The monetarist experiment in Chile: A critical survey

World Development, Vol. 11, No. 11, pp. 905-926, Printed in Great Britain.

0305-750X/83 $3.00 + 0.00 0 1983 Pergamon Press Ltd.

1983.

The Monetarist Experiment in Chile: A Critical Survey* RICARDO

FFRENCH-DAVIS?‘

Corporation for Latin American Economic Research (CIEPLAN), Santiago Summary. - Chile constitutes the most outstanding case of implementation of an extreme market economy model. During nine years, between 1973 and 1982, a model was implemented that for its ‘pureness’, deepness and extension induced a drastic transformation of the Chilean economy. The main features of the model are examined, focusing on the anti-inflationary policy, the reform of the financial system, and the external opening. Then the global results concerning output, income distribution and saving-investment are studied. The paper shows that the balance of the results wasclearly negative during the 1973-81 period: output stagnated, the concentration of wealth was spectacular, and saving and investment rates fell significantly. The characteristics themselves of the model and the weakening of the productive apparatus that they originated, additionally explain that the international recession was multiplied during 1982 within the domestic economy. The paper concludes with an attempt to interpret the

main causes of the failure of this ‘experiment’.

widely publicized as a ‘success’ with the support of representatives of certain financial concerns, some international institutions, and ‘liberal’ circles which seem to give absolute priority to ‘economic freedom’ over other dimensions of human activity. The experiment has frequently been cited by these media as the model for other developing countries to follow. Hence an understanding of its real features and the results it has provoked has a significance that goes beyond the particular case of Chile. In view of the depth, coverage and continuity of the application of the model, the analysis developed in this article is necessarily selective, and even in the areas dealt with the treatment has had to be schematic.’

1. INTRODUCTION In the course of the last 30 years the economic policies put into practice throughout the world have tended to be heterodox. Within that period the implementation of extreme approaches was an exceptional event. During the past decade, however, economic models have been applied in the Southern Cone of Latin America which belong to the monetarist extreme of the spectrum of strategy options open to developing countries. The most orthodox monetarist example is that of the model imposed in Chile since 1973.’ There are four reasons for the particular significance of the Chilean experiment. First, Chile was noted for its long democratic tradition and the broad pluralism characteristic of its institutions and citizens. After the coup in 1973 an authoritarian rCgime was established during which the existing monetarist model was developed. Under the aegis of this rCgime the executors of the model have enjoyed exceptional autonomy in the design, implementation and adjustment of their measures. Second, it is the chief example of a contemporary application of monetarist orthodoxy because of its ‘purity’, depth and extensive coverage. Third, its prolonged survival for close to a decade provides a broad field for the assessment of its effects. Fourth, the case has been

* This paper is part of a research program on Macroeconomics and Balance of Payments supported by the International Development Research Centre (IDRC). A shorter version was published in Probltmes d’Am&ique Lathe No. 66 (Paris), and in Coleccidn Estudios CZEPLAN 9 (Santiago: December 1982). t Researcher at the Corporation for Latin American Economic Research, CIEPLAN. I gratefully acknowledge the comments of E. Garcia, R. Lagos, J. Ramos, J. Ruiz-Tagle, R. Zahler and researchers at CIEPLAN, particularly J. P. Arellano, R. Cortrizar and A. Foxley. Naturally, all the opinions expressed here are my sole responsibility. 905

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In this paper we shall concentrate on the economic aspect, beginning with a study of the most characteristic features of the model (Section 2). Then comes an analysis of the policies applied in three areas strategic for the model, i.e. the anti-inflationary programme, the financial sector reform and the opening to foreign trade (Section 3). There follows an exposition of the main results in relation to national production, distribution of income and wealth, and the implication of the results obtained for future growth, especially as regards investment-saving (Section 4). The article ends with a brief recapitulation of lessons to be learnt from this experiment in orthodox monetarism. As in all practical experience, there have been successes and failures in this case. The net balance emerging from our analysis, and from researches conducted by various authors in the difficult conditions prevailing in Chile, is negative, both from a social and a purely economic standpoint. As against successes such as the expansion of non-traditional exports and the reduction of inflation, there have been notorious failures or mediocre results in numerous other areas. Throughout the study it is shown that the performance of national output has been deficient, that the concentration of wealth and income has been marked, and that the bases of production have been weakened by the adoption of the particular economic model applied in Chile. These results are due to the incapacity of orthodox monetarism in three strategic areas, which prevent it from functioning effectively in developing economies. First, the heterogeneity of the productive structures, the sectoral and regional problems and the persistent segmentation of the markets present inescapable obstacles to the efficacy of global and indirect economic policies. Second, the initial inequality of the economic agents, which are indiscriminately launched into competition among themthe overall liberalization and selves, causes privatization, and the ‘neutrality’ imposed on the policies, to increase the concentration of the presence of Third, economic power. destabilizing and asymmetrical trends in the in the macroeconomic adjustment processes, context created by orthodox monetarism, makes them exceptionally costly from a social and economic standpoint. The resulting macroeconomic framework has tended, in practice, to benefit speculation to the detriment of production and investment.

2. CENTRAL

FEATURES

OF THE MODEL

In Latin America there have been many attempts to establish economic policies that allow the market a more important role than it had before. This, however, can involve very varied intensities in the sphere of action of the market, in the role of the state, in the ownership of the means of production, and in the participation of the different social forces in decision-making and the distribution of the benefits of development. It is undeniable that in 1973 there were substantial macroeconomic imbalances that. had to be corrected. Likewise the economy was over-intervened, with excessive ‘microeconomic’ controls over private and public enterprises. Evidence of this appears in the self-criticism advanced during 1972-73 by various spokesmen of Popular Unity, the governing coalition with President Allende (Bitar, 1979, Chap. V). The size of the imbalances and the open inconsistency of public interventionism facilitated, though it by no means justified, the of the orthodox monetarist introduction approach after September 1973. Thus in Chile, in contrast with other authoritarian regimes in Latin America, an extreme version of integral monetarism was imposed. The model under discussion is an extreme case because of the amplitude of the role assigned to the market, the intensive privatization of ownership of the means of production, and the change imposed on the social organization of the country. Various channels of social participation and development which had arisen in the continuing process of democratization in Chile during the preceding decades were suppressed, controlled or disarticulated after 1973. The application of the model gave rise to substantial changes in the role played by the public sector in the economy. It implied a general withdrawal, gradual or abrupt, from the broad field of action covered by the State. This embraced public ownership, the active role of the State in development and the orientation of indirect economic policies, which it was stated should be absolutely ‘neutral’.4 The conception of the ‘subsidiary state’ was applied with markedly narrow limits and on the premise that the private market could assume numerous functions which in fact it could not perform satisfactorily. The ‘structural transformations’ in the economy were put into effect without having resolved the serious short-run problems confronting the Chilean economy. This procedure

THEMONETARISTEXPERIMENTINCHILE was due in part to the priority assigned to the structural transformations; it was thought then that delay in initiating them might mean the loss of opportunity provided by the authoritarian political framework and the widespread anti-interventionist mood prevailing in the country at the time. Additionally, the proponents of the model claimed that the existing problems had resulted from statist and interventionist policies applied both in the regime of President Allende and in the 40 preceding years,’ transcending governments which covered the entire political spectrum. The main economic transformations took place in the fiscal, financial and labour fields, international economic relations, and public ownership of the means of production; while later on a profound reform in social security was also introduced. In all these areas economic action by the public sector has been persistently reduced throughout the period being studied (Vergara, 198 1). Fiscal policy comprised a taxation reform and a restructuring and reduction of the greater part of public expenditure. The taxation reform included the elimination of taxes on wealth and on capital gains and a reduction of the charge on profits. On the other hand, the adoption of a value-added tax was strengthened and completed and the existing exemptions for basic consumer goods were in general suppressed. The object of the changes was to reduce the burden of taxation, concentrating this in taxes which, in the opinion of the economic team, were ‘neutral’. The official speech claimed that any differentiation ‘distorted’ resource allocation. Public expenditure recorded as a proportion of the GDP was reduced by somewhat more than a quarter from the levels it had reached towards the end of the 1960s after having risen to abnormally sizeable expenditures and budget deficit in 1972-73.6 There was a. dramatic fall in government investment, which diminished by more than half as a percentage of the GDP between 1970 and 1979. Public expenditure also decreased in the productive sectors, in activities in support of the private sector, in subsidies to public enterprises and in infrastructure. Social expenditure - mainly on education, health, social security and housing increased its share of public expenditure. This has been repeatedly proclaimed as an indicator of the ‘social’ character of the model. However, real per capita expenditure decreased: in 1979 it was 17% less than in 1970 and 10% less than in 1974, and it also declined as a proportion of the GDP.’ As will appear later on, the drop in

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public social expenditure per inhabitant took place in the context of a marked increase in unemployment and deterioration in the real income of the middle and lower class sectors. The socioeconomic frame required, in fact, a increase in expenditure, compensatory which did not take place. In the financial field, a far-reaching reform was introduced in 1975. The greater part of the banks that had been nationalized under the previous regime were returned to private ownership. The main commercial bank - the Banco de1 E&ado, constituted in 1953 - remained in public hands, but its share in the market fell from around 50% at the beginning of the decade to 14% of the loans in 1981. Interest rates were left totally free, regulations respecting repayment terms and allocation of credit were eliminated, new financial entities were authorized with few restrictions, and easy entry was given to foreign banks. Finally, there was a gradual easing of restrictions on capital movements.* As regards international trade, practically all restrictions other than tariffs were removed, and these were rapidly reduced from the high level in force in 1973 (a simple mean rate of 94%) to a uniform tariff of 10% for all goods, which has continued in force since 1979.’ Thus Chile, after decades of high import was rapidly transformed into a restrictions, country with less effective protection of manufactured goods than nations such as those of the EEC, United States and Japan. Korea and Brazil, usually considered to be open economies, appeared ultra-protectionist in comparison with the indiscriminate liberalization adopted in Chile. Likewise, the liberalization of the terms of trade resulted in the suppression of the mechanisms designed to attenuate the transmission of external instability to the national economy. In the case of exports, the chief instrument used was the exchange rate.” In line with the objective of opening the market indiscriminately to the external sector, Chile withdrew in 1976 from the Andean ‘Pact (Ffrench-Davis, 1976). The Agreement then in force with another five South American countries envisaged a preferential margin for Andean production as against the rest of the world, and common treatment of foreign investment in all the member countries (the so-called Decision 24). As regards the return to the private sector of the means of production, the process was similarly intense. It was not limited to transferring businesses which had been taken over or expropriated during the regime of President

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WORLD DEVELOPMEN?

Allende. It was also extended to enterprises created in the successive governments that ruled Chile from the time of the establishment of the Development Corporation (CORFO) in 1939.” In 1970 CORFO controlled the ownership of 46 enterprises, a number which rose to around 300 in 1973.r2 In 1980 there were only 24 enterprises in the hands of this institution, half of which were in process of being sold. There are also some dozen public enterprises dependent on other governmental departments. Among these are the Copper Corporation (CODELCO) and the National Petroleum Enterprise (ENAP). The sale of enterprises was largely conducted in periods of internal recession and very high rates of interest in the domestic market. Hence very few groups were able to contemplate their purchase. This was one of the reasons for the acute concentration of ownership during those years.13 In this process there was little direct participation by transnational corporations, in contrast with the official expectations of a vigorous flow of direct investment. However, a massive increase in foreign credits from the international commercial banks provided a substantial proportion of the finance required by national economic groups to gain possession of the enterprises offered. In the agricultural sector the transfer of ownership has had dramatic significance. The agrarian reform which took place during the governments of President Frei and Allende came to an abrupt end. After 1973 around 30% of the expropriated land was returned to its former owners and 20% was auctioned among non-rural dwellers. Scarcely 30% of the area was assigned to peasant farmers. Given that one of the former functions of the State, i.e. provision of credit and technical support for peasants and cooperatives, was one of the victims of the restructuring of public expenditure, it is estimated that already in 1979 about half of the peasants who had been assigned land had found themselves obliged to sell or let their farms.14 In parallel, there has been a massive expulsion of peasants from the farms in which they lived before and during the agrarian reform, The dismantling of state participation in economic life was extended to other areas also. In very concise and by no means exhaustive terms mention can be made of the network of agricultural ‘infrastructure’ (such as coldstorage plant, supply centres for seeds and inputs, purchasing powers, technical assistance to medium and small farmers), and the network of mining infrastructure (mineral-processing plants).

In 1980 another major step was taken in the process of privatization, this time in relation to the social security system. The retirement pension scheme, hitherto financed through a distribution system, was replaced by one of individual capitalization in private social securit financing societies created by the new system. IY Existing pensions and those of workers who would retire in less than five years will continue to be the responsibility of the public sector. The rest of the workers may choose between remaining in the old system or transferring to a social security financing society. For merely making the transfer the government decreed an automatic wage increase of 1 IYo. The choice between financing societies was to be made by the worker through an assessment of the expected profitability of each during the lapse of time before his retirement; for example, 40 years for a 25-year-old man. The return to the worker wih be determined by various commissions he has to pay, which can be freely modified by each society, and the profits or interest obtained from its investments of the security funds. An appreciable proportion of these has consisted of deposits not for 30 years, but for 30 days, with a notoriously fluctuating interest rate. There is one activity of supreme importance that has resisted privatization, and that is the large-scale copper mining industry. The state copper corporation (CODELCO) has undergone powerful onslaughts from the economic team but has succeeded in warding them off. Even so, it has suffered budgetary restrictions imposed by the Ministry of Finance despite the substantial profits it has contributed to the treasury. It has only been able to make investments that have allowed it to maintain the production level reached in 1977. Within the contradictions produced by the privatizing dogma, the government has encouraged, unsuccessfully hitherto, the development of other copper deposits to be operated by foreign companies. Paradoxically, these desposits, although rich in a world context, are less so than those mined by CODELCO, which has suffered systematic constraint in its expansion.16 The dogma of privatization has proved stronger than the search for economic efficiency.r7 Parallel with the changes in the specifically economic field there have been modifications, also ‘structural’, in social organization. According to the official economic speech, these are part of the project to create a competitive society of ‘free men’. This involves changes in the university system, in the organization and dependence of elementary schools, in the health services, professional colleges and student and

THEMONETARISTEXPERIMENTINCHILE The last example has union organizations.” undoubtedly been instrumental in imposing the wage policy that has caused real wages in 1981 to be even lower on average than the levels reached in 1970, and during 1982 they fell additionally over 10%.

3. MONETARISM IN THREE STRATEGIC AREAS One of the distinctive features of monetarism is its globalism; its neglect of problems of a sectoral nature, of the heterogeneity of the productive structures and the access to power of different sectors, of the significance of market segmentations, and of the difficulty of transmitting information to the economic agents so that they can contribute to the realization of the aims of public policy. In effect, it underestimates the frequent presence of destabilizing adjustment processes and of lags and overshooting. These elements represent inescapable obstacles which prevent the ‘neutral’ and indirect global economic policies from being effective by themselves in developing nations or in those in process of transformation. In this section we consider three expressions of ‘neutral’ globalistic policies to which the government assigned a starring role. And this, in fact, they achieved, but with different results from those foreseen. First the anti-inflationary policy is considered, and the extreme monetarism of a closed economy which is applied until 1976, and then the extreme monetarism of an open economy imposed between 1979 and 1982. Then the financial reform introduced in 1975 is analysed and, finally, there is a concise study of openness to the external sector in the commercial and financial spheres. (a)

The anti-inflationary

policy’g

The monetary policy constituted, until 19 76, the instrument on which anti-inflationary action was based. In the twelve months prior to September 1973 inflation had reached an annual 400% and in the months of July and August of that year it was in the region of 16% per month. The fiscal deficit was close to 30% of GDP, strongly influenced by the price control of the goods and services sold by public enterprises. The price control, which extended to broad areas of the private sector, involved heavily repressed inflationary pressures and an extensive black market.20 A few days after the coup most of the controlled prices were freed within a context of great uncer-

909

tainty. The result, which was foreseeable, was a dramatic upsurge of inflation, which soared to 88% in one month and reached 590% in the course of the first year of application of the model.21 Undoubtedly there was an overshooting of market prices, which far exceeded the inflationary pressures previously repressed. As the fiscal situation was gradually brought under control, the monetary policy was able to become effectively restrictive in the course of 1974. The official line was that the new price fixers - the private entrepreneurs - had to take into account the performance of the money supply in order to define the price of their products. It was claimed that in their own interests they would restrict their price increases in order to maintain their share in the market. And this they would promptly do as soon as they observed a reduction in the expansion rate of the money supply. The concrete fact is that the information on money supply became widely available some months in arrears and with various contradictory indicators, and that prices, given the high inflation, were often adjusted once a month and sometimes even more frequently. In these circumstances the chief point of reference for each economic agent became the actual behaviour of all entrepreneurs measured through the variation of the official consumer price index, the one easily available and up-todate indicator. This was published in the first days of each month with reference to the preceding period. The consequence was that annual inflation rates exceeding 300% persisted until far into the third year of application of the model. The monetary restriction, rather than influencing prices, had a greater impact on the level of economic activity: during 1975 industrial production fell by 28%, the GDP declined by 13%22 and open unemployment peaked at a rate of 20% at the beginning of 1976.23 The ‘price’ which was in effect adjusted swiftly downwards was wages: towards 1975 they had lost about 40% of ‘their purchasing power owing to the modification of the norms of legal readjustment and the drastic repression of union activity. In the meantime, as already mentioned, inflation persisted at annual rates above 300% for around three years, despite the monetary restriction and a fiscal deficit which was below 3% of GDP already in 1975. The monetary formula for controlling inflation did not function in the way predicted by the supporters of the model. On the contrary, it multiplied the effects deriving from the international recession and involved a notable cost both socially and in terms of economic activity (see Foxley, 1979, Ramos, 1978).

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WORLD DEVELOPMENT

As late as mid-1976 the economic team recognized implicitly that monetary control was proving incapable of restraining inflation on its own. Nonetheless, they only incorporated a second variable into the antiinflationary policy, which was the regulation of the exchange rate conditioned to that objective. This began a long process in which the exchange rate was used to slow down inflation by reducing the cost of imported goods and attempting to influence inflationary expectations. In June 1976 and March 1977 exchange revaluations were made (a fall in the number of pesos per US dollar), which were accompanied by a systematic campaign through the communication media.24 The measure had an appreciable effect, since inflation rapidly fell to levels below 100% annually after the first revaluation and below 50% with the second.” It was a belated realization, with a huge social and productive cost for Chile, that the inflation was not being generated by an excess of demand and monetary expansion. The belated realization was, moreover, incomplete, since only one additional regulating instrument was applied; that is, the exchange rate. This involved its conditioning, in excess, to the anti-inflationary policy, thereby sacrificing aims of equilibrium with the external sector and the production of exportables and import-substitutes. The anti-inflationary policy culminated in 1979 with the freezing of the exchange rate, once again supported by all the weight of publicity in most of the communication media. The new official version was that, with a fixed exchange rate in an economy with free importation, as the Chilean economy was now, domestic prices could not rise more rapidly than international inflation. At this late stage, therefore, they had adopted sight unseen the ‘balance-of-payments approach’, monetary popularized in certain academic and orthodox financial circles. Thus the executors of the model transferred from the closed economy monetary approach, the official doctrine up to 1976, to one of an open economy. In the former case, domestic inflation was considered to be the exclusive result of monetary expansion. In the latter case, domestic inflation was assumed to be due to international price variations plus that of the exchange rate; with the exchange rate frozen, there should be a rapid equalizing of domestic and external inflation. When the exchange-rate was pegged (June 1979), domestic annual inflation was above 30%, while international inflation was near 12%. The convergence between the two inflation rates took place, but slowly; for a year and a

half domestic inflation was markedly higher than the international rate, so that the exchange rate lost purchasing power. Hence, the rBgime of free importation caused an inundation of the domestic market and an untenable disequilibrium in the balance-of-payments current account during 198 1. To resolve the deficit on current account the official policy relied on the operation of an ‘automatic adjustment’ in the style of the gold standard in force before the world crisis of 1929: it claimed that the real exchange rate would automatically adjust itself with the contraction of monetary liquidity associated with the current loss of international reserves in the Central Bank. This contraction, in the official view, should provoke a drastic fall in prices and nominal wagesz6 However, a detail apparently overlooked was the fact that the exchange lag which accumulated between 1979 and 198 1 was in the region of 30%. The required adjustment was slow in coming and then only in a small proportion through the ‘automatic adjustment’ of prices, when negative inflation rates were achieved in some months. At the same time, however, there was a drastic fall in sales, production and employment - much more severe than the recession experienced in 198 l-82 by the world economy - and a progressive strangulation of business firms by way of increasing indebtedness at interest rates that were more than double the international rates. We shall return to this forthwith. The final outcome, in mid-1982, was an inflationary phenomenon repressed to levels lower than those of the industrialized nations,” but with untenable disturbances in the productive and financial system, which led to massive devaluations: between June and February 1983 the exchange rate was devalued by more than 95% in the midst of a general crisis. Once again the failure to adapt the chosen approach to the national situation ended in another long and costly experimentation with the Chilean economy. (b) Reform

of the financial

system2’

At the end of 1973 the commercial’banks were mainly in the hands of the State as a result of the nationalization of banking promoted by the previous government. During 1975 most of the banks were auctioned back into the private sector. Earlier - in 1974 - authority was given for the creation of private financing societies that could receive and lend resources at a freely determined rate of interest. Conversely, the

THE MONETARIST

EXPERIMENT

banks remained subject to a legal maximum interest rate until April 1975. This and other discriminations against the banks, while they remained under state control, contributed to the prosperity of the new financing societies during that period. A discrimination in the same direction took place against the cooperative system of saving and loans linked to the acquisition of housing (SINAI’). The notorious discrimination against this organization caused the funds received by SINAP to decrease from 28% of the total financial assets in 1973 to 7% in 1977. In addition to freeing the interest rate, in 1975 the government eliminated the norms relating to the quantitative control of credit in national currency and the selectivity of bank reserve regulations, which were largely directed towards the channelling of funds into production rather than consumption. Next, a progressive uniformity was imposed on the different financing institutions in respect of both the operations permitted them and their conditions. Within this trend towards uniformity of treatment came the regulation of external banking. In December 1974 the restrictions to their operation in the country were raised. At the present time there are 19 foreign banks operating in the national market.29 The liberation of interest rates, the elimination of restrictions on the maturity of banking operations (minimum of 30 days) and the suppression of control on the allocation of loans had extremely significant effects. The governing economic team expected that the liberalization of the domestic financial market, accompanied by the gradual opening of finance to the external sector, would lead to an increase in national saving and the quality of investment, in response to the suppression of the former subsidies and the removal of discrimination between credit users. The result has been strikingly different and places the financial reform and the official handling of the external sector in the heart of the economic crisis that surfaced in 1982. The two most notable features of the functioning of the domestic capital market have been the maturity terms and the interest rates that have prevailed during the seven years’ application of the reform. The most usual term for deposits and loans has been 30 days, with a manifest fall in long-term funds. The average real interest rate (discounting inflation) was of the order of 40% annually during 1975-81, covering a range varying from 12 to 1 20%.30 In other words, the real rates of interest in the domestic market, apart from a markedly high

IN CHILE

911

average level, have varied enormously in the course of the period. In addition, the margin of financial intermediation, or spread between the lending and borrowing rates has been higher than an annual average of 15 percentage points. Credits available for medium-terms and- at an interest similar to the international rates have been mostly those related to external loans. These have been mainly available to enterprises connected with the commercial banks and to economic groups which grew like wildfire during the period under discussion (see Dahse, 1979; Herrera and Morales, 1979). The notable segmentation of the market to which this gave rise was partially recognized only recently after the emergence of the crisis. As recently as mid-1982, for example, it became public knowledge that the principal bank of the largest of the economic groups had 44% of its total loans (those financed with internal and external funds) in enterprises openly connected with its directors or owners. Repeatedly, throughout the seven years of the financial reform, the advocates of the model predicted decreases in the real interest rates. Falls were frequent but they were of short duration. Only during 1980 was there a significant drop in the real cost of finance which lasted for nine months. This was associated, on the one hand, with the freezing of the exchange rate during the whole year and with an average internal inflation rate still above 30% annually. Hence the real cost of foreign loans was negative (-8%) for national debtors. On the other hand, external financing rose rapidly, increasing to more than 7% of the GDP of that year. Thus the volume of external credit came to represent two-thirds of bank financing of domestic origin (and 40% of the total). Its high volume and negative real cost, despite the persistent segmentation of the domestic and external market, pulled down the cost of credit of domestic origin to rates in the region of 12%; this is 20 points higher than the rate applied to the large enterprises and banks which attained access to funds deriving from the international commercial banks. The official policy throughout the seven years anticipated that the market, once freed from its intervention, would result in an equalization of domestic and external interest rates, an integrated financial market, and a functioning which would stimulate investment and its efficiency. The outcome was very different: (a) there were persistent gaps between internal and external rates of over 25 points annually; (b) in the domestic market the spread between active rates (loans) and passive rates (deposits)

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DEVELOPMENT

was around 15 points; (c) the nominal and real rates were very unstable, as were the spreads mentioned; (d) consumer credit expanded, predominantly for imported consumer goods; (e) the high cost of credit, its instability and the short maturities (mainly 30 days) discouraged productive investment: what non-speculative investments could pay real interest rates with annual averages of 400/o? In effect, the rate of capital formation (gross domestic investment as a proportion of the GDP) was lower during the application of the orthodox model than the normal historical figures, and the performance of saving was even more deficient. We shall return to this in Section 4(c). (c) Indiscriminate opening to the external sector31 In the period under discussion there was a liberalization of imports that suppressed all selectivity in commercial policy, a uniform tariff of 10% being fixed for practically the whole range of imports. The opening to trade has been accompanied by an opening equally unrestriited to foreign investment and the reduction of restrictions on the buying and selling of foreign currency and on financial capital movements. The main accounts of the external sector have evolved sizeably, as can be seen in Table 1.

Practically all the operations of international trade expanded during these years, especially non-traditional exports and imports. The expansion of imports was the more intense, resulting in a major trade deficit from 1978. A similar phenomenon has occurred in the current account (equivalent to the variation of the net indebtedness of the country), in consequence of the combined effect of the trade deficit and the increment in interest payments for the increasing private external debt. In contrast, the balance of payments (equivalent in simplified terms to the net variation of reserves) has exhibited appreciable surpluses in response to a notable increase in the inflow of foreign loans between 1977 and 198 1; only in the middle of this last year have the international reserves begun to fall persistently. The main feature of foreign trade policy has been the rapid reduction of the protection (then excessive) conceded to import substitutions in September 1973. The target of theliberalization process underwent major changes during the course of its application. At the beginning of 1974 there was a general announcement of a tariff reform which would take place gradually within the space of three years. Later, in May 1974, it was stated that in 1977 there would be no tariff higher than 60%. Then in 1975 it was announced that the tariff range would be between 10 and 35% and that this

Table 1. Balance of payments,infernational reserves and cost of imports

A. Balance of payments millions) 1.

II.

Ill. IV.

1914

1976

1978

1980

-255.8 432.1 (2607.3) (-2174.5) -471.6 -224.2 264.2 -20.6 284.8 -66.7 408.8

158.5 692.9 (2280.2) (-1587.3) -212.3 -351.3 214.4 -1.1 215.5 446.1 667.5

-964.5 -311.1 (2180.9) (-2558.5) -215.4 -433.5 1725.2 156.9 1568.3 631.2 1245.2

-1382.3 -535.8 (3299.7) (-3835.5) -273.5 -652.2 2219.7 119.2 2100.5 872.4 2943.1

1981

1982

(US $1977

Balance on current account 1. Trade balance (a) Exports FOB (b) Imports FOB 2. Non-financial services 3. Financial services Net autonomous capital 1. Direct foreign investment 2. Autonomous credits Balance of payments Gross international reserves

-3347.1 -1806.7 (2753.8) (-4560.5) -617.5 -993 .o 3316.4 261.5 3054.9 48.7 2659.0

-1696.1 155.2 (2704.4) (-2549.2) -462.8 -1549.7 928.5 259.9 668.6 -829.5 1839.8

B. Cost of imports V. VI.

Real exchange rate (1977 pesos per 1977 us $) Average tariff (% over cif price)

23.40

25.89

23.81

20.09

16.93

19.63

75.5

35.7

13.7

10.0

10.0

10.1

Source: Calculations based on figures in current US $ of Central Bank, Balanza de Pagos and Boletin Mensual, No. 663 (May 1983). The current US $ were deflated by an index of external prices (Ffrench-Davis, 1981), which is a weighted sum according to its incidence in Chilean trade, of the indexes of export prices and of the exchange-rate relations of the Federal Republic of Germany, France, the United Kingdom, Japan and the United States.

THE MONETARIST EXPERIMENT IN CHILE would be reached through successive adjustments in the first half of 1978. Nevertheless, the final reductions were made earlier, the process culminating in August 1977. Finally, three months later, a programme of monthly adjustments was announced by virtue of which, since June 1979, there has been a uniform tariff of 10% for almost all imports. It was repeatedly stated that the real exchange rate would rise as the effective tariff protection decreased. Nevertheless, a short time afterwards the exchange rate began to be used to reduce inflationary expectations and to compensate for the monetary effects of massive inflows of financial capital, as has happened in other countries of the region. The result was that advanced phases of the tariff liberalization were accompanied by intensive exchange-rate accentuating the effects on revaluations, domestic importables and contributing to a growing deficit on current account. In practice, therefore, especially with the presence of significant voluminous capital movements, deviations occurred in respect of the supposed compensation between tariff reductions and the exchange rate. Total imports, measured in constant purchasing power, considerably expanded in relation Table 2.A4ain imports of consumergoods:

to domestic economic activity. The influence of the liberalization policy is mainly observable in the category of consumer goods, particularly non-food products, where the greater part of ‘new’ imports concentrated. (See Table 2.) The real value of 13 of the main ‘non-traditional’ import lines brought into Chile, which in 198 1 covered 70% of consumer goods (including, among others, colour television sets, cars, clothing and textiles, perfumes, alcoholic drinks, confectionery, toys and radios) increased 12-fold in relation to 1970, and their value rose by an amount 50% higher than the rise in imports of fuels and lubricants. Non-traditional exports show a marked growth and diversification according to products and destination. Their share in the GDP rose by around four points between 1970 and 1980. This brought total exports up to 20% of the GDP for this year. Even so, there is an evident break in the expansive trend towards the end of the period. Additionally, the diversifying process has shown a tendency to retract; in effect, the exports which continue to expand are mainly lines intensive in natural resources (Ffrench-Davis, 1979a). Just as import-substitution has its ‘easy’ stage, so there is an initial ‘easy’ stage in 1970, 1980, 1981 (US $ millions of 1977)

1970 Confectionery items Leather and fur manufactures Alcoholic drinks and cigarettes Carpets, articles of clothing, knitwear, textile materials Photographic and cinematographic products Footwear, hats, umbrellas Musical and optical instruments Toys and recreational goods Processed foods from cocoa, meat, shellfish, vegetables and market produce Perfumery and cosmetics Television sets Radios Cars and motorcycles

913

1980

1981

Percentage variation 1970-81

0.2 1.3 1.1

8.2 9.0 22.8

10.5 17.5 27.5

5150.0 1246.2 2400.0

24.8 8.0 2.1 4.4 3.5

171.9 17.4 24.0 18.1 32.0

271.6 25.2 43.3 28.7 42.4

995.0

215.0 1961.9 552.3 1111.4

5.3 0.1 0.7 4.7 19.5

34.6 13.7 49.0 46.0 144.4

41.3 19.6 66.2 45.8 263.0

679.2 19,500.o 9357.1 874.5 1248.7

I. Subtotal main imports II. Wheat, maize and-sugar III. Fuels and lubricants IV. Other consumer and intermediate goods V. Transport equipment VI. Other capital goods

75.7 43.6 118.0 1155.5 157.4 408.6

591.1 309.9 666.9 1561.2 317.5 376.6

902.6 262.1 689.5 1714.3 395.8 480.6

1093.0 757.3 484.3 48.4 151.5 17.6

Total imports

1958.8

3823.2

4444.9

127.0

Source: National Customs Authority Bank for the rest in 1980 and 1981.

for 1970 and categories II, III, V and VI; import registers of the Central

914

WORLDDEVELOPMENT

the promotion of exports in semi-industrialized economies. The expansion of non-traditional exports in recent years relates in general to this stage. In fact, it has relied on rich natural resources and underutilized installed capacities. The underutilization characteristic of overprotected import-substitution was intensified by the great depression in domestic demand in 1975-76 and its slow recovery. This situation enabled exports to expand without major investments. The increase in exports was assisted by three additional factors. First, an exchange-rate policy of mini-devaluations was applied which, despite contradictory movements since 1976, and in combination with the sharp fall in labour costs, initially favoured nontraditional exports. Second, the presence of Chile in the Andean Pact until 1976 provided an enlarged market for more than a third of the increase in new exports. Finally, in conjunction with the above factors, the privileged position assigned to export promotion in the official speech gave a speedy impetus to the hitherto incipient export mentality of the entrepreneurial sectors of the country.32 The gap between imports and exports has widened persistently from 1977. Imports have increased more rapidly than non-traditional exports, while the quantum of traditional exports has remained almost stationary. Further, the terms of trade, after being very favourable during the first year of the model, underwent a marked deterioration which has persisted, with ups and downs, up to the present time. The worsening was mainly due to the fall in the price of copper, a traditional product representing around half of the country’s exports.33 Several factors account for the growing gap between imports and exports, and the deficient performance of the production of tradeable goods. The economic policy in force claims that resources should be assigned according to ‘comparative advantages’ and that the market, free from all state interference, achieves that objective. This theoretical premise, which represents an extreme among the diverse economic approaches now current, implies an idealized and simplistic conception of ‘comparative advantages’. In fact, the market ‘comparative advantages’ depend on the level and stability of the exchange rate, the degree of national and international economic activity, the fluctuations of prices in the external markets, and many other factors, In their turn, the market and social ‘comparative advantages’ differ among themselves owing

to the disequilibria and distortions characteristic of developing economies; the differences can be striking in a country faced with a violent change in economic policy and a public sector which abruptly abandons its guiding or directing role in the field of production. The most painful part of the tariff liberalization was effected at great speed, and its negative impact was reinforced by the exchange-rate revaluation. To make matters worse, this policy was applied in the context of a very depressed domestic demand, and a situation of notoriously high open unemployment. In consequence, the macroeconomic frame was not propitious for the identification of ‘comparative advantages’ and the corresponding opportunities for investment. The result was a markedly low level of investment and of utilization of installed capacity and labour. The domestic recession of the mid-1970s helped to obscure the effects of the liberalization, but it also made it more inefficient. Regarding the first point, when the recession had reached its nadir in 1976, inevitably, sooner or later, the recovery of the economic activity level had to begin. Given the depth of the recession, the rates of recovery of demand and production were bound to be high, as was actually the case between 1977 and 1979. As the tariff liberalization was introduced at the same time, a superficial view of the background would lead to the view that liberalization stimulated output growth. As was demonstrated in Ffrench-Davis (1980) the opposite occurred, and it was largely owing to the imposition of free trade that the recovery of production remained permanently lower than that of the aggregate demand, the latter becoming increasingly dependent on imported components. The recession itself had an unfavourable effect on the efficiency of the liberalization. The fact that the level of global demand was depressed during its early years tended to raise the average production costs of the national producers, making it more difficult for them to cope with external competition; at the same time, the almost generalized surplus of installed capacity discouraged domestic investment. The low level of investment was also associated with domestic interest rates several times higher than ‘normal’. Real rates of the order of 40% between 1976 and 1978 discouraged investment, and distorted relative prices and ‘comparative advantages’ observed in the market. Investment lower than the historical level was clearly insufficient to produce a symmetrical adjustment between the sectors which would have to contract and those which hypotheti-

THE MONETARIST

EXPERIMENT

tally would need to expand in response to the removal of tariff protection. Obviously, the adjustment required of the national production structure would have been more viable with a higher investment rate. Lastly, open unemployment increased the gap between market and social ‘comparative advantages’. In fact, the high open unemployment and an abnormally low level of investment meant that the possibility of achieving an effective reallocation of resources was slight; thus it frequently happened that the resources set free remained unused. Hence the opportunity cost of the resources released by the sectors unfavourably affected by the opening to external trade has tended to be clearly less than its market cost, so that the corresponding &substitution of imports has been inefficient in many cases: imports displaced domestic output that under ‘normal’ conditions, for instance of interest rates and exchange-rate, would have been able to compete successfully. Unemployment, insufficient investment and depressed demand generated a framework quite different from the theoretical one on which the arguments in favour of free trade were based. It is not too much to say, however, that even in conditions of full employment, the presence of indirect and dynamic effects and the nature of the information available in the market of a developing country like Chile provide theoretic and pragmatic support for policies which give selective protection to the national production and which actively regulate the market (Ffrench-Davis, 1979c, 1982). This makes it possible to raise both social efficiency and the volume of investment. Neither excessive protection nor extreme liberalization provides the appropriate solution. Furthermore, the resulting scant domestic investment has concentrated mainly on lines intensive in natural resources, such as fruit and forestry, and less on activities intensive in value added on the natural component and in ‘acquirable comparative advantages’. Indeed, the available data support the hypothesis that it has been easier to identify ‘comparative advantages’ possessing a definite base of natural resources. In the case of the other activities, these advantages have been ‘diffuse’ in practice. The numerous changes made in the Chilean economy, the depressed domestic demand, the high interest rates, the instability of the exchange-rate and the extreme passivity of the public sector have made it difficult to know where to find the possible ‘comparative advantages’ - those which, in fact, possess an acquirable component that determines not only the

IN CHILE

915

social costs of production but also those of the market. This has been one of the factors that account for the low rate of internal investment. There is no doubt that the phenomenon was aggravated by the freezing of the exchange rate in 1979, and its large real appreciation in the following years. Even those exports based on the more valuable natural resources, such as fruit, were affected by the deterioration in the exchange rate. The unqualified adoption of the ‘balance-of-payments monetary approach’ and the belief in an ‘automatic adjustment’ was prejudicial even to one of the few successes that the economic policy could boast in its nine years of application. In effect, the reallocative message provided by the liberalization of trade has been clearer for the sectors that should have contracted than for those in a position to expand. This reflects the detachment from the reality of the developing countries evidenced by the standard theory of ‘comparative advantages’ (Ffrench-Davis, 1982). The economic model adopted it in its simplest form. The more rapid growth of imports than of exports has been a decisive factor in the deterioration of the current account. The deficit has been covered by increasing capital inflows. In the early years the government expected a vigorous inflow of indirect foreign investments (DFI) in response to the ‘economic and political system’ it offered and to the markedly favourable norms established by the new statute for foreign investment (Decree 600). It was hoped that foreign investment would exploit the ‘comparative advantages’, previously repressed, which the model was liberating and that it would make a decisive contribution to a rapid development. In fact, however, the response of the DFI disappointed the hopes of the economic team. There were promises of considerable amounts, but their realization has been slow (see Lahera, 1981 and Vignolo, 1980). Moreover, an appreciable proportion of the inflows is linked to two lines which do not involve direct creation of productive capacity. One relates to the capital contributed by branches of transnational banking entities, and the other to the purchase of productive assets and equity. In contrast, access to finance capital in the private international markets has been the main source of financing for the growing deficit on current account. Its main destination has been the private sector, which received a proportion which increased through the years until it represented more than 85% of the net flows at the end of the decade. Among the oil-importing

916

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DEVELOPMENT

developing countries, debtors of the transnational banks, Chile was only behind Brazil, Mexico, Argentina and Korea in respect of the disbursed outstanding debt, and all these countries have economies and populations proportionally greater than Chile. It is well known that during a good part of the 1970s real interest rates were low and access to funds in the private international capital markets was expeditious. Both factors led the economic team, and many other groups throughout the world, to believe that to incur debts was ‘good business’ and that if the countries did it through the private sector there would be an assurance that the funds would be invested efficiently. Thus there would be no problem in servicing the debt. Once again the facts belied the expectations of the supporters of the model. A significant part of the foreign credit was devoted to consumption. The massive inflow of funds, in its turn, helped to promote and make viable in the short run the excessive import liberalization and the exchange appreciation. In fact, if foreign credit had been less accessible the government would have been obliged to moderate the tariff liberalization and/or the exchange-rate lag. Indeed, the credits made available to Chile were ample and greater than the country could absorb productively. After a moderate increase in the debt in 1977-79 it accelerated in 1980 and grew spectacularly in 198 1, rising by about 35% in this last year. In contrast to other countries which channelled external financing into investment, Chile, instead of having a process of ‘debt-led economic growth’, incurred a ‘debt-led deficit on current account’ with a negative impact on domestic output caused by the crowding-out of the domestic market with imports and the discouragement of exports. Finally, external conditions also changed towards the end of the period: real interest rates rose abruptly and access to funds became less expeditious in 1981-82. The experiment in this area culminated in mid-1982 with the sudden devaluation of the exchange rate, after several months of costly and inefficient ‘automatic adjustment’ (Arellano and Cortazar, 1982).

4. PRODUCTION, DISTRIBUTION INVESTMENT

AND

In this section we propose to make a concise study of results obtained in three different fields: first, what has happened with the gross domestic product and its chief components;

second, how the benefits and the costs of the application of the model have been distributed; and third, to what extent the performance of the economy has been generating new productive capacity and new currents of saving. The background data show that (a) the ‘growth’ has been largely fictitious, (b) the limited benefits have been received by a minority and high costs have burdened the majority, alongside a marked deterioration in the distribution of income and wealth, and (c) the gross capital formation rate has been notably less than customary in the past. (a) Global production

and its composition

The national accounts, which measure the evolution of the GDP and its composition, show a high ‘growth’ between 1976 and 198 1. There are doubts as to the quality of these figures. Here, however, we shall confine ourselves to the use of these official data. When analysed more carefully they show that the overall growth of production has been very low and that its composition reveals the great vulnerability of the Chilean economy. In the first place, the model was not initially applied in 1976 but was put into practice, even though in partial form, in 1973 (see note 4). In the second place, in 1975 there was a marked recession in the national economy which increased about three-fold the depressive effects of the international market. The domestic result was a fall of 13% in the GDP. Hence, to measure the economic evolution as from that low point is to record a ‘growth’ which in fact is simply a ‘recovery’ of the former levels; whereas 1976-80 gives a per capita rate of increase of an annual 6.6%, the period 1974-80 gives one of 2.0%.% It is obvious that the greater the recession in 1975, the greater would be the subsequent recovery. Thus, the greater the loss of production as a result of the recession, the higher will appear the ‘growth’ if the period of recession is not taken into account and the measurement begins at the lowest point. Paradoxically, the domestic recession was ‘useful’ in several senses to the executors of the model. First, it enabled them to show with extensive publicity in the ‘growth’, national and foreign communication media. This gave rise to the mistaken impression that Chile was growing vigorously and would continue to grow at rates in the order of 8% per of what might happen in year, 3s irrespective the rest of the world. Second, they were able to show that employment ‘was improving’, but

THE MONETARIST

EXPERIMENT

after the unemployment rate had risen from 6% to 20%, ignoring again the starting point.36 Third, on a more political level, after an intense recession, in an authoritarian regime which allowed the orthodox monetarist policy to be maintained, the subsequent recovery brought a sensation of relief to both employers and workers. The scene becomes less favourable for the model when the composition of the gross domestic product is disaggregated. This is done in Table 3. First, there was a rise in external indebtedness and its cost, especially in the two years 1980-81. Around a fifth of the per capita ‘growth’ recorded between 1974 and 198 1 was used to pay interest and profits abroad, which meant that the rate of expansion of the national product was less than that of the GDP. Secondly, two sectors of great ‘dyna-

917

IN CHILE

spreads have been inordinately high, increasing the cost of financing. Thus the ‘dynamism’ of this sector depended on an abnormal factor which was also prejudicial to productive activity and investment. There can be no doubt that, owing to the distortion they produce in the national economy, the two sectors contain a sizeable share of artificiality. Hence it is very significant that the rest of the value-added per capita, which in 1974 amounted to 91% of the gross has remained virtually national product, as can be seen in column 4 of ;;Ena;lYl Over and above this poor performance, GDP fell 14% in 1982. Thus, Chile was the Latin American country that showed by far the poorest productive performance, and a notorious vulnerability vis-a‘-vis the world market recession.

Table 3. Evolution of the GDPand its composition* Total

I. Gross domestic product 2. Gross national product 3. Value-added (a) Marketing of imports (b) Financial services 4. Gross national product excluding value-added in (3)

Per capita

1974-80 (1)

1974-81 (2)

1974480 (3)

1974481 (4)

3.8 3.4

4.0 3.6

2.0 1.7

2.2 1.8

15.5 14.5

16.2 13.6

13.5 12.6

14.2 11.8

1.9

1.9

0.2

0.2

rates of growth. Calculations based on official figures in Cuentas Nacionales de Chile. 1960-81, Columns (1) and (2) assume constant terms of trade. The 1981 figures are provisional.

*Annual Source:

in their contribution to the GDP were value-added through the marketing of imported products and financial services; in mism’

the

other words, two sectors linked with the essence of the model, which exhibit a dramatic cumulative expansion rate of around 13% annually, as can be seen in Table 3. The first sector expanded as a result of the rapid growth of imports of consumer and other goods. As was shown in Section 3, these were not mainly financed by greater exports, but by an increase in credits from the international commercial banks. This source of ‘dynamism’ was unsustainable in an economy without real productive support. The second source of ‘dynamism’ was connected with the financial reform and responded in large measure to the spread between the rates of interest on deposits and loans and to the transfer in Chile of foreign credits. As was indicated in Section 3, the

in pesos of 1977.

Within this context, the deterioration observed in industrial production does not now attract so much attention, even though it it is still worse than the performance of the above+-mentioned 91% of the GNP. Table 4 shows that manufacturing output per capita fell 2% in 1974481 and 23% in 1982; this contrasts with the expansion observed in the rest of the developing world and in the industrialized countries (line 2). Developing nations as a whole show production indexes notably better than those of Chile. During 1974-82, on average, developing countries had an output 30% above 1973, while Chile shows a decrease of 9%; in each of the nine years the index of Chile was substantially below that of the two groupings, as shown in Table 4. The manufacturing sector in Chile also felt the recession of 1975 more acutely than the rest of the national economy, its production

918

WORLD Table 4.

1. Value-added per inhabitant _ Chile 2. Total value-added ~ Chile - Developing countries - Industrialized countries

DEVELOPMENT

Manufacturing output: Chileand the world economy (1973 = 100) Average 1974-82

1974

1975

1976

1977

1978

1979

1980

1981

1982

95.8

70.2

73.2

78.1

83.8

89.0

92.9

93.7

72.0

83.2

97.4 106.3 100.1

72.6 108.1 91.8

77.0 116.7 100.1

83.5 125.3 10.37

91.3 133.6 107.9

98.5 139.7 113.3

104.6 146.8 112.3

107.3 147.0 112.8

83.8 149.6 108.5

90.7 130.3 105.6

Source: Chile, calculations based on Central Bank, Cuentas Nacionales de Chile, 1969-80. Developing and industrialized countries, United Nations, Monthly Bulletin of Statistics (May 1983). The 1974-82 average is the arithmetic mean of annual figures

falling by 28% in one year. Obviously, therefore, the subsequent recovery was substantial, once again giving fuel to the advocates of the model for their claim that the manufacturing industry was ‘growing’ on the basis of import liberalization. As already demonstrated, the converse was true: the excessive liberalization had a negative impact on industry and its effects were transmitted to sectors such as agriculture.38 (b)

Concentration

of income

and wealth

The great majority of indicators show a deterioration in the distribution of income and wealth. Here we shall give a brief look to indicators on wages and pensions, employment, consumption, infant mortality and wealth. Table 5 shows the evolution of some indicators on active and passive wage-earners. All

these indicate a regressive performance. Remunerations, in the period 1974-8 1, reached scarcely three-quarters of the level attained in 1970. After a sharp fall in 1973 and 1974, real wages began to recover somewhat in 1977, without having achieved even in 198 1 the level reached 11 years before.3g Decisive factors, explaining the drop in the wage-earners’incomes, were union repression, incomes policies linked to the official index of inflation, and the high level of unemployment. The pensions received by retired workers and the social security allowances for the wage-earners’ dependents (wife and children not working) also worsened considerably, as can be seen in columns (2) and (3).40 Finally, as a palliative to the growth of unemployment, the government adopted in 1975 an emergency programme called minimum employment (PEM); its members mainly work

Table 5. Indicators of income distribution and unemployment Incomes Average remuneration (1) 1970 1974 1976 1978 1980 1981 1982 1974-82

100.0 65.0 64.9 76.0 89.3 97.4 97.2 78.4

(1970

Average pension (2) 100.0 59.3 56.3 67.0 82.8 n.a. n.a. 70.6*

= 100) Average family allowance (3) 100.0 69.5 61.8 56.0 54.4 54.0 53.1 58.6

Unemployment

(%)

PEM (%) (4)

Open (5)

PEM (6)

Total (7)

_ _ 80.5 45.5 31.6 32.1 36.9 47.1t

5.7 9.2 14.4 13.6 12.0 10.8 22.0 13.6

5.4 4.3 5.3 4.8 ::;t

5.7 9.2 19.8 17.9 17.3 15.6 27.0 17.8

Source: Cortizar (1982a) for columns (1) to (3). Column (4) indicates the income in cash of the PEM workers as a percentage of the minimum wage in force in 1970. All the figures in current pesos have been deflated by the corrected consumer price index (Cortizar and Marshall, 1980) up to 1978, and by the official index for the later years. Columns (5) to (7) are based on estimates of ODEPLAN, Exposicick de la Hacienda I%blicu, 1982, and Ministry of the Interior, Social Division. The 198 l-82 figures are provisional. TAverage for 1974-82, assuming 1981-82 equal to 1980. TAverage for 1976-82.

THE MONETARIST

EXPERIMENT

institutions and public municipalities in (Aldunate, 1980). In 1981 they represented around 5% of the employed population, and their income was equivalent to a third of the minimum wage in force in 1970. The employment situation also reveals a marked deterioration. Despite some improvement between 1976 and 198 1, open unemployment in the latter year doubled the 1970 rate; and if the PEM workers are included, the unemployment rate is three times that of the year of reference (Table 5, col. 7). With the crisis that arose in 1982, open unemployment climbed to an annual average of 22% of the labour force. The decline in real wages and employment is apparent in the distribution of the consumption of the population classified according to income strata. The scant background data available refer to 1969 and 1 978.41 With the households divided into five quintiles, the poorest is found to have reduced its consumption by 31% between the two years of reference; the second and third quintiles lost 20 and 12%, respectively. In contrast, the quintile with the highest incomes concentrated the counterpart of the deterioration in the position of the other groups. There is an important indicator which shows an appreciable improvement during the period under discussion. This is the infant mortality rate. Despite the worsening in the situation of employment and income distribution, the fall in the infant mortality rate continues the positive trend noted in the period 1962-73.42 In the present period there is a trend towards a lower birth rate, the concentration of births in more favourable parities and an improvement in the level of schooling of the mother. These factors, however, were also present earlier. The main compensating factor for the negative impact of the deterioration in the economic situation of the majority of the population since 1973 seems to be associated with the emphasis placed by the National Health Service on the maternal and child sector and on the nutrition programmes directed to breast-fed and undernourished infants (Raczynski and Oyarzo, 198 1). In contrast to this specific area, as shown in Section 2, the total social expenditure of the public sector (education, health, social security and housing), diminished between 1970 and 1979, falling by 17% per inhabitant (Marshall, 1981). Nevertheless, as the total expenditure declined in even greater proportion, it came to represent a higher proportion of the public budget.

IN CHILE

919

The distribution of assets and wealth also became highly concentrated. This phenomenon was associated (a) with the changes in wages and employment, (b) with the privatization of public enterprises, and (c) with the impact of the recession on the entrepreneurs independent from the main economic groups, in conjunction with the peculiar functioning of the capital market. There is no doubt that the deterioration in employment and workers’ incomes has influenced the distribution of expenditure and wealth. Moreover, there was a striking improvement in the incomes of the highest-paid workers, which increased the dispersion between high incomes and medium and low ones. But the concentration was also fostered by other components of the economic model. As demonstrated in Section 3, numerous enterprises in the hands of the public sector were rapidly transferred to the private sector. This took place in an economy-in recession, and with high interest rates. Only a small part of the private sector was able to take them over, and at prices very favourable to the purchasers. Lastly, the recession also hit many private business men who lacked privileged access to internal or external credit. Hence, many of these entrepreneurs were obliged to sell their businesses or their stake in them to the same economic groups that acquired the former public enterprises. Additionally, the access to foreign loans another source of concentration. implied It signified, apart from the purchasing power it conceded, a capital gain corresponding to the difference between the internal and external interest rates: in the period 1975-8 1 it reached an annual average of 25 points (see Section 3).43 The available data show the marked concentration of wealth with two groups well ahead of the rest. At the end of 1978 the two main economic groups controlled enterprises representing around 50% of the wealth of the corporations registered in the stock exchanges of Santiago and Valparaiso, a figure notably higher than in 1970 (Herrera and Morales, 1979, p. 148). Data on the 250 largest national and foreign private firms in Chile indicate that the two aforesaid groups control at least 37% of the wealth of these firms in 1978 (Dahse, 1979, pp. 146-7). The process of concentration continued in subsequent years. Updated information shows that between 1978 and 1980, the capital of the firms controlled by the two main groups doubled in real terms (Dahse, 1982). More recent data (Balsa de Cornercio, June 1982) on distribution of the shares of 177 ‘open’ private companies

WORLD

920

DEVELOPMENT

indicated that the 10 chief shareholders of each of these had direct control, on average, of 72% of the capital. These data do not include information on the interrelations between the main shareholders, who may belong to the same economic group. Finally, there is a more recent factor which illustrates the bias of the model in favour of concentration. The social security reform, in addition to causing a sizeable loss of income to the public budget, will transfer a considerable volume of funds to private security financing societies. It is estimated that in the lapse of six years the Administrators of Security Funds (AFP) could capture funds equivalent to the present stock of bank deposits. According to information accumulated to date, practically all the AFP have been organized by the economic groups which control 71% of the capital and reserves of the private financial system (Arellano, 1981; Dahse, 1979). The AFP formed by the two main groups have concentrated three quarters of the deposits received (Cortizar, 1982a). During its first year of life, the social security reform constituted another factor of concentration and stimulus for the economic groups at the expense of the great majority of Chileans. (c)

The nexus with the future

The connection with the future, in the economic field, relates to saving and investof the model claimed ment. 44 The supporters that it was to achieve a substantial increase in savings, investment and efficiency. The privatization of the means of production, the reduction to passivity and/or dismantling of the public sector and the liberalization of the markets were expected to achieve the said objectives. The financial reform and the opening to external trade were two key policies in the strategy adopted. The foregoing analysis has shown that the results were negative in respect of production. However, this could be compatible with a vigorous process of slow-maturing investment. Unhappily for the future of Chile, the opposite comes nearer to the truth. In each of the years between 1974 and 1980 the gross investment rate was lower than that of each year in the 196Os;4’ and in 1981 it was lower than in 1970. In parallel, a lower proportion of this investment was financed by national savings; in 1970 around 90% was covered by national savings, whereas in 1978-81 scarcely a half came from this source. The sharp increase in the inequality of wealth and income observed in these years

has apparently differentiation higher levels of investment; this rate of national and 1973.

expressed itself in a notorious in life styles rather than in saving destined for productive is attested by the fall in the saving in relation both to 1970

5. LESSONS OF THE MONETARIST EXPERIMENT In recent years orthodox monetarism came to the forefront in various countries and achieved a leading position in many academic centres in industrialized and developing countries. Nonetheless, its practical application in the post-war period has been generally limited and for brief periods. The case of Chile, as is particularly significant indicated earlier, because of the depth, coverage and continuity with which the orthodox monetarist model was applied. The political regime that permitted its imposition likewise conceded great autonomy to its advocates, which invests this case, properly speaking, with the character of an ‘experiment’. The external situation prevailing during the years of application of the model had its unfavourable aspects for the Chilean economy, which affected the success of the model. A case in point was the low price of copper, which persisted during most of the nine years considered. Even so, the external situation also contained features which facilitated the operation and duration of the model. One of the chief of these was that from 1977 Chile had expeditious access to external financial capital which, up to 1981, enabled it to more than offset the loss of income caused by the deterioration in the terms of trade.46 The increasing adherence to orthodoxy from 1974 onwards met its first obstacle in 1981, and in 1982 it suffered several notable These were associated with the setbacks.47 domestic crisis which arose in 1981-82 with unusual virulence and which spread to practically all sectors and groups in the domestic economy. During 1982, GDP and manufacturing output fell by 14 and 22% respectively, and open unemployment was affecting one in every four workers. These and other indicators revealed a substantial worsening in relation to the already deficient levels attained in 198 1, which have been analysed in the course of this study; the domestic recession has been reinforced by the depression of the world economy, but this represents only a fraction of the generalized problem facing the Chilean economy.

THEMONETARISTEXPERIMENTINCHILE The problems existing in the productive apparatus are closely linked with the functioning of the financial system and with the indiscriminate opening to foreign trade. The model conceded a leading role to the financial reform, as was described in Section 3. In effect, the financial system was transformed into the dominant centre of decision-making in the Chilean economy. In 1982 it became clear that the indebtedness of the enterprises (and of individuals) was a factor which was strangling its activity and which was growing rapidly owing to the high interest rates in force, while the revenues from the operation of enterprises were declining as a result of the domestic recession. The financial reform and the opening to foreign capital movements constituted at first a determinant factor in the concentration of wealth and a deterrent to national productive investment. Then towards the end of the period under discussion it revealed the additional vulnerability that it had introduced into the national economy and the functional dislocation of economic development created by the unbridled ‘financing fever’ to which it gave rise. The results observed are actually due both to intrinsic features of the model and to errors in its application. For example, the freezing of the exchange rate at $39 per dollar is not intrinsic to the model, which was compatible with a higher fixed rate and/or a free rate, such as that which was imposed in August 1982 for a brief period. However, in view of the model, the absence of a frozen exchange rate would have prevented the fall in inflation achieved in 1981,48 and this was the priority aim of the official economic team at the time when the freezing of the exchange rate was introduced. The intrinsic components of the model are in a different category and are observable in three areas which form the pillars of orthodox monetarism. These are the assumption (a) that privatization and the suppression of state intervention rapidly result in integrated, flexible and well-informed markets, and spontaneously generate a dynamic development; (b) that the processes of adjustment are stabilizing and characteristically speedy; and (c) that ‘competition’, even among unequals, leads to greater well-being for the majority. The three assumptions have been proved false in the experiment being analysed.

921

First, the indirect and ‘neutral’ economic policies were introduced in a context of ‘competition’ between unequals which only intensified the differences Furthermore, the ‘neutrality’ was broken in several decisive instances, so that institutions such as the cooperatives and a system of mixed saving (SINAP) were subjected to discrimination. The restraint on union activity did most to accentuate the inequality between ‘suppliers’ and ‘demanders’. As has been shown, the concentration of income and wealth was dramatic. Second, the slowness of adjustment processes involve substantial costs, because of the inefficient underutilization of resources and the disincentive it implies for capital formation. The orthodox monetary approach, through being static and not appreciating the fact that to reach the long term it is necessary to traverse a succession of short terms, ignores these costs. Third, although a mistaken interventionism can accentuate the structural segmentation and heterogeneity of the markets, the extreme alternative option, consisting in the dismantling of state action and the indiscriminate privatization of the means of production, does not lead to the rapid integration and flexibility of the markets; these problems are characteristic of underdevelopment. Consequently the resulting macroeconomic context is not propitious for the coexistence of the trilogy of growth, equity and national autonomy; the three are basic ingredients of a national development project. The solution of these problems demands that the state, subject to strict norms of efficiency, should act as leader in the development process. In synthesis, the monetarist experiment has been unsuccessful both in the social and the productive fields. It has produced a society with increased inequality on many fronts and a predominance of economic considerations over the other human activities. It has markedly deepened the unemployment problem. It has discouraged investment and has in general favoured speculative and finance-prone trends to the detriment of activities likely to increase productivity and national capitalization. It has intensified vulnerability to the external sector, as attested irrefutably by the greater impact of the recession on the Chilean economy in relation to the rest of the world. In brief, a failed experiment, which in the democratic tradition of Chile could not have taken place.

922

WORLD

DEVELOPMENT NOTES

1. The model imposed in Chile has been variously described as orthodox, integral or global monetarism, neoliberal, neoconservative, and as a social market economy. The last denomination, which is the one in general official use, lends itself to misinterpretation when confused with approaches such as that of the Federal Republic of Germany and those which give priority to social aspects. 2. Throughout the text references are given which provide more detailed background information and analyses. See especially Foxley (1982). Semesterly reports by the Department of Economics of the Universitv of Chile and the Boletin Mensual of the Central Bank provide information and interpretations on the various economic policies being adopted. The main official speeches can be found in DIPRES (1978). Lastly, a series of columns and notes for non-specialists, published between 1976 and 1982, are collected in CIEPLAN (1982). 3. Notwithstanding the intensity of the privatization, public ownership is still more prevalent in Chile than in several Latin American countries. The norm, however, is the passivity imposed on public enterprises. The case of the state-owned copper enterprise, which is described later in this work, is an example of this. 4. The more extreme aspects of the model were not fully apparent at the outset. The economic team was taking shape and consolidating its hegemony between 1973 and 1975 and at the same time imposing its orthodoxy. The greatest extremism of the economic policy occurs between 1975 and 1981, with a continuing intensification of its distinctive features. Only in 1981, with the appearance on the surface of the underlying problems provoked by the application of the model, do deviations from monetarist orthodoxy begin to occur. The landmark was the intervention of the government in eight banks and financing societies. 5. See references to assertions DIPRES (1978) and in Moulian pp. 23 et seq.

by public officials in and Vergara (1979),

6. There are serious problems of comparability in the figures on public expenditure. Homogenized figures for the period 1969-79 and an analysis of the main components appear in Marshall (1981). All the figures in the text come from that work. There it can be seen that public expenditure, excluding debt servicing and the investment of public enterprises, amounted in 1979 to 27% of GDP. An exhaustive study of the distributive impact of public revenues and expenditure towards the end of the 1960s is contained in Foxley, Aninat and Arcllano (1980). 7. See Marshall (1981), Tables 1, 13 and 14. A comparative analysis of different definitions of ‘social appears in pp. 75-81. The official expenditure’ figure overestimates the level of social expenditure towards the end of the period, in comparison with

1970 or 1974, owing to biases in the definition and an erroneous deflator.

used

8. The successive norms in force are examined in Herrera and Morales (1979), Zahler (1980) and Ffrench-Davis and Arellano (1981). 9. The import policy and the successive announcements of tariff liberalization and their effects are expounded in Ffrench-Davis (1980) and Vergara (1980). 10. See expansion

Ffrench-Davis (1979a) in relation of exports, its origin and its effects.

to

the

11. An analysis of the circumstances surrounding the creation of CORFO, its functions and evolution is given in Mufioz and Arriagada (1977). 12. This does not include the enterprises in which the government intervened; these were around 220 in 1973. See Veraara (1981). Bitar (1979. Chap. X) _ examines the programme of constitution of the Area of Social Ownership, the deviations it underwent and the problems that this involved. 13. Additionally, it is estimated that the was made at prices lower than the normal values. See Dahse (1979) and Foxley (1982).

transfer market

14. A financial factor which contributed to force the sale or letting of their allotted land by the peasants was the high cost of credit in the domestic capital market and the lack of prior relations between the peasants and the commercial banks. It seems to have been assumed that they would ‘compete’ on equal terms with the other users. With reference to the agricultural and peasant situation see Crispi (1980), Franc0 Mesa (1980, 1982) and ICECOOP (1981). 15. The characteristics of the distribution system, the new dispositions and a comparative analysis with other options are discussed in Arellano (1980, 1981). 16. See Vignolo (1982). The main foreigninvestment, made by the Exxon through the purchase of a deposit in exploitation, is discussed in Tironi and Barria (1978). 17. A further example of the strength of the dogma of privatization is provided by the fact that amidst the deep domestic recession taking place in 1982, the government decided to continue the transfer of several of the remaining public enterprises. Among them were included the National Telephone Company and the producer of iron pellets, one of the few significant investors of the nine-year period. 18. See Brunner (1981), Camper0 and Valcnzuela (1981), Moulian and Vergara (1980) and Vergara (1981) and various articles in Revista Mensaje, especially Ruiz-Tagle (1979a, b, 1980, 1981) and Zaiiartu (1980).

THE MONETARIST

19. The subject Ramos (1975,1978)

is discussed and Foxley

20. A complete analysis of applied in the period 1970-73 (1979).

in greater (1982).

depth

the economic is contained

EXPERIMENT

en

policy in Bitar

21. All the figures of inflation used here refer to the consumer price index corrected in Cortrizar and Marshall (1980). The official index significantly underestimated the effective rise in prices, mainly in 1973 and in 1976-78. 22. In the course of 1975 there arose a serious balance-of-payments problem, associated with a fall in the terms of trade, which the government also tackled by intensifying the restriction of the money supply and fiscal expenditure. The effects of the deterioration in the terms of trade, owing to the policy adopted, were multiplied by three in the domestic economy. The direct impact of the deterioration in the terms of trade observed in 1975 is discounted in the figure given in the text of the fall in the GDP. 23. The serious limitations of the official figures on the level of employment and a series corrected for the period 1974-78 are set out in Meller, Cortazar and Marshall (1979). 24. After the publicized revaluations, mini-devaluations were applied daily. The exchange-rate policy is analyscd in detail in Ffrench-Davis (1979b). 25. The figures in the text refer to the corrected CPI. At that same time there was also a rise in the percentage of underestimation of actual inflation by the official consumer price index (Corta’zar and Marshall, 1980). This fact, contributed to slow down all prices that were officially or informally indexed to the CPI. See Cortazar (1982b). 26. A lucid analysis of the emergence is given in Arellano and Cortiizar (1982).

of the crisis

27. It is important to point out that the external inflation confronting the Chilean economy was negative, owing to the appreciation of the dollar in relation to the rest of the currencies of the industrialized countries: a weighted index of external prices, converted into dollars, from May 1981 showed negative rates of annual inflation. Between that date and June 1982 inflation in 12 months reached an average of -2%. 28. The subject is analysed in greater and Morales (1979), Ffrench-Davis (1981) and Lagos (1981).

detail in Herrera and Arellano

29. Even though the 19 foreign banks represent a half of all banks in the financial market, their rapidly growing share of loans is still merely 10%. 30.

All the

figures

on interest

rates

and

payment

923

IN CHILE

periods are based on Ffrench-Davis and Arellano (1981), and cover a period beginning in mid-1975, after the liberalization of bank interest rates. 3 1. The subject is analysed in more detail in FfrenchDavis (1979a, b, 1980) in respect of exports,exchangerate policy and import liberalization; Herrera and Morales (1979), Zahler (1980) and Ffrench-Davis and Arellano (1981) in relation to capital movements and external debt; and Pinto (1981b). 32. The official policy included active promotion through a public institution (PRO-CHILE). This involved a deviation with respect to orthodoxy, which claimed to base the promotion of exports exclusively on the liberalization of imports and the supposed compensatory increment in the exchange rate. As the orthodox approach gained more and more control of public action, PRO-CHILE rapidly lost importance. 33. The background information on the trade deficit and the current account deficit must be qualified by the presence of various ‘transitory’ components of international trade. One of them relates to the terms of trade. See Ffrench-Davis (1980). 34. The recession had an associated with the fall in the direct effect of this (which was been discounted from the figures

external component terms of trade. The negative) has already given in the text.

35. See, for example, the illustrative in Foxley (1980), pp. 5,6.

citations

included

36. Additionally, for a long period (1976-78) the official figures markedly overestimated the number of workers employed. See Meller et al. (1979). 37. The value-added in the marketing of national goods also grew more rapidly than the production of goods. If the value-added in that marketing is also excluded, the cumulative rate of annual variation of the remaining per capita GDP, between 1974 and 1981, is 0.0%. and this corroborates the 38. It is noteworthy, analysis in the text, that the share in GDP of ‘tradeable goods and services’ has diminished from 41 to 36% between 1974 and 1981. See Cuentas Nacionales de Chile. Table 48. 39. Note that 1970 is taken as a ‘normal’ point of reference. 1971 is much higher and 1972 somewhat lower than 1970. See Cortizar (1982). The index of salaries and wages available, calculated by the INE, does not include firms with less than 20 workers or agricultural wage-earners or workers in the Minimum Employment Programmc. 40. In 1973 the family allowances for workers and employees were made equal. The equalization was made ‘downwards’, so that all the allowances diminished, though less in the case of the blue-collar workers:

924

WORLD

in 1981 their allowances were around a fifth the purchasing power they held in 1970.

DEVELOPMENT

below

Nacionales referring to the gross fixed capital as a proportion of the GDP.

formation

41. Information based on surveys of family budgets conducted in Santiago by the Instituto National de Estadisticas (INE). See Cordzar (1982a).

46. The cost of the debt and the impact of world inflation on the real value of the debt are discussed in Ffrcnch-Davis and Arellano (1981).

42. The infant mortality rate fell from 65.8’/00 in 1973 to 37.Y0/,,0 in 1979. At the beginningofthe 1960s it was llO”/OO and in 1969 it was 83’/,,

47. Examples of these arc the establishment of a preferential exchange rate to enable private debtors to pay their foreign creditors, the reintroduction of control on access to foreign currency, and the ‘purchase’ by the Central Bank of overdue debts (cartera vencida) in the private banks; these last had risen to over 50% of the capital and reserves of the national private banks by mid-1982, when the Central Bank adopted the above-mentioned decision. The ‘cartera uencida’ held by banks plus that sold to the Central Bank continued to accumulate rapidly; by the end of the year, it doubled that of June, and for the average bank it exceeded its capital and reserves.

43. Zahler (1980, Table 14) calculates that the transfer in favour of private debtors, because of interest rate differentials, would have been around US $1500 millions between 1976 and mid-1979. 44. There are many other connections with the future which are not considered here. They include the impact that the model may have had on the capacity for technological absorption and adaptation; the degree of creativity of the technical and university education system; the national cultural development; the channels of participation which could serve as a basis for development strategies which represent the national consensus; the dynamism and efficiency of the function of the State as activator of development. 45.

Official

figures,

according

to the

new

Cuentas

48. The freezing of the exchange rate was due, in part, to a variant of the orthodox monetarist model which consists in the ‘balance-of-payments monetary approach’ and its aftermath of neutral monetary policy. Paradoxically, despite its marked extremism. this approach represented the ‘irrefutable truth’ for officialdom and for most of the communication media for three years. Now this no longer applies.

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THE MONETARIST

EXPERIMENT

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