That Haunting Chilean Model

It is certainly not a terrifying ghost nor is it a ghoulish apparition that announces itself by dragging chains in the dark.

The reason why Mr. Franz deems the Chilean model a “spectre” is that there has been a lot of talk in Latin America in praise of its many virtues though few people in the region have really seen it at close range.

By “not seeing it” Mr. Franz also means that apparently no ruler in the region seems to be willing to draw any lessons from the way Chile has attained economic growth and political stability during the last twenty years. It probably has something to do with Chile’s geographic remoteness, but the fact is that today this small, arid country with a population of 16.3 million is undoubtedly at the forefront of Latin America.

Chile’s rapid and sustained economic achievements over the last two decades deserve a detailed breakdown. Between 1987 and 2007, Chile’s economy grew at an annual rate of 6 per cent. The equivalent figure for Latin America as a whole during those two decades was only 2.8 per cent.

In January 2005, Chile’s finance minister, Nicolás Eyzaguirre, told Michael Reid, at the time The Economist‘s chief editor on Latin America, that by keeping that growth rate up for another decade Chile will have reached a similar income per head to Portugal, Greece or Spain today.2

Though income distribution in Chile is still much more unequal than in those European countries, poverty has fallen from 45% of the population in 1987 to 13.7% in 2007.

Today, from the Davos Economic Forum to dinner parties in Caracas or Lima, foreign investors and local experts point to Chile as the teacher’s pet that most Latin American nations should emulate to expand their economies, reduce poverty and strengthen their democracies.

In a way that I think remindful of a matroska, that Russian egg-shaped doll within a doll, propagandists of the Chilean model show around , say, a Chilean retirement pension fund model or a Chilean water rights model, both presently being followed in a dozen of countries the world over. But there is a big problem, both political and cultural, with Chile that refrains many of the region’s democratic leaders and their economic officials to intently advance deep economic reforms.

The uneasiness about Chile’s successful diversified economy and export-led growth dynamics stems from the historical fact that its foundations were laid by General Augusto Pinochet’s dictatorship. I think this calls for a digression on Latin American intelligentsia’s collectivist and populist instincts.

While attending a conference of Latin American freelance writers and magazine contributors, in Bogotá,. back in November, 2006, I heard the news of Milton Friedman’s passing away. During recesses in between the conferences, I took to asking my fellow conferees what, if any, have been Milton Friedman’s ideas’ impact in Latin America from the early 1970s to the turn of the century..

I was meticulously told—erroneously—about Mr. Friedman’s being the unofficial adviser of a team of Chilean economists trained at the University of Chicago—the so-called “Chicago Boys”—that ran Chilean economy under a murdering dictatorship.

Indeed, the ruthless military regimen that followed Mr. Allende’s downfall ranks high among the most cruel episodes of Latin American 20th-century political history. It was partly an outcome of the most ferociously fought periods of the Cold War. But it was also the ultimate result of many decades of economic policies, widely popular among Latin American governments and intellectuals, that emphasize “growth” and income distribution while dismissing the risks of inflation and deficit finance.

Mr. Allende’s experiment in attaining a Communist society by electoral consensus embodies that Latin American populist paradigm. It was reflected in erratic, aggressive non-market economic policies during his tenure. These policies inevitably unleashed internal forces that ultimately brought about a major political change—though not the one Mr. Allende and his followers pursued—as hyperinflation and the Chilean middle class reaction to it sanctioned a growing threat of total social chaos.

Shortly after Mr. Allende’s downfall, Chilean economy was subject to a drastic adjustment program that would only be the beginning of a long , costly and painful process of trial and error.

For instance, during the privatization spree set forth by the “Chicago Boys”, Chile’s military government paid no heed to competition or regulation thus favoring highly indebted conglomerates. Trying to arrest inflation, Chile’s officials fixed the exchange rate in 1978 only to see the peso quickly overvalued. This prompted an import boom. With its export sector suffering a severe contraction, Chile’s terms of trade experienced one of the sharpest declines in Latin America, falling 27 percent between 1979 and 1983. Chilean GDP fell by 15 percent and unemployment climbed to 30 per cent over the same time lapse.

Chile was hit harder by the 1982 debt crisis than any other Latin American country, mainly because foreign commercial banks were creditors to 85 per cent of Chile’s external debt. Though Chile’s total debt was less than that of Mexico or Brazil, it was the highest external debt relative to GDP when the crisis broke out. In time, the domestic financial system collapsed and its many banks were re-nationalized. The government bailed out the banks by shouldering a burden equivalent to 35 per cent of GDP. A new economic team was then summoned to implement more gradualist policies. Gradual as they were, they unmistakably aimed at attaining a full-fledged free market economy.

These policies included temporary raising of some tariffs, selective price indexing, pegging the exchange rate to inflation and taxing short-term capital inflows. A second round of privatizations was undertaken, but this time regulation and fair competition were duly enforced. Tight fiscal discipline abated inflation. Domestic savings began to grow and eventually invested in local manufacturing . Exchange rate was then let to float freely. Exports diversified at a steady pace and growth resumed in a sustained way. Still, the successful “model” lacked legitimacy in the eyes of the rest of the region.

In 1988, general Pinochet stepped down from power as the result of a referendum in which an intelligent and united coalition of centre-left opposition parties defeated him. This coalition—known as “Concertación Democrática”—has ruled Chile since 1990 without arresting drive to the dictatorship’s economic policies. To the contrary, the new democratic rulers have deepened some of the reforms adopted during the military dictatorship. This single fact is unique in Latin American contemporary political history because it bestowed democratic legitimacy to “the model.”

Effective economic reforms have quintupled Chile’s exports while, at the same time, reduced the share copper used to have in the GDP. Once Chile’s only commodity, copper represented 80% of GDP in 1970. Due to export diversification, copper now accounts for only 40 per cent of the GDP. Since 1990, income per head has more than doubled. Undeniably, most important than choosing the right policies is the broad political consensus that legitimates them.

That Chileans have managed to reach a strong consensus on economic policies while at the same returning to democracy and restoring the rule of law defeats the populist beliefs and all-pervading statism that prevail in Latin America.

“Other countries in our region are dominated by the cult of instant gratification.” writes Paula Escobar, a senior editor of the Chilean daily El Mercurio. “Our neighbors—she argues—may want Chile’s results, but without Chile’s process, pain and effort—a quintessentially Latin attitude.”3

Sadly enough, many people in Latin America who believe in the virtues of free-market economies still argue that it takes a non-elected government to accomplish sustained economic growth.

Chile’s relentless success during the last twenty years strengthens the case for democracy by showing that good public policies may not only be understood by a significant majority of the people but also be put to good effect by their elected representatives.