jon lowenstein/NOOR/Redux

Chile Falters

by robert looney
 

robert looney teaches economics at the Naval Postgraduate School in California.

Published December 7, 2017

 

Chile is one of a handful of countries in the developing world that has made an enduring effort to rely on free markets, rather than state involvement, to accelerate economic growth and move the country toward affluence. The results have been nothing less than spectacular, vaulting GDP per capita (measured in purchasing power) to the top of the heap in Latin America and putting it in the same league as Russia and Turkey.

Amend that: The results were spectacular. In recent years growth has sharply decelerated, raising questions about the sustainability of the Chilean model and where it went wrong.

Free Markets, Autocratic Rule

Chile’s free-market approach began as a series of economic reforms put together by a bunch of American-educated Chilean economists (dubbed the Chicago Boys) soon after General Augusto Pinochet’s bloody toppling of a defiantly Marxist (but democratically elected) government in 1973. The reforms quadrupled GDP per capita, proving so successful that center-right and center-left governments retained many of the free-market institutions even after Pinochet was relegated to the ashcan of history. As a result, Chile enjoyed a prolonged period of policy continuity that allowed it to avoid the disastrous experiments in populist, structuralist and heterodox policies that cursed neighbors ranging from Argentina to Brazil to Venezuela.  

Dross at the End of the Rainbow

Chile’s early success invited comparisons with the East Asian “Tiger Economies.” As with the Tigers, rapid growth was achieved by unleashing the private sector and opening the economy to foreign trade and investment. Even after the reestablishment of democracy in 1990, Chile’s growth rate averaged nearly 5 percent for 2 decades, almost double that of Latin America as a whole. And it seemed immune to the boom-bust cycles that undermined productivity and living standards in Argentina and Brazil.

However, unlike the Asian Tigers, where decades of sustained growth have led to income convergence with advanced countries, Chile’s development stalled well short of the mark. In fact, Chile’s growth slowed from an average annual rate of 6.1 percent in the 1990s to 4.6 percent in the 2000s to 3.9 percent in 2010-16. Since 2014, growth has been in crawl mode; current IMF estimates put the 2014-17 growth rate at 1.9 percent annually. With no improvement in sight, ratings agencies began downgrading Chile’s bonds in 2017, and President Michelle Bachelet’s center-left economic team resigned soon after.

Bachelet’s finance minister, Rodrigo Valdés, blamed the reversal of fortune on “one-off factors,” including the worst forest fires in Chile’s history. Others link the economy’s malaise to the falloff in copper prices that began in mid-2011, to the collapse of businesses’ confidence in Ms. Bachelet or to growing evidence of corruption in high places.

Although these factors no doubt contributed to the malaise, a full explanation of Chile’s sagging growth eludes easy explanation. Among other confounding evidence: Chile still ranks a very respectable 33rd out of 138 countries on the latest World Economic Forum’s Global Competitiveness Index ahead of Spain, Italy and Turkey as well as 1st in Latin America. The roots of Chile’s economic problems, I believe, are in the fraying social contract.

While the Asian Tigers and Chile carved out similar approaches to development, their starting conditions were dramatically different in key ways. When the Tigers began their development push, they had already completed significant land reforms, which meant that income and wealth were relatively evenly distributed. The Tigers also began with reasonably healthy financial systems and a commitment to quality universal public education that insured the benefits of growth would continue to be spread through the population.

 
The roots of Chile’s economic problems, I believe, are in the fraying social contract – Chile currently has the highest level of inequality among the 34 members of the OECD. This income-based disparity not only fosters widespread resentment, but also deprives Chile of the labor force required to propel the country to fully developed status.
 

By contrast, Chile was a highly stratified society in the 1970s in which the elites not only controlled a disproportionate share of income and wealth, but also had the power to distort policy – beginning with blocking land reform and opting for a largely private (and very expensive) educational system. The Chilean financial sector, moreover, was weakened by a legacy of high inflation that dogged investment decisions.

If the Chicago Boys expected that the rising tide would allow Chile to outgrow its inequalities, they were disappointed. In 2013 the World Bank reported that the wealthiest 10 percent of Chileans received 41 percent of the nation’s income. In contrast, less than 2 percent of national income trickled down to the poorest 10 percent. Consequently, Chile currently has the highest level of inequality among the 34 members of the OECD.

Education, which mirrors Chile’s class divisions, gilds this poisonous lily. Only the wealthiest Chileans can afford high quality schools that adequately prepare students for skilled work in Chile’s increasingly sophisticated economy. Chileans lower on the income scale – especially the middle class – often run up massive debts for education they later discover was substandard. In 2016-17, Chile ranked 103rd of 138 countries in the quality of primary education, 99th in quality of math and science education and 86th in the overall quality of the education system on the World Economic Forum’s competitiveness indexes. This income-based disparity not only fosters widespread resentment, but also deprives Chile of the labor force required to propel the country to fully developed status.

The state pension system, which Pinochet’s government privatized in the 1980s under the Chicago Boys’ tutelage, is another flash point for popular dissatisfaction as well as a drag on worker morale. The defined-contribution pension system compels workers to set aside 10 percent of their income in personal retirement accounts managed by financial services companies. In the early years, spectacular gains in the stock market made everyone look good. Indeed, economists worldwide were touting a system that was adequate to retirees’ needs, but guaranteed to never be a burden on taxpayers.

That was then. Lower returns on pension fund investments, exacerbated by a lack of competition among the financial services providers, have left many Chileans nearing retirement in dreadful financial shape. With an average benefit of just $340 a month, nearly 80 percent of Chilean pensions generate less income than the minimum wage.

Politics Follows the (Lack of) Money

When growth was rapid, the frictions between the haves and the have-nots did not manifest in open unrest. Now demonstrations protesting the broken education system, poor working conditions and dismal pension prospects are a regular occurrence in the capital city of Santiago. Unusual for Latin America (though now a familiar sight in Venezuela), the demonstrations are predominantly a middle-class phenomenon, fueled by rising frustration at unmet expectations.

As social tensions have increased, there has been a marked deterioration in the quality of governance. During the 1990s and into the 2000s, Chile had scores on the World Bank’s governance indexes approaching those of the advanced industrial democracies. Since then, however, Chile’s governance scores have either fallen or, at best, remained static. Chile’s ranking for voice and accountability (a measure of democracy) deteriorated from the 89th percentile in 2005 to the 75th percentile in 2015, and political stability/absence of violence fell from the 77rd to the 59th percentile.

Not surprisingly, there has been a correspondingly sharp decline in Chileans’ confidence in their government and institutions. The London-based Legatum Institute reported that Chile dropped 25 places in social capital ranking, an indicator of societal trust, between 2007 and 2016.

In an attempt to reduce the sting of inequality, the center-left government introduced a series of reforms to address the imbalance in services and benefits, only to be met with active opposition from the country’s elites. Tax reforms to increase education funding were vehemently opposed by business groups, while labor reforms were challenged in the courts by business owners and never made it through the Congress. Attempts to reform the pension system were derailed by a series of government corruption scandals and Pres. Bachelet’s own low approval ratings.

With Bachelet’s successor to be elected this month (she is not eligible for re-election), Chile’s future is clouded. But one thing is apparent: the Chicago Boys’ economic model has hit the skids. A pure free-market approach can produce high rates of growth as resources are initially allocated more efficiently. But sustaining that growth usually requires good governance and a broad commitment to social inclusion. Unfortunately, Chile shows few signs of finding ways to make that happen. 

main topic: Latin America
related topics: Global Economy