The fiscal impact of the War of the Pacific

Abstract

In the War of the Pacific (1879–1883), Chile defeated Peru and Bolivia, and acquired territories that contained vast deposits of sodium nitrate, a leading fertilizer. Chile’s export tax on nitrates later accounted for at least one half of all government revenue. We employ a multi-country model of export taxation in order to simulate the potential government revenues that Bolivia, Chile and Peru could have earned under the counterfactual scenario that Chile did not conquer the nitrate-rich provinces of its adversaries. Our results are that Peruvian and Bolivian government revenues could have been at least double their historical levels. We estimate that, over the remainder of the nineteenth century, Chile’s earnings from nitrates would have fallen by 80%.

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Notes

  1. 1.

    See Partington and Parker (1922, p. 25). Soto Cardenas (1998, p. 75) and Yunge (1909, pp. .308–324); Chile, Memoria de la Delegación Fiscal de Salitreras (1893, 1897, 1902). See also annual reviews of the chemicals trade in the Economist.

  2. 2.

    See Brown (1963, p. 231); Bermúdez (1984, p. 198), Greenhill (1977, p. 247), Partington and Parker (1922), Wheeler (1918); Chile, Memoria de la Hacienda (1889); Chile, Memoria de la Delegación Fiscal de Salitreras (various years).

  3. 3.

    The Shanks system was widely employed from the 1870s until the 1920s. See Bain and Mulliken (1923), Bermúdez (1963), Crozier (1997) and Whitbeck (1931).

  4. 4.

    See Bermúdez (1963, p. 343) and Cruchaga (1929, pp. 257–260) and Greenhill and Miller (1973, p. 125). The model we analyze below assumes export taxation by all three countries. A possible extension of this model is to model one or more of the countries as operating a state-owned monopoly.

  5. 5.

    In 1878 10 Bolivian cents were equal to roughly 3.7 pence, so the tax amounted to 7 shillings per ton. As the price of nitrate was 10.6 pounds sterling per ton, the tax was equivalent to about 3% ad valorem. For Bolivian–British exchange, see Penalozo Cordero (1984, p. 49).

  6. 6.

    See Bermúdez (1963), Dennis (1967), Kiernan (1955), Mayo (1979) and Querejazu Calvo (1995).

  7. 7.

    See Bermúdez (1984, pp. 148–194); Billinghurst (1889, pp. 38–46) and Sater (1986, pp. 135–140). The report of the commission, known as the Comisión Consultiva de Salitres, is reproduced in the Memoria de la Hacienda (1880). The tax rate was that proposed by the commission, and it was approved by the Chilean Congress after considerable debate. Proponents argued that the rate struck a balance between the need to raise revenue for the nation at war, and the desire not to damage the industry. They maintained that foreign consumers would bear most of the burden of the tax.

  8. 8.

    The figures for revenues include nitrate of soda and iodine. Some oficinas also produced iodine from the nitrate deposits. The vast majority of these iodine-producing oficinas were in Tarapacá. See Crozier (1993), and Memorias de la Delegación de Salitreras, various years, for iodine exports by port. Iodine export tax revenues were about 15% of the total for most of the period. Government revenues include both export tax revenues and revenues from government sales (the Peruvian Government company for 1876–1879 and the Chilean government during 1880–1882). Figures for Chile do not include proceeds from the privatization of nitrate deposits, which could amount to 200,000 pounds sterling per year (see Resumen de la Hacienda Pública de Chile desde 1833 hasta 1914).

  9. 9.

    See Tantalean Arbulu (1983), Madueño (1919), Greenhill and Miller (1973) and Mamalakis (1971, p. 184). Nitrates were about 70% of total Chilean exports.

  10. 10.

    Perfect competition requires homogeneous products, many firms and ease of entry. Although the nitrate deposits were of distinct qualities, the processed product was homogeneous. As far as the number of firms, there were dozens of firms in Peru, but initially fewer in Bolivia and Chile. The ease of entry depends upon capital requirements, capital markets, and legal barriers. Barriers were not likely to be too high. Many firms freely accessed international capital markets. Furthermore, governments could auction lands to prospective producers if they deemed competition inadequate. To the extent that domestic industries were imperfectly competitive, this would have reduced the revenues accruing to the government with jurisdiction. If, for example, imperfect competition would have been more severe in Chile and Bolivia than in Peru, then Peruvian government revenues would have been higher, and the other governments’ revenues would have been lower. Finally, nitrate producers attempted to form cartels beginning in the 1880s. Some of these cartels were more successful in their collusion than others. Insufficient quantitative evidence remains to model and estimate the cartel subgame. As discussed below, in our empirical estimation we account for imperfect competition by including a dummy variable in our regression for years in which cartels operated. This approach follows that of Irwin (2003a), in his study of U.S. steel exports, who includes a dummy variable to measure the effect of the U.S. steel merger.

  11. 11.

    Yilmaz (1999, 2006) applies this framework in his empirical investigation of the international cocoa market. Our approach differs from that of Irwin (2003b) in his analysis of the optimal export tax on cotton in the antebellum U.S. The most significant difference is that our model explicitly includes the reaction functions of all market participants while Irwin does not model the optimal reactions of other countries to an optimal U.S. export tariff. Our methodological choice is motivated by our desire to obtain estimates for all three countries simultaneously, and to empirically investigate the importance of the strategic interaction.

  12. 12.

    Quantity is from Chile, Ministerio de Hacienda, Memoria de la Hacienda. Nitrate and ammonium prices are from Chile, Ministerio de Hacienda, Antecedentes. We use United Kingdom prices for both of these products. The U.K. nitrate price was the international standard. The country was the first major export market, and remained an important market and trans-shipment point. Chilean sources continued to quote UK, rather than German, French or U.S. prices, into the 1920s. The countries in the foreign income index are the United Kingdom, Germany, France, the United States, the Netherlands, Belgium and Italy. Together they accounted for over 90% of nitrate consumption. The GDP data are from Maddison (2000). The consumption weights are from Chile, Antecedentes.

  13. 13.

    We thank an anonymous referee for providing us with this figure.

  14. 14.

    The wage is calculated from Wagner (1992) and Braun et al. (2000). Coal prices are from Mitchell (1988), and the freight rates are from Oribe Stemmer (1989). Interest rates are from Braun et al. (2000).

  15. 15.

    Information on cartel operation is from Brown (1963) and Chile, Ministerio de Hacienda (1935).

  16. 16.

    We conducted similar analyses for the optimal tariff. The maximum revenue tariff is more sensitive to changes in supply elasticity than the optimal tariff, as in Table 3. These results are available upon request.

  17. 17.

    See Bonilla (1980), Paz (1927) and Sater (1979).

  18. 18.

    See Diaz and Wagner (2004). Coatsworth and Williamson (2002) obtain a similar result.

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Acknowledgments

The authors would like to thank Mauricio Drelichman, Bill Gibson, Marc Law, Art Woolf, Kamil Yilmaz, and participants in the 2005 Canadian Network for Economic History conference, the 2007 Economic History Association conference, and the University of Massachusetts-Amherst economic history workshop for helpful comments on previous versions of the paper. We would also like to thank Matthias Aschenbrenner for assistance with the simulations.

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Correspondence to Richard Sicotte.

Appendix A: three-country model of export taxation

Appendix A: three-country model of export taxation

Three countries export a product to a world market. None of the countries has a domestic market for the product. We assume linear demand and supply, and a perfectly competitive industry. The relevant demand and supply equations are:

World demand:

$$ Q^{D} = A - BP $$

Country 1 supply:

$$ q_{1}^{s} = a_{1} + b_{1} p_{1} $$

Country 2 supply:

$$ q_{2}^{s} = a_{2} + b_{2} p_{2} $$

Country 3 supply:

$$ q_{3}^{s} = a_{3} + b_{3} p_{3} $$

Each country sets an ad valorem tariff with respect to the world price:

$$ P_{1} = P(1 - t_{1} ) $$
$$ P_{2} = P(1 - t_{2} ) $$
$$ P_{3} = P(1 - t_{3} ) $$

We proceed with the equations for country one, noting that the equations for the other countries are symmetric.

Country one residual demand:

$$ \begin{aligned} Q_{1}^{D} & = Q^{D} - q_{2}^{s} - q_{3}^{s} \\ & = (A - a_{2} - a_{3} ) - (B + b_{2} (1 - t_{2} ) + b_{3} (1 - t_{3} ))P \\ \end{aligned} $$

The marginal revenue function for country one is:

$$ {\text{MR}}_{1} = \frac{{ - 2Q_{1}^{D} + A - a_{2} - a_{3} }}{{B + b_{2} (1 - t_{2} ) + b_{3} (1 - t_{3} )}} $$

The marginal cost function for country one is:

$$ {\text{MC}}_{1} = p_{1} = \frac{1}{{b_{1} }}(q_{1}^{s} - a_{1} ) $$

We now solve for the reaction functions yielding the Nash optimum export taxes.

First, set \( {\text{MC}}_{1} = {\text{MR}}_{1} \)

and \( q_{1}^{s} = Q_{1}^{D} = q_{1} \)

$$ \frac{{q_{1} }}{{b_{1} }} - \frac{{a_{1} }}{{b_{1} }} = \frac{{ - 2q_{1} + A - a_{2} - a_{3} }}{{B + b_{2} (1 - t_{2} ) + b_{3} (1 - t_{3} )}} $$

solve for q 1

$$ q_{1} = \frac{{a_{1} (B + b_{2} (1 - t_{2} ) + b_{3} (1 - t_{3} )) + (A - a_{2} - a_{3} )b_{1} }}{{B + b_{2} (1 - t_{2} ) + b_{3} (1 - t_{3} ) + 2b_{1} }} $$

Now, by substituting the above expression for q 1 into country one’s demand we get P as a function of the parameters, A, B, a i , b i .

$$ P = - \left( {\frac{{q_{1} - A + a_{2} + a_{3} }}{{B + b_{2} (1 - t_{2} ) + b_{3} (1 - t_{3} )}}} \right) $$

And by substituting the expression for q 1 into country one’s supply we get p 1 as a function of the parameters.

$$ p_{1} = \frac{1}{{b_{1} }}(q_{1} - a_{1} ) $$

With expressions for P and p 1, we can derive the reaction function for optimal export tariff:

$$ t_{1} = \frac{{P - p_{1} }}{P} $$

We now solve the reaction functions yielding the Nash maximum revenue taxes for country one. From above, we know that:

$$ T = (P - p_{1} )q_{1} $$

where T is tax revenue.

$$ P = - \left( {\frac{{q_{1} - A + a_{2} + a_{3} }}{{B + b_{2} (1 - t_{2} ) + b_{3} (1 - t_{3} )}}} \right) $$

Solving for T:

$$ \begin{aligned} T & = \left( {\frac{{ - q_{1} + A - a_{2} - a_{3} }}{{B()}} - \frac{{q_{1} - a_{1} }}{{b_{1} }}} \right)q_{1} \\ & = \left[ {\left( {\frac{{A - a_{2} - a_{3} }}{{B()}} + \frac{{a_{1} }}{{b_{1} }}} \right) - \left( {\frac{1}{{B()}} + \frac{1}{{b_{1} }}} \right)q_{1} } \right]q_{1} \\ \end{aligned} $$

Maximize taxing revenue, the first-order condition is:

$$ \frac{{A - a_{2} - a_{3} }}{{B()}} + \frac{{a_{1} }}{{b_{1} }} - 2q_{1} \left( {\frac{1}{{B()}} + \frac{1}{{b_{1} }}} \right) = 0 $$

Solving for q 1

$$ q_{1} = \frac{{a_{1} (B + b_{2} (1 - t_{2} ) + b_{3} (1 - t_{3} )) + (A - a_{2} - a_{3} )b_{1} }}{{2(B + b_{2} (1 - t_{2} ) + b_{3} (1 - t_{3} ) + b_{1} )}} $$

Substituting, we obtain expressions for P and p 1 as a function of the parameters.

$$ P = - \left( {\frac{{q_{1} - A + a_{2} + a_{3} }}{{B + b_{2} (1 - t_{2} ) + b_{3} (1 - t_{3} )}}} \right) $$
$$ p_{1} = (1/b_{1} )*(q_{1} - a_{1} ). $$

And from these we get the reaction function for country one:

$$ t_{1} = (P - p_{1} )/P. $$

This is the same form as the reaction function under the optimal tariff, but q 1 under the maximum revenue tariff is less than q 1 under the optimal tariff. Note that under the maximum revenue tariff the denominator is multiplied by two. As consequence, when substitutions are made, the reaction functions are algebraically different. We solved the simulations using the mathematical software MAPLE.

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Sicotte, R., Vizcarra, C. & Wandschneider, K. The fiscal impact of the War of the Pacific. Cliometrica 3, 97 (2009). https://doi.org/10.1007/s11698-008-0028-6

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Keywords

  • Export tax
  • Nitrates
  • War of the Pacific
  • South America

JEL Classification

  • C72
  • F13
  • F14
  • F17
  • H21
  • N46
  • N76