History of the Chilean Economy

2.The nation of Chile, just slightly larger than the state of Texas, achieved independence in 1818. Until 1830, the fledgling nation was in a state of chaos when Diego Portales ushered in the period of the autocratic republic. This period, from 1830-1861, was a time of firm-handed rule tempered by moderation. Conservative landowners and merchants were in control of a centralized government, and an 1833 constitution endured until 1925. The Conservatives, though challenged by a strengthening liberal movement begun in the 1840’s, managed to maintain control until 1873.

The Liberals, allied with the Radicals, assumed control from the Conservatives and the period from 1875-1885 witnessed considerable modification of the national political institutions. The church lost many privileges, including power over education, suffrage was extended, and ministers were made responsible to Congress.

During this, Chile’s early nationhood, political change was constitutionally driven and peaceful, and the resulting stability allowed for a steady economic development. Strong political organization was the deciding factor in Chile’s defeat of Bolivia and Peru in the War of the Pacific and subsequent conquest over the indigent Indians in the far reaches of its territory. The war yielded a bounty of an expansion of the northern borders; lands which are rich in nitrate and copper deposits. Chile’s economy was reliant on primary exports of which wheat, copper, and sodium nitrate dominated. The resources from the new lands added to the already strong mining industry to make Chile’s sodium nitrate deposits the largest in the world.

Following civil war in 1886, a parliamentary style government moved toward an unregulated market economy, which prevailed until 1925. Marred by problems of violent labor strikes, the country experienced a rural-to-urban population shift; labor exploitation prospered. Urban industrial expansion followed the new labor force and was geared to providing finished products for the consumer market.

Under a new Constitution adopted in 1925, presidential rule was reestablished and the separation of church and state was imposed. New social justice codes were also established. From 1927 until 1929 (the year of the world depression), Chile flourished economically with the generous foreign investment of the United States and other foreign capital, as well as, its near monopolistic production of sodium nitrate. Then disaster struck.

Chile fell into the great world depression of the early thirties while simultaneously, newly developed synthetics drastically reduced world demand for sodium nitrate. Ironically, in 1931, then President Ibanez resigned and a brief period of political instability followed, coinciding with the depression. Exports dropped by 85% and imports by 80% between 1929 and 1932. Mass unemployment swelled and the urban labor built shantytowns.

Although political chaos ended with the election of Arturo Alessandri in 1932, the scarcity of imported goods and the shortage of foreign currency from the depression and WWII , made manufacturing development a major concern. Industry expanded into the production of steel and automotives. Chile installed high import tariffs to protect these industries thus making them susceptible to loss of protection with future governmental changes.

Additionally, balance of trade deficits developed along with fiscal crises, due to the continued reliance on copper and nitrates exports for the majority of foreign exchange.
Through the early seventies, Chile continued the trend toward urbanization and industrialization. Spurred by the creation of the National Development Corporation (CORPO), industry continued to expand into textiles, chemicals, locomotives, armaments, rubber and glass, among many others. Education and health care were also expanded. Chile continued; however, to ignore its agricultural industry, failing to modernize and the subsidies and tariff protections afforded to support the new industries made them uncompetitive in world trade and contributed to the spiraling inflationary problems; as high as 86% in 1956. Further, foreign investment by the United States lead to non-Chilean domination of the key mining and industrial sectors.

Elected in 1964, Eduardo Frei initiated dramatic reforms to right the economy. He began the process of nationalizing Chile’s copper and mining industries, began agrarian reforms, began redistribution of wealth programs, and expansion of social programs. The administration took on large-scale construction projects, provided credit for agricultural and industrial expansion, and encouraged foreign economic investment. It also fueled the creation of farm labor unions, and the populace into cooperatives and unions. All of this was funded by high world market prices for copper and aid from the U.S. Alliance for Progress.
Frei’s successor, Salvadore Allende then finished the nationalization of the U.S. copper firms and all private banks, and accelerated land redistribution. Allende was the world’s first democratically elected Marxist president in Latin America. Allende’s attempt to socialize Chile initially improved living conditions, wages for civil workers, and generated economic expansion. This at the ire of the U.S. and domestic opposition. As opposition intensified, the price of copper fell, food imports increased, foreign reserves declined, and inflation spiraled to over 160% in 1972.

The U.S. influenced the World Bank to deny new aid to Allende’s administration and persuade the InterAmerican Development Bank to reduce its loans to Chile. In 1973, the bottom fell out. Inflation swelled to over 700% annually and finally the Congress declared the Allende government unconstitutional. Led by Pinochet, a military junta killed Allende while he was defending the presidential palace. Pinochet, financed by the U.S. Central Intelligence Agency, declared a new authoritarian democracy and took the reigns of Chile’s future.

Under the military dictatorship of President Pinochet, opposition and political rivals were suppressed, and Pinochet began a campaign of economic reform designed to privatize the national economic entities. The government returned many factories, banks and expropriated lands to private owners. Health, social security, and educational programs were decentralized and privatized. On the dark side, Pinochet outlawed opposing political parties, dissolved the national labor confederation, censored the press, and arrested tortured, and killed thousands of Chileans.

In his effort to adopt a free market economy, Pinochet recruited from the Chicago School of Economics and the ideals of Milton Friedman. A government group of economists trained at the University of Chicago, dubbed the “Chicago Boys”, were handed control of the Chilean economy. Their programs worked to further dismantle or decentralize the Chilean state are far as was humanly possible. They began by deregulating the market, liberalizing trade, rolling back trade unions, and rewriting the constitution and laws.

In 1975, the Chicago boys held an economic seminar that received national attention. The guest speakers were prominent economists from all over the world, among them was Milton Friedman. The plan they presented as “shock treatment” to revive the Chilean economy was unveiled and praised by these economists. The plan called for drastically reducing the money supply and government spending, privatization of government services, massive deregulation of the market, and liberalization of international trade. The plan was jointly designed by the Chicago Boys, the International Monetary Fund, and the World Bank and was a precondition for future loans.

Soon after the conference, the new government instituted the Economic Recovery Program (ERP). The initial phase of reducing the money supply and government spending resulted in a sharp reduction in inflation. At the same time it drove unemployment to 18.7% in 1975, and output fell to 12.9%, resulting in a shocking recession. However, by mid-1976 the economy began its recovery and from 1978-1981, the infamous “Economic Miracle” had been achieved. With nearly all restrictions lifted on foreign direct investment, loans and foreign investment flooded the economy.

The Chicago Boys reduced import duties to a maximum base level of 10% and virtually eliminated all other trade barriers. This reduction effectively removed the protection devices that shielded the Chilean manufacturers and forced them to compete internationally or dissolve. It also reduced the cost of imports, allowing for increased capital investment. Exports increased also, as the comparative advantage theory predicts.

The general idea behind this comparative advantage theory is that a country should specialize in what it does best and import where it is inefficient. This would mean the loss of such industries as auto-making and appliance manufacturing in Chile, yet invigorated industries based on the nation’s natural resources. These invigorated industries include agriculture, mineral production, marine industries, and timber.

The downside to this program is a sharp rise in foreign debt. Imports became so much cheaper that importing foreign consumer products meant the expenditure of billions of dollars. Half of this debt was financed with short-term loans from international banks operating on the Euro-dollar market, the other half by the strong marketing of exports.
Additionally, between 1977 and 1981, 80% of Chile’s growth was in unproductive sectors, i.e., marketing and financial services. This was driven by speculation to capitalize on Chile’s extremely high interest rates. In 1977, this was 51% for Chile, the highest in the world.
Chile was hit extremely hard by the 1982 international recession as foreign capital and markets dried up, and was harnessed by astronomical interest rates on its massive foreign debt. Unemployment soared to a high of 34.6% in 1983, and manufacturing production fell 28%. The large financial groups were devastated and with tight money supply in Chile, industry went bankrupt. Government intervention was inevitable.

The Pinochet regime was forced to move away from some of the market reforms of the Chicago Boys, and prop up banks and other industries to prevent their collapse. The government devalued the peso by 18% and the decree of free float weeks later devalued the currency another 55%. Further, the government intervened in the production of goods and services as more than 1300 large industries had already defaulted. Next, the government issued a decree to loosen the money supply to slow the unemployment rate. The IMF stepped in providing bailout loans to float Chile’s massive debt – a staggering US$7.7 billion.

The economy responded and began recovering in 1984. By 1986 Chile was again experiencing exceptional growth at an average of 7.7% between 1986 and 1989. The problem was, as before, the growth was actual growth, not potential growth. In reality, the laid off workers returned to work but the potential productivity was never reached because no new capacity was installed.

Still, the revolutionary reforms installed by the Chicago Boys achieved an annual growth in per capita real income of an average of 5% between 1985 and 1996, an astounding rate and far above that of any other Latin American country. With Pinochet’s resignation in 1990, the military dictatorship was dismantled and Congress and political parties resumed functioning. The civilian succeeding governments carried on the free market programs instituted by the Chicago Boys, but with some changes; a drastic increase in spending on social programs for one. In 1997, political competition and direct presidential elections were restored and a National Security Council was established to keep the military in its proper place in national politics. In the same year, the World Trade Organization praised Chile’s achievements in liberalizing trade and reducing inflation; however, the economy still depends heavily on the market prices of exports – particularly copper.

Currently, thanks to restored democracy and hence heavy government investment in domestic social programs, Chile is again on a stable economic footing. Its financial institutions are strong, and real GDP growth was just over 5% for year 2000. The peso is allowed to float freely on the international market and closed the year 2001 at 669.14 pesos/dollar.

Several factors are responsible for this bright economic outlook. Asian markets and copper prices worldwide have rebounded strongly since 2000 and this, along with Chile’s focus on strong economic macroeconomic management and the shift from short-term to long-term foreign capital inflows, has lead to an economic resurgence. Unemployment has fallen to around 10%, interest rates continue a long decline, and the Central Bank has relaxed its monetary stance . Inflation was checked at 2.6% in 2001 and the balance of payments deficit was down to 1.6% of GDP. Private consumption is expected to increase over the next year and economic growth will rely heavily on this increased internal demand.

Adding to the resurgence was Chile’s newfound membership in Mercosur in 1996, as well as, free trade agreements with Mexico and Canada thereafter. As the next new member in line for membership in NAFTA and several other pending trade agreements, Chile’s outlook is great, and looks very attractive for foreign trade and investment.

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