dependent on natural resources. That dependency drives cities economic growth and make them susceptible to variations in resources availability. Simultaneously, hexogen factors as external demand or changes in environmental regulations lead to sudden changes in growth pace of such cities. Employment evolution analysis helps to explain the dynamics of the economic structure of a region and to identify the dominant sectors within that economy. In the case of Peru, lack of broken-down data in geographical and economic scale (stats are grouped in five sectors that represents the whole economic structure of cities) limits the accuracy and reliability of economic growth models at local scale. This report studies economic growth in three cities in Peru, identifying the dominant sectors in their economy and their dependence on natural resources consumption. The analysis is based on the assessment of employment time series for the cities of Huaraz, in the Department of Ancash; Ica, in the Department of Ica; and Puno-Juliaca, in the Department of Puno. The three cities presents different geographical conditions; Huaraz is in the Andean region (Peruvian tropical glaciers region), Ica is located close to the Pacific Coast; and Puno-Juliaca is close to the border imposed by Lake Titicaca in the south region of Peru. Although the three cities sample part of the geographical diversity of Peru, they coincide on high dependence on natural resources exploitation. Employment data extracted from the National Survey of Monthly Employment Change (2003-2012) has been used to analyze the economic growth of the three cities. The survey time series include 5 economic sectors: extractive, manufacture, non-personal services, personal services, and trade. Each monthly time series was decomposed into trend, seasonality, and random components and the driving sectors for each

city were identified, not just based in the magnitude of employment they provide, but also on the correlation or sector dependence in which they are immersed. That is, Can a sector explain economic growth in other sectors? The method proposed in this report seeks to answer that question and explains how the applied correlation test provide some insights about the assimilation lag of changes between sectors and hence the expected delay on policies effect for them. 2. Three regions, three different stories: brief approach to the geography, history, and economy of the cities of Huaraz, Ica, and Puno-Juliaca

2.1. City of Huaraz: in the shadow of the glaciers Huaraz is the capital city of the Department of Ancash. It is located in the tropical-glacier region of Peru, 3052 m.a.s.l. and 250 miles away from Lima. The urban area of Huaraz is settled in the highland section of the department, limited towards north-east and south-east by the White and Black ranges, respectively, in the valley known as Callejon de Huaylas. This valley represents the axis of physical, economic and political development of Ancash highlands. The physical barriers imposed by both ranges, the parallel path of Santa River (the highest flow river in the department) and the inter-department highways have set conditions for settling of other cities across the valley (Recuay and Carhuaz cities, for instance).

Figure 1. Location of the city of Huaraz

In the same way that geographic conditions set the pattern of regional growth across Callejon de Huaylas valley, these same conditions make the settled cities vulnerable to natural disasters. Huaraz has suffered two destruction and reconstruction cycles over the last century due to a glacier lake outburst flood in 1941 and an earthquake in 1970. Current population in Huaraz are descendant of migrants that were attracted to Huaraz by the reconstruction processes started after those natural disasters occurred; they keep weak links with the original inhabitants. Population of Huaraz reached 100,931 inhabitants in 2007 (National Census of Population, 2007) and has increased sustainably since 1970. Despite its vulnerability, the city keeps its role as the center of finance and tourism services that supports productive activities in the Callejon de Huaylas valley, specially surrounding mining activities: copper, zinc, gold, and silver extraction (Mines and Energy Ministry of Peru). Agriculture activity is mostly irrelevant within the extractive sector, because crops are exposed to freezing processes; agriculture becomes a domestic activity for selfconsumption. 2.2. City of Ica: zero unemployment at the coast Ica is located in the south-central region of Peru, close to the Pacific Ocean coast, in the Ica River valley, just between the Andes and Ica ranges. The city is the capital of the Department of Ica and its current population exceeds 130,000 inhabitants (INEI, 2012). Ica River valley is irrigated by the water supply of Ica River, and ironically surrounded by the desert dunes of Lancha and Villacuri.

Figure 2. Location of the city of Ica

The city of Ica is the core of current agro-industrial business development in Peru. The country has become the largest exporter of fresh asparagus in the world and most of it comes from Ica (Los Angeles Times, 2011). The agro-industrial demand of labor has attracted migration of Andean indigenous population to the coast attracted by job opportunities. 2.3. Puno-Juliaca: trade convergence in highlands Puno and Juliaca are two cities of the Department of Puno, in the south region of Peru. They are located close to Lake Titicaca, in Andean highlands (3,825 m.a.s.l.). Although they are geographically independent, they work as complementary urban regions. Puno is a government and tourism center, while Juliaca, 45 km towards the north, is the trade, manufacture, and finance center of the region. Juliaca is also well connected with other cities of the coast, mountain and forest areas at the south of Peru (Arequipa, Tacna, and Cuzco), and even with Bolivian border cities like Nuestra Seora de La Paz, across Lake Titicaca (Geddil, 2012). The strategic position of Ica favors its role as the main trade and finance center in the region, whose population exceeded 254,000 inhabitants in 2011 (INEI). According to the Trande and Production Chamber of San Ramn (Puno), trade and finance were the dominant activities in the region the last 8 years (RPP, 2012).

Figure 3. Location of the cities of Puno and Juliaca

Mining in Puno focuses on extraction of tin (Puno is the only region of Peru that produces tin and the third world producer), lead, zinc, gold, and silver (BCRP, 2012). However, mining activity has a high level of informality in the region. The Ministry of Energy and Mining of Peru started in February 2012 a process to legalize small mining activities. The process should conclude in 2014. In spite of informal mines, Puno registered considerable increases in the last decade, from 30 registered concessions in 2001 to 600 in 2011. This mining boom has had consequences in the economic development of Puno-Juliaca, but the impact is not clearly quantified. According to the Trade Chamber of Puno, from 2005 to 2011 informal mining made land prices rise due to increases in population incomes (La Republica, 2013). The ongoing legalization process is expected to impact and decrease the real estate boom during the next years. 3. Correlation tests: alternative methodology to assess economic growth Conventional analysis (shift-share or quotations analysis) of urban economies is difficult to apply in cities of Peru due to lack of disaggregated data. Expect by Lima, cities of Peru only keep records of economic sector activities broken down into 5 main sectors (no further subdivision is available): extractive (mining, agriculture, fishing, etc), manufacture (any kind of industrial processes), personal services (hotels, shops, restaurants, cleaning, tourism services, etc.), non-personal services (finance, water and energy utilities, transportation, etc), and trade. Each sector absorbs many activities of different nature and hide their individual effect into the cumulated employment of the whole sector. The only advantage of using this aggregated dataset is that small scale economies in Peru apparently are not highly diversified and there are dominant subsectors that plays a more relevant role (for instance, mining in the city of Puno dominates the extractive sector). Alternatively, instead of analyzing economies structure matrices using shift-share or quotations analysis, this report proposes to study economic growth in Huaraz, Ica, and Puno-Juliaca, using time series analysis. Time series analysis allows to explore the evolution of employment for each sector. As long as strong correlations are observed between sectors and those relations are steady over time, they can be considered significant and representative of the economy interaction between sectors. The advantage of this approach is precisely that the signal of the main sectors activity is being tracked over the time series and distortion due to transitory or minor activities is neglected. The analysis of the economies of Huaraz, Ica, and Puno Juliaca required (1) to decompose employment time series to get trends, seasonality, and random components; (2) to plot cross correlation functions (ccf) between all the sectors of each city and to identify the dominant relationships in its economic structure; and (3) to estimate the statistical correlations between sectors as well as their significance.

3.1. Finding trends: decomposition of employment time series Decomposition allows to remove seasonality and random variation in time series. In the case of employment, seasonality might reflect cycles of production or demand inherent to each sector. This report assumes that inter-sectorial relations are best described by the trends of employment evolution rather than by small variations. In this way, seasonal or random variations of each sector are a source of distortion and they were removed before testing inter-sectorial correlations.

Figure 4. Decomposition of employment time series for the trade sector in the City of Ica

The applied decomposition calculates the moving average trend of employment for each sector of the three analyzed economies (Figure 4b). In this case, the moving average trend is estimated considering consecutive periods of 6 months length. The difference between the original time series data and its trend is the variability of the series (seasonality plus random variation), from which standard seasonality is extracted1.

3.2. Identifying dependencies: cross correlation functions

1

The applied statistical routines are implemented in R statistical package.

Dependencies between sectors can appear either simultaneously or lagged for the trends of employment time series. That is, changes in one sector can have an immediate effect over other sector, or they can have a delayed effect. The dependent sector will not receive any impact until a given period has gone by; that period is called lag. Cross correlation functions (ccf) provides a mean to find the lag associated to the maximum correlation between two related time series (regularly, it is expected that the correlation decreases as the lag increases, but it is not a rule)

Figure 5. Cross correlation function (ccf) for extractive and manufacture sectors in Ica

In the case of the personal services and trade sector for the City of Huaraz, Figure 5 shows that the maximum correlation is produced between both time series when there is no lag between them. But also shows that there is a long term correlation between them. Although the correlation diminishes as the lag increases, it remains significant at least 24 months back (negative lag) because the significant threshold (dot line in Figure 5) is not crossed. 3.3. Statistical correlation and significance Even though the ccf functions identify dependent relationships and approximate correlations between sectors, they do not provide the significant level of that correlation (only the threshold indicated in Figure 5). A simple Pearsons correlation test, instead, provide both the statistical significance of the correlation between sectors and a more accurate correlation coefficient. In this report, Pearsons coefficients were

estimated for the strongest relations indicated by the ccf function. In Pearsons test, correlation coefficients are high if they are close to one, while the significance of the indicated correlation is inferred trough the p-value or probability value (the probability that the calculated correlation had appeared by chance for the assessed time series). Significant correlations are associated with low p-values (p < 0.05 is the threshold in this case). 4. Driving sectors: results 4.1. City of Huaraz Huaraz economy is the less diverse of the studied cities. The trends of employment shows that the extractive sector has sustainably decreased since 2005 (see trend graphs in Appendix 1). This decrease is accompanied by the absence of medium or large scale industries in the city (firms with more than 10 employees). The National Employment Survey does not provide data for firms whose size is lower than 10 employees or informal activity, hence the estimated trends do not directly capture the scale or informality effect on the local economy. In the other hand, trends seem to indicate that growth of personal services (hotels, restaurants, etc.) and non-personal services have inverted the structure of the Huaraz local economy over the last decade to become the dominant sectors of the economy. Likewise, correlation test between employment trends (Table 1) indicates that growth of personal services sector is strongly linked to the parallel sectors (trade and non-personal sectors). Therefore, personal services sector is a potential driver of economic growth in Huaraz. Correlations are significant in both cases (0.88 and 0.98).
Table 1. Correlation tests results for the City of Huaraz Sectors Corr. Coef Driving Personal services Personal services Dependent Non-personal services Trade 0.88 0.98 < 2.2E16 < 2.2E16 0 0 p-value Lag Max. Lag >24 >24

The correlation results also indicates that the linked sectors are coupled in such a way that they are immediately sensitive to changes in the driving sector (zero lag). Therefore, it is expected that incentive policies applied to this sectors can become effective and multiply in short term. 4.2. City of Ica

The city of Ica is more economically diverse than Huaraz and shows more uniform growth. However, despite this apparent uniform growth across sectors, extractive and services sectors seem projected to rise at the end of the 2003-2012 period (see trend graphs in Appendix 2), while manufacture and trade are stagnated since 2009. This stagnation or even drop in manufacture is reasonably due to the concentration of the sector in export oriented agro-industry products. After the drop of employment in 2009, the manufacture sector required approximately a year to stabilize again, and there is no evidence of increases in manufacture employment since 2010. Pearsons correlation test results (Table 2) shows significant correlations between extraction and manufacture sectors, as well as between non-personal services and trade sectors regarding personal services sector. Correlations seem to show a division between exports oriented sectors (extractive and manufacture) and more local sectors (services and trade).
Table 2. Correlation tests results for the City of Ica Sectors Corr. Coef Driving Extractive Personal services Personal services Dependent Manufacture Non-personal services Trade 0.87 0.95 0.96 <2.2e-16 <2.2e-16 <2.2e-16 0 0 0 p-value Lag Max. Lag 3 >24 >24

In comparison with Huaraz, the economic structure of ICA is more consolidated. There are no important variations in its structure over the last decade. Agroindustry, which influences extractive and manufacture sectors, concentrated about 20,000 employments during the last five years (2008-2012), whereas services and trade sectors provided approximately 50,000 permanent employments. Correlations also indicate that more relevant coupled relationships between sectors are immediately transmitted across sectors (zero lag) and their effects are rapidly dissipated over time (correlation is not significant after three months) 4.3. City of Puno-Juliaca The boom in mining started in the cities of Puno and Juliaca in 2005 has led to sudden changes to the region economy. Before the mining occurred, Puno was characterized by an inexistent extractive sector and a decreasing manufacture sector. However, only accounting for formal mining activities, more than 600 concessions were awarded from 2001 to 2011, while the previous decade, the total concessions never exceeded 30.

Again, like for the Ica case, exports sectors (extractive and manufacture) are directly sensitive to positive mutual changes on employment generation and the extractive sector looks like the potential driving sector (see trend graphs in Appendix 3). Contrarily, non-personal and trade sectors are apparently more independent. Persons correlation tests (Table 3) confirms that the relation between extractive and manufacture sectors in Puno is significant, and that, in spite of the sudden changes in manufacture tendencies, manufacture and non-personals services are paired with each other. Furthermore, a correlation between trade sector and non-personal services seems also feasible. The whole change of correlations might be potentially driven by the extractive sector, particularly mining activities.
Table 3. Correlation tests results for the City of Puno Sectors Corr. Coef Driving Extractive Manufacture Non-personal services Dependent Manufacture Non-personal services Trade 0.83 0.79 0.92 <2.2e-16 <2.2e-16 <2.2e-16 3 14 0 p-value Lag Max. Lag >24 >24 >24

Changes in the extractive sector in Puno immediately affect manufacture employment, but because the analyzed period includes the curve of introduction and consolidation of mining activities (rise curve in the trend of the extractive sector: see trend graphs in Appendix 3) the impact of changes in extractive sector over manufacture extends two or even 3 years back in a long assimilation process. Legalization promoted by the Ministry of Energy and Mining should unhide the masked data in extractive and manufacture trends since 2013 (see trend graphs in Appendix 3), but it will not necessarily lead to positive increases in the rest of the economy. According to the Chamber of Trade of Juliaca, decreases in informal mining activities will negatively affect parallel sectors. Real State subsector, for instance, had been benefited for the sudden flux of newcomers to Puno and the increasing incomes they informally produced). 5. Conclusion The proposed method of economic growth analysis allowed to evaluate and compare the evolution of the economic structure of the cities of Huaraz, Ica, and Puno-Juliaca. In general, results confirmed what sectors played a more important role and drove relevant changes in the economies of the cities over the

last decade: agroindustry (extractive and manufacture sectors) in Ica case, and mining (extractive sector) in the case of Puno. However, the exception is given by the case of Huaraz, because it was expected to play a more relevant role in the economy of the city. That contradiction might derive from the scale of the analysis, because just the employment generated by firms with more than 10 employees was accounted for. Therefore, correlation models are ignoring the influence of small scale and informal industries. The effect of scale is more evident for Huaraz case than for Puno or Juliaca because the economy of Huaraz is less diverse and the magnitude of overall employment is lower than in the other two cities.