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ECONOMIC REFORMS IN CHILE: FROM DICTATORSHIP TO DEMOCRACY
Palgrave, London, 2010 and New York, 2010
FIRST PART
AN ACCOUNT OF FOUR DECADES
Chapter I
ECONOMIC DEVELOPMENT IN CHILE SINCE THE 1970s
One main reason for the relevance of the Chilean experience for other emerging economies,
with the implementation of a free market economic model, rests in the depth of
transformations and the long period since this process was started. The first intense reforms
were launched in 1973, under the dictatorship of general Pinochet. Usually, it has been
generalized the idea that there is “one” successful Chilean model. The fact is that the over
one-third of a century elapsed since 1973 includes several sub-periods, with different
approaches, diverse external environments, and notably diverse economic and social
outcomes. This diversity is of great significance, since Chile not only teaches of relevant
successes but also of deep mistakes and failures to be avoided.
The first stage of the reforms (1973-81) was characterized by the implementation of
a neo-liberal model in its purest and ideological form. Deep trade and financial
liberalizations, and the adoption of “neutral” economic policies, were accompanied by
massive privatizations. In general, by 1981, success was achieved in reducing the inflation
rate and eliminating the fiscal deficit, but at the expense of the external balance and
recording a low investment ratio. The consequence was an economic and social collapse in
1982, with a GDP drop of 14%, high unemployment exceeding 30% of the labor force, and
a significant increase in poverty with a worsening income distribution.
The second stage (1982-89) implied moves toward more pragmatic policies to
overcome the effects of the deep crisis. It involved a series of foreign debt renegotiations,
several policy interventions aimed to balance the external deficit –such as tariff increases
and “selective” export incentives- and the direct take-over of the collapsed financial
system, and then privatizing it again when their balance sheets were in order thanks to
heavy public subsidies to banks and debtors. At the end of this period, the economy had
recovered, while income distribution had worsened even further than in the seventies.
During recovery, actual GDP grew vigorously, but after due consideration of the 1982
recession, it emerges that average annual growth was under 3% in both halves of the
Pinochet regime.
2
By 1990, in the return to democracy, the Chilean economy faced the challenges of
achieving a sustained high average GDP growth and of serving the great social debt
accumulated in the years of dictatorship.
Thus, a third variant of the economic model began in 1990, under democracy. We
have named this stage that of the reforms to the reforms, since it started from what had been
inherited; the formal slogan of the Concertación Democrática, a center-left coalition of
socialists and Christian democrats, was “change with stability” for achieving growth with
equity in the socio-economic dimension of the program of the new government. There were
significant reforms of the market model, strengthening the social component and correcting
severe failures of economic policies. It included labor reforms (that restored several labor
rights) and a tax reform (that raised public revenue in order to improve social expenditure).
In addition, substantive counter-cyclical changes in fiscal, monetary, capital markets,
exchange rate and regulation policies were implemented, aiming for a stable and
sustainable macroeconomic environment, functional for economic development. It was in
this context in which Chile expanded its productive capacity, in a sustainable manner in the
nineties, growing at annual rates exceeding 7%, improving at the same time the social
indicators; that is, it was partly achieved the elusive economic growth with equity.
Nevertheless, gradually, after de mid-1990s, Chile weakened its counter-cyclical
macroeconomic approach and became, as a consequence, vulnerable to the turbulences
originated by the Asian crisis: the real exchange rate appreciated significantly and the
external deficit doubled. As a consequence, the economy exhibited a stagnating actual
output and a drop in the growth of potential GDP in the quinquenium 1999-2003. After a
partial and hesitating recovery in 2004-08, and the arrival of the contagion of the global
crisis in 2009, today it should be seeking reforms to the model that would allow resuming
sustained growth after the weak economic performance of 1999-2008. We analyze all these
situations across the text.
Section 1 presents a brief summary of outstanding features of the Chilean economy
since the fifties, advancing rapidly up to the period in which this book focuses, which
begins with the military coup of 1973. Section 2 covers the Pinochet regime. Section 3
summarizes the four democratic governments of Presidents Patricio Aylwin, Eduardo Frei
Ruiz-Tagle, Ricardo Lagos, and Michelle Bachelet. Finally, a methodological annex digs
3
into the long-run trends of Chile’s economic growth during the past half of a century; we
emphasize (i) the contrast between average figures recorded in dictatorship and in
democracy, and (ii) the respective instabilities exhibited by the real economy (employment,
investment, output) in diverse sub-periods; finally, the annex presents alternative
measurements of potential GDP or productive frontier.
1.
A historical perspective on development strategies
At the time of the Great Depression, the Chilean economy was one of the most developed
of the region. The Great Depression affected the Chilean economy severely. The decline in
the terms of trade and the collapse of exports were disastrous (see Muñoz, 1986). Following
the worst years, however, the Chilean economy enjoyed a significant recovery, with a rate
of industrial growth that mitigated the constraints imposed by the trade slump. Principally,
this was the result of economic policies that responded actively to the crisis with new
industrialization strategies.
During the 1950s, however, the development model began to encounter new
problems.1 On the one hand, indiscriminate protection to import substitutes reduced its
productivity and discouraged the development of new exports. The instability of traditional
export prices was transmitted to the domestic economy through recurrent balance of
payments shocks. One main warning signal about the intensity of failures in the Chilean
economy was the accelerating inflation of 1952-55, when the annual rate of increase in the
index of consumer prices (CPI) jumped from 12% to 86%. The government of President
Carlos Ibáñez, which had been elected by a large majority in September 1952, with the
support of independents and leftists, lost its popularity, encountered growing social unrest,
and ended up adopting an orthodox stabilization program. Both the money supply and
government spending were sharply curtailed, and the complex system of regulations
introduced during the Depression and World War II was cut back. But soon, the
recessionary effects of these initiatives led to widespread social rejection.
1
The next three presidential periods –1952-58, 1958-64 and 1964-70– are analyzed in detail in FfrenchDavis (1973).
4
In 1958 was elected a rightist government. Given the prevailing high inflation,
President Jorge Alessandri focused on achieving price stabilization. In his view, that was a
pre-requisite for stimulating private investment. Stabilization was to be achieved by
eliminating the "inflationary financing" of the fiscal deficit and pegging the nominal
exchange rate. Consequently, a stabilization program anchored to a pegged exchange rate
and import liberalization was designed, supported by abundant foreign loans to the
government.
This program enjoyed temporary success. Inflation was indeed substantially reduced
in 1960-61, but the balance of payments deficits grew so large that international reserves
were soon depleted. The investment ratio and output had risen, but the increase in exports
was unable to offset the great expansion in imports, which exceeded the available external
financing. As a result of a currency crisis, in 1962 the exchange rate was devalued, import
restrictions were reinstalled, and inflation climbed back.
In 1964 the Christian Democrat Eduardo Frei Montalva was elected President. The
government strategy was based on a three-point platform: a gradual, multi-anchored, nonrecessionary stabilization program; an industrial modernization program that reactivated the
role of the State as the generator of investment initiatives, introducing new, leading sectors
(such as telecommunications and the petrochemical industry), and developing nontraditional exports; and a program of structural and social change that included a significant
agrarian reform, the first steps in the nationalization of the nation’s large copper mines, and
the development of community and labor-based grassroots organizations (Ahumada, 1966;
Molina, 1972).
In 1964, productive capacity was underutilized and real wages were depressed,
which made it possible to reconcile a boost in output, wage increases, and a reduced
inflation. This was facilitated by improved terms of trade in 1965-66. Increased fiscal
expenditures of 1965 were funded by a significant tax reform, which raised revenue,
diminished evasion, and improved tax equity. After strong growth of gross domestic
product (GDP) in 1965-66, underutilized productive capacity gradually became exhausted,
while investment continued at moderate levels. Real wages also rose much faster than
planned, with a sharp surge in the organized sectors. This resulted in cost pressures on
prices and had a negative impact on the government budget and on inflationary
5
expectations. Strikes spread, and relations between the government and urban labor unions
deteriorated. Inflation, that had been dampened in 1965-67, began to rekindle in the
subsequent years.
The macroeconomic outcome was a gradual rise in the underutilization of
productive capacity since 1967. In fact, actual average growth consisted of a vigorous 5.9%
in the first biennium and a modest 3.1% in the final four years of the Frei Presidency. After
reaching a high rate of use of labor and capital in 1966, the gradual underutilization of the
capacity had generated a significant output gap by late 1970.2 Nevertheless, no disequilibria
as traumatic as those of 1955 and 1962 in the past, or 1975 and 1982 in the future, were
recorded.
A great disequilibrium that increased over the years took place in the socio-political
arena. Political antagonisms prevented the formation of a broad-based coalition
government. The scope of the new development strategy was extremely ambitious.
Evidently, without a broad and solid coalition the chances for success were slim.
Differences concerning the nature and degree of change prevented the formation of a large
center-left majority in favor of progressive reforms. Only after the military coup these two
political sectors would reach consensus for the accomplishment of sustained economic and
social reforms, gaining all elections since 1988 and in charge of the four presidential
regimes from 1990 to 2010, until a defeat in the latter date.
In brief, the Frei government implemented an ambitious program of progressive
reforms. Productive capacity growth averaged only 4.3%, rather low compared with the
5.6% average recorded by Latin America. But currency crises were avoided and inflation
was curbed (see table I.1). A significant reform of the tax system was accomplished and
51% domestic control over the large copper mines was achieved, leading to the capture of a
sizable share of the economic rent from that rich natural resource. The rural sector –with
the implementation of structural reforms, most notably the agrarian reform– and the
industrial sector were modernized. Exports were diversified, with a steady increase in non-
2
After a drop in 1967, a sharp improvement of the terms of trade in 1968 and 1969 was recorded
(equivalent to 6% of GDP), followed by a partial negative shock of 3% in 1970. A significant share of the
improved external balance was captured by the Chilean government and saved as international reserves in
the Central Bank, in order to face future deterioration of copper prices. This was a pioneer approach
toward the implementation of a counter-cyclical copper stabilization fund, seeking to stabilize both the
fiscal expenditure and the foreign exchange market.
6
mining items, and there was a strengthening of Latin American regional integration, which
was also instrumental in trade diversification. The State apparatus was modernized by
providing it with better qualified human resources. A stable real exchange rate policy was
put in place and sustained, assisted by a sort of pioneer copper stabilization fund, and
strides were made in rationalizing the import regime and export promotion.
Table I.1]
In 1970, President Salvador Allende was elected by one third of the national electorate. The
Unidad Popular (UP) government sought far-reaching structural change, particularly with
respect to property and without regard for macroeconomic equilibrium. It proceeded
without a social and political majority.
President Allende inherited idle installed capacity and large international reserves.
This allowed an expansionary policy with rapidly rising wages and social expenditures.
Economic activity responded positively, with an 8% rise in GDP and no significant
inflationary pressures in 1971. However, the expansion was carried out with public revenue
losses due to drops in real (public) utility tariffs, an appreciating real exchange rate, and a
rapidly expanding money supply which financed a rising fiscal deficit. The fiscal deficit
climbed to 12% of GDP in 1972-73, financed principally with Central Bank money
printing. The huge deficit was strongly influenced by repressing price controls on the goods
and services sold by public enterprises (Larraín, 1991), while public and private investment
became depressed. Meanwhile, structural changes, including completion of the
nationalization of the large copper mines and the nationalization of the banking system and
several other enterprises, were under way. In addition, many firms and farms were taken
over arbitrarily by workers or political groups.
Aggregate demand rose disproportionately with respect to the slowing creation of
new productive capacity, while external, fiscal, and monetary balances worsened at an
accelerating pace. This deterioration was intensified by the persistent worsening of the
terms of trade from 1970 to 1972, and by the sharp cut-off of private and US government
loans (see Bitar, 1979; Dornbusch and Edwards, 1991).
7
A change of the head of the economic policy team in the middle of 1972 was
accompanied by a serious attempt to correct the course taken. Nevertheless, the magnitude
of the macroeconomic imbalances and the lack of governance frustrated this and several
later attempts of rectification. During 1972-73, actual GDP declined 4.1% because of
sectoral imbalances and bottlenecks resulting from import restrictions, countless strikes,
distortions in official relative prices, a growing black market, rising underutilization of
potential GDP, and accelerating inflation (Bitar, 1979).
Meanwhile, income distribution initially improved due to significant expansion of
employment and nominal wages, but it step-back later with the climbing hyperinflation (an
annualized 700% in the four months before the September 1973 coup) and the
underutilization of potential GDP in 1972-73. In all, this period shows a distributive
improvement but within a deteriorated economy: a less concentrated distribution of a
smaller cake.
Economic policy ended up hurting the government politically, providing
ammunition to a tough opposition. The size of idle productive capacity at the outset, as well
as the State's inability to enforce price controls (at levels sometimes as low as 1/10 of
generalized “black” market prices) and to sustain balance of payment imbalances, were
highly overestimated. Macroeconomic imbalances were fully felt in the second year of the
administration, and from there on the struggle for power absorbed most of the energies of
both government and opposition. Economic disequilibria, black markets, hyperinflation,
low governance and the growing inability to reach political agreements finally gave way to
the dramatic institutional break-up and the prevalence of the coup supporters in September
11, 1973 (Baño, 2003).
2.
The neo-liberal strategy, 1973-893
The period covered by the dictatorship of Augusto Pinochet is longer than the three
democratic governments that preceded it (Alessandri, Frei Montalva and Allende) and the
3
This section is based on an abridged and revised version of “Economic and political instability in Chile:
1950-89”, co-authored with Oscar Muñoz, published in S. Teitel (ed.), Towards a new development
strategy for Latin America: Pathways from Hirschman’s thoughts, Inter-American Development Bank,
1992. I am indebted with Sergio Bitar, Manuel Marfán, Patricio Meller, Oscar Muñoz, Dagmar Raczynski,
Joseph Ramos, John Sheahan, and Simón Teitel for their valuable comments.
8
three that followed it (Aylwin, Frei Ruiz-Tagle and Lagos). This long period can be divided
into two halves.4 The first one, between 1973 and 1981, is a case of orthodoxy or neoliberalism in its purest or extreme form. The second one, from 1982 until March 1990,
within the same general approach, introduced numerous heterodox interventions, which
gave a more pragmatic, down to earth, shade. They were stimulated by the severe crisis
resulting from the most ideological policies of the first half. This second period can be
identified as pragmatism (what is positive because it tries to adapt to the real economy);
nevertheless, many of the interventions had a strong regressive bias (evidently negative),
favoring sectors with high income and at the expense of medium and low income sectors.
That explains the significant worsening of income distribution and poverty during the
1980s.
a)
Pure neo-liberalism, 1973-81
One distinctive feature of neo-liberalism is its “globalism”: that is, its neglect of the
implications of sectoral imbalances; of the heterogeneity in productive structures and
among economic agents, and in access to voice and power of different sectors; of the social
and allocative implications of market segmentations, and of the difficulty of transmitting
transparently information to all sorts of economic agents so that they can contribute to
fulfilling the expectations of policy-makers. Ultimately, neo-liberalism also underestimates
the frequent presence of destabilizing adjustment processes, lags and overshooting, and the
incompleteness of markets and institutions in developing nations. These elements represent
severe obstacles that prevent “neutral” and indirect global economic policies from being
effective, by themselves alone, in emerging economies that are in the process of deep
transformation like Chile was.
In parallel with the changes in the economic field, there were structural reforms in
social organizations. According to the rhetoric of the dictatorship, these were part of the
project to create a competitive society of “free men”. This involved reforms in the
4
The economic and social dimensions are examined in CIEPLAN (1982; 1983); Büchi (1993); Edwards
and Cox-Edwards (1987); Fontaine (1989); Foxley (1983); Larraín (1987); Larraín and Vergara (2000);
Meller (1996a); Ramos (1986). Texts of wider coverage, with abundant references, are Correa, Figueroa,
Jocelyn-Holt, Rolle and Vicuña (2002); Huneeus (2001); Moulián (1997).
9
university system, in the organization and dependence of elementary schools, in health
services, professional associations, and student and labor organizations.5
The initial concerns of Pinochet's government lay with controlling the
macroeconomic disequilibria and especially the hyper-inflation inherited in 1973.6 Soon,
the arguments shifted into the inefficiencies of the prevailing economic system, according
to the international speech that became in fashion in the following years. Increasingly,
structural changes deepened, as an extreme neo-liberal group extended its power until it
dominated the public policy making.
(i)
The reforms
The main reforms were abolition of price controls; across-the-board import liberalization;
sharp deregulation of the domestic financial market, both in terms of access by new
financial institutions and of interest rates and lending policies, followed at the end of the
decade by a deregulation of capital inflows; reduction of the public sector and restrictions
on the activities of public enterprises; privatization of the pension system and part of the
national health service; the return of expropriated businesses and lands to their former
owners; privatization of many traditional public enterprises; suppression of most current
labor union rights; and a tax reform, which, along with eliminating some distortions (e.g.,
the cumulative effects of sales taxes corrected by implementing a value-added tax), sharply
reduced the share of direct and progressive taxes. The traditional role of the State, as
entrepreneur and promoter of investment and industrialization, was to be curtailed as
quickly as possible so that those functions might be fulfilled exclusively by private agents
in liberalized open markets, under the “neutral” rules of a free-market economy.
Privatization was not limited to transferring businesses expropriated during the
regime of President Allende. It was also extended to enterprises created during successive
governments after the establishment of the public Development Corporation (CORFO) in
1939. In 1970, CORFO controlled the ownership of forty-six enterprises, a number that
5
6
See Campero and Valenzuela (1981); Vergara (1981) and several articles in Revista Mensaje, especially
Ruiz-Tagle (1979; 1980) and Zañartu (1980).
Consumer prices rose 600% in 1973; as said, in the last four months of the UP government the annualized
inflation rate reached 700%.
10
rose to around three hundred in 1973.7 In 1980 there were only twenty-four enterprises left
in the hands of this institution, half of which were in the process of being sold. There were
also a dozen public enterprises dependent on other governmental departments. Among
these were the Copper Corporation (CODELCO) and the National Oil Enterprise (ENAP).
The sale of enterprises was largely conducted amidst domestic recession and
extremely high domestic interest rates. Hence, few agents were able to participate as
buyers. This was one of the causes for the resulting acute concentration of wealth. 8 It is
interesting that there was weak participation by multinational corporations, in contrast with
the official expectations of a vigorous flow of foreign direct investment (FDI). However,
massive loans from international commercial banks provided a substantial share of the
financing required by the domestic economic groups acquiring the enterprises being
privatized.
In the agricultural sector, the transfer of ownership had dramatic significance. The
agrarian reform that had taken place during the governments of Presidents Frei and Allende
came to an abrupt end. After 1973, around one-third of the expropriated land was returned
to former owners and close to another one-third was auctioned to non-rural dwellers. Barely
one-third of the area was allocated to peasants. Given the curtailment of State provision of
credit and technical support to peasants and cooperatives, these were some of the principal
victims of the restructuring of public expenditure. It is estimated that, as early as 1979,
about half of the peasants who had been assigned land had been forced to sell or rent out
their farms (see Ortega, 1987).9 At the same time, a massive expelling of peasants from the
farms on which they had been living before and during the agrarian reform took place.
In 1980, another major step in the process of privatization was taken in the social
security system. The pension regime, hitherto financed through a pay-as-you-go system,
was replaced with individual capitalization in private social security societies (AFP) created
7
8
9
This figure does not include about 220 enterprises subject to intervention in 1973. See Vergara (1981);
Bitar (1979, chap. X) examines the social property area program, its evolution, and resulting problems.
It is well documented that the transfers were made at prices significantly lower than normal market values.
See Dahse (1979); Devlin and Cominetti (1994); Foxley (1983); Marcel (1989).
Two financial factors that contributed to the pressure on peasants to sell or lease their allotted land were
the high cost of credit in the domestic capital market and the lack of prior relations between peasants and
commercial banks. On the agriculture and peasant situation (see Ortega, 1987).
11
by the new system.10 Existing pensions and those of workers who would retire within five
years continued to be the responsibility of the public sector; the rest of the workers could
choose between remaining in the old system or transferring to an AFP. For merely making
the transfer, the worker benefited from an automatic take-home increase of 11%.
One enterprise of great importance that was able to evade privatization was
CODELCO, the Copper public firm. It underwent powerful onslaughts from the economic
team but succeeded in warding them off. Even so, it suffered budgetary restrictions and
systematic constraints on its expansion imposed by the Ministry of Finance, despite the
substantial profits it contributed to the Treasury. It was only permitted to make investments
that allowed maintaining the production level reached in 1977. Within the contradictions
produced by the privatization dogma, the government encouraged, unsuccessfully hitherto,
the development of other copper deposits to be operated by foreign companies.11
With regard to trade liberalization, practically all non-tariff restrictions were
removed. Tariffs were rapidly reduced from the high level predominant in 1973 (a simple
mean rate of 94%) to a uniform tariff of 10% for all goods, since 1979. Likewise, trade
reforms included the suppression of price bands, anti-dumping devices, and public
purchasing mechanisms designed to attenuate the transmission of external instability into
the domestic economy. In line with the objective of the unilateral and across-the-board
opening to international trade, Chile withdrew from the Andean Pact in 1976. As well, a
quite liberal statute for FDI was launched early in 1974. Chapter II covers in detail import
and other trade policies.
In the financial field, a drastic reform of the domestic market was introduced in
1975. The banks that had been nationalized under the President Allende regime were
privatized. Interest rates were left totally free, regulations with respect to the terms and
allocation of credit were eliminated, and new financial local and foreign entities were
authorized with few restrictions. Finally, in relation to the capital account, there was a
gradual relaxation of restrictions on financial inflows. Chapter III analyzes financial
reforms, and their effective contribution to the acute recession that exploited in 1982.
10
11
The features of the pay as you go system and a comparative analysis with other options are discussed in
Uthoff (2001). The health reform is analyzed in Titelman (2001).
The main foreign investment in the 1970s was performed by Exxon through the acquisition of a deposit in
exploitation. See Vignolo (1980) and Bande and Ffrench-Davis (1989).
12
(ii)
Achievements and failures
Utilization rates of installed productive capacity had recovered in the first twelve months
following the military coup. Labor discipline (imposed through the repression of unions
and persecution of leaders), the liberalization of prices, exchange rate devaluation,
increased public works investment, and high copper prices, had removed bottlenecks and
favored higher use of potential GDP. Rising copper prices in 1973-74 more than offset
increased spending on oil imports, with a net improvement in the terms of trade equivalent
to almost 5% of GDP in 1974 compared with 1972.
A novel feature for Chile was the strength of the increase in the export volume.
There were four causes for this outcome: (i) a very sharp real devaluation, (ii) export
capacity installed in earlier years, (iii) removal of bottlenecks in the sector and the
liberalization of imports of inputs, and (iv) a sharp reduction in domestic demand (see
Ffrench-Davis, 1979).
The implementation of the neo-liberal strategy was disturbed by two developments
that affected negatively the Chilean economy during the 1970s: (i) an extremely high
domestic inflation rate, which the monetarist stabilization policy had great difficulty in
controlling, and (ii) the first international oil-shock, which, coupled with the sharp decline
of copper prices in 1975, then created a severe balance of payments crisis.
Until 1976, anti-inflationary action was based solely on monetary policy. From May
to August of 1973, as said, the annualized inflation rate had sky rocked to 700%.12 A few
days after the coup, most of the controlled prices were freed within a context of high
uncertainty. The foreseeable result was a dramatic upsurge of inflation (88% in October
1973). As the fiscal situation was being brought under control, monetary policy became
effectively restrictive in the course of 1974. The official line was that the new price fixers,
the private entrepreneurs, had to take money supply behavior into account in order to define
the price of their products. The concrete fact is that the information on money supply
became widely available with a lag of some months and with various divergent indicators,
12
All the inflation figures used here refer to the consumer price index as corrected in Cortázar and Marshall
(1980). The official index significantly underestimated the actual rise in prices, mainly in 1973 and in
1976-78.
13
and given the high inflation, prices were often adjusted more frequently than once a month.
Under these circumstances, the main point of reference for each economic agent became
the actual behaviour of entrepreneurs as a whole, measured through changes in the official
monthly consumer price index (CPI), the more easily available and up-to-date indicator.
The consequence was that annual inflation rates exceeding 300% still persisted by the third
year of implementation of the model, despite monetary restrictions, a fiscal budget already
under control in 1975, and a large recessive output gap (20% in 1975-76).
Additionally, the price of copper dropped sharply by the second half of 1974, while
the oil shock persisted, with a net negative terms of trade effect amounting to the equivalent
of 6.4% of GDP in 1975 as compared to 1972. This sharp negative shock, coupled with
persistent inflation, prompted the government to introduce a tougher adjustment program in
1975, based on a restriction of aggregate demand, led by fiscal and monetary contraction
and significant exchange rate devaluation.
The monetary restrictions, rather than influencing principally the price level, had a
greater impact on economic activity: during 1975 industrial production fell by 28%, GDP
declined 17% (see figure I.1),13 and open unemployment (including emergency programs)
peaked at 20% (see Jadresic, 1986). The predominance of sharp demand-reducing policies
over a weaker set of switching policies (those affecting the composition of demand and
supply) explains the significant underutilization of productive capacity or output gap. This
generated high unemployment, numerous bankruptcies, and depressed capital formation.
The “price”, which was in fact adjusted swiftly downward, was that of labor: by 1975
wages had lost about 40% of their purchasing power owing to the drastic repression of
unions, the huge unemployment, and the legal readjustment based on an underestimated
CPI.14
[Figure I.1]
13
14
Naturally, the direct impact of the deterioration in the terms of trade observed in 1975 is not included in
the figure of GDP decline. GDP measures real output; the terms of trade affect the real purchasing power
resulting from a given GDP.
As Cortázar and Marshall (1980) document, in that period there was a systematic, month after month,
underestimation of the CPI; the official CPI was used as reference for wage and pension readjustments.
Nonetheless, even the corrected CPI shows a gradual drop in the rate of inflation.
14
The monetarist recipe for controlling inflation multiplied, in the domestic economy,
by three the depressive effects deriving from the negative external shocks and involved a
notably high cost, both socially and in terms of economic activity (see Foxley, 1983;
Ramos, 1986). By mid-1976, the economic team recognized –implicitly– that monetary
control was proving to be incapable of restraining inflation on its own. Then the exchange
rate anchor was incorporated into the anti-inflationary policy: Thus, began a long process in
which this rate was used to slowdown inflation by reducing the cost of imported goods and
attempting to influence inflationary expectations: analytically, it was a transition from
closed to open monetarism. In June 1976 and March 1977, exchange rate revaluations were
made (a reduction in the number of pesos per U.S. dollar), which were accompanied by a
systematic mass media campaign.15 The measure had a significant effect, since inflation
rapidly fell to levels below 100% annually after the first revaluation and below 60% after
the second. There was a belated understanding that inflation was not being generated by an
excess of demand and monetary expansion. The belated realization was, however,
incomplete, since it implied an excessive conditioning of the exchange rate to the antiinflationary policy, thereby sacrificing external equilibrium and the production of tradables.
The severe crisis of 1982 would show that had been a wrong bet.
The evolution of anti-inflationary policy ended in 1979 with the freezing of the
exchange rate. As a consequence, a new stage of automatic macroeconomic policy was
introduced when the government fully adopted the “monetary approach to the balance of
payments” then in fashion in several academic and orthodox financial circles. The new
official version was that, with a fixed exchange rate, in an economy with free imports,
domestic prices could not rise more rapidly than international inflation. This policy was
supported by heavy foreign lending, which more than covered, until 1981, an expanding
external deficit (see chap. III).
When the exchange rate was pegged, domestic annual inflation exceeded 30%,
while international inflation neared 12%. Subsequently, the convergence between the two
rates occurred, but only gradually; as a consequence, for a couple of years, domestic
inflation was markedly higher than the external rate, so that the exchange rate lost
15
After the publicized revaluations, daily mini devaluations were applied. Exchange rate policy is analyzed,
abridgedly, in chap. II, and at length in Ffrench-Davis (1981).
15
purchasing power.16 Hence, the regime of free imports and an appreciated exchange rate
caused a flood on the domestic market and an unsustainable disequilibrium in the current
account during 1981. To face the external deficit, the official policy relied on an “automatic
adjustment” in the style of the gold standard: it claimed that the real exchange rate would
automatically adjust with the contraction of monetary liquidity associated with the current
loss of international reserves in the Central Bank. This contraction was expected to have
provoked a sharp drop in domestic prices and nominal wages. However, it was overlooked
the fact that the exchange rate between 1979 and 1981 had accumulated, not a 2 or 3% but
a 30% appreciation (besides the still lagged effect of import liberalization, as analyzed in
chap. II). The outcome was a drastic fall in sales, output and employment, and a
progressive strangulation of business firms through increasing indebtedness at extremely
high real interest rates (see chap. III).
Despite numerous tough restrictions on labor union activities and a real wage that
remained below the average level of 1970, the authorities blamed salaries for their failure to
achieve a fluent and rapid automatic adjustment.17 In mid-1982, they tried to establish a
general reduction of nominal wages, but the economic team was unable to impose such a
measure. Consequently, they turned to exchange rate devaluation, but with unsustainable
disturbances in the productive and financial systems: between June and October of 1982,
the nominal exchange rate was devalued by over 70% amidst a general crisis. The
corresponding inflationary impact implied that the CPI increase in the following twelve
months jumped to 32%, in contrast with the 4% recorded in the previous period.
In brief, the exchange rate anchor was effective in curbing inflation, which by early
1982 stood at the international level, even below zero in some months.18 But once again the
severity of the macroeconomic imbalances generated was underestimated. Efforts had been
16
17
18
It is relevant that external inflation (IEP, measured in US dollars) also decreased due to the sharp
appreciation of the U.S. dollar with respect to the currencies of the other industrialized countries: in the 12
months before June of 1982, the IEP reached an annualized average of -2%.
The lower limit for the adjustment in wages was determined by the official CPI of the preceding period.
Various authors blame this rule for the costly recessive adjustment. Nonetheless, there were no
international precedents of cases of massive deflation that had resulted from restriction of the money
supply, which had operated fluently, at the required intensity, and without causing severe problems for
debtors or economic activity.
Several indicators of this episode in Chile are similar, in sign and size, to those in the currency crisis of
Argentina that exploited in 2002: negative inflation preceding the crisis; sharp GDP drop, huge
unemployment, and dramatic rise in poverty with the crisis.
16
concentrated on bringing down inflation, while external equilibrium and investment in
human and physical capital were overlooked. As said, since 1979, the real exchange rate
had lost a third of its purchasing power, the external debt doubled, the export boom faltered
in 1981-82, and the current account deficit had climbed to 21% of GDP in 1981.19
(iii)
Vulnerability and spurious growth
The weaknesses of the model are highlighted when the composition of GDP is
disaggregated (see table I.2). First, there was a rise in external indebtedness and of its cost.
Around one fifth of per capita GDP “growth” recorded between 1974 and 1981
corresponded to interest and profit payments accrued to foreigners, which meant that the
rate of expansion of the national product was lower than that of GDP. Second, the valueadded in (i) the marketing of imported products and (ii) financial services contributed a
high share to GDP “dynamism”; these two sectors exhibited a dramatic cumulative
expansion of 13% annually.
[Table I.2]
The first sector expanded as a result of an unsustainable rapid growth of imports of
consumer and intermediate goods. As was discussed earlier, most of these imports were
financed not by higher exports but by an increase in private foreign debt. This source of
“dynamism” –value-added in the marketing of imports– was unsustainable in an economy
that lacked vigorous real productive support and that was experiencing a notably high
external deficit. The second source of “dynamism” was associated with the financial reform
and responded principally to the spread between the rates of interest on deposits and loans
and to the transfer of foreign credits in Chile. Thus, these two sources of “dynamism”
rested on outlier values of imports and financial spreads, both of which were prejudicial to
productive activity and investment.
19
Figures were calculated on the basis of the average exchange rate in 1976-78. With the very appreciated
exchange rate of 1981, the deficit is 14.5% of GDP. Notice that GDP measured in current US dollars was
US$15 billion in 1978, US$33 billion in 1981 and US$16 billion in 1985. Given the enormous volatility in
these years, it is wise to “normalize” the exchange rate used, in order to make inter-temporal comparisons
of GDP expressed in foreign currency.
17
There can be no doubt that, owing to the distortion implied by both sectors in the
Chilean economy, the overall performance contained a sizable share of spuriousness.
Hence, it is very significant that the rest of per capita value-added, which in 1974 amounted
to 91% of gross national product, remained virtually stationary, as can be seen in column 4
of table I.2.20 Over and above this poor performance, GDP fell by 14% in 1982-83, while
Latin American GDP diminished only 3.2% in the same biennium.
The link with the future relates to national savings and investment.21 The supporters
of the model claimed that it would achieve a substantial increase in savings, investment,
and efficiency, all crucial sources of economic growth. The foregoing analysis has shown
that the results were negative with respect to production. However, this could be consistent
with a vigorous process of slow maturing investment. Unfortunately, in each of the years
between 1974 and 1980, the gross fixed investment ratio was lower than that of each year
in the 1960s; only 1981 recorded a ratio comparable with that decade. In 1974-81, the
average investment ratio was 15.7%, in contrast with 20.2% in the sixties. In parallel,
savings financed a lower share of investment; in 1970, around 90% was covered by
national savings, whereas in 1978-81 scarcely one-half came from this source.
The high rate of external borrowing followed by a sudden stop in 1982, led the
country into a new recessionary crisis as severe as the 1975 one. For the second time in a
decade, the Chilean economy underwent a sharp recession, the deeper in Latin America in
1982, with GDP declining 14%, followed by a widespread bank crisis and massive
unemployment in 1983.
Those disequilibria had been induced by excessive domestic spending on the part of
the private sector, spurred by financial liberalization, huge capital inflows and the so-called
monetary approach to the balance of payments. Underlying these disequilibria there was a
20
21
As mentioned earlier, production of exportables also grew at a significant pace. Therefore, a contraction in
the rest of the economy –the non-exporting sectors– occurred. Within this subset, the industry, which
accounted for the major share of economic activity, suffered the negative pulls of the recession in 1975,
trade liberalization, and then exchange rate appreciation. See chapter II and Marcel and Meller (1986).
By investment is meant what in the national accounts is called gross capital formation or gross investment
in fixed capital or what I also call productive investment in contrast with purely financial or speculative
investment. Besides investment, there are many other connections to the future that are not considered
here. These include the impact that the model may have had on the capacity for technological absorption
and adaptation; the degree of creativity of the technical and university education systems; national cultural
development; the channels of participation and social capital that could serve for development strategies,
based on a national consensus; and the dynamism and efficiency of the state as a development leader.
18
severe diagnosis error. The government assumed that, since it had achieved a fiscal surplus
and external borrowing was being decided by private agents, a foreign exchange crisis
would never occur. The explicit and strong support of the International Monetary Fund (see
Robichek, 1981) reassured the government in that wrong assumption. It failed to realize
that an unsustainable medium-term deficit could be generated in the private sector (Marfán,
2005). With the crisis, the producers of GDP faced massive bankruptcies. Political
discontent against the iron-fisted dictatorship spread, while demonstrations of opposition
proliferated even amongst many regime supporters.
National accounts, both official and corrected (Marcel and Meller, 1986), show high
“growth” between 1976 and 1981. However, in the first place, the model was not initially
put in motion in 1976 but (in partial form) in 1973. Second, in 1975 there was a sharp
recession, which multiplied threefold the depressive effect of external shocks, with the fall
of 17% in GDP. Hence, to measure economic evolution from the low 1975 point implies
measuring as “growth” what in fact was simply a recovery of the 1974 level. This gave rise
to the mistaken impression that Chile was growing vigorously and would continue to do so
at rates in the order of 8% per year,22 even irrespective of what might happen abroad.
Whereas 1976-81 gives an annual per capita GDP increase of 4.7%, the period 1974-81
merely averages 1.4%. It is obvious that the greater the recession of 1975, the greater could
have been the subsequent recovery. Thus, the greater the loss of production as a result of
the recession (a true social and private cost) the higher appears the “growth” if the
measurement begins at the lowest recessed point. This is an extremely gross technical error,
but it is quite frequent. This misleading implication would emerge again in the second half
of the dictatorship.
b)
Introduction of pragmatism, with a regressive bias in 1982-89
The impacts of the deep crisis of 1982-83 and the subsequent recovery were the dominant
features of this sub-period. Renegotiations of the foreign debt with bank creditors, the IMF,
World Bank and the US government played an outstanding place. As the government's
power weakened with the 1982 recession, it was compelled to revise its strategy in several
22
See, for example, the illustrative statements quoted in Foxley (1983).
19
respects, including the change of the head of the economic team and the “nationalization”
of the private debt. The government, that by 1981 held merely one-third of total debt, by
1987 held 86% of it. The determinant of the level of economic activity, in a very explicit
way, was the availability of foreign country; thus the volume of the service of the debt and
the loans from international financial institutions was crucial for the speed of recovery.
With respect to the policy approach, the crisis revealed the extreme vulnerability to external
shocks created by neo-liberal policies and the passivity of the State. The apparent economic
success of the late 1970s had been based on a shaky policy of external and domestic
borrowing with minimal regulations. The economic collapse and the climate of discontent
made possible the reconstitution of some social movements that had been dismantled,
especially labor unions and political parties of the Center and Left.
In the economic arena, several adjustments were made by the government, along the
next four years, including successive devaluations, the increase of import tariffs, band
prices for the main agricultural products, subsidies to non-traditional exports, stringent
regulation of the financial system, implicit nationalization of private debt and massive
financial aid to the private sector (see chap. IV). All these changed policies, previously
sharply dismissed by the neo-liberal approach, were signals of “pragmatism”, in order to
reduce the “scarcity of foreign currency” (the binding external constraint) and to recover
economic activity. This implied a substantial change in fiscal policy, which after exhibiting
a strong surplus until 1981 went on to a deficit, averaging 3.4 % of GDP in 1983-85.
However, this greater pragmatism was biased in favor of upper-income sectors, including
generous subsidies, while a tough position was maintained toward labor and grassroots
organizations. The consequence was a further deterioration in income distribution; indeed,
the year 1987 recorded the worst income distribution since statistics are available (see chap.
VII).
A strong and sustained recovery of economic activity and domestic output began in
1986. Exports were quite vigorous, encouraged by a spectacular depreciation of the real
exchange rate (130% between 1982 and 1988). In 1986-87, a gradual recovery of domestic
activity proceeded in a sustainable macroeconomic framework, under a binding external
restriction, but generously alleviated by loans from international financial institutions (IDB,
IMF and WB). In the next two years, the situation changed, with the disappearance of the
20
restriction of external financing, due to a spectacular rise of the copper price. As a
consequence, the expansion of aggregate demand and economic activity accelerated,
culminating in the overheating of the economy in 1989, when actual GDP increased 10%.
The jump in aggregate demand resulted from expansion of the money supply, tax
reductions, and import liberalization with some exchange rate appreciation, which made
imports cheaper. The installed capacity still available by 1987 and the sizable improvement
in the terms of trade (copper prices) in 1988-89 made a sharp transitory jump in economic
activity feasible.
The last biennium of the Pinochet regime exhibited that high growth of actual GDP,
in contrast with a quite moderate rise in potential GDP. Paradoxically, then, as it had
happened in the late 1970s, the domestic recession of 1982-87 was useful for the
“marketing” of the model. The model was able to show “growth” for several years, a
circumstance that attracted extensive publicity in the national and foreign mass media. The
prior sharp recession was underestimated or ignored by the media under a strong dictatorial
regime. Hasta hoy, es común que la evaluación económica de ese régimen inicie el contéo
del crecimiento desde 1986, desconociéndose la enorme brecha entonces existente entre
PIB efectivo y potencial.
In brief, the 1980s ended with the Chilean economy recording a high rate of
capacity utilization and growth of actual GDP. However, average growth in the whole
1982-89 period was low: merely 2.9% annually, while per capita GDP only in 1988 reached
the level it had exhibited in 1981. Additionally, the economy did show substantial
disequilibria. During 1988-89, a number of macroeconomic variables exhibited inconsistent
trends over the medium term. Real aggregate demand had grown swiftly –22%– in the
biennium, and GDP had risen by 18%. Exports grew vigorously in the two-year period, but
imports rose even faster. The large gap between changes in expenditure and production was
compensated by an improvement in the terms of trade equivalent to 6% and 7% of GDP in
1988 and 1989, respectively, as compared to 1986. Output, in turn, rose sharply due to the
progressive exhaustion of idle capacity. However, productive capacity was expanding a
total 8% in the biennium. The contrast with the 18% increase in actual GDP led to full
utilization of installed capacity and overheating of the economy. This manifested itself in
21
accelerating inflation and a deteriorating external sector during 1989. By January 1990,
inflation in 12 months reached 23%, twice the 1988 rate.23
c)
A summary of outcomes
Notwithstanding that some key policies were significantly different, economic growth
recorded similar annual averages in both halves of Pinochet's government: 3% and 2.9%,
respectively (see table I.3). How can similar results be explained? The low average of both
periods was associated with the severe abrupt crises of 1975 and 1982-83, and with the
gradual recovery processes, which in both cases involved high rates of underutilization of
productive capacity for several years. This persistent gap between actual and potential
GDP, in turn, was the main factor discouraging capital formation (Agosin, 1998; Servén
and Solimano, 1993), which was under 16% of GDP in each sub-period; that is, around four
points (one-third in net investment) lower than in the sixties.
[Table I.3]
The reforms had significant different effects on the productive structure. Trade
liberalization contributed to the significant expansion of exports. However, applied
simultaneously with a tough monetary stabilization policy induced a depression that
featured a 26% drop in industrial output in 1975. Nonetheless, in parallel with numerous
bankruptcies, the sector achieved a rise in productivity among the surviving companies and
by 1978 manufactured exports had risen by an average of 15% (Vergara, 1980), with
greatly increased heterogeneity in the sector. It must always be recalled that what is
relevant for the nation as a whole is the evolution of productivity including all people, not
only those with a job!
The high rate of business bankruptcies cannot necessarily be attributed to
inefficiency resulting from protection under the earlier development strategy. In fact, after
1973, the long recession, real annual interest rates averaging 38%, and the accelerated
23
This is the inflation rate for the twelve months ending in January 1990. Between August 1989 and January
1990 the annualized rate of increase in the consumer price index (CPI) was 31%.
22
import liberalization-cum-exchange rate revaluation, can be identified as the determinant
factors leading to high business mortality. Manufacturing lost a significant share of GDP.
Exports, on the other hand, achieved great dynamism, particularly of non-traditional goods.
In fact, between 1974 and 1980, the share of non-traditional exports (including
manufactures) in total sales of goods abroad rose from 9% to 19%. These exports exhibited
a falling share in 1981-85 (averaging 16%), and then renewed an upward trend to 22% in
1989. In all, in 1974-89, the volume of non-copper exports averaged an annual growth of
15%, undoubtedly a significant figure (see chap. V).
The modernized business sector featured a surge of new economic groups and
managers exhibiting vigorous innovative competitiveness. This modernization went in
parallel with that of the Internal Revenue Service and of the Budget Office. Together with
the export drive, they contributed, but not determined the economic success achieved latter
in the 1990s. Furthermore, many classical conditions for development arose, among them,
“correction” of some prices (especially exchange rate depreciation in the 1980s and reduced
cost of imported inputs), market deregulation, and guaranteed property rights. But it also
was the consequence of the substantial fall of real wages and of taxes on capital, and the
elimination of many labor rights, while modernization still eluded the large majority of
firms.
At the end, there was a notable progress for some people, with exclusion of many.
An extreme neo-liberal interpretation reports a vigorous growth, because only the results
obtained after 1986 are considered. But, it does not have any justification to assess a set of
reforms counting only the years with positive results and ignoring the negative ones. It
induces to severe pitfalls of diagnosis and action, and encourages other nations to repeat the
experience, what happened to a large degree among Latin American economies in the
1990s (see Ffrench-Davis, 2006, chapter. I). The concrete fact, that requires deep
corrections, is that average GDP growth was mediocre in both sub-periods.
Until 1982 “price corrections” had been very contradictory. In fact, the neo-liberal
orthodoxy did not consider that financial liberalization could lead to high outlier interest
rates or that trade liberalization could be accompanied by continuous exchange rate
appreciation, as was the case between 1979 and 1982. Neither was it foreseen that the
private sector would be “promoted” amidst a sharp restriction of aggregate demand, as in
23
1975-76 and 1982-83. In turn, the debt crisis dismantled the financial system, implying that
the government did allocate the equivalent to 35% of an annual GDP to the rescue of some
affected sectors, diverting these resources from the generation of economic and social
development. This combination of events helps to explain why modernization in some
sectors coexisted with a mediocre economic growth averaging 2.9% between 1974 and
1989, why the average investment ratio was notoriously below the sixties level, and why
income distribution worsened so much (see chapter VII).
As on many other occasions in Chilean history, economic policy was strongly
influenced by a transitory notably improvement in the copper price. 24 It is undeniable that
1988-89 would have been quite different had there been a “normal” copper market in those
years. Based on that abnormally high price, the Pinochet regime could finally boast an
economy with impressive export values and actual GDP growth figures in 1988-89. But,
evident macroeconomic imbalances had to be corrected in 1990. This explains the strong
policy adjustment carried out in January 1990 –in full transition from dictatorship to
democracy– in order to stop an overheating of the economy led by excessive aggregate
demand. The adjustment was implemented, in January 1990, by the new independent
Central Bank, ruled by Pinochet few days before the presidential election of 1989. The
Bank acknowledged the severity of the disequilibria and the risk to wait until the
inauguration of the democratic government in March 1990.
Income inequality was notably greater than two decades earlier, as a consequence of
strong worsening in the seventies and eighties. In fact, the share of the poorest quintile on
total expenditure had been reduced from 7.6% in 1969, to 5.2% in 1978 and 4.4% in 1988
(see chapter VII, table VII.2). A determining variable of that outcome was the deterioration
of the labor market, with average and minimum wages that in 1989 were below those in
1981 and 1970. The major swings in distributive worsening were associated to the 1975
and 1982 crises.
In political terms, a salient development was the effective organization of social
movements and political parties, which were able to compel the democratization of the
system, even under the rules unilaterally imposed by the dictatorship. Following the
triumph of the opposition, led by a center-left coalition, the Concertación Democrática, in
24
In fact, as was to be expected, copper prices did decline since late 1989.
24
the October 1988 plebiscite and the December 1989 presidential election, a democratic
president, Patricio Aylwin, took office in March 1990.
3.
Democracy, reforming the reforms and development, 1990-200925
Since 1990 the political arena was dominated by the administration of the Concertación de
Partidos por la Democracia. The Democratic Concertación, a center-left coalition of
Christian democrats and Social democrats, took over power with the successive elections of
Patricio Aylwin (1990-94), Eduardo Frei Ruiz-Tagle (1994-2000), Ricardo Lagos (200006), and Michelle Bachelet (2006-10). The two first administrations gave rise to a period of
the greatest prosperity in Chilean economic history, with a sustained average 7% GDP
growth rate between 1990 and 1998. It marked a clear break with the historical trend (see
table I.1). High capital formation and a generalized atmosphere of stability prevailed until
1998, when the Asian crisis hit Latin American countries.
The vigorous growth was led by a 10% annual expansion of exports, a figure similar
to the average recorded in the seventies and eighties (see chaps. V and VI). Nevertheless,
GDP growth was radically different: 7% in the nineties and 2.9% in the two previous
decades.26 Given the shared good export performance, evidently, the main factor explaining
the success in the nineties was the strong expansion of the rest of GDP (non-tradables plus
import substitutes) which averaged 6.5% per year in 1990-98 (see chap. VI, table VI.6). As
in the three decades of intensive development of Korea and Taiwan (1965-95), a key of
success were the links between the export sector with the rest of the economy and the
persistence of a comprehensive real macroeconomic balance.
The end of President Frei administration (1999) and the first years of President
Lagos (2000-03) were characterized by a depressed economic environment. The sharp and
sustained fall in economic activity was focused in the non-exported GDP, which
represented around 70% of the whole economy. A drop in export dynamism –undoubtedly,
25
26
Collections of studies with diverse approaches and authors can be found in Bosworth, Dornbusch and
Labán (1994); Pizarro, Raczynski and Vial (1996); Cortázar and Vial (1998); Larraín and Vergara (2000);
Ffrench-Davis and Stallings (2001); Larraín, G. (2005); Meller (2005); Muñoz (2007); Vega (2008).
Notice that in the three cases we “end the decades” in peak years: 1981, 1989, and 1998 in order to be
“fair” in the comparison. From peak to peak, actual growth reflects better the creation of productive
capacity than using mechanically calendar decades.
25
very significant– only explains 1.0 out of 4.5 points of lower growth in 1999-2003 with
respect to 1990-98 (falta mencionar 2004-09!!).
In all, GDP growth averaged 5.4% in the nineteen years between 1990 and 2008
(5% if the recession of 2009 is included). In turn, per capita GDP expanded 4% annually in
the same period, in contrast with 1.3% in 1974-89. This notable difference, that is
associated with improvements in the quality of macroeconomic policies since 1990 and
some efforts to “complete” factor markets, explains the substantive economic and social
progress achieved. Nevertheless, the brake in 1998 is significantly associated with setbacks
in the quality of macroeconomic management (see chap. IX).
a)
From the reform of the reforms to the Asian contagion, 1990-98
The new administration of Patricio Aylwin focused its efforts on achieving stronger,
stabler, and more equitable GDP growth. This required stabilizing the economy after the
1988-89 overheating generated by the Pinochet regime, and, among other things, an
increasing investment ratio, the implementation of macroeconomic policies achieving
sustained equilibrium in financial markets and in the real economy, diminishing
vulnerability to external shocks, and progress in solving the most urgent social demands by
enabling larger segments of population to benefit from the modernization of the economy.
The aim was to reconcile macroeconomic and macrosocial equilibria, and implement a
style of economic policy that would become legitimate within the new democratic
framework.
The new government had decided to avoid a radical change in existing economic
policy, seeking "a change-with-continuity" and thus breaking with the rehashing tradition
of several previous governments. In order to accomplish this goal, the government of
President Aylwin had to gain support of trade unions and incorporate their organizations
into the macrosocial decision-making process.
The new administration had to cope with the potential conflict between
macroeconomic stability and demand for more resources to be allocated to lower income
groups. On the one hand, it changed the composition of public expenditure, increasing the
share of social spending in the budget, and, on the other, it rapidly presented to the
26
Parliament a tax reform to increase fiscal income. Tax reform included a reintroduction of
profit taxes abolished in 1988, and an increase of 2 percentage points of the value-added
tax.27
Likewise, in 1990 the government proposed a reform of the labor code to Congress.
It was aimed at balancing the bargaining power of employers and workers and sought to
endow current labor legislation with greater legitimacy. To get this law passed, an
agreement was reached between the government, labor and employer organizations, and
most political parties. However, the reforms agreed (including the tax reform) were always
less comprehensive than those originally proposed by the government. (Cortázar, 1996;
Marfán, 1998). A determining fact was the group of senators that had been appointed under
the Constitution designed by Pinochet, which more than compensated for the majority
achieved by candidates of the new government in 1989 and 1993 parliamentarian elections.
In 1990, a tripartite agreement was also reached between the government and the
representatives of unionized workers and employers; this agreement provided for an
increase of 28% in the real minimum wage between 1989 and 1993. In the early 1990s,
significant progress in income distribution and poverty reduction was achieved in this
constructive climate. Since 1994, poverty continued to decline, although more slowly.
While 45% of the population lived in poverty in 1987, by 1994 had progressed to 27.5%,
and by 1998 this share had been reduced to 22% (see chap. VII).
It should be pointed out that greater social effort was attained with notable fiscal
responsibility. As a result of the 1990 tax reform, the expansion of economic activity and
imports, a higher than expected copper price (captured by Chile thanks to the fact that the
nationalization of large copper mines had survived; now they were grouped under
Corporación Nacional del Cobre, CODELCO), and a decline in tax evasion, the fiscal
burden rose by 3% of GDP (to 18% of GDP). This allowed the government to increase
public spending, in particular social expenditure, and at the same time expand non-financial
public sector savings from 2% in the 1980s to nearly 5% of GDP in the 1990s (see table I.5,
27
It can be argued that the increase in value-added taxes included in the reform would tend to impose a
regressive effect as low income families consume a larger part of their income. Nevertheless, a coherent
comparison also has to consider that most resources are transferred to lower income families through an
increase in social spending. The net effect results evidently progressive.
27
below).28 Higher savings not only financed public investment but also generated an average
fiscal surplus of 1.8% of GDP in 1990-97; the surplus was used to reduce the high stock of
public debt accumulated during the dramatic financial crisis of 1982-83.
A new political agreement in 1993 enabled the approval of several previously
transitory modifications on a more permanent basis. Subsequent evidence rejected the
prediction of critics of the 1990´s tax reform, who claimed that it would have a negative
impact on investment. After a decline of the investment ratio in 1991 –associated with the
lagged effect of the 1990 adjustment - capital formation increased in 1992 and again in
1993, reaching in the next five years levels never achieved in the previous three decades
(see table I.1). This high productive investment was the main factor behind the outstanding
annual GDP growth, which rose from below 3% in 1974-89 to over 7% in 1990-98. As
empirical studies show robustly, private investment, given its irreversibility, is positively
correlated with real macroeconomic equilibria whenever they appear to be sustainable and
fulfil two key conditions. First, for real equilibrium, effective demand has to be consistent
with the productive capacity being generated, and, second, key macro-prices (interest and
exchange rates) must be right (see Agosin, 1998; Coeymans, 1999; Ffrench-Davis, 2006,
chap. II; Servén and Solimano, 1993). This is what we call real macroeconomic balances.
Given the macroeconomic disequilibria generated in 1988-89, a severe adjustment
through the increase in interest rates had been carried out in order to control the expansion
of aggregate demand and a new outbreak of inflation. This adjustment was considerably
complicated soon after by large capital inflows, which, like other economies in the region,
Chile had been receiving since the early 1990s. The gap between domestic and international
interest rates had increased significantly. In the meantime, risk-rating agencies had upgraded the Chilean economy inducing a strong inflow of short-term “hot money” and an
appreciation in the exchange rate in the second half of 1990 (with a drop from the
depreciated ceiling to the appreciated floor of its 10% crawling band of the price in pesos of
28
Depreciation of capital goods in public firms is included in gross private savings. Moreover, the fiscal
sector generated financing to cover the deficit of the public social security system. Under the social
security reform of 1981, the public sector continued paying already retired workers and financed part of
the new pensions, while income was shifted to the private system. The fiscal figures do not consider the
quasi-fiscal deficit of the Central Bank –which was initially caused by the government intervention to
prevent a massive bankruptcy of the domestic financial system in 1983; it was enlarged, subsequently,
with the operational losses in monetary sterilization in the 1990s (on this latter issue, see chap. VIII).
28
the U.S. dollar). The Central Bank was forced to buy large amounts of foreign currency to
defend the band’s floor.
Particularly, economic authorities faced the need to differentiate between permanent
appreciation pressures, resulting from Chile’s net improvement in productivity and from
having surmounted the debt crisis, and transitory pressures. Having identified the former,
an attempt was made to avoid the latter in order to maintain the competitiveness of
tradables. The strong external supply of both short-term and portfolio capital threatened to
considerably diminish the capacity of the authorities to conduct monetary policy and to
avoid excessive fluctuations in both the real exchange rate and aggregate demand.
Faced with a massive capital inflow, Chilean authorities sought to reconcile these
two objectives –an interest rate suited for keeping domestic balances and an exchange rate
consistent with external balances– by applying several counter-cyclical policies. Among
these were active exchange rate policy and monetary sterilization; selective liberalization of
capital outflows; establishing a reserve requirement (encaje) on foreign loans and liquid
inflows, which increased their costs, in order to avoid what considered an excess supply;
and the extension of a tax, which had previously applied only to domestic currency loans,
to include foreign currency loans.
Empirical research documents that these policies were successful in reducing shortterm and volatile inflows and provided space for monetary policy and avoiding
destabilizing exchange rate appreciation (see chap. VIII). But foreign direct investment
(FDI) –risk capital was exempted from the reserve requirement– became increasingly large.
FDI was stimulated by the attractive features of the Chilean economy: rich natural
resources and the almost tax free transfer of the economic rent abroad (a loophole inherited
from the dictatorship that required correction),29 high quality macroeconomic policies, and
the positive perception of the democratization process. Therefore, a large surplus in the
capital account, with effective long term financing, higher than the moderate deficit in the
current account, was generated. The Central Bank responded with active purchases of
foreign currency (implying a welcome replenishment of the low international reserves held
by 1990) and open market monetary sterilization.
29
In 2006 it gradually began to operate a tax that plays a similar role to a royalty.
29
The set of policies, especially those affecting short-term and volatile capital inflows,
contributed to keeping the current account deficit within sustainable levels (2.3% of GDP in
1990-95) and preventing an excessive increase in more volatile external liabilities. In so
doing, Chilean economic authorities contributed significantly to macroeconomic stability,
to the improvement of the social indicators, to the export strategy, and to overall growth.
This became evident when Chile showed nearly complete immunity during the Mexican
crisis of 1994-95 (see Ffrench-Davis, 2006, chap. VI).
In 1990-95, GDP growth peaked at 7.8%. If the dynamism achieved in this period is
compared with that of other episodes of high GDP growth in the past four decades, in
contrast to previous occasions, this time a comprehensive set of positive features were
fulfilled: (i) GDP growth, both actual and potential, was sustained for several rather than
one or two years; (ii) growth occurred in a context of fast rising productive investment and
national savings; (iii) growth occurred without significant inflationary or external account
pressures; (iv) an orderly fiscal balance was maintained, and (v) no major macroeconomic
disequilibria was built, thanks to several mini-adjustments thus avoiding the common need
of traumatic maxi-adjustments.
After each of these years of unsustainable macroeconomics in the past four decades,
an adjustment program with heavy welfare costs had to be implemented. These significant
changes in the macroeconomic environment are associated, in the external front, to the
instability of the terms of trade and financing. On the domestic front, they reflect the high
sensitivity of aggregate demand to external shocks, especially when the economy is
operating under pro-cyclical policies.
The impact of the adjustment program in 1990 on other economic variables was less
severe and quickly reversed. As mentioned earlier, investment ratios recovered in 1992 and
reached record levels since 1993. One main merit of policies in 1990-95 rests in that it was
resisted successfully the temptation of achieving a faster disinflation with an increased
domestic absorption of capital inflows and at the expense of exchange rate appreciation and
a larger external deficit.
Up to 1995 authorities implemented an effective monitoring of the counter-cyclical
regulation on capital inflows. The strength of regulations (the cost or implicit fee and the
coverage of the encaje) was adjusted continuously to the strength of the external supply of
30
funding. In the six year period 1990-1995, actual and potential GDP rose at similar rates,
with the economy working close to the production frontier (that is, with a minor output gap
between potential and actual GDP).
However, policies lost their strength after 1995, thus allowing a real appreciation of
the peso and imbalances in the external accounts in 1996-97. Chile did bend, partially, to
the powerful international fashion promoting the liberalization of the capital accounts. That
fashion was in general command, pressed by the US government, the World Bank and the
IMF, the OECD and the academic world in the most influential spheres. It had been
reinforced under the belief that the management of the tequila crisis had shown that the
world had learnt to control financial crisis; such over optimism was absorbed domestically
by business leaders and some public authorities. Recall that the IMF was in the road to
impose all countries the obligation to open capital accounts. That extreme position
experienced a sudden stop with the arrival of the Asian crisis in 1997. Fortunately, Chile
did step back, since 1995, only to a mid-of-the-road position. Did not dismantle regulations
but allowed a weakening of their effects, as discussed in chapter VIII (see also Le Fort and
Lehmann, 2003) Consequently, Chile entered “vulnerability zones” --particularly with an
appreciated real exchange rate and a large external deficit-- where it was caught by the
Asian crisis.
Additional factors, beyond the acute international fashion, can explain the policy
change. First, the strength shown by the Chilean economy in face of the Mexican crisis in
1995 created a misleading sense of invulnerability. It led to disregard that immunity had
been the result of a policy approach that had prevented (i) excessive exchange rate
appreciation, (ii) a high current account deficit, and (iii) a significant stock of liquid
external liabilities, and (iv) most inflows had been directed to capital formation, thus
strengthening the capacity to respond to critical situations and to absorb efficiently inflows.
Second, after 1995 a change in Central Bank priorities could be observed, with the
prevalence of an anti-inflationary bias. Third, the outstanding performance of Chile
transformed it into a preferred destination for foreign investors, in a context in which huge
amounts of capital were being supplied to emerging economies. Despite this larger capital
surge, most counter-cyclical regulations were kept unchanged instead of being
31
strengthened. Evidently, counter-cyclical policies must be adapted to the strength of the
cycle, what did not happen in the second half of the 1990s.
Therefore, when the Asian contagion reached Chile in 1998, with a strong negative
terms of trade shock, the economy had accumulated significant imbalances: the real
exchange rate had appreciated 16% between 1995 and October 1997, and the current
account deficit had jumped to 4.2% of GDP in 1996-97, as compared to 2.3% in 1990-95,
which worsened further with a sharp negative terms of trade shock in 1998.
The fiscal policy of these two years (1996-97) deserves special consideration, since
it has been an object of a misinformed debate. The fiscal policy of the nineties harmonized
a significant expansion of social expenses with an increase of both public savings and
investments. As said, a responsible fiscal management financed increases in expenses with
the tax reform and the reduction of evasion. Real macroeconomic balances placed the
economy in the productive frontier or potential GDP, with the corresponding high fiscal
revenue. In the particular case of 1996-97, fiscal responsibility was kept. The actual fiscal
surplus was 2.1% of GDP, exceeding that of the previous years. Consequently, the assertion
that fiscal performance was responsible for the macroeconomic imbalance of this period
has no support. The external deficit was evidently located in the private sector and was
financed and encouraged by the weaker regulation of the capital account (see table I.4).
[Table I.4]
It is true that fiscal expenditure registered a rise in that biennium. But it must be said
that it was an increase in items unanimously agreed by all political parties, related to
education, health and pensions; additionally, recall that it was financed with taxes and not
with indebtedness. In the meantime, GDP and productive investment kept growing up to
1998. All evidence show that where it was necessary to act strongly was on the cause of the
real macroeconomic imbalance, that is, the excess of capital inflows in 1996-97. Because of
that excess, the Asian crisis found the Chilean economy vulnerable, with a too cheap dollar
price and a high external deficit.
b)
Recessive adjustment, 1999-2003
32
The final year of President Frei administration (1999) and the first four years of President
Lagos (2000-03) were characterized by a depressed economic environment that frustrated
the expectations of a spontaneous rapid recovery. The sharp and sustained fall in economic
activity was focused in the non-exported GDP, which represented around 70% of the
economy. As said, a drop in the volume of exports –undoubtedly, very significant– only
explains 1.0 out of 4.5 points of lower growth in 1999-2003 with respect to 1990-98 (see
chapter VI).
The Asian crisis contagion arrived through two channels. On the one hand, there
was a sharp deterioration of the terms of the trade (equivalent to 3% of GDP). On the other
hand, a widespread reduction of capital flows towards emerging economies took place.
Thus, since late 1997 there arose strong expectations of depreciation, which the Central
Bank resisted during 1998, due to the fear of an inflationary overheating and the explicit
concern for allowing domestic economic groups to reduce their debt denominated in
dollars. First, massive sales of foreign currency were carried out by the Central Bank with
an artificially low market price. Then, by mid-1998, the Bank reduced drastically the
crawling band width intending to give a signal of nominal exchange rate stability, in
combination with a rise in the real interest rate, which reached 14.5%. In this critical
context, not only there was a drop of financial inflows, but also a massive residents' capital
flight took place. In fact, from early 1998, there were voluminous capital outflows,
principally from the private pension funds -speculating against the domestic currency, in
the context of successive capital account liberalizations- totalizing almost 5% of GDP in 18
months (see Ffrench-Davis and Tapia, 2001; Zahler, 2006). It naturally had a strong
contractionary impact on domestic liquidity and aggregate demand.
Consequently, once again, a macroeconomic imbalance led by excessive capital
inflows in 1996-97, was followed by an adjustment costly for both economic growth and
equity. Beginning by mid-1998, aggregate demand fell sharply (with a 6% drop in 1999,
while GDP decreased by 0.8%). Meanwhile, productive capacity kept rising, resting on the
still high investment ratio of 1998. Consequently, with the fall in actual GDP and the
increase in potential GDP, a large recessive gap between both output measures emerged.
It is useful to examine in some detail the size and evolution of the output gap. It is
not of obsolete physical capacity. It is economically productive capacity that was in use in
33
1997.30 New capacity was being created at a speed of about 7% per year which, as said,
continued in 1998 and 1999, determined by the high investment ratios up to 1998 included.
The downward adjustment in economic activity started by mid-1998, with actual GDP
rising only 3.2% in 1998 and falling 0.8% in 1999. All added, a sizable recessive gap of
about 6% of potential GDP was generated in 1999 and was still persisting in 2003. That
was determinant of the sharp drop in the investment ratio in 1999-2003. As a consequence,
the plateau of potential GDP growth had dropped from 7% to 4% per year, but actual
growth fell even further, to 2.6%.
As has been shown repeatedly, a significant gap between actual GDP and the
production frontier is usually followed by a drop in productive investment. As in Mexico
1995, Argentina 1995 and 1999-2001, and Korea 1998, in Chile the investment ratio
diminished substantially (by 18% in 1999) and remained depressed until 2003; the output
gap plus the drop in investment had a deepening impact on employment too.
The presidential campaign of 1999 was marked by the target of a fast return to 6-7%
growth rates. Both Concertación Democrática and the opposition built their programs based
on expectations that ex-post turned out to be overoptimistic. This mismatch between
expectations of an imminent recovery and a depressed economy, with a stagnated aggregate
demand, determined an imbalance between the resources needed to fulfil the government
program and the depressed tax revenue. To face this context, the government implemented
a new fiscal rule that works with the concept of fiscal structural balance (see Marcel et al.,
2001; Tapia, 2003). The rule consists of sustaining a level of expenses consistent with
structural fiscal income; that is, for each budget year the fiscal income is estimated as if the
economy were fully using the “potential or trend GDP” and were facing the expected
medium term copper price.31 Consequently, when the economy is overheated the Treasury
accumulates savings; and under a recession it uses those funds (or borrow) to cover the
foregone wastage of productivity and employment associated with an economic activity
below potential GDP. This new public policy has been a great conceptual progress in fiscal
30
31
In order to estimate that capacity, to actual GDP of 1997 it was discounted an estimate of the output that
was identified as non-sustainable in that year (see Annex).
Two independent consulting committees, named by the Ministry of Finance, provide each year an estimate
of the trend price of cooper (used to determine withdrawals and deposits to a copper stabilization fund)
and inputs to estimate “trend GDP” for the next budget year.
34
and macroeconomic management, given the volatility of international trade and financial
markets.
This innovative fiscal rule was accompanied by two features that are not intrinsic of
the rule. One is defining as target a structural surplus of 1%; after some time, inevitably,
that goal leads to a net creditor state, a strange and non-desirable situation in a developing
economy.32 The other one is to define as potential GDP what has been the trend GDP of the
Chilean economy, which evidently includes the intense recessions that it has suffered.
Obviously, trend GDP moves well below potential GDP or productive frontier (see Annex
and chapter IX).
The features of the Chilean rule implied a neutral fiscal policy with respect to the
economic cycle, which involves a progress with respect to the pro-cyclical traditional norm
of balancing actual fiscal budget period after period. In fact, initially it did not move
decidedly into including counter-cyclical changes in public expenditure and taxes, a
shortcoming which became evident in 2001-03. Beyond the highly praissable progress
achieved in facing international volatility, the evidence provided by 1999-2003 shows that
there is need for effective counter-cyclical policies to contribute further to a fast recovery of
economic activity in recessions. As I stress along this book, that capacity is an essential
ingredient of real macroeconomic balances.
The Central Bank foreign exchange policy was evolving since the mid-nineties,
when the monetary authorities began to lose confidence in the instruments that had been so
successful in the first half of the 1990s. In September 1999, the exchange rate was fully
liberalized, leaving behind the crawling band. During 2000-01, in what it was considered to
be a policy consistent with the new floating regime, the majority of the remaining controls
on financial flows were eliminated. One of the effects has been an intense financial
activism, with voluminous inflows and outflows. Associated with the recessive
environment, helping to keep it like that, in 2002-03 a net outflow of portfolio investments
equivalent to 3% of GDP took place. Thus, national investors joined international markets
in their pro-cyclical behavior.
32
By 2008 the Treasury was a heavy creditor, particularly in foreign currency. Correspondingly, in a belated
decision, the surplus target was reduced to 0.5% of GDP in 2008 and to 0% in 2009.
35
Notwithstanding the persistent output gap, the government continued developing
social reforms. In 2001 there was a second reform enhancing labor rights. Also, temporary
public employment programs were intensified, covering nearly 2% of jobs in 2002-03
(naturally, with a countercyclical impact). It continued with the educational reforms, the
complete day school, infrastructure improvements and some modernization of educational
programs. Public health was significantly improved with the new "AUGE" health program,
which includes universal access to a progressively growing number of pathologies. The
"Chile Barrio" and "Chile Solidario" programs were started, in order to eradicate shanty
towns and to incorporate indigents into the social network supported by the State (see
Galasso, 2006).
In 2002, there was started an unemployment insurance scheme that is financed by
contributions of both private workers and employers (which go to an individual account of
the worker) and government contributions (which go to a "solidarity fund"); in September
2009, after seven years in force there were 3.2 million (cifra por corregir con Super?) active
contributors (about 85% of AFP private waged-workers). The high coverage in terms of
number of workers affiliated has been accompanied by very modest amounts of benefits
and a minimal use of the solidarity fund (see chap. VII). In brief, this insurance was a
progress, but it needed great strengthening in terms of its magnitude, expeditious access,
the expansion of the solidarity fund, and in its connection with effective labor training
programs. In 2009 the parliament approved a project of the government that enhanced the
extent and the access to the solidarity fund, including workers with short term contracts,
introduced counter-cyclical features in the benefits, and offered job search intermediation
labor training for the unemployed.
All these progresses, very novel and promissory, were limited in their financing
because of the output gap. But as much significant is the regressive impact that the gap has
had on the labor market. In the period between mid-1998 and 2003, the number of workers
with a job (including people in special programs financed by the government) grew in all
the period scarcely 3.3%, while the 18-year-old or over population increased around 9%.
The rate of labor participation, which had been rising during the 1990s but was still low by
1998 (54%), diminished 1 point, and open unemployment rose four points (above 10% of
the labor force). The main determinant factor of this labor market deterioration was the real
36
macroeconomic imbalance, as we define it here: the high gap between actual and potential
GDP, which implied underutilization of labor and capital, discouraging productive
investment. In fact, the investment ratio (at 2003 constant prices) in 1999-2003 was three
points below the average recorded in 1995-98.
Chile could have implemented a vigorous domestic positive shock, taking advantage
of all the strengths accumulated by the Chilean economy: large international reserves, a
Treasury and a Central Bank with low external liabilities, outstanding fiscal discipline,
among other attributes, and, a main issue, the great recessive output gap prevailing in all the
period 1999-2003.
c)
Recovery led by a positive external shock in 2004-08 and the contagion in 2009
Along 2003, there was a sharp rise in the international prices of commodities, which lasted
until the contagion of the international crisis in 2008.33 The commodity boom implied a
strong positive shock for several Latin American countries LACs).34 In the case of Chile,
the terms of trade improved the equivalent of 10% of GDP between the recessed 1999-2003
period and 2004-05; the hike in the price of copper and other commodities exported by
Chile was notably stronger than that for the imports of oil.
That was an exogenous shock contributing to a significant jump in GDP growth
from 2.6% to 5.8% in the same sub-periods. Given that potential output was rising merely
about 4% annually, this implied a noticeable reduction of the output gap. Generalized
improved terms of trade and volume of exports enhanced, directly, the spending capacity of
the private sector, and expectations returned to broad optimism. After a usual lag,
productive investment started to rise.
Naturally, the outstanding merits accumulated by the Chilean economy were a
factor supporting the sharp recovery. But the leading force was the positive external shock.
This reveals a macroeconomic weakness, since the merits of the Chilean economy were
33
34
Surprisingly, in 2009, amidst the intense global recession, prices relevant for the Chilean economy --such
as of copper and oil—resumed comparatively high levels. A similar outcome has been recorded in stock
markets: high prices in a depressed world economy could be interpreted as risky bubbles, as stressed in
several occasions by the Nobel Prize Paul Krugman.
It is noteworthy that actual GDP growth also jumped in Latin America, from 1.3% to 5.4%, between those
two periods. The driving force was the same one for Chile. See a discussion in Ffrench-Davis (2008).
37
already present in the recessive period 1999-2003. Thus, the conditions for a domestic
reactivating shock were at hand since the moment the excessive external deficit as well as
the over-appreciated exchange rate of 1998 had been corrected in 1999.35
Given a large output gap by the debut of the positive external shock, domestic
supply was able to respond with a rising GDP and low inflation pressures (within a target
band of 2-4% set by the autonomous Central Bank). In the meantime, once again, the Bank
allowed the real exchange rate to appreciate 20% between March 2003 and December
2005, contributing to anchor inflation and to further increase the purchasing power.
Nevertheless, the partial recovery lost force in 2006, opening a period in which actual GDP
grew below the expansion of potential GDP. In contrast with the experience of the 1990s,
the Chilean economy performed under the average speed of Latin America, thus losing the
lead that had exerted in the region since the late 1980s. It is true that, still, by 2008
exhibited a much better record since 1990, with the average 5.3% vis-à-vis the 3.2% of
LACs, but in the margin (2004-08) had lost ground with a 4.9% average, lower than the
5.3% recorded by Latin America in the latter period.
A mix of factors explains directly that weakening. The direct origin is located in
2006. The Central Bank overshoot the rise of the interest rate and left the exchange rate to
revalue further; as well, the Ministry of Finance sterilized the positive impact of the copper
price rise, and allowed most of the negative impact of the increasing oil price to penetrate
in the domestic economy. A great virtue --the existence of the copper stabilization scheme-overshoot, sterilising in excess. The moderated increase in aggregate demand was strongly
biased toward imports. Again, it prevailed a severe inconsistency between the current
exchange rate policy and the consensus objective of fostering exports with higher valueadded, while SMEs faced external competition with reduced import tariffs and an
appreciated exchange rate (see chapter VI).
In brief, there was a combination of excessive priority for inflation, a sliding of
economic policy towards more neutral policies, and the belief that actual GDP was already
35
For instance, at domestic positive shock, implemented by Korea and Malaysia in 1999 was highly
successful, achieving a sharp recovery in one year (see Mahani, Shin and Wang, 2006). In my view, that
option was also available for Chile.
38
too close to potential GDP.36 The fact is that in 2006 actual GDP grew somewhat less than
the rise of potential GDP, thus resulting in an enlarged instead of a diminished recessive
output gap. That implied forgone employment, wages and profits. Additionally, uncertainty
was reintroduced in entrepreneurs’ minds, particularly in exporters and small entrepreneurs,
and optimism was weakened.
During the next biennium, effective demand experienced several ups-and-downs,
affecting economic activity; the significant effects of demand on the response of real supply
(that is, actual GDP) reflected that the Chilean economy was operating persistently below
the production frontier. Exchange rate instability contributed to the weak performance.
Actually, imports rose systematically nearly twice as faster than the volume of exports;
high prices hided that persistent fact. Evidently, the exchange rate was an outlier, and quite
unstable. That is the exchange rate regime combined two bads for the contribution of
exports, and more broadly for tradables in general, to development.
The international scenario played a relevant role, naturally enhanced by the
openness of the Chilean economy. There were positive features for Chile, such as the
spectacular price of copper and other large exports, which allowed the Treasury, with high
responsibility, to accumulate sizable funds for eventual bad years (or awful years such as
2009); fiscal surpluses jumped further to an annual average over 7% of GDP in 2006-08.
As well, world trade was dynamic up to the arrival of the international financial crisis. On
the contrary, international prices of food were climbing. From mid 2007 to mid 2008, the
price of food in the Chilean CPI increased 22%, what generated significant inflationary
pressures, explaining about half of the nearly 10% annual inflation recorded at the peak of
the commodities boom (by the third quarter of 2008; see Ramos, 2008). It was, mainly, an
imported inflation. The Central Bank consistently expressed its bias for the inflation target,
at the expense of growth. By late 2008, when already Chile was exhibiting negative
monthly inflation, the monetary policy interest rate (8.25%) exceeded by over 7 points that
of the USA.
When the contagion of the global crisis arrived in 2008, the economy moved into
open recession. In 2009 experienced a drop in GDP of 1.7%, similar to the Latin American
36
This belief was associated to the biased methodology that, working with a trend that includes recessive
periods, leads to underestimating potential GDP.
39
average. Now the government adopted a decided counter-cyclical approach, making use of
the stabilization fund, which provided broad space for counter-cyclical fiscal policy.
Notwithstanding a drop in tax revenue resulting from a depressed demand, some taxes were
reduced transitorily (on fuels, loans, SMEs). In parallel, expenditure was increased 18%,
which implied a 4.5% actual fiscal deficit. The strong counter-cyclical fiscal policy was the
main force compensating for the negative shocks, principally that suffered by the volume of
exports. In fact, the volume of Chilean exports, which had risen 7.9% in the previous two
decades, dived 5.6% in 2009. Fiscal policy softened to a significant degree the
multiplication to the domestic market of the shock on exports. The domestic economy
contracted by a negligible amount (see chapter VI, table VI.6), being in a significant
recovery push already by the last quarter of 2009. For the first time since the opening of the
economy started in 1973, the recessive adjustment, in face of external shocks, was stronger
on exports than on the domestic economy. Counter-cyclicality of fiscal policy was effective
and efficient in 2009.
In all, as said, growth was moderate, but low compared with the potentiality of the
domestic economy and the positive shocks from abroad. In 2004-08, the average 4.9% rise
of GDP was determined by a 6.6% expansion of the volume of exports and 4.2% of the rest
of GDP. This latter figure contrasts sharply with the 6.5% dynamic growth of non-exports
in 1990-98. Systemic competitivity was failing. The failure was associated with the second
variable behind the weak economic performance: a hesitant development agenda, whose
shortcomings rank from unlucky shortages in the supply of energy, to a faulty exchange
rate policy, and to lags and lacks in the incomplete links of capital markets with productive
sectors (particularly SMEs), labor training and incentives to innovation. There have been
relevant announcements of designing a more powerful productive development focused on
SMEs, but notwithstanding some concrete progresses, still are mostly at the level of
announcements.
Chile made ambitious social reforms in this period; pensions and health were
substantially improved, as detailed in chapter VII. They contributed to an improvement in
income distribution, that today in notably less unequal than in the 1980s, and better than in
the 1970s. Nonetheless, the Chilean economy is still quite regressive. That is related to the
fact that the strong social agenda was not well matched by the economic agenda. Fiscal
40
responsibility was outstanding but derailed from a development concern. Structural reforms
(as well as macroeconomic management, as shown) were weak and somewhat
contradictory with introducing equitability in the market behavior. The latter required deep
reforms in the capital market, away from the priority for the overnight markets, and moving
decidedly toward enhancing the long-term market segment; developing segments for
SMEs, and for entrepreneurs without wealth or history. As well, incentives to innovation
were weak and have been taking a relevant shape only recently. Labor training for
untrained workers has been improving but too mildly. The sharp increase in the number of
years of education has come associated to a lowered quality, what demanded even more
effective labor training. In brief, Chile missed, to a significant degree, what we call taking
the road that leads from financierism to productivism.
d)
A summary of outcomes
Notwithstanding the recessive gap in 1998-2003, actual GDP rose 5.3% in 19902008, in contrast with the 2.9% recorded in the 1970s and 1980s. The leading force behind
that outstanding performance was the vigorous investment ratio achieved in the 1990s. The
average ratio (21.4% in 1990-2008) was seven points larger than during the neo-liberal
experiment (13.6% in 1974-89; all in 2003 prices). Even in the recessive period of 19992003, capital formation was significantly higher than that in the seventies and eighties, and
sustained a potential GDP growth rate of 4%.
It is important to stress that though the foreign direct investment (FDI) exhibited a
very significant boom, 82% of the generation of productive capacity in 1990-98 was carried
out by domestic agents (see Ffrench-Davis, 2003). During the years of significant recessive
adjustment, 1999-2003, greenfield FDI also contracted, temporarily, but the major
reduction focused on private national investment, demonstrating the strong sensitivity of
domestic investment ratios under a persistent output gap.
On the other hand, in 1990-2008 the national savings ratio averaged 22% (at current
prices), the highest in recent decades (see table I.5). The higher savings ratio was associated
with the stimulating macroeconomic environment faced by firms, with rather small gaps
41
between actual and potential GDP, leading to greater use of installed capacity, higher profit
margins, and larger reinvestment of profits (Agosin, 1998).37
[Table I.5]
The savings capacity is strongly affected by the terms of trade, which continue to be
extremely unstable for Chile, as documented by the several mentions above of fluctuations
of the terms of trade effect as measured by the national accounts. The main determinant of
these fluctuations has been the price of copper, with a smaller influence of oil imports. For
instance, in 1989 the high copper price implied additional foreign currency inflows
equivalent to 3.7% of GDP into the copper buffer fund (CBF), which is one source of
public and domestic savings. On the contrary, in 1999 the fund lost 0.8% of GDP. The
change represents a net difference of 4.5 percentage points, which ought to be taken into
account when analyzing the evolution of public and national gross saving figures in table
I.5; that is required in order to measure actual savings effort in each year. However, that is
only part of the story. The CBF covered only the proceeds of the large public firm
CODELCO. But price fluctuations of copper have an effect on the taxes paid by the private
producers.38 With the replacement of the CBF with the Social and Economic Stabilization
Fund in 2006, the stabilization force of the fund was enhanced. In all, the copper
stabilization fund has represented an outstanding factor of macroeconomic stabilization. In
general, the authority has operated efficiently and responsibly with it. The CBF contributed
to the implementation of the structural budget, thus allowing a move from pro-cyclical to
neutral fiscal policies during the recessive years. But that valuable “credibility asset” was
underutilized during 1999-2003, principally, as made explicit by the authority, because of
the fear to be criticized and “punished” by financial agents if had adopted a counter-cyclical
macroeconomic policy.
37
38
As pointed out above, the convergence between the productive frontier and effective demand is an
essential ingredient for an efficient macroeconomic policy. The absence or weakness of this fundamental
macroeconomic equilibrium has been characteristic of Latin American economies since the 1980s. See
Ffrench-Davis (2006, chap. II).
All the profits of CODELCO are transferred to the Treasury. The issue was a matter of discussion,
particularly in recent years, when the fiscal budget had a huge surplus with funds provided by the profits
of CODELCO, and this firm had to borrow abroad to finance its investment. In 2008 the Ministry of
Finance allowed CODELCO to retain a fraction of its profits after taxes, raised to a significant US$1
billion (0.6% of GDP) for 2009.
42
Exports were the driving forces behind economic growth, increasing the external
links of the Chilean economy and its potential for sustainable growth. It is interesting to
note that the rate of export growth was relatively similar in the past three decades,
contrasting with highly volatile GDP growth. In this context, it must be underlined that
GDP growth in the 1990s performed notably better, than in the Pinochet regime, because
the rest of GDP (non-exports) also grew dynamically, reflecting broader systemic
competitiveness and the positive impact of sustainable macroeconomic equilibria. In fact,
non-exports rose annually 6.5% in 1990-98, merely 1.7% in 1999-2003, and recovered to
the already mentioned 4.2% in 2004-08. The sharp swings are mostly associated to
domestic macroeconomic changes.
Income distribution continues being very unequal in Chile. Nevertheless, it must be
recognized, considering the diverse available data (see chap. VII), that in 1990-98 an
improvement on income distribution took place. Both the decennial Household Budget
Survey and the annual employment survey of the University of Chile for Santiago, show a
diminishing ratio between income of the richest and the poorest quintiles of population. For
example, the latter survey indicates that the ratio was 13 times in the sixties, 15 times in
1974-81, 20 times in 1982-89 and 14 times in 1992-95 (see figure VII.3). The regressive
impact of recessive output gaps is evidenced in subsequent years, particularly in 19992002, with a stepback to 16 times. With the recovery of economic activity and strengthened
social policies, a distributive progress was recorded in 2004-09, returning to a 14 times
ratio. Nevertheless, still there is an enormous pending debt of the economy with most
Chileans.
The labor situation is a main determining factor of income distribution. It is a fact
that the improvements of the labor market, recorded between 1990 and 1998, contributed to
the distributive progress in those years, and that its worsening was a key factor explaining
the partial deterioration in 1999-02. With regard to the unemployment rate, though lower
than one-half the average rate under the Pinochet regime, it did not recover to the level of
the 1960s in a sustainable pattern. Still more, after the long recessive imbalance since mid
1998, unemployment and income inequality worsened, and labor market informality arose
as one of the greater challenges to restart the path of growth with equity. In recent years the
positive features have been a significant increase in the participation of women in the labor
43
market, with its share rising to 43%, and the gradual increase in the share of the labor force
under social security contributions, a progress toward formality and workers with the
protection that contracts likely grant. The share of members of the labor force contributing
to the private system had risen from 41% in 1989 to 54% in 2008.
In summary, however, the Concertación administration compares favorably with all
regimes since the 1950s in terms of (actual, potential and per capita) GDP growth,
productive investment ratio, inflation, real wages, social expenditure and fiscal surplus (see
table I.1). This good average performance implied that, in the years of democracy, Chile
shortened the distance with the developed world, as it is documented in table I.6.
Nevertheless, this performance was not sustained nor continuous. As it is known, the first
half of the period (1990-98) involved a vigorous growth (tripling the speed of the US), with
a strong convergence with the developed countries and a reduction on income inequality. In
the second half (1999-2008), in continued shortening distance, but per capita GDP growth
trend halved, and the strong development convergence exhibited in 1990-98, for example,
with the United States was weakened, as well as previous improvements on income
distribution.
Table I.6)
What explains this so remarkable change in the development trend? A mix of
factors. Here, we mention four that are, naturally, interrelated. First, with no doubt, the
Asian crisis constituted a significant negative external shock; however, we show that its
direct influence via slowing exports growth only explains a minor share of the slower GDP
growth (see chap. VI).
Second, one of the structural elements: dynamism in exports was strongly
influenced by natural resource exploitation (as in copper and forestry), and the development
of public services (as in energy and telecommunications) in mega-projects that could be
hardly replicated, at the same level of rising productivity, in the 2000s (Moguillansky,
1999). Consequently, a large number of smaller projects in sectors more demanding of the
still pending systemic competitiveness became necessary in this new framework.
Third, the strong social agenda was not well matched by the economic agenda.
Evidently, there are several progresses. But a rather poor economic outcome in the second
decade is what needs an explanation. There was need for a more comprehensive effort to
44
complete long-term capital markets; encourage diffusion, assimilation, and adaptation of
technology; broaden labor training; and open external markets for Chilean non-traditional
products (all with special emphasis on Small and Medium Enterprises, SMEs
development). All this are essential ingredients of a renewed national agenda for growth
with equity. My view is that these shortcomings had a relevant influence in the defeat of
Concertación Democrática in the recent presidential (January 2010) and parliamentarian
elections. But political analysis is beyond the reach of this book.
Fourth, there is consensus that fiscal responsibility was outstanding, but some
structural progressive reforms were weak and some changes were contradictory with
introducing equitability in the market behavior. The latter required deep reforms in the
capital markets, away from the priority for the overnight markets, and moving decidedly
toward enhancing the long-term market segment; developing segments for SMEs, and for
entrepreneurs without wealth or history.39 As well, incentives to innovation were weak,
even though they have been taking relevant shape recently. 40 Labor training, for untrained
workers has been improving but too mildly. The sharp increase in the years of education
have come associated to a lowered quality, what demanded even more effective labor
training. There appears to be a growing shortage of more trained workers and
entrepreneurs, in an economy that has doubled GDP per capita, whose requirements for
growth are now more demanding. In brief, Chile missed, to a significant degree after the
promising start in the early 1990s, what we call taking the road that leads from financierism
to productivism.
A fifth factor refers to the macroeconomic environment. As will be detailed in
chapter IX, policies applied in the second half of the 1990s, gradually, lost coherence and
the ability to control the vulnerability of the Chilean economy in face of external shocks.
Consequently, when the Asian crisis exploded, a climate of instability returned to Chile
once again, opening a significant gap between actual and potential GDP since mid-1998.
39
40
There have been several reforms of the capital markets, which have improved the access to financing for
SMEs and micro-credit. However, still the market is intensive in short-term and liquid dealings and the
access remains quite limited for SMEs (see Consejo de Trabajo y Equidad, 2008).
In 2008 was decided to focus the allocation of the proceeds of a royalty recently established on mining to
a selected group of clusters. It represented an encouraging deviation from allocative neutrality (see
Consejo Nacional para la Innovación, 2007).
45
This gap, as will be demonstrated throughout the text, was the main cause of the sharp drop
in the investment ratio in 1999-2003 and the loss of entrepreneurship pull.
It is essential to find the way back to real sustainable macroeconomic equilibria,
after some confusing swings between the neo-liberal and the growth-with-equity
approaches. Thus, along with deep microeconomic development–friendly reforms (proSMEs and pro-employment) -decidedly enhanced, located indeed as a priority of public
policy- Chile can recover sustained high rates of growth of GDP and a progressive
reduction of inequality. For both growth and equity it is necessary to reach sustainable real
macroeconomic balances. Beyond low inflation and fiscal responsibility, also foreign
exchange and interest rates approaches functional for productive development are required,
as well as an active management of aggregate demand in levels consistent with productive
capacity.41 The recent performance has been deficient on this matter.
41
It is fashionable to repeat that with the adoption of a floating exchange rate the national was immunized
from external shocks. The truth is that exchange rate crises are eliminated, but at the expense of
transferring great instability to the real economy, especially to the allocation of resources between
tradables and non-tradables, and to aggregate demand.
46
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51
Table I.1 (27/04/10)
Comparison of key macroeconomic variables, 1959-2009a
During the government of:
Alessandr
Pinoche Concertació
Frei M. Allende
i
t
n
1959-64 1965-70 1971-73 1974-89 1990-2009
Aylwin
Frei R.
1990-93
1994-99
Bachele
t
2000-05 2006-09
Lagos
GDP growth
3.7
4.0
1.2
2.9
5.0
7.7
5.4
4.3
2.8
(%)
Exports
6.2
2.3
-4.1
10.7
7.2
9.6
9.7
6.3
2.4
growth (%)
Inflation rate
26.6
26.3
293.8
79.9
7.0
17.7
6.1
2.9
4.0
(%)b
Unemployme
5.2
5.9
4.7
18.0
8.7
7.3
7.5
10.7
8.8
nt rate (%)c
Real
wages
62.2
84.2
89.7
81.8
129.7
99.8
123.4
140.0
153.5
(1970=100)
Gross
fixed
investment (%
of GDP)
In
1977
20.7
19.5
16.1
15.7
25.0
20.7
25.1
24.2
30.2
pesos
In
2003
17.9
16.8
13.9
13.6
21.5
17.9
21.6
20.8
26.0
pesos
Government
surplus (% of
-4.7
-2.5
-11.5
0.3
1.9
1.9
1.2
0.7
4.3
GDP)
Structural
surplus (% of
n.a.
n.a.
n.a.
n.a.
0.7
0.4
0.8
0.7
0.4
GDP)d
Income
distribution
12.1
13.7
12.8
17.7
15.3
16.0
15.5
15.6
14.0
(Q5/Q1)
Population
2.5
2.1
1.8
1.6
1.3
1.8
1.5
1.1
1.0
growth (%)
Sources: Central Bank, Budget Office (DIPRES) and National Bureau of Statistics (INE).
a
Annual growth rates of GDP and exports; average of annual rates of inflation and unemployment.
b
From December to December.
c
With emergency employment correction; without correction it is 13.3% in 1974-89, 7.4% in 1994-99, 9.7%
in 2000-05 and 8.1% in 2006-09.
d
Official estimates that use trend GDP as structural tax base, underestimating potential GDP.
52
Table I.2
Evolution of GDP and its composition, 1975-81
(annual average rates of growth, %)
Total
1975-80
(1)
3.8
3.4
1975-81
(2)
4.0
3.5
Per capita
1975-80
1975-81
(3)
(4)
2.3
2.5
1.9
2.0
1. Gross domestic product
2. Gross national product
3. Value added
a) Marketing of imports
15.5
16.2
13.8
14.5
b) Financial services
14.6
14.2
12.9
12.5
4. Gross national product excluding value added in 3.
1.9
1.8
0.4
0.3
Source: Calculations based on official figures of National Accounts, 1960-81, in pesos of 1977. Revised
figures by Marcel and Meller (1986) give GDP growth of 2.6% for 1975-81, and not the official 4.0%; the
main correction was placed in the industrial sector (here included in line 4). There are no disaggregated
corrected figures in order to build a revised table.
Table I.3
Macroeconomic variables during dictatorship: 1974-89a
(annual averages)
1974-81
1982-89
1974-89
GDP growth (%)
3.0
2.9
2.9
Exports growth (%)
13.6
7.8
10.7
Inflation rate (%)b
138.9
20.8
79.9
Total unemployment rate (%)c
16.9
19.2
18.0
Official unemployment rate (%)
13.0
13.6
13.3
Real wages (1970=100)
75.7
88.0
81.8
Gross fixed investment (% of GDP)
In 1977 pesos
15.9
15.6
15.7
In 1996 pesos
16.1
15.8
15.9
Government surplus (% of GDP)
1.6
-1.1
0.3
Sources: Same sources as table I.1.
a
Annual growth rates of GDP and exports; average of annual rates of inflation and unemployment.
b
From December to December.
c
With emergency employment correction.
Table I.4 (28/04/10)
Public and private budget balances, 1990-2008
(% of GDP at current prices)a
Total
Private sector
Public sector
1990-95
-2.3
-4.4
2.0
1996-97
-4.2
-6.4
2.1
1998
-4.9
-5.3
0.4
1999-2003
-0.9
0.1
-1.0
2004-07
3.2
-2.7
5.8
2008
-1.5
-6.8
5.3
Sources: Author's calculations based on Balance of Payments data from the Central Bank and DIPRES for
the public sector.
a
Total balance is the current account deficit or use of external savings. Public sector corresponds to Central
Government (excluding public enterprises). Private sector is estimated by difference.
Table I.5 (28/04/10)
Gross savings ratios, 1982-2008
(% of GDP at current prices)
External
National
Public sector
Stabilization funds
Other
(1)
(2)=(3)+(4)+(5)
(3)
(4)
(5)
1982-84
8.4
3.1
-1.8
4.9
1985-89
4.9
16.5
3.3
1.6
11.7
1990-95
2.5
22.1
4.6
0.8
16.8
1996-98
4.7
22.7
4.8
0.0
17.9
1999-2003
0.9
20.6
2.3
-0.5
18.7
2004-08
-2.2
23.8
5.1
3.8
14.8
Sources: Author's calculations based on National Accounts data from the Central Bank and DIPRES. (3) The
public sector includes here cash profits of public firms, principally of CODELCO (the public
copper producer) collected by the Treasury, excluding Stabilization funds. (4) Corresponds to the
Copper Buffer Fund until 2006, and the Economic and Social Stabilization Fund and Pension
Reserve Fund since then. (5) Includes net private savings plus the Central bank balance, profits of
public firms not transferred to the Treasury and capitalized by these firms, and depreciation
reserves of all public and private firms.
Table I.6 (04/04/10)
Per capita GDP growth, 1974-2009
(annual average growth rates, %)
Chile
1974-81
1.5
1982-89
1.2
1990-98
5.4
1999-08
2.6
2009
-2.5
Sources: Central Bank of Chile, ECLAC and the IMF.
54
Latin America
2.0
-0.7
1.4
2.0
-2.8
United States
1.5
2.6
1.7
1.6
-3.3
Figure I.1
ActualActual
and potential
GDP,
and potential
GDP,1960-2009
1952-2009
(log scale,
GDP*1996
1996 ==100)
(log scale,
GDP*
100)
106
Frei Montalva Allende
Alessandri
Frei R.T.
Aylwin
Pinochet
Bachelet
Lagos
104
GDP growth and output gap
(annual average growth rates, % of GDP)
1974-89 1990-2008
Actual GDP(%)
2.9
5.3
Potential GDP (%)
2.5
5.6
Output Gap (%)
10.4
2.5
102
100
98
96
94
92
90
Actual GDP
Potential GDP (ICOR)
Source: Author's calculations detailed in the annex of this chapter.
55
2008
2006
2004
2002
2000
1998
1996
1994
1992
1990
1988
1986
1984
1982
1980
1978
1976
1974
1972
1970
1968
1966
1964
1962
1960
88
Figure A.1
Comparison
ofof
underutilized
capacity,
1960-2008
Comparison
two estimatesproductive
of the Output
Gap, 1960-2008
(% of
GDP*)
(%
of GDP*)
25,0
20,0
ICOR
PF
15,0
10,0
5,0
0,0
-5,0
Source: Author's calculations detailed in this annex. Corresponds to columns (3) and (4) of table A.1.
56
2008
2006
2004
2002
2000
1998
1996
1994
1992
1990
1988
1986
1984
1982
1980
1978
1976
1974
1972
1970
1968
1966
1964
1962
1960
-10,0