December 13, 2006
Chile blazes trail for Latin America
The deaths of Augusto Pinochet and the failing health of Fidel Castro mark the end of an era for Latin America. We should look back at the bearded revolutionaries and military despots, ideological fervour and utopian dreams, without any regret. Despite the recrudescent populism of Hugo Chávez in Venezuela and Evo Morales in Bolivia, a more sober style of democratic politics is cementing its hold across the region. This is the theme of a fascinating book by Javier Santiso, deputy director of the development centre of the Organisation for Economic Co-operation and Development. “Since its independence,” he argues, “one of Latin America’s core dependencies has been its belief in miracles: the miracles forged by the Marxist or free-market magicians, revolutionaries and counter-revolutionaries, on the basis of a few grand theories and paradigms.” There is, instead, “a dual movement of economic reforms and a transition to democracy”, a move to “the political economy of the possible”. In its broad outlines, Mr Santiso’s story is convincing. Economic reform – by which is meant a move towards greater reliance on the market – has indeed spread, in fits and starts, across the region. Huge mistakes have been made. But only President Chávez, fortified by the wealth that comes out of oil wells, feels free to ignore economic rationality altogether. The remainder of Martin Wolf’s column can be read here (FT.com subscribers only). Discussion from our guest economists is free - click ‘Comments’ below
Sebastian Edwards: A Few Points on Pinochet and Chile’s “Economic Miracle.”
A.- WHY DID PINOCHET SUPPORT MARKET ORIENTED REFORMS IN 1973?
In some ways this is a puzzle. At that time – as now –, most Latin military were highly nationalistic. There are two interrelated reasons why the Chilean Junta turned to market orientation. First, Chile had just tried social democratic policies under the Christian Democrats and the first president Frei (1964-1970), and it had not worked. Of course, socialist policies under Allende had been a disaster. Thus, market-oriented reform was, in a way, the only alternative that hadn’t been tried. Second, and perhaps more important, during 1972-73 a group of economists known as the “Chicago boys” had prepared a blueprint for reform. It was a coherent, well thought and comprehensive program. They presented it to the Junta, and after some discussion, and with some reluctance the military supported it. Looked at from today’s perspective this blueprint was very timid – for instance, it called for reducing import tariffs gradually to three levels 10%, 15%, and 20%. Today, Chile’s effective import duties average 2%.
Initially the monetarist and market oriented policies didn’t work. In particular, inflation – which was running at 500% per year – didn’t decline. After Milton Friedman’s visit in 1975 Chile applied a “shock treatment” and inflation began to subside. Also, following Friedman’s advice, the military opened up the economy to international competition much faster than originally planned. Although in his memoirs he played downplayed his role, Milton was quite influential.
B. THE MOST IMPORTANT EARLY POLICIES
Probably, the most important early decision to abandon, in 1976, the “Andean Pact,” a highly inefficient and protectionist customs’ union. After that decision was taken, import duties were reduced to a flat 10%, with no exceptions. Having a uniform import tariff was very important, as it deflated the call for exemptions and special treatment of specific sectors. Once the economy was opened, everything else followed.
C. EARLY MISTAKES
As Martin points out in his column, having pegged the exchange rate in mid 1979 was a major mistake. It created a very high overvaluation, a current account deficit in excess of 10%, and a major currency crisis in 1982. As a result unemployment shot up to 20%, and the experiment almost came to an end.
D. IMPORTANT MICRO AND INSTITUTIONAL REFORMS
Some of the most important early reforms include the creation of a privately managed, capitalization pension system in 1982, and granting independence to the central bank in 1989.
E. THE RETURN TO DEMOCRACY AND THE REFORMS
Posted by: Sebastian Edwards | December 13th, 2006 at 7:27 pm | Report this commentWhen democratic rule returned in 1990, there was the concern that the new center-left government was going to undo the reforms. After all the new authorities had been severe critics of market orientation, and many cabinet members had been exiled and tortured.
But the new government didn’t backtrack. Instead of undoing them, it consolidated them, deepened them, and supplemented them with active social programs.
Dani Rodrik: Martin Wolf and Javier Santiso are right that pragmatism has been the key to Chile’s success. When Pinochet slavishly followed some textbook theory of how macroeconomics worked, the results were a disaster.
In 1982-83, Chile experienced the largest collapse of any country in the region. Under Pinochet, Chile’s per-capita GDP growth averaged no more than 1 per cent per year, which hardly makes the Pinochet period an economic success. The economy took off only when Pinochet jettisoned economic orthodoxy in the aftermath of the 1982-83 crisis, engineered an undervalued exchange rate and jacked up import tariffs to 35 per cent.
During the 1990s, Chile continued to buck the trend by taxing capital inflows (to prevent the real exchange rate from appreciating too much), keeping its largest exporter under state ownership, and engaging in industrial policies that spawned new export industries such as salmon. Market-oriented? Yes. Willing to interfere with markets when growth seems to demand it? Also yes.
Posted by: FT Forum - Dani Rodrik | December 14th, 2006 at 3:57 pm | Report this commentSebastian Edwards: As I pointed out in my post – and in my 1991 book “Monetarism and Liberalization: The Chilean Experiment” - allowing the exchange rate to become overvalued in the late 1970s and early 1980s was a major mistake of the early “Chicago boys”. More generally, arguing that a huge current account deficit – in excess of 10% of GDP - didn’t matter, because the fiscal deficit was in check, was a serious mistake. Looking at current account deficits in a number of countries today – many of them advanced – makes me wonder whether this lesson was learned.
It is incorrect, however, to argue that capital controls (on inflows) were instrumental to Chile’s success. This is for two reasons: First, during the 1970s and early 1980s there were very strict controls on capital inflows. This did not stop the currency from becoming severely overvalued, nor did it stop the country from developing a major external imbalance. Second, there is plenty of empirical evidence suggesting that the controls in place during the first half of the 1990s had, at best, marginal effects. This doesn’t mean that they had no effect; all it means is that the effects were marginal.
It is very hard to make the argument that maintaining Chile’s main exporting company in the hands of the State helped Chile achieve high growth. Codelco – the State owned copper giant – has been the source of corruption and has been inefficient. Current Finance Minister Andrés Velasco is on record saying – before he entered politics – that Codelco should be privatized. Currently Codelco is not subject to the same regulations, supervision or oversight as the rest of Chile’s corporations. There is no justification for this. In many countries with large State owned enterprises, these have some private share holders and they are subject to the same scrutiny as publicly traded companies. This is the case in France, Brazil and Malaysia, to mention just three cases.
Dani Rodrik of course is right when he calls for pragmatism. The government of President Michelle Bachelet is doing exactly that. It is trying to find ways of furthering Chile’s modernizing reforms, at the same time as it is improving social conditions.
Posted by: Sebastian Edwards | December 15th, 2006 at 4:14 pm | Report this commentMartin Wolf: I don’t have anything much to add to Sebastian’s comments - he is the expert here. I admire Dani’s determination to maintain agnosticism to the last, but sometimes he seems to take this attitude a little bit far.
In the case of Chile, it is necessary to distinguish the macroeconomic blunder of a fixed exchange rate, combined with inflexible real and nominal wages, from the microeconomic policies. The big microeconomic error was inadequate regulation of a financial sector from which the government was, unable to walk away. Otherwise, the improvements in microeconomic policies clearly began under Pinochet in the 1970s. The strength and length of the initial recovery and subsequent growth, after the resolution of the 1982 crisis, reflected the range and depth of these long-standing microeconomic reforms. This is the difference, I would argue, between Chile after the financial crisis and Mexico after its 1995 crisis.
I agree, however, on the importance of social reforms that ensure wide sharing of the benefits of growth and greater opportunities for all.
Posted by: FT Forum - Martin Wolf | December 15th, 2006 at 7:17 pm | Report this comment