Kat Fisher
Mark Sintetos
Alex Vela
ECON317 Sec:0301

Chile
Chile has been one of the most studied economies in recent history due to its impressive feats during global recessions. Being a small, copper export dependent economy until the 1980s, Chile often went under the radar on the global marketplace. Due to policy changes starting in 1985 and a political regime change in 1990, Chile began to thrive. Chile now boasts an economic model which encourages economic freedom, competitiveness, and investment. This model has allowed for Chile to have the highest per capita income in Latin America. Although Chile has had successes with its economy, it is still considered a developing country. Large efforts have been made for the past century to secure development. While these efforts have brought Chile closer to its goal, high inequality and a relative dependency on copper prices has made it difficult for any of these efforts to have a final impact allowing for the actual transition to developed status. This paper analyzes the timeline of Chile’s economy, focusing specifically on the period of high growth of 1985 to present day and any recessions that fell between these dates. It also aims to highlight the successes and failures of the policy reforms of the past as a way to determine what will be effective in the future for allowing Chile to achieve its goal of development.
Before the arrival of the Spanish in the 1500’s, the Inca ruled the northern part of Chile while the Mapuche inhabited the central and southern parts. Although Chile declared its independence in 1810, victory over the Spanish was not successfully achieved until 1818. In the War of the Pacific, Chile defeated Peru and Bolivia. This victory won Chile its presence in the northern regions. It was not until the 1880s that the Mapuche and the Incas were brought under central government control.
By the early 1900’s Chile was moving from a parliamentary government towards a more presidential type of government. During this transitional period, Chile was in the early stages of developing its social class system. By this time the majority of the population consisted of the working and middle classes. They wanted a new type of government that would enable social equality for all and with that respect they elected Arturo Alessandri. As the first liberal president of Chile, Alessandri was a firm believer in social reforms that would make the state of Chile a more collectivist society. Unfortunately, the conservative congress, backed by the military, would not allow the proposed reforms to be enacted by the government. From this point on until 1970 there is an ongoing battle between the liberal socialist and the military conservatives. Much of these year are represented by political instability that has led to countless defeated elected parties that have not lasted very long.
By 1970 a new president was elected by the name of Salvador Allende. His vision for Chile was that from a Marxist point of view. He believed that Chile should become a socialist government that controlled every aspect of the economy. By the beginning of his first term Allende goal was to nationalize every enterprise within Chile. He started with the banking sector and then moved on to nationalize many of the industrialized sectors of the economy, like mining, construction, and steel industries. In addition, Allende’s policy also included prices controls of certain goods, increase in wages, and a tax reform that redistributed income to those in need. Although Allende’s policies worked in the short run, they could not be sustained. After about a year into his presidency much of the new reforms enacted were beginning to fail. First, Chile experienced capital flight in many of the public works projects it had established under Allende. Second inflation began to increase at an exponential rate. It was reported that inflation surpassed 200%. And finally a combination of plummeting private investment and increased bank withdraws caused a massive upheaval within Chile. Some of the negative effects included, the public sector deficit was over 25% of GDP, international currency reserves were staring to decrease dramatically, and real wage fell by approximately 15% and continued to fall.
After three years, the Marxist government under Salvador Allende was overthrown in 1973 by a military coup led by Augusto Pinochet. The new military government, now under Augusto Pinochet, acted quickly to get the economy back on track. With the advice from the “Chicago Boys”, a group of Chilean economist that studied at the University of Chicago under the supervision of Milton Freidman, Pinochet followed the idea of free markets. First, they enacted policies that would re-privatize all the banks and other enterprises. Second, they had to increase monetary policy by reducing inflation and stabilizing their currency. Then they eliminated all governmental price controls, they called it the liberalization if the economy. Fourth, fiscal policy had to be adjusted by balancing the budget and introduced value added taxes, which was a tax on consumption. Finally, they had to correct the massive trade imbalance by reducing tariffs and reopening Chile’s markets to global trade.
For almost a decade Chile was experiencing economic prosperity up until 1982. Prior to the 1982 Chilean crisis, Chile’s economy was growing at a rapid pace. The financial industry was surpassing the growth of GDP even as GDP was grown at 12% annually. Also, capital inflows was increasing that led to the abundance of credit. Many household and business took advantage of such credit without looking at the negative consequences. Also, banks took on too much risk in their loan portfolios. In addition, asset prices were increasing in combination with an enlarging trade deficit. Chile’s economy was growing too quickly that is was not sustainable once interest rates started to increase because during this time the world was in a global recession. This caused a dramatic decrease in the supply of international loanable funds that the Chilean banking system heavily relied on. Also, one major policy that sounded viable but turn out to make things worse was fixing the exchange rate. As a result, when prices retraced back current markets the Chilean peso was greatly devalued. Furthermore, inflation began to rise, GDP fell by 15% in two consecutive years and unemployment is at record highs.
By 1983 the economy begins to see signs of recovery. The banking system was nationalized once more and then re privatized once people started gaining confidence in the financial sector. The government also instituted new banking regulation and tax laws. Furthermore, financial and consumer regulatory agencies are created with then necessary authority and resources. Sound economic policies, maintained consistently since the 1980s, contributed to steady growth, reduced poverty rates by over half, and helped secure the country's commitment to democratic and representative government. Chile has increasingly assumed regional and international leadership roles befitting its status as a stable, democratic nation.
The late 1980s’ and the 1990’s were some of the most important years in Chilean history, both politically and economically. While politics and economics are highly intertwined, there are few examples that better depict this connection than Chile and their economic growth coinciding with a political regime change.
In 1990, Augusto Pinochet handed power to Patricio Aylwin after an election at the end of the previous year, thus ending the military party’s regime and reforming a democracy. Aylwin represented a new beginning for Chile, however power seemingly remained split between military and civilians­­­­­ meaning that military officers appeared to stay above the law. As president, Aylwin showed great leadership and stood up to the military party in many instances to the surprise of even his advisors. The main power Aylwin had, as president, over the military party was his ability to veto the promotions of military officers and did so cleverly to counteract Pinochet’s power as best he could.
Aylwin also assured investors that the government would maintain a free-market economy; by showing investors that Chile would sustain solid economic policies as a democracy, Aylwin helped create an even friendlier economy that was not shrouded by the potential for political turmoil or conflict. The newly instated democratic government also made it a priority to integrate Chile in the global economy by reducing tariffs and adopting multiple free trade agreements with many Latin American countries and Canada. Despite economic and political success during the transition and early phases of the democratic regime, not all was positive as many citizens failed to exercise their right to vote in 1997 congressional elections. This raised questions of citizens’ approval and possible corruption giving citizens no reason to vote.
Along with their new global economic policies reducing tariffs and forming free-trade agreements, the Chilean government implemented different domestic policies that helped set up the country for long-term success. One of the most important changes in the 1990’s was the improvement of public education due in large part to the increase of expenditures designated to do so. By improving education, the new democratic government hoped to improve worker efficiency and people marketable skills upon graduation. This was proven extremely successful as productivity growth with respect to overall employment growth grew exponentially from the 1970’s and 1980’s.
One of the greatest economic successes in Chile during the 1990’s growth period was the reduction of poverty and increase in average quality of life as measured by per capita GDP. In ten years, from 1987 to 1997, the percentage of Chile’s population living in poverty decreased by 20 percent. This can be attributed to the rise in GDP per capita, which started at 100 in the base year of 1987 and climbed to nearly 200 by 1998. Between 1961 and 1985, average per capita GDP growth rate was less than one percent while the rest of the world was at two percent. Then, from 1986 to 1999, average per capita GDP growth rate was over four and a half percent, nearly eight times as large as had been in the previous period. Economic growth during this time accounts for over 85 percent of the overall reduction of poverty in the country. While poverty had decreased significantly, the inequality gap in the 1990s has remained stable meaning that both poor and wealthy people were better off than before.
Perhaps most impressive of all was that Chile thrived and grew more than it ever had before while the rest of Latin America and the world struggled. Chile’s growth in the late 1980’s and the 1990’s while the rest of the world was in a recession has raised many questions, and perhaps the most commonly asked is how did they do it? Investment was on the major factors that played a key role in GDP growth, accounting for 27% of total GDP in 1993. Imports grew by 10 percent per year from 1990-94 and they became much less dependent on the price of copper as their leading export as it fell from over 80 percent of total exports in the 1970s to under 50 percent in the 1990s. They did this by diversifying their sources of income in large part by increasing their service and industry sectors as well as improvements in other areas of the primary sector.
An unforeseen appreciation of the peso led to speculation that “Dutch disease” effects would be seen. However, since there are multiple reasons for Chile’s growth and the appreciation was expected to be long-term, scholars have ruled out Chile as having contracted the “disease.” To compare it to other global currencies, the peso appreciated nearly 30 percent in relation to the U.S. dollar from 1989 to 1994. Many feared that this appreciation would hurt Chile’s exports in the short term leading to special tariff protection of industries such as textiles and agriculture. The government tried to fund “reconversion” training for the workers who had been victimized by the appreciation; the goal in mind here is to train those who worked in fields that are no longer globally competitive so they can find work in different emerging markets.
The Asian financial crisis in the late 1990’s triggered a decline in growth and productivity in Chile. While Chile’s implementation of market-friendly capital controls allowed for it to weather the crisis successfully, it wasn’t left entirely unscathed. The country’s ICOR (or incremental capital output ratio) values increased, indicating inefficient production. Additionally, TFP (or total factor productivity) fell from 2.2% (1992-1997) to -0.7% (1998-2003). It did increase during the second half of this past decade, although very minimally to 0.0% from 2004-2008. The decline in growth after the Asian financial crisis marked the beginning of a period dubbed “The Chilean Nap”.This period of declining growth was accompanied by a decrease in labor-market productivity, an increase in unemployment, and stagnant wages.
Efforts were made during the 2000s to return to the high growth seen during the late 1980s and 1990s. These included the signing of several free trade agreements. The most notable of these was with the United States in 2004 and China in 2006. Additionally, a series of structural reforms allowed for steady growth in Chile. The reforms included capital market reforms and competition policy reforms to increase investment and competition. Competition forces the firms with inefficient production to exit the market, increasing the market’s overall productivity. In 2006, the Chilean government approved the Fiscal Responsibility Law. This law created sovereign wealth funds, more specifically, the Pension Reserve Fund, and the Economic and Social Stabilization Fund. The initial intent of these funds was to stabilize the economy even as the price of copper fluctuated. The funds were accumulate during periods when copper prices were high and would be used to fund a deficit when copper prices were low.These main state investments amounted to $20.3 billion (12% of GDP), and allowed Chile to maintain a positive fiscal profile while entering the global recession.
Indeed, Chile suffered much less than other nation’s economies during the global recession. For an example, Argentina, who had financed increased spending during the years prior to the crisis was hit hard when consumption decreased significantly with the recession. However, Chile’s economy was not left untouched. The growth rate once again took a dip, this time to an annual average of -1.04% in 2009 (at its lowest point, the growth rate dipped to -2.3% in 2009). This was due to the sharp decline in demand for Chilean products and services as global consumption decreased. Chile was able to use its main state investments to finance the deficit. The Fiscal Responsibility Law proved to be a countercyclical fiscal policy that allowed Chile to emerge from the recession in a better position than many other economies. However, poverty rates for the first time in 20 years began to increase causing public support of the Chilean government to decline.
In 2010, the people elected Sebastián Piñera Echenique as President. Piñera was a member of the centre-right coalition, a strong contrast to Michelle Bachelet Jeria, the former president, a member of the Socialist Party of Chile. Piñera laid out a program that he hoped to implement when he took office. The program’s aim was to transition Chile from developing to developed country by 2020. Piñera’s program emphasized strengthening public and private fundamental institutions. Government transparency and decentralization were key factors in the program that Piñera hoped would steer the country towards a developed status.
The implementation of Piñera’s program was cut short by the catastrophic earthquake and Tsunami that hit Chile in 2010, just weeks before Piñera took office. The damage caused by the earthquake and tsunami cost Chile $30 billion (15% of GDP). Piñera, despite opposition from policy makers, continued with the program for economic development.
Fiscal discipline was a top priority for Piñera who implemented a structural budget that set limits on fiscal spending. Chile had a large success with having sovereign wealth funds tucked away in the case of a crisis. Piñera wanted to continue using these funds, but increase savings. Piñera believed that limited public spending would also have a positive effect on inflation control. This proved to be true throughout his term. In December of 2013, the inflation rate was 3%, and stark contrast to the -1.3% inflation rate in January 2010. Another important aspect of Piñera’s plan was to use the encouragement of entrepreneurship and the inclining growth rates to create one million jobs between 2010 and 2014. This implementation had an immediate effect on the labor market. Unemployment rates fell from 9% in 2010 to 6% in 2012. At the end of Piñera’s term, the unemployment rate was at 5.67% (December 2013).
Great measures were taken by Piñera to reduce the national poverty rate. During the late 1980’s,1990’s, and 2000’s the poverty rate had been reduced from 45% to 13.7%. In 2006 the poverty rate began to increase to 15.1% in 2009. Piñera implemented a series of “promotional” policies aimed at encouraging people to raise themselves out of poverty. Cash-transfers were administered to families based on achievements in certain areas of human capital (i.e. education and health) with the “Ethical Family Income” policy. Piñera believed that this policy would not only decrease the national poverty rate, but further encourage entrepreneurship. By 2011, the poverty rate had decreased to 14.4% in 2011.
In 2013, Michelle Bachelet Jeria was reelected as the incumbent President. Bachelet ran on a platform that sought to reform the education and tax systems and write a new constitution. More specifically, Bachelet’s proposal would allow public university to be free for students in just 6 years and rid the education system of “for-profit” educational systems. The tax reform would raise corporate taxes from 20 to 25 percent and decrease personal tax from 40 to 35 percent, a reform that Bachelet estimated would generate $9.5 billion in tax revenue.
Public opinion has been in favor of an educational reform. In fact, in the past 4 years many strikes and demonstrations of students and parents of students have taken place in Chile. The protesters claim that the education system is unfair, providing them with low-quality education at a high price due to privatized education systems. Both Piñera and Bachelet have run on platforms that promised to end “profit-making in education”, but neither have succeeded thus far and it is taking a toll on public opinion. Additionally, while it is of general agreement that a reform of Chile’s educational system is necessary, economists speculate as to whether the tax reform Bachelet hopes to implement is the right path to be taken. And the people seem to agree. Bachelet’s tax reform was passed into law September 2014 and a public opinion poll taken the same week showed strong majority disapproval of the tax reform.
The Chilean finance minister, Alberto Arenas, seems to agree with the direction Bachelet is taking with the education and tax reforms. Arenas believes that in order to reform education there needs to be an increased public spending in the education sector, which will not happen unless there is a matched increase in government income. This increase in government income comes from the expansionary fiscal policy that Bachelet has implored with the tax reforms. Higher taxes might initially have a negative impact on investment, but the focus is not on the short run. In the long run, the increase in tax revenue will be invested in human capital (i.e. education and health) which will in turn increase productivity and growth.
Apart from those of taxation, Bachelet’s reforms do not alter the economic model that has brought Chile success in the past. Chile’s market-oriented economy continues to promote economic freedom, competitiveness, and investment. However, if Chile wants to reach developed status by 2020 it needs to kick up its growth, productivity, and human capital a notch. Bachelet’s education and tax reforms have this outcome in mind, but will it be enough? Chile still relies very heavily on is metal ore production making it very susceptible to price changes, especially in copper. Additionally, while it has fought to decrease inequality, it still remains the OECD country with the highest income inequality. Chile’s current inequality coefficient is .50, .03 points higher than Mexico’s inequality coefficient and .19 points higher than the OECD average. If Chile can institute public policy that allows for these things it may reach its goal.

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