Chile: Still a Latin tiger?

OECD Economics Department

Chile has elected its first female president, in Michelle Bachelet. As head of the left-leaning coalition which has led Chile since the country’s return to democracy in 1990, the new leader has promised continuity, though with a promise of more jobs and social justice. Tackling these issues could indeed make a difference, even if the economy has fared relatively well, as our OECD experts explain.

The Chilean economy is booming again. Not that it ever really declined. True, a small dip in GDP of 0.8% in 1999 spelt the end of a long period of growth that had lasted since the mid-1980s. In that 15-year period, Chile became known as “Latin America’s Tiger”, with an economy whose growth performance showed more in common with dynamic countries in southeast Asia than its neighbours. Indeed, though not a member of the OECD, Chile outperforms some OECD countries, in labour productivity, for instance.

Since 1999 growth remained relatively sluggish by Chile’s standards, before rebounding in 2004 with a rise of 6% in GDP. Opinions are divided on the main causes of that slowdown, some blaming cyclical and external developments, others emphasising internal structural weaknesses. Both camps are right. But the strength of the recovery leaves little doubt that the Chilean economy can notch up fast growth, especially when external conditions are favourable.

Copper prices are at a 15-year peak, and copper accounts for about 40% of exports. Overall fixed investment leapt by nearly 13% last year, while private consumption also rose by nearly 6%, the fastest expansion in years. Chile’s GDP per capita has risen faster than, say, in Mexico or Turkey.

However, as a recent OECD survey argues, Chile needs to sustain robust growth over the longer term if it is to close the gap in living standards with the OECD area as a whole. Income per capita measured in purchasing power terms is only about 40% of the OECD area average.

There can be no sustained growth without a sound economic foundation and Chile has done a great deal to create one. Monetary policy is working well, delivering low, stable inflation, at 2.4% in 2004. Fiscal management has also been exemplary. Those high copper prices have helped, of course, but the government has nonetheless managed to resist pressures to spend the revenue windfalls. This is because the authorities introduced a fiscal rule in 2000 requiring copper-related revenue windfalls to be saved in good times and to retire debt and finance spending in lean years. Compliance with this rule is paying dividends.

The public debt is coming down, too. The net debt of the central government and central bank combined accounted for less than 6% of GDP in 2004, down from about a third of GDP in 1990. This has allowed the government to begin to spend more on social programmes and reduce its dependency on foreign financing–the Achilles’ heel of many economies in the region. In fact, Chile is now the only region. In fact, Chile is now the only country in Latin America, other than Mexico, to have an investment-grade sovereign credit rating.

At the time of writing, Chile was in the throes of an election campaign and whatever new administration takes office in March 2006 should build on these achievements. It should maintain the fiscal rule for a start, while preparing the budget for contingencies, particularly those associated with ageing and retirement in the years to come. Chile pioneered pension reform in the early 1980s, replacing a pay-as-you-go, government-funded pension regime by a system in which workers save for retirement through contributions to a personal pension fund. While the system is working well, it has not fulfilled all of its promises. Individual workers’ contribution records are patchy, and many of those who contribute regularly do so at a level that is not sufficient to ensure a satisfactory income after retirement.

Resolving such challenges is important for the country’s future public finances and will help Chile lift its growth potential. Other actions would help, too, beyond the essential condition of delivering economic stability. One is to boost innovation, and several conditions are already in its favour. Real interest rates are low, the international trade and foreign investment regimes are fairly liberal, and regulation in product and labour markets is reasonably pro-competition. While Chile’s research and development spending in GDP terms may seem comparable with some poorer OECD countries, it is still too low, at 0.7% of GDP in 2002, and financed predominantly by the government in a rather fragmented institutional set-up. The authorities intend to provide more support by using the proceeds of a new mining tax. They also plan to create a council linked to the president’s office to advise the government on innovation policy. But for these initiatives to bear fruit, public funds will have to be spent wisely in a transparent, cost-effective and competitive manner, and on R&D projects that exploit Chile’s comparative advantages. This may include developing technology for agribusinesses and mining, for instance. Time will be the ultimate judge of the appropriateness of policies in this area.

Click on the image for bigger graph

A second challenge is to continue to strengthen the investment climate in network industries. Current regulation works reasonably well, but there is still scope for improvement. In electricity, for example, a new law was approved to ensure the security of supply against a backdrop of repeated cuts in natural gas shipments from neighbouring Argentina. The option of unbundling retailing from distribution should also be considered. This would encourage more efficiency by allowing retailers to design price schedules adapted to consumer preferences. Public-private partnerships have helped to reduce Chile’s “infrastructure deficit” over the years, in areas like roads and ports. But, as this deficit narrows, governance within those partnerships will need to be enhanced. That means strengthening independent checks and balances and taking steps to safeguard the budget from contingencies.

Chile’s growth potential also requires making better use of the labour force. This is the third challenge: to find ways to encourage people to work and to upgrade their skills. Labour-force participation is fairly low in Chile, especially for females and youths. There may be cultural reasons for this low participation, though a lack of affordable options for day care and pre-school education also makes it difficult for women to work. Major long-term gains can be expected from making more progress in accumulating so-called human capital, especially in today’s knowledge-based economy.

This is the area in which Chile lags the most in relation to the OECD. In this sense, improving the quality and results achieved at all levels of the education system is probably the single most important challenge for the years ahead. Meeting it would not just boost Chile’s long-term growth potential, but help reduce income inequality, too. Although social indicators have improved over the years, including a fall in poverty, Chile remains a highly unequal society.

© OECD Observer, No. 252/253, November 2005

References

OECD Policy Brief: “Economic Survey of Chile, 2005”.



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