Economic history of Chile
Encyclopedia
The economy of Chile
Economy of Chile
The economy of Chile is ranked as an upper-middle income economy by the World Bank, and is one of South America's most stable and prosperous nations, leading Latin American nations in human development, competitiveness, income per capita, globalization, economic freedom, and low perception of...

 has shifted substantially over time from the subsistence agriculture practised by its indigenous peoples to an early husbandry-oriented economy and finally to one of mining and agriculture. Chile started to industrialize in the 1930s with the creation of CORFO
CORFO
Production Development Corporation is a Chilean governmental organization that was founded in 1939, by President Pedro Aguirre Cerda, to promote economic growth in Chile...

 that established forestry enterprises, pulpmills, steel mill
Steel mill
A steel mill or steelworks is an industrial plant for the manufacture of steel.Steel is an alloy of iron and carbon. It is produced in a two-stage process. First, iron ore is reduced or smelted with coke and limestone in a blast furnace, producing molten iron which is either cast into pig iron or...

s and sugar
Sugar refinery
A sugar refinery is a factory which refines raw sugar.Many cane sugar mills produce raw sugar, i.e. sugar with more colour and therefore more impurities than the white sugar which is normally consumed in households and used as an ingredient in soft drinks, cookies and so forth...

 and petroleum refineries
Oil refinery
An oil refinery or petroleum refinery is an industrial process plant where crude oil is processed and refined into more useful petroleum products, such as gasoline, diesel fuel, asphalt base, heating oil, kerosene, and liquefied petroleum gas...

. In the 1980s under the influence of the Chicago Boys
Chicago Boys
The Chicago Boys were a group of young Chilean economists most of whom trained at the University of Chicago under Milton Friedman and Arnold Harberger, or at its affiliate in the economics department at the Catholic University of Chile...

, Pinochet's military dictatorship initiated neoliberal economics policies, that have resulted in booms for Chilean fruit, wine and salmon industries.

Century of the suet

In colonial times, the segmentation of Chile into small parcels of land for native American
Indigenous peoples of the Americas
The indigenous peoples of the Americas are the pre-Columbian inhabitants of North and South America, their descendants and other ethnic groups who are identified with those peoples. Indigenous peoples are known in Canada as Aboriginal peoples, and in the United States as Native Americans...

 and mestizo
Mestizo
Mestizo is a term traditionally used in Latin America, Philippines and Spain for people of mixed European and Native American heritage or descent...

 villagers to cultivate. Cattle raised were a source of tallow and hides, which were sent, via Peru
Peru
Peru , officially the Republic of Peru , is a country in western South America. It is bordered on the north by Ecuador and Colombia, on the east by Brazil, on the southeast by Bolivia, on the south by Chile, and on the west by the Pacific Ocean....

, to Spain
Spain
Spain , officially the Kingdom of Spain languages]] under the European Charter for Regional or Minority Languages. In each of these, Spain's official name is as follows:;;;;;;), is a country and member state of the European Union located in southwestern Europe on the Iberian Peninsula...

. Wheat was Chile's principal export during the colonial period. From the inquilinos (peons), indentured to the encomenderos
Encomienda
The encomienda was a system that was employed mainly by the Spanish crown during the colonization of the Americas to regulate Native American labor....

, or latifundio owners, to the merchants and 'encomenderos' themselves, a chain of dependent relations was established that ran all the way to the Spanish metropolis.

The government played a significant role in the colonial economy. It regulated and allocated labor, distributed land, granted monopolies, set prices, licensed industries, conceded mining rights, created public enterprises, authorized guilds, channeled exports, collected taxes, and provided subsidies. Outside the capital city, however, colonists often ignored or circumvented royal laws. In the countryside and on the frontier, local landowners and military officers frequently established and enforced their own rules.

The economy expanded under Spanish rule, but some criollos
Criollo people
The Criollo class ranked below that of the Iberian Peninsulares, the high-born permanent residence colonists born in Spain. But Criollos were higher status/rank than all other castes—people of mixed descent, Amerindians, and enslaved Africans...

 complained about royal taxes and limitations on trade and production. Although the crown required that most Chilean commerce be with Peru, smugglers managed to sustain some illegal trade with other American colonies and with Spain itself. Chile exported to Lima
Lima
Lima is the capital and the largest city of Peru. It is located in the valleys of the Chillón, Rímac and Lurín rivers, in the central part of the country, on a desert coast overlooking the Pacific Ocean. Together with the seaport of Callao, it forms a contiguous urban area known as the Lima...

 small amounts of gold, silver, copper, wheat, tallow, hides, flour, wine, clothing, tools, ships, and furniture. Merchants, manufacturers, and artisans became increasingly important to the Chilean economy.

Mining was significant, although the volume of gold and silver extracted in Chile was far less than the output of Peru or Mexico
Mexico
The United Mexican States , commonly known as Mexico , is a federal constitutional republic in North America. It is bordered on the north by the United States; on the south and west by the Pacific Ocean; on the southeast by Guatemala, Belize, and the Caribbean Sea; and on the east by the Gulf of...

. The conquerors appropriated mines and washings from the native people and coerced them into extracting the precious metal for the new owners. The crown claimed one-fifth of all the gold produced, but the miners frequently cheated the treasury. By the seventeenth century, depleted supplies and the conflict with the Araucanians reduced the quantity of gold mined in Chile.

As precious metals were scarce, most Chileans worked in agriculture. Large landowners became the local elite, often maintaining a second residence in the capital city. Traditionally, most historians have considered these great estates (called haciendas or fundos) inefficient and exploitive, but some scholars have claimed that they were more productive and less cruel than is conventionally depicted.

The haciendas initially depended for their existence on the land and labor of the indigenous people. As in the rest of Spanish America, crown officials rewarded many conquerors according to the encomienda
Encomienda
The encomienda was a system that was employed mainly by the Spanish crown during the colonization of the Americas to regulate Native American labor....

 system, by which a group of native Americans would be commended or consigned temporarily to their care. The grantees, called encomenderos, were supposed to Christianize their wards in return for small tribute payments and service, but they usually took advantage of their charges as laborers and servants. Many encomenderos also appropriated native lands. Throughout the sixteenth and seventeenth centuries, the encomenderos fended off attempts by the crown and the church to interfere with their exploitation of the indigenous people.

The Chilean colony depended heavily on coerced labor, whether it was legally slave labor or, like the wards of the encomenderos, nominally free. Wage labor initially was rare in the colonial period; it became much more common in the eighteenth and nineteenth centuries. As there were few native Americans or Africans, the mestizo population became the main source of workers for the growing number of 'latifundios', which were basically synonymous with haciendas.

Those workers attached to the estates as tenant farmers became known as inquilinos. Many of them worked outside the cash economy, dealing in land, labor, and barter. The countryside was also populated by small landholders (minifundistas), migrant workers (afuerinos), and a few Mapuche
Mapuche
The Mapuche are a group of indigenous inhabitants of south-central Chile and southwestern Argentina. They constitute a wide-ranging ethnicity composed of various groups who shared a common social, religious and economic structure, as well as a common linguistic heritage. Their influence extended...

 holding communal lands (usually under legal title).

Century of the wheat

The Habsburg dynasty's rule over Spain ended in 1700. The Habsburgs' successors, the French Bourbon dynasty, reigned for the rest of the colonial period. In the second half of the eighteenth century, they tried to restructure the empire to improve its productivity and defense. The main period of Bourbon reforms in Chile lasted from the coronation of Charles III
Charles III of Spain
Charles III was the King of Spain and the Spanish Indies from 1759 to 1788. He was the eldest son of Philip V of Spain and his second wife, the Princess Elisabeth Farnese...

 (1759–88) in Spain to the end of Governor Ambrosio O'Higgins, Marquis of Osorno
Ambrosio O'Higgins, Marquis of Osorno
Ambrosio Bernardo O'Higgins, 1st Marquis of Osorno born Ambrose Bernard O'Higgins , was a member of the O'Higgins family and an Irish-born Spanish colonial administrator...

's tenure in Chile (1788–96).

The Bourbon rulers gave the audiencia of Chile (Santiago
Santiago, Chile
Santiago , also known as Santiago de Chile, is the capital and largest city of Chile, and the center of its largest conurbation . It is located in the country's central valley, at an elevation of above mean sea level...

) greater independence from the Viceroyalty of Peru
Viceroyalty of Peru
Created in 1542, the Viceroyalty of Peru was a Spanish colonial administrative district that originally contained most of Spanish-ruled South America, governed from the capital of Lima...

. One of the most successful governors of the Bourbon era was the Irish-born O'Higgins, whose son Bernardo O'Higgins
Bernardo O'Higgins
Bernardo O'Higgins Riquelme was a Chilean independence leader who, together with José de San Martín, freed Chile from Spanish rule in the Chilean War of Independence. Although he was the second Supreme Director of Chile , he is considered one of Chile's founding fathers, as he was the first holder...

 would lead the Chilean independence movement. Ambrosio O'Higgins promoted greater self-sufficiency of both economic production and public administration, and he enlarged and strengthened the military. In 1791 he also outlawed encomiendas and forced labor.

The Bourbons allowed Chile to trade more freely with other colonies, as well as with independent states. Exchange increased with Argentina
Argentina
Argentina , officially the Argentine Republic , is the second largest country in South America by land area, after Brazil. It is constituted as a federation of 23 provinces and an autonomous city, Buenos Aires...

 after it became the Viceroyalty of the Río de la Plata
Viceroyalty of the Río de la Plata
The Viceroyalty of the Río de la Plata, , was the last and most short-lived Viceroyalty of the Spanish Empire in America.The Viceroyalty was established in 1776 out of several former Viceroyalty of Perú dependencies that mainly extended over the Río de la Plata basin, roughly the present day...

 in 1776. Ships from the United States
United States
The United States of America is a federal constitutional republic comprising fifty states and a federal district...

 and Europe were engaging in direct commerce with Chile by the end of the eighteenth century. However, the total volume of Chilean trade remained small because the colony produced few items of high unit value to outsiders.

Freer trade brought with it greater knowledge of politics abroad, especially the spread of liberalism in Europe and the creation of the United States. Although a few members of the Chilean elite flirted with the ideals of the Enlightenment
Age of Enlightenment
The Age of Enlightenment was an elite cultural movement of intellectuals in 18th century Europe that sought to mobilize the power of reason in order to reform society and advance knowledge. It promoted intellectual interchange and opposed intolerance and abuses in church and state...

, most of them held fast to the traditional ideology of the Spanish crown and its partner, the Roman Catholic Church
Roman Catholic Church
The Catholic Church, also known as the Roman Catholic Church, is the world's largest Christian church, with over a billion members. Led by the Pope, it defines its mission as spreading the gospel of Jesus Christ, administering the sacraments and exercising charity...

. Notions of democracy and independence, let alone Protestantism
Protestantism
Protestantism is one of the three major groupings within Christianity. It is a movement that began in Germany in the early 16th century as a reaction against medieval Roman Catholic doctrines and practices, especially in regards to salvation, justification, and ecclesiology.The doctrines of the...

, never reached the vast majority of mestizos and native Americans, who remained illiterate and subordinate.

Independence

After Chile won its independence in 1810, the economy prospered through a combination of mercantilist and free-market policies. Agricultural exports, primarily wheat, were the mainstay of the export economy. By mid-century, however, Chile had become one of the world's leading producers of copper. After Chile defeated Bolivia
Bolivia
Bolivia officially known as Plurinational State of Bolivia , is a landlocked country in central South America. It is the poorest country in South America...

 and Peru in the War of the Pacific
War of the Pacific
The War of the Pacific took place in western South America from 1879 through 1883. Chile fought against Bolivia and Peru. Despite cooperation among the three nations in the war against Spain, disputes soon arose over the mineral-rich Peruvian provinces of Tarapaca, Tacna, and Arica, and the...

 (1879–82), nitrate mines in areas conquered during the war became the source of huge revenues, which were lavished on imports, public works projects, education, and, less directly, the expansion of an incipient industrial sector. Between 1890 and 1924, nitrate output averaged about a quarter of GDP. Taxes on nitrate exports accounted for about half of the government's ordinary budget revenues from 1880 to 1920. By 1910 Chile had established itself as one of the most prosperous countries in Latin America.

Sheep were introduced to Chilean Patagonia
Patagonia
Patagonia is a region located in Argentina and Chile, integrating the southernmost section of the Andes mountains to the southwest towards the Pacific ocean and from the east of the cordillera to the valleys it follows south through Colorado River towards Carmen de Patagones in the Atlantic Ocean...

 from the Falkland Islands
Falkland Islands
The Falkland Islands are an archipelago in the South Atlantic Ocean, located about from the coast of mainland South America. The archipelago consists of East Falkland, West Falkland and 776 lesser islands. The capital, Stanley, is on East Falkland...

 in 1865 http://itotd.com/articles/472/whats-left-of-patagonia/ and between about 1890 and 1940, Magallanes Region became one of the world's most important sheep-raising regions, with one company (Sociedad Explotadora de Tierra del Fuego) controlling over 10,000 square kilometres in southern Chile and Argentina.

World wars and depression


Dependence on revenues from nitrate exports contributed to financial instability because the size of government expenditures depended on the vagaries of the export market. Indeed, Chile was faced with a severe domestic crisis when the nitrate bonanza ended abruptly during World War I
World War I
World War I , which was predominantly called the World War or the Great War from its occurrence until 1939, and the First World War or World War I thereafter, was a major war centred in Europe that began on 28 July 1914 and lasted until 11 November 1918...

 as a result of the invention of synthetic substitutes by German scientists. Gradually, copper replaced nitrates as Chile's main export commodity. Using new technologies that made it feasible to extract copper from lowergrade ores, United States companies bought existing Chilean mines for large-scale development.

Chile initially felt the impact of the Great Depression
Great Depression
The Great Depression was a severe worldwide economic depression in the decade preceding World War II. The timing of the Great Depression varied across nations, but in most countries it started in about 1929 and lasted until the late 1930s or early 1940s...

 in 1930, when GDP dropped 14 percent, mining income declined 27 percent, and export earnings fell 28 percent. By 1932 GDP had shrunk to less than half of what it had been in 1929, exacting a terrible toll in unemployment and business failures. The League of Nations
League of Nations
The League of Nations was an intergovernmental organization founded as a result of the Paris Peace Conference that ended the First World War. It was the first permanent international organization whose principal mission was to maintain world peace...

 labeled Chile the country hardest hit by the Great Depression because 80 percent of government revenue came from exports of copper and nitrates, which were in low demand.

Influenced profoundly by the Great Depression, many national leaders promoted the development of local industry in an effort to insulate the economy from future external shocks. After six years of government austerity measures, which succeeded in reestablishing Chile's creditworthiness, Chileans elected to office during the 1938-58 period a succession of center and left-of-center governments interested in promoting economic growth by means of government intervention.

Prompted in part by the devastating earthquake of 1939, the Popular Front
Popular Front (Chile)
The Popular Front in Chile was an electoral and political left-wing coalition from 1937 to February 1941, during the Presidential Republic Era...

 government of Pedro Aguirre Cerda
Pedro Aguirre Cerda
Pedro Aguirre Cerda was a Chilean political figure. A member of the Radical Party, he was chosen as the Popular Front's candidate for the 1938 presidential election, and was triumphally elected. He governed Chile until his death in 1941...

 created the Production Development Corporation (Corporación de Fomento de la Producción, CORFO
CORFO
Production Development Corporation is a Chilean governmental organization that was founded in 1939, by President Pedro Aguirre Cerda, to promote economic growth in Chile...

) to encourage through subsidies and direct investments an ambitious program of import substitution industrialization
Import substitution
Import substitution industrialization or "Import-substituting Industrialization" is a trade and economic policy that advocates replacing imports with domestic production. It is based on the premise that a country should attempt to reduce its foreign dependency through the local production of...

. Consequently, as in other Latin American countries, protectionism
Protectionism
Protectionism is the economic policy of restraining trade between states through methods such as tariffs on imported goods, restrictive quotas, and a variety of other government regulations designed to allow "fair competition" between imports and goods and services produced domestically.This...

 became an entrenched aspect of the Chilean economy.

Import-substitution industrialization was spurred on by the advent of World War II
World War II
World War II, or the Second World War , was a global conflict lasting from 1939 to 1945, involving most of the world's nations—including all of the great powers—eventually forming two opposing military alliances: the Allies and the Axis...

 and the loss of access to many imported products. State enterprises in electric power, steel, petroleum, and other heavy industries were also created and expanded during the first years of the industrialization process, mostly under the guidance of Corfo, and the foundations of the manufacturing sector were established. Between 1937 and 1950, the manufacturing sector grew at an average annual real rate of almost 7 percent.

Despite initially impressive rates of growth, import-substitution industrialization did not produce a sustainable expansion of the manufacturing sector. Industrialization brought with it an array of restrictions, controls, and often contradictory regulations. In time, consumer-oriented industries found that their markets were limited in a society where a large percentage of the population was poor and where many rural inhabitants lived at the margins of the money economy. The economic model did not generate a viable capital goods industry because firms relied on imports of often outmoded capital and intermediate goods. Survival often depended on state subsidies or state protection. It was because of these import restrictions that many of the domestic industries were able to survive. For example, a number of comparative studies have indicated that Chile had one of the highest, and most variable, structures of protection in the developing world. As a consequence, many, if not most, of the industries created under the import-substitution industrialization strategy were inefficient. Also, it has been argued that this strategy led to the use of highly capital-intensive production, which, among other inefficiencies, hampered job creation.

During the import-substitution industrialization period, copper continued to be the principal export commodity and source of foreign exchange, as well as an important generator of government revenues. The Chilean government's retained a share of the value of copper output, which increased from about one-quarter in 1925 to over four-fifths in 1970, mainly as a result of higher taxes. Although protectionist policies better insulated Chile from the occasional shocks of world commodities markets, price shifts continued to take their toll.

1950-1970

Between 1950 and 1970, the Chilean economy expanded at meager rates. GDP grew at an average rate of 3.8 percent per annum, whereas real GDP per capita increased at an average yearly rate of 1.6 percent. Over this period, Chile's economic performance was the poorest among Latin America's large and medium-size countries.

As in most historical cases, Chile's import-substitution strategy was accompanied by an acute overvaluation of the domestic currency that precluded the development of a vigorous non-traditional (that is, non-copper) export sector. Although some agrarian reform was attempted, the government increasingly resorted to controlling agricultural prices in order to subsidize the urban working and middle classes. The agricultural sector was particularly harmed by the overvaluation of Chile's currency. Stagnation of the agricultural sector became one of the most noticeable symptoms of Chile's economic problems of the 1950s and 1960s. Over this period, manufacturing and mining, mainly of copper, significantly increased their respective shares in total output.

By the early 1960s, most of the easy and obvious substitutions of imported goods had already been made; the process of import substitution was rapidly becoming less dynamic. For example, between 1950 and 1960 total real industrial production grew at an annual rate of only 3.5 percent, less than half the rate of the previous decade.

During the 1950s, inflation, which had been a chronic problem in Chile since at least the 1880s, became particularly serious; the rate of increase of consumer prices averaged 36 percent per annum during the decade, reaching a peak of 84 percent in 1955. The main source of the inflationary pressure on the Chilean economy was a remarkably lax fiscal policy. Chile's economic history has been marked by failed attempts to curb inflation. During the 1950s and 1960s, three major stabilization programs, one in each administration, were launched. The common aspect of these efforts was the emphasis placed on tackling the various consequences of inflationary pressures, such as prices, wages, and exchange-rate increases, rather than the root cause of money growth, the monetization of the fiscal deficit. In spite of the efforts of presidents Carlos Ibáñez del Campo
Carlos Ibáñez del Campo
General Carlos Ibáñez del Campo was a Chilean Army officer and political figure. He served as dictator between 1927 and 1931 and as constitutional President from 1952 to 1958.- The coups of 1924 and 1925 :...

 (1927–31, 1952–58) and Jorge Alessandri Rodríguez (1958–64), inflation averaged 31 percent per annum during those two decades. In 1970, the last year of the government of President Eduardo Frei Montalva
Eduardo Frei Montalva
Eduardo Frei Montalva was a Chilean political leader of world stature. In his long political career, he was Minister of Public Works, president of his Christian Democratic Party, senator, President of the Senate, and president of Chile from 1964 to 1970...

 (1964–70), the inflation rate stood at 35 percent.

During the 1960s, and especially during the Frei administration, some efforts to reform the economy were launched. These included an agrarian reform, a limited liberalization of the external sector
External sector
The external sector refers to a basket of economic measures regarding any individual country. These measures include:*Balance of payments*Current account*Capital account or financial account*Foreign direct investment*Portfolio investment*Other investment...

, and a policy of minidevaluations aimed at preventing the erosion of the real exchange rate. Under the 1962 Agrarian Reform Law, the Agrarian Reform Corporation (Corporación de Reforma Agraria—Cora) was created to handle the distribution, but land reform proved to be slow and expensive. In spite of these and other reforms, toward the end of the 1960s it appeared that the performance of the economy had not improved in relation to the previous twenty years. Moreover, the economy was still heavily regulated.

Popular Unity Government

In September 1970, Salvador Allende
Salvador Allende
Salvador Allende Gossens was a Chilean physician and politician who is generally considered the first democratically elected Marxist to become president of a country in Latin America....

, the UP candidate, was elected president of Chile. Over the next three years, a unique political and economic experience followed. The UP was a coalition of left and center-left parties dominated by the Socialist Party of Chile
Socialist Party of Chile
The Socialist Party of Chile is a political party, that is part of the center-left Coalition of Parties for Democracy coalition. Its historical leader was the late President of Chile Salvador Allende Gossens, who was deposed by General Pinochet in 1973...

 (Partido Socialista—PS) and the Communist Party of Chile
Communist Party of Chile
The Communist Party of Chile is a Chilean political party inspired by the thoughts of Karl Marx and Lenin. It was founded in 1922, as the continuation of the Socialist Workers Party, and in 1934 it established its youth wing, the Communist Youth of Chile .In the last legislative elections in Chile...

 (Partido Comunista de Chile—PCCh), both of which sought to implement deep institutional, political, and economic reforms. The UP's program called for a "Chilean road to socialism".

When Allende took office in November 1970, his UP government faced a stagnant economy weakened by inflation, which hit a rate of 35 percent in 1970. Between 1967 and 1970, real GDP per capita had grown only 1.2 percent per annum, a rate significantly below the Latin American average. The balance of payments
Balance of payments
Balance of payments accounts are an accounting record of all monetary transactions between a country and the rest of the world.These transactions include payments for the country's exports and imports of goods, services, financial capital, and financial transfers...

 had shown substantial surpluses during all but one of the years from 1964 to 1970, and, at the time the UP took power, the Central Bank of Chile
Central Bank of Chile
The Central Bank of Chile is the central bank of Chile. It was originally created in 1925 and is incorporated into the current Chilean Constitution as an autonomous institution of constitutional rank.-History:...

 had a stock of international reserves of approximately US$400 million.

The UP had a number of short-run economic objectives: initiating structural economic transformations, including a program of nationalization
Nationalization
Nationalisation, also spelled nationalization, is the process of taking an industry or assets into government ownership by a national government or state. Nationalization usually refers to private assets, but may also mean assets owned by lower levels of government, such as municipalities, being...

; increasing real wages; reducing inflation; spurring economic growth; increasing consumption, especially by poorer people; and reducing the economy's dependence on the rest of the world. The UP's nationalization program was to be achieved by a combination of new legislation, requisitions, and stock purchases from small shareholders. The other goals, output and increased consumption, with rising salaries and declining inflation, were to be accomplished by a boost in aggregate demand, mainly generated by higher government expenditures, accompanied by strict price controls and measures to redistribute income.

The UP's macroeconomic program was based on several key assumptions, the most important being that the manufacturing sector had ample underutilized capacity. This provided the theoretical basis for the belief that large fiscal deficits would not necessarily be inflation
Inflation
In economics, inflation is a rise in the general level of prices of goods and services in an economy over a period of time.When the general price level rises, each unit of currency buys fewer goods and services. Consequently, inflation also reflects an erosion in the purchasing power of money – a...

ary. The lack of full utilization was, in turn, attributed to two fundamental factors: the monopolistic nature of the manufacturing industry and the structure of income distribution. Based on this diagnosis, it was thought that if income were redistributed toward the poorer groups through wage increases and if prices were properly controlled, there would be a significant expansion of demand and output.

With respect to inflation, the UP program identified structural rigidities (namely, an inelastic response to price increases, in terms of increased supply), bottlenecks, and the role of monopolistic pricing, and it played down the role of fiscal pressures and money creation
Money creation
In economics, money creation is the process by which the money supply of a country or a monetary region is increased due to some reason. There are two principal stages of money creation. First, the central bank introduces new money into the economy by purchasing financial assets or lending money...

. Little attention was paid to the financial sector, given the orientation of the new regime's economic technocrats toward import-substitution combined with the structuralist philosophy of the Economic Commission for Latin America. In fact, Allende's minister of foreign relations and vice president, Clodomiro Almeyda
Clodomiro Almeyda
Clodomiro Almeyda Medina was a Chilean politician. A leading member of the Socialist Party, served as Minister of Foreign Affairs of Chile from 1970 to 1973 during the Presidency of Salvador Allende....

, relates in his memoirs how in the first postelection meeting of the economic team, these technocrats argued expressly and convincingly that monetary and financial management did not deserve too much attention. Alfonso Inostroza, the Central Bank president, stated in early 1971 that the main objective of the monetary policy was to "transform it into a key instrument . . . to achieve the complete mobilization of productive resources, and their allocation to those areas that the government gives priority to . . ." This was consistent with the view of inflation of those espousing structuralism.

The UP perspective on the way the economy functioned ignored many of the key principles of traditional economic theory. This was reflected in the greatly diminished attention given to monetary policies, but also in the complete disregard of the exchange rate as a key variable in determining macroeconomic equilibrium. In particular, the UP program and policies paid no attention to the role of the real exchange rate as a determinant of the country's international competitive position. Moreover, the UP failed to recognize that its policies would not be sustainable in the medium term and that capacity constraints were going to become an insurmountable obstacle to rapid growth.

1972

During 1972 the macroeconomic problems continued to mount. Inflation surpassed 200 percent, and the fiscal deficit surpassed 13 percent of GDP. Domestic credit to the public sector grew at almost 300 percent, and international reserves dipped below US$77 million. Real wages fell 25 percent in 1972

The underground economy
Underground economy
A black market or underground economy is a market in goods or services which operates outside the formal one supported by established state power. Typically the totality of such activity is referred to with the definite article as a complement to the official economies, by market for such goods and...

 grew as more and more activities moved out of the official economy. As a result, more and more sources of tax revenues disappeared. A vicious cycle began: repressed inflation encouraged the informal economy, thus reducing tax revenues and leading to higher deficits and even higher inflation. In 1972 two stabilization programs were implemented, both unsuccessfully.

When evaluating the problems faced by the economy, UP economists generally held the view that the authorities had failed to impose appropriate controls in implementing Allende's program. This view guided the first, rather weak, attempt at stabilizing the economy that was launched in February 1972. Price controls
Price controls
Price controls are governmental impositions on the prices charged for goods and services in a market, usually intended to maintain the affordability of staple foods and goods, and to prevent price gouging during shortages, or, alternatively, to insure an income for providers of certain goods...

 were the main ingredient of the program. By mid-1972 it was apparent that the February stabilization program was a failure. The underground economy was now widespread, output had begun to fall, open inflation reached an annual rate of 70 percent in the second quarter, foreign exchange reserves
Foreign exchange reserves
Foreign-exchange reserves in a strict sense are 'only' the foreign currency deposits and bonds held by central banks and monetary authorities. However, the term in popular usage commonly includes foreign exchange and gold, Special Drawing Rights and International Monetary Fund reserve positions...

 were very low, and the blackmarket value of the currency was falling rapidly. Parliamentary elections scheduled for March 1973 made the situation particularly difficult for the UP. In August 1972, a new stabilization program was launched under the political monitoring of the PCCh. This time, not only prices were officially controlled, but the distribution channels were taken over by the government, in an attempt to reduce the extent of the black market.

Unlike the previous plan, the August 1972 stabilization program was based on a massive devaluation of the escudo
Chilean escudo
The escudo was the currency of Chile between 1960 and 1975, divided into 100 centésimos. It replaced the peso at a rate of 1 escudo = 1000 pesos and was itself replaced by a new peso, at a rate of 1 peso = 1000 escudos...

. The government expected that the result would be an easing of the mounting pressures on the balance of payments. The program also called for two basic measures to contain fiscal pressures. First, nationalized firms were authorized to increase prices as a means of reducing the financing requirements of the newly formed nationalized sector. Second, the program called for a massive increase in production, especially in the recently nationalized manufacturing and agriculture sectors (large manufacturing firms and farms had been expropriated arbitrarily). The devaluation and a large number of price increases resulted in annualized inflation rates of 22.7 percent in August and 22.2 percent in September.

In mid-August 1972, the government announced that it had drafted a new wage policy based on an increase in public and private-sector wages by a proportion equal to the accumulated rate of inflation between January and September. In addition, the new policy called for more frequent wage adjustments.

At the same time, the United States
United States
The United States of America is a federal constitutional republic comprising fifty states and a federal district...

 conducted a campaign to deepen the inflation crisis. Chilean economist Jacobo Schatan writes, "It was clear that the scarcity had been manipulated for political reasons, to create a climate favourable to both the coup and, subsequently, the total change of the economic system."

1973

During the first quarter of 1973, Chile's economic problems became extremely serious. Inflation reached an annual rate of more than 120 percent, industrial output declined by almost 6 percent, and foreign-exchange reserves held by the Central Bank were barely above US$40 million. The black market by then covered a widening range of transactions in foreign exchange. The fiscal deficit continued to climb as a result of spiraling expenditures and of rapidly disappearing sources of taxation. For that year, the fiscal deficit ended up exceeding 23% of GDP.

The depth of the economic crisis seriously affected the middle class, and relations between the UP government and the political opposition became increasingly confrontational. On September 11, 1973, the UP regime came to a sudden and shocking end with a violent military coup and President Allende's death.

When the military took over, the country was divided politically, and the economy was a shambles. Inflation was galloping, and relative price distortions, stemming mainly from massive price controls, were endemic. In addition, black-market activities were rampant, real wages had dropped drastically, the economic prospects of the middle class had darkened, the external sector was facing a serious crisis, production and investment were falling steeply, and government finances were completely out of hand.

1975-81

After the military took over the government in September 1973, there was a year and a half of benign neglect of the economy as the regime consolidated its power. When in April 1975, the so called "Chicago Boys
Chicago Boys
The Chicago Boys were a group of young Chilean economists most of whom trained at the University of Chicago under Milton Friedman and Arnold Harberger, or at its affiliate in the economics department at the Catholic University of Chile...

" took control of economic policy, a period of dramatic economic changes began. Chile was transformed gradually from an economy isolated from the rest of the world, with strong government intervention, into a liberalized, world integrated economy, where market forces were left free to guide most of the economy's decisions. This period was characterized by several important economic achievements, bolstered by increased support from the US administration: inflation was reduced greatly, the government deficit was virtually eliminated, the economy went through a dramatic liberalization of its foreign sector, and a strong market system was established. Along with these achievements, drops occurred in the standard of living of the poorest citizens, poverty jumped dramatically, wages declined, and the gap between rich and poor widened significantly.

From an economic point of view, the era of General Augusto Pinochet Ugarte (1973–90) can be divided into two periods. The first, from 1975 to 1981, corresponds to the period when most of the reforms were implemented. The period ended with the international debt crisis and the collapse of the Chilean economy. At that point, unemployment was extremely high, above 20 percent, and a large proportion of the banking sector had become bankrupt. During this period, a pragmatic economic policy that emphasized export expansion and growth was implemented. The second period, from 1982 to 1990, is characterized by economic recovery and a further movement towards a free market economy, although at a slower pace than that of the early 1980s.

Trade policy

One of the fundamental economic goals of the military regime was to open up the economy to the rest of the world. However, this was not the first attempt at liberalizing international trade
International trade
International trade is the exchange of capital, goods, and services across international borders or territories. In most countries, such trade represents a significant share of gross domestic product...

 in Chile. Between 1950 and 1970, the country went through three attempts at trade liberalization without ever reaching full liberalization. Moreover, all three attempts quickly ended in frustration and in a reversion to exchange controls, the use of multiple exchange rates, and massive quantitative restrictions. A particularly interesting feature of the three attempts at liberalization is that, although they took place under three different exchange-rate systems, they all collapsed, at least in part because of a highly overvalued real exchange rate.

Starting in 1974, Chile adopted unilaterally an open trade regime characterized by low uniform import tariffs, a lack of exchange or trade controls, and minimum restrictions on capital movements. Starting in 1979, Chile's trade policy became highly liberalized; subsequently, there were no quantitative restrictions, licenses, or prohibitions. A uniform import tax varying between 10 percent and 35 percent took effect, and, until 1980, real exchange rate over valuation generally was avoided. By 1990 Chile was the only country, according to the World Bank
World Bank
The World Bank is an international financial institution that provides loans to developing countries for capital programmes.The World Bank's official goal is the reduction of poverty...

, whose index of liberalization reached the maximum possible level of 20, indicating an absence of external-sector distortions.

In 1973 import tariffs averaged 105 percent and were highly dispersed, with some goods subject to nominal tariffs of more than 700 percent and others fully exempted from import duties. In addition to tariffs, a battery of quantitative restrictions were applied, including outright import prohibitions and prior import deposits of up to 10,000 percent. These protective measures were complemented by a highly distorting multiple exchange-rate system consisting of fifteen different nominal exchange rates. By August 1975, all quantitative restrictions had been eliminated, and the average tariff had been reduced to 44 percent. This process of tariff reductions continued until June 1979, when all tariffs but one (that on automobiles) were set at 10 percent. In the mid-1980s, in the midst of the debt crisis, temporary tariff hikes were implemented; by 1989, however, a uniform level of 15 percent had been established.

During the early period (1975–79) of the military regime, the opening of Chile's external sector was accompanied by a strongly depreciated real exchange rate. In 1979, however, the authorities adopted a fixed-exchange rate policy that resulted in an acute over valuation of the Chilean peso
Chilean peso
The peso is the currency of Chile. The current peso has circulated since 1975, with a previous version circulating between 1817 and 1960. The symbol used locally for it is $. The ISO 4217 code for the present peso is CLP. It is subdivided into 100 centavos, although no centavo denominated coins...

, a loss in international competitiveness, and, in 1982, a deep crisis. In 1984-85 this situation was reversed, and a policy of a depreciated and highly competitive real exchange rate was implemented. The combination of these two policies—low tariffs and a competitive real exchange rate—had a significant impact on Chile's economic structure. The share of manufacturing in GNP dropped from almost 29 percent in 1974 to 22 percent in 1981. Productivity in tradable sectors grew substantially, and exports became highly diversified. Chile had also diversified its export markets, with the result that no individual market bought more than 20 percent of the country's total exports. By the early 1990s, exports had become the engine of growth, and the Chilean trade reform was winning praise from multinational institutions and observers of different ideological persuasions. Largely thanks to the boom in exports between 1986 and 1991, particularly the increasing growth in exports of fresh fruits and manufactured products, Chile experienced the highest rate of GDP growth in Latin America (the "Miracle of Chile
Miracle of Chile
The "Miracle of Chile" was a term used by free market Nobel Prize winning economist Milton Friedman to describe liberal and free market reorientation of the economy of Chile in the 1980s, 1990s and the purported benefits of his style of economic liberalism...

"), with an annual increase of 4.2 percent.

In what was perhaps the surest sign of the success of trade reform, the new democratic government of President Patricio Aylwin Azócar (1990–94), elected in December 1989, decided to continue the opening process and reduced import tariffs to a uniform 11 percent. Interestingly, Aylwin's economic team, including the minister of finance and the minister of economy, development, and reconstruction, had been relentless critics of the trade reform process during its implementation in the mid- and late 1970s.

Banking reform and the financial sector

A major policy objective of the military regime was the liberalization and modernization of the banking sector. Until 1973 the domestic capital market had been highly repressed, with most banks being government owned. Real interest rates were negative, and there were quantitative restrictions on credit. The liberalization process began slowly, in early 1974, with the sale of banks back to the private sector, the freeing of interest rates, the relaxation of some restrictions on the banking sector, and the creation of new financial institutions. International capital movements, however, were strictly controlled until mid-1979. In June 1979, the government decided to begin to liberalize the capital account of the balance of payments, lifting some restrictions on medium- and long-term capital movements.

The opening of the capital account
Capital account
The current and capital accounts make up a country's balance of payment . Together these three accounts tell a story about the state of an economy, its economic outlook and its strategies for achieving its desired goals...

 resulted in a massive inflow of foreign capital that contributed to Chile's subsequent international debt problems. In 1980 capital inflows were more than double those of 1979—US$2.5 billion versus US$1.2 billion—and in 1981 the level of capital inflows nearly doubled again, to US$4.5 billion.

An important result of the reforms of the financial sector was that the number of financial institutions and the volume of financial intervention both increased greatly. For example, in 1981 there were twenty-six national banks, nineteen foreign banks, and fifteen savings and loan institutions (financieras), a number significantly higher than the eighteen national banks and one foreign bank in operation in September 1973. Furthermore, between 1973 and 1981 the real volume of total credit to the private sector increased by more than 1,100 percent.

At least in terms of increasing the degree of financial intermediation, liberalization was a success. However, it was apparent from the beginning that capital-market liberalization faced three major obstacles. First, interest rates were very high. Second, in spite of the significant growth in the extent of financial intermediation, domestic savings had not increased to the extent that the proponents of the reforms had expected. In fact, domestic savings were at one of their lowest levels in history from 1974 to 1982. There are several possible explanations for the behavior of domestic savings. One of the most popular of these relies on the notion that the appreciation of domestic assets that was taking place at the time, such as stocks and land prices, resulted in a real accumulation of assets without saving. This increase in private-sector wealth was consistent with higher levels of consumption at a given income. Third, and perhaps more important, the rapid growth of the financial sector took place in an environment in which monetary authorities exercised no supervision. As a result, many banks accumulated an unprecedented volume of bad loans, a situation that led to the financial crisis of 1982-83. As a consequence of this crisis, a number of banks went bankrupt during 1983-84, were placed temporarily under government control, and then were reprivatized
Reprivatization
Reprivatization refers to the process of restoring to its former owners properties seized by a government, or to the process of compensating previously uncompensated former owners. This is often a component of larger privatization schemes...

. By 1992, after monetary authorities had learned the hard way the importance of bank supervision, Chile's financial sector had become highly stable and dynamic.

Rural land market reform

At the time of the military coup, about 60 percent of Chile's irrigated land and 50 percent of total agricultural land was in control of the public sector. Land reform had started in the 1960s with expropriations of large landholdings (those larger than eighty basic irrigated hectares—BIH), and the encouragement of small farms (about 8.5 BIH) managed by their owners. The Allende administration favored large-scale farms under cooperatives and state-farm management over private ownership of agricultural land. Starting in 1974, the military government began using Cora to end agrarian reform by distributing land to establish family farms with individual ownership. In a period of three years, 109,000 farmers and 67,000 descendants of the Mapuche had been assigned property rights to small farms. About 28 percent of the expropriated land was returned to previous owners, and the rest was auctioned off.

Three key legal issues were then clarified by decree law in 1978. Government authority to expropriate land was repealed, the ceilings on landholdings (the equivalent of eighty BIH) were removed, and the ban on corporate ownership of land was eliminated. At the end of 1978, all farmland owned publicly had been distributed, and Cora was legally closed.

Reforms in the legislation that regulated land rentals and land subdivisions in 1980 added flexibility to the rural land markets. But perhaps more crucial aspects of the reforms were the separation of water rights from the land itself and the legal possibility of transferring water titles independently of land transactions.

Labor-market reform

Immediately after the 1973 coup, many labor institutions, that is, traditional channels of influence, such as government offices, which unions used to get their voices heard, were disbanded, and some important unions were dissolved. Thus, wage adjustments became mainly a function of indexation, which, given Chile's history of inflation, had become an established element of any wage negotiation. Indexation was kept in place until 1982, through ten years of declining inflation.

Starting in October 1973, the government mandated across the board periodic wage adjustments tied to the rate of inflation. Lower wages were adjusted proportionally more than higher ones. From 1973 to 1979, indexation to past inflation with varying lags was the norm throughout the economy. The 1979 Labor Plan formalized this practice by requiring that collective bargaining agreements allow for wage adjustments at or above the rate of inflation. In 1982 the indexation clause of the Labor Plan was eliminated. The government continued the practice of periodically announcing wage readjustments and bonuses, with the wage increases usually not keeping pace with inflation and covering the non-unionized sector only. The dynamism of the economy in the early 1990s resulted in actual wage increases above officially announced readjustments.

The Employment Security Law established that in the absence of "just cause" for dismissal, such as drunkenness, absenteeism, or theft, a dismissed employee could be reinstated to the job by a labor court. This law was replaced by a less costly system of severance payments in 1978. Decree Law 2,200 authorized employers to modify individual labor contracts and to dismiss workers without "cause". A minimum severance payment was established that was equivalent to one month of salary per year of service, up to a maximum of five months' pay. This new system applied to all contracts signed after August 1981.

The changes introduced by Decree Law 2,200, along with the 1979 reforms, which established new mechanisms to govern union activity (Decree Law 2,756) and collective bargaining (Decree Law 2,758), became known in Chile as the Labor Plan. Decree Law 2,756 departed significantly from traditional legislation: union affiliation within a company became voluntary, and all negotiations would now have to be conducted at the company level; bargaining among many companies would be eliminated. According to the previous law, which had applied until the 1973 coup, once the majority of the workers of an enterprise chose to join an "industrial union" all workers became part of that union. That is, one union would have exclusive representation of all workers in an enterprise. The right to collective bargaining was granted to unions at the enterprise level and also to union federations and confederations. This resulted in some negotiations at the industry level with the participation of the Ministry of Labor and Social Welfare through the Labor Inspectorate. As in the past, the new law required participation of 10 percent of the workers or a minimum of twenty-five workers (whichever was greater) for creation of a union. Workers were not required to be represented by a union in collective bargaining.

Decree Law 2,758 stipulated that in the event of a strike, a firm could impose a lockout and temporarily lay off workers, which the previous law had prohibited. At the same time, Decree Law 2,758 established norms about collective bargaining, and in its Article 26 the law established that unionized workers' nominal wages should be adjusted to at least match the rate of inflation. This article, which became a severe constraint to downward real wage flexibility during the 1982-83 crisis, can be understood only in the context of a previously existing policy of 100 percent indexation across the board. In 1982, at the onset of the debt crisis, Article 26 was amended, eliminating the downward inflexibility of real wages. This reformed law was in effect until April 1991, when some important changes proposed by the Aylwin administration were approved by the National Congress (hereafter, Congress).

Public employment programs

Two public employment programs affected the labor market during the period of economic reforms between 1975 and 1987. The Minimum Employment Program (Programa de Empleo Mínimo—PEM) was created in 1975 at a time when unemployment had reached record levels. The program, administered by local governments, paid a small salary to unemployed workers, who, for a few hours a week, performed menial public works. At first, the government tightly restricted entry into the program. Gradually, most of these restrictions were lifted, and a larger number of unemployed people were allowed to participate. Thus, the proportion of the labor force employed by the program remained virtually constant between 1977 and 1981, despite the economic recovery and a reduction in the real value of PEM compensation.

When Chile entered a new and more severe recession, the number of individuals employed by PEM in the Metropolitan Region of Santiago increased from about 23,000 in May 1982 to 93,000 in May 1983. An Employment Program for Heads of Households (Programa de Ocupación para Jefes de Hogar—POJH), created in October 1982, employed about 100,000 individuals in the greater Santiago area by May 1983. The two programs combined absorbed more than 10 percent of the labor force of the greater Santiago area in May 1983. These programs were also implemented in other regions of the country. The PEM program was cut back drastically in February 1984. Likewise, by December 1988, there were only about 5,000 individuals employed by the POJH in the entire country.

Debt crisis

The international debt crisis unleashed in 1982
Latin American debt crisis
The Latin American debt crisis was a financial crisis that occurred in the early 1980s , often known as the "lost decade", when Latin American countries reached a point where their foreign debt exceeded their earning power and they were not able to repay it.-Origins:In the 1960s and 1970s many...

 hit the Chilean economy with particular severity, as foreign loans dried up and the international terms of trade turned drastically against Chile. The policies implemented initially to face the 1982 crisis can best be described as hesitant. In early 1983, the financial sector was nationalized as a way to avoid a major banking crisis, and a number of subsidy schemes favoring debtors were enacted. The decision to subsidize debtors who had borrowed in foreign currency during the period of fixed exchange rates, and to bail out the troubled banks, resulted in heavy Central Bank losses, which contributed to the creation of a huge deficit in public sector finance. This deficit, in turn, would become one of the underlying causes of the inflation of the early 1990s. Different exchange-rate systems were tried, including a floating rate, only to be abandoned rapidly and replaced by new plans. Policies aimed at restructuring the manufacturing sector, which had entered a deep crisis as a consequence of the collapse of some of the major conglomerates, the so-called groups (grupos), were implemented. In spite of this array of measures, the economy did not show a significant response; unemployment remained extraordinarily high, and the external crisis, which some had expected to represent only a temporary setback, dragged on.

In early 1985, increasingly disappointed by the economy's performance, Pinochet turned toward a group of economists who favored free markets and macroeconomic stability. Led by newly appointed finance minister Hernán Büchi Buc, an economist who had studied business administration at Columbia University, the new economic team devised a major adjustment program aimed at reestablishing growth, reducing the burden of the foreign debt, and rebuilding the strength of the financial and manufacturing sectors. Three policy areas became critical in the implementation of the program: active macroeconomic policies, consolidation of the market-oriented structural reforms initiated in the 1970s, and debt-management policies geared toward rescheduling debt payments and making an aggressive use of the secondary market. With the help of the International Monetary Fund, the World Bank, and improved terms of trade, these policies succeeded in achieving their objectives.

Chile suffered during the early 1980s from a currency linked to a rapidly appreciating dollar. Between 1982 and 1988, the international competitiveness of Chilean exports was increased greatly by a real exchange-rate depreciation of approximately 90 percent. This policy not only helped generate a boom in nontraditional exports but also contributed to reasonable interest-rate levels and to the prevention of capital flight
Capital flight
Capital flight, in economics, occurs when assets and/or money rapidly flow out of a country, due to an economic event and that disturbs investors and causes them to lower their valuation of the assets in that country, or otherwise to lose confidence in its economic...

.

The adjustment program that started in 1985 also had a structural adjustment
Structural adjustment
Structural adjustments are the policies implemented by the International Monetary Fund and the World Bank in developing countries. These policy changes are conditions for getting new loans from the International Monetary Fund or World Bank, or for obtaining lower interest rates on existing loans...

 component that was aimed at consolidating the market-oriented reforms of the 1970s and early 1980s, including the privatization process, the opening of the economy, and the development of a dynamic capital market. There were several structural goals of the 1985 program: rebuild the financial sector, which had been nearly destroyed during the 1982 crisis; reduce import tariffs below the 35 percent level that they had reached during 1984 to a 15% uniform level; and promote exports through a set of fiscal incentives and a competitive real exchange rate.

Perhaps the most important aspects of these structural reform measures were the privatization and recapitalization of firms and banks that had failed during the 1982-83 crisis. As a first step in this process, the Central Bank bought private banks' nonperforming portfolios. In order to finance this operation, the Central Bank issued domestic credit. The banks, in turn, paid a rate of 5 percent on the nonperforming portfolios and promised to repurchase them out of retained profits. This recapitalization program had as its counterpart a privatization plan that returned the ownership of those banks and firms that had been nationalized in 1983 to the private sector. Economist Rolf J. Lüders estimates that about 550 enterprises under public-sector control, including most of Chile's largest corporations, were privatized between 1974 and 1990. By the end of 1991, fewer that fifty firms remained in the public sector. The overall privatization program undertaken after 1985 has been criticized by some Chileans and also by some international economists because banks and manufacturing firms were sold too rapidly and at "very low prices."

Chile's structural adjustment of the second half of the 1980s was unique from an international comparative perspective. The most difficult, controversial, and costly reforms—including the bulk of privatization, trade liberalization, financial deregulation, and labor market streamlining—were undertaken in Chile in the 1975-80 period; the measures taken after 1985 were minor, in comparison. The success of the post-1985 period was rooted in the early reforms. For example, the boom in nontraditional exports that took place in the second half of the 1980s was only possible because of investments begun almost ten years before. The markets' flexible and rapid response to incentives was also a direct consequence of the microeconomic reforms of the 1970s.

One of the most hotly debated issues of the Chilean recovery of the second half of the 1980s concerns the different foreign-debt conversion plans aimed at rapidly reducing foreign indebtedness. When the debt crisis erupted in 1982, Chile's foreign debt was US$17.2 billion, one of the highest debts per capita in the world. Through the aggressive use of a variety of debt-conversion plans, between 1985 and 1991 Chile retired an estimated US$10.5 billion of its debt, most of which was converted into equity in Chilean companies.

Chile's net international reserves totaled US$9 billion in 1992, enough to cover a year of imports and equivalent to roughly half of its foreign debt. The stock of foreign direct investment in Chile was estimated to be between US$10 billion and US$13 billion, roughly 30 percent of GDP. About US$4 billion of this was acquired through debt-equity conversions. The debt-swap program was ended when the growth of direct investment and the strength of the economy had done away with the need for special incentives to attract foreign capital.

Return to democracy

On March 11, 1990, General Pinochet handed the presidency of Chile to Patricio Aylwin. When Aylwin's Coalition of Parties for Democracy (Concertación de Partidos por la Democracia--CPD) government took over, Chile had the best performing economy in Latin America.

For years, opponents of the Pinochet government had argued that its economic program was based on ideas alien to the Chilean tradition. In early 1990, analysts, scholars, stockbrokers, and politicians throughout the world wondered if the new democratic government of President Aylwin would maintain some, or for that matter any, of the most important aspects of the military government's market-oriented policies, or if the CPD government would reform the system along the lines of the decade-long criticisms of the opposition. What made this question particularly interesting was that at the time of the restoration of democracy, Chile was considered by many, including international institutions such as the World Bank and the IMF, as a premier example of the way the adjustment process after the debt crisis should be carried out. A number of analysts asked themselves how the advent of democracy would affect Chile's economic policy. In particular, analysts were concerned about the new government's attitude toward the free price system
Free price system
A free price system or free price mechanism is an economic system where prices are set by the interchange of supply and demand, with the resulting prices being understood as signals that are communicated between producers and consumers which serve to guide the production and distribution of...

 and Chile's new openness to international competition.

Regarding price competition, the Aylwin program's position was stated as follows: "We affirm that within an efficient economic policy there is no role for price controls." In discussing the role of the market, the program noted: "The market cannot be replaced as a mechanism for consumers to articulate their preferences." These views were a far cry from those sustained by Frei's Christian Democratic government of the 1960s and, especially, from those of Allende's UP government of 1970-73. They were also substantially different from those of the new market critics of the 1970s and mid-1980s. Indeed, the CPD program conveyed that there had been a significant convergence of domestic views on the role of markets in the economic process.

Addressing the opening of the economy to the rest of the world, the CPD program stated: "The most important instruments of the external sector policy are the maintenance of a stable high real exchange rate and a reasonably low import tariff" [emphasis added]. This statement suggests that from its onset the Aylwin government was not prepared to implement major changes to one of the most fundamental features of Chile's new economics.

Social programs

In seeking funding for new social programs, the Aylwin government made clear immediately that the only way of increasing social spending without generating unsustainable macroeconomic pressures was by finding secure sources of government revenue. Economists associated with Aylwin's CPD coalition calculated in 1989 that in order to implement their antipoverty social programs, annual funds on the order of 4 percent of GDP would be required. They argued that these resources could be obtained through a combination of expenditures, reallocation, foreign aid, and increased tax revenues. In order to implement these programs rapidly, in April 1990 President Aylwin submitted to the newly elected Congress a legislative proposal aimed at reforming the tax system. The main features of the package were the following: the corporate income-tax rate was to be increased temporarily from 10 percent to 15 percent for 1991-93; and the tax base, which in 1985 had been defined as distributed profits, was to be broadened to include total profits. The progressiveness of the personal income tax was to be increased by reducing the income level at which the maximum rate was applicable; and the rate of the value-added tax would be increased to 18 percent from 16 percent. During most of the Pinochet government, the VAT rate had been 20 percent. It was only reduced to 16 percent prior to the electoral contest before the plebiscite on Pinochet's continuation in power. After intense and often frustrating negotiations between the Aylwin administration and the opposition, the tax reform was approved in late 1990.

Pinochet's labor reforms of 1978-79 had been, from the beginning, strongly criticized by the opponents of the military regime. Although the 1979 decrees had modernized labor relations in some areas, they had also severely limited the activities of unions and, as initially conceived, had made real wage rates unusually rigid. Reforming the labor plan was an important priority of the new democratic government.

After the support of some opposition senators was obtained, a mild labor reform was passed in 1991. An important characteristic of Chile's constitution of 1980 is that it stipulates the seating of nine nonelected senators in the legislature's upper house, as well as former presidents and former justices of the Supreme Court. The CPD coalition lacked a parliamentary majority because the nonelected senators had been appointed by Pinochet. Consequently, in order to approve legislation it had to obtain support from the opposition for some measures.

The new labor legislation restricted the causes for firing employees, increased the compensation that firms had to pay to lay off employees, and restricted employers' recourse to lockouts. Although there was little doubt that these new regulations had increased the cost of labor, it was too early to know the effect of the new legislation on job creation. It was known, however, that the reform of labor laws by a democratically elected government had greatly legitimated the modernization of labor relations. In a way, the concept of labor-market flexibility had ceased to be associated exclusively with the authoritarian military regime.

See also

  • Economy of Chile
    Economy of Chile
    The economy of Chile is ranked as an upper-middle income economy by the World Bank, and is one of South America's most stable and prosperous nations, leading Latin American nations in human development, competitiveness, income per capita, globalization, economic freedom, and low perception of...

  • Chilean nationalization of copper
    Chilean nationalization of copper
    The nationalization of the Chilean copper industry commonly described as the Chilenización del cobre or "Chileanisation of copper," was the progressive process by which the Chilean government acquired control of the major foreign-owned section of the Chilean copper mining industry. It involved the...

  • Miracle of Chile
    Miracle of Chile
    The "Miracle of Chile" was a term used by free market Nobel Prize winning economist Milton Friedman to describe liberal and free market reorientation of the economy of Chile in the 1980s, 1990s and the purported benefits of his style of economic liberalism...

  • Chile pension system
    Chile pension system
    The Chile Pension system refers to old-age, disability and survivor pensions for workers in Chile. The pension system was changed by José Piñera, during Augusto Pinochets military government on November 4, 1980 from a PAYGO-system to a fully funded capitalization system run by private sector...


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