Abstract
In the 15 years from 1999 to 2013, Chilean GDP growth averaged 3.9%. Although this was above the 3.2% Latin American average, it represented a sharp drop from the country’s sustained 7% annual growth in 1990–1998, the first 9 years after its return to democracy. This article seeks to explain this significant outcome reversal. Given the absence of deep backwards steps in the microeconomic approach, we focus on macroeconomic policies. Two cycles are distinguished: (a) 1999–2007, between contagion from the Asian crisis and a peak in economic activity in 2007 before the contagion from the global crisis, and (b) 2008–2013, between the start of recession in 2008 and a GDP peak in 2013, just before a significant new deceleration. We show that the adoption of inflation targeting combined with full opening of the capital account and exchange rate liberalisation successfully kept inflation low and avoided balance of payments crises, but implied that the economy was usually operating below potential output, while the exchange rate and current account became extremely unstable. Pro-cyclical financial markets and the price of copper again became active channels of transmission of external instability to domestic macroeconomic markets. On the other hand, fiscal policy moved from being rather neutral to effectively counter-cyclical in 2009 and, more recently, to pro-cyclical. Pro-cyclicality discouraged capital formation and productivity. Real macroeconomic instability was a determinant variable underlying the worsened growth outcome.
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Notes
Economic reforms, policies and outcomes in Chile since the military coup of 1973 are covered in Ffrench-Davis (2010c); an update in Spanish is in Ffrench-Davis (2014).
Ffrench-Davis (2010c, Chapter I). The economy experienced two deep recessions (in 1975 and 1982) and overheating in 1989, with GDP growth fluctuating between plus 10% and minus 17%, with the 2.9% cumulative average for the 16 years.
Between 1973 and 1989, the development gap with respect to the G-7 increased. Per capita income (PPP) in Chile fell from 29% of that of the G-7 in 1973 to 25% in 1989; in other words, development divergence prevailed.
Interestingly, Latin America’s GDP growth was similar in 1990–1998 and in 1999–2013. In the first period, Chile far outpaced the region while, in the latter, it tended to converge with the region’s poor performance.
There is a series of outstanding works by Latin Americans on an approach concerned with the real economy, beyond the CPI. I cite three of them: ECLAC (2010) on economics and inequality; Ocampo (2011) on macro/micro links and Frenkel and Rapetti (2011) on exchange rate policy. An excellent related book is Ocampo and Ros (2011). I summarise my views on macroeconomics for development in Ffrench-Davis (2010b).
The managed flexibility implemented in 1990–1995 gradually lost consistency in 1996–1997, permitting an appreciation led by pro-cyclical capital inflows (Ffrench-Davis, 2010c, Chapters VIII and IX). On the managed flexibility see, also, Edwards and Rigobón (2009).
After close coordination in 1990–1995 in implementing a set of counter-cyclical policies, several expressions of lack of coordination emerged in 1996–1998, particularly with respect to exchange rate policy, with the government criticising its pro-cyclical bias. However, by 1999, the Finance Minister appeared to have accepted the formal adoption of ‘inflation targeting’. See www.bcentral.cl/politicas/sesiones-consejo/pdf/Sesion794E.pdf.
The Bank usually used the expression ‘flexible’, implicitly implying ‘fully flexible’ with only exceptional interventions and no explicit exchange rate or current account ‘targeting’.
It should be noted that the policy tool of the reserve requirement on capital inflows, systematically used in 1991–1995, is still available to the Bank (though with some bounds by now) if it decides to make use of this counter-cyclical regulation in the case of future capital surges.
Note that we mention the nominal price of the dollar but the relevant figure is that of the real exchange rate of a basket of currencies of Chile’s main trade partners, as calculated by the Bank monthly. This is the data used in the curve in Figure 6. The peaks and minimums of the basket and the dollar coincide when the stronger force is the position of the peso and not that of the dollar with respect to the euro or other currencies.
See press release of 10 October 2002 at www.bcentral.cl/prensa/comunicados-consejo/otros-temas/.
The MPR was indexed to the CPI (actually, to the Unidad de Fomento, UF, linked to the CPI with one month lag), which was replaced by a nominal interest rate in a quest for further reductions in inflation. A discussion in favour of the change can be found in Morandé (2002). See Shiller (2008) for a strong argument in support of the UF in Chile as an effective tool for generating segments of long-term savings and lending.
By 2008, the Treasury was a heavy creditor, particularly in foreign currency. It had accumulated $22.7billion in funds equivalent to 13% of GDP (Table 3). Correspondingly, in a belated decision, the structural surplus target was reduced to 0.5% of GDP in 2008 and to 0% in 2009.
Conventional measurements use a sort of Hodrick-Prescott filter, assuming symmetrical deviations of actual GDP above and below trend GDP. In the real world – particularly under the globalisation of financial volatility – actual GDP tends to fluctuate mostly below potential GDP. See Ffrench-Davis (2014, Annex I) where estimates are presented of a production function excluding time series observations in which actual GDP is evidently out of equilibrium.
There were some counter-cyclical components, such as emergency job programmes when unemployment rose and, in 2002, an unemployment insurance scheme was launched. This is financed by contributions from both private-sector workers and employers to the worker’s individual account and government contributions to a ‘solidarity fund’. In September 2009, some 85% of private-sector payroll employees were contributing to the scheme. This high coverage was accompanied by modest benefits and a minimal use of the solidarity fund (see Ffrench-Davis, 2010c, Chapter VII).
Annual CPI inflation averaged 2.2% in 2001–2004, below the 3% centre of the target band.
Actual GDP growth averaged 2.6% in 1999–2003 while most estimates of the rise in capacity were around 4%. Note that potential GDP had grown about 7% per year in 1990–1998.
These figures for gross fixed investment ratios are from the National Accounts calculated by the Central Bank with base year 2003. The depreciation of the capital stock represented around 13% of GDP. Thus, these three points implied a 30% fall in net capital formation. It should be remembered that the estimate of trend GDP fell from 7% to a 4% plateau.
It is noteworthy that actual GDP growth also climbed in Latin America from 1.3% in 1999–2003 to 5.7% in 2004–2007.
The nominal exchange rate depreciated 17% between the first auction in April and the last one in September 2008. Depreciation then accelerated as a result of contagion from the global financial crisis.
See Blanchard et al. (2010), for a highly relevant ‘regret’ from the IMF.
The sharp rise in the CPI in 2007–2008 could be interpreted as an overheating generated by the rise in domestic demand. However, as discussed above, it was mostly related to the jump in international food prices.
The impact on the domestic economy and the policy response are discussed in Ffrench-Davis and Heresi (2015).
The AFPs recorded net outflows equivalent to 10% of annual GDP in 2009. See Ffrench-Davis (2014, Table X.1).
For instance, for small loans (up to the equivalent of around $7,500), the spread over the annual MPR rose from an already huge 27 percentage points in 2007 to 33 points in 2009, while for larger loans (over $190,000), it increased from 2.6 to 4 percentage points (SBIF, 2014).
Monthly Central Bank estimate of economic activity (IMACEC). For more details, see Ffrench-Davis (2014, Table X.4).
Over the course of 2008, there was evidence of the effects of the crisis; GDP only grew 3.3%, below estimates of the increase in potential GDP. Consequently, 2007 is used here as the previous annual peak.
Given that this destruction was not because of economic policy, an estimate of the negative impact of the earthquake – 1.0%–1.5% of potential GDP, according to the Central Bank – must be added to the increase in actual GDP in order to measure the effectiveness of economic policy.
There had been an increase of 9 percentage points between 2002 and 2008.
Calculations based on the new 2008 chain mobile base of national accounts.
The SFB, measured with a nominal trend copper price of $1.00 per pound, showed a surplus of 1.2% of GDP in 2004–2007.
This is the main, albeit, simplified outcome. The relevant copper price is that in real terms (deflated by the international inflation relevant for Chile, measured monthly by the Central Bank and estimated at 71% in 1999–2013). In addition, climbing copper production costs, mostly related to falling ore grades, must be considered. Nonetheless, in all, the real proceeds for Chile from copper have been more favourable in recent years than in the 1990s.
For instance, the quantum of exports rose by 9.9% annually in 1990–1998 while world trade increased 6%.
Owing to the many free trade agreements signed by Chile in the past decade, SMEs face imports with a practically zero tariff, minor non-tariff restrictions and an unstable RER. At the same time, the net effect of the set of policies appears to be negative for export diversification, notwithstanding preferences in free trade agreements.
The fact that – after a significant increase in the 1990s when GDP grew by 7.1% – total factor productivity slowed sharply as from 1999 was also disregarded. This change affects the sustainable level of the ‘equilibrium’ RER.
It is fashionable to repeat that, with the adoption of a floating exchange rate, the domestic economy became immune to external shocks. The fact is that foreign exchange crises are eliminated but at the expense of transferring great instability to the real economy, particularly the allocation of resources between tradables and non-tradables, and to the level and composition of aggregate demand, deterring development. On convergent views on the link exchange rate/development see Frenkel and Rapetti (2011); Rodrik (2008); Williamson (2000 and 2008).
Also used in the Latin American literature are the expressions ‘financierism’ or ‘nominal stability’ for the neo-liberal approach and ‘productivism’ or ‘real economy’ for a ‘neo-structuralist’ or macro for development approach. See ECLAC (2010, Chapter II), Ffrench-Davis (2010b) and Ocampo (2011).
A related issue is the tax burden and its composition. Only minor and, in some cases, regressive adjustments were made after the major overhaul introduced in 1990. The government that took office in 2014 considered that the current tax burden was insufficient to finance the public goods required for inclusive development and the composition of revenue was not progressive. There were three main challenges: the need to dismantle clearly regressive exemptions and channels for tax avoidance and to combat evasion, to increase taxation of wealth and profits and to enhance pro-development links of public expenditure and revenue. Some of these challenges were addressed by a tax reform enacted in 2014.
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Acknowledgements
I appreciate the research support of Nicolás Fernández and Simón Ballesteros and the highly useful comments of the editor, Paul Wachtel and the referee.
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Ffrench-Davis, R. Chile Since 1999: From Counter-Cyclical to Pro-Cyclical Macroeconomics. Comp Econ Stud 57, 426–453 (2015). https://doi.org/10.1057/ces.2015.7
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DOI: https://doi.org/10.1057/ces.2015.7