The Economic Miracle:
Chile’s Economic Progress During the 1990’s; Primary Causes and Future Implications
By Edem Abotsi, Spring, 2004
“Chile, with just 15 million people, is considered the paragon of open trade and the economic miracle of Latin America, a region where such miracles are rather scarce.”-J. Moreno-Brid & R. Hernández[1]
From 1990-1999, almost all Latin American economies trudged along at a painstakingly slower pace than that of the period of 1960-1980[1]. Decades of dismal economic performances, from low GDP growth to high instances of governmental debt, had weathered the strength and vigor from hopes of an economic recovery. In the South American region, sputtering economies yielded low rates of employment, polarized the distribution of wealth, and were a recurrent cause of civil unrest due to the embittered frustrations of the poor. Plagued by financial crisis and suffering shocks from the Asian Crisis and a slowdown in the U.S. economy, high rates of poverty (44% of Latin Americans live in conditions of poverty[1]), many of the economies had a bleak outlook of the future. Among such discouraging economic performances, one nation vigorously broke this trend with its strongest economic performance in years. Commonly referred to as an “economic miracle of Latin America” Chile’s GDP grew annually at a rate of 3.5% during the decade of the 1980s, while in the 1990s skyrocket to a rate 7% per year, with the only deviation being the international crisis in 1997.2 Chile experienced phenomenal growth in contrast to the other languid economies of South America. Internationally recognized Chilean economist, Oscar Muñoz regarded this marvel as an “An extraordinary leap of development and modernization, with a very dynamic economy accompanied by a growing macroeconomic stability.”[2] With one of the best ten-year economic performances in its history, what were some of the principal contributors to the success of Chile’s economy? Drawing from these trends, what future strategies for growth can be predicted? How can such success help to bridge the differences in education, distribution of wealth, and technological advancement of Chile? Foreign trade, high foreign direct investment (FDI), low inflation rates, and a prudent fiscal policy, were the principal factors for Chile’s remarkable performance. I will analyze these factors in relation to the success of Chile in the 1990s and provide insight to future strategies for Chile’s growth.
I.Importance of Foreign Trade
When experts look at the success of the Chilean economy in the years from 1990-2000, a prevailing aspect of the economy that arouses interest is the phenomenal growth rate of the GDP. Aside from the Asian international crisis in 1997, Chile had an impressive average annual growth rate of 7%, from the end of the 1980s to 1997.[2] The growth rate of 7% more than doubled the twentieth century average of about 3% for Chile.[3] This performance was considerably grounded in successful foreign trade practices.
One component of Chile’s success has been its fortuitous geographic location. Chile is located along the Pacific coast of South America, stretching an impressive 2600 miles in length. With the advantageous position of many seaports along the Pacific Ocean, Chile is able to strategically take advantage of its abundance in natural resources and ship many of its products to Asiatic countries and others in the Western Hemisphere. Chile’s lucrative position between Asia and Europe, along with its proximity to the U.S., creates an opportune situation to maximize trade among and between these regions. For example, the main export markets for Chilean processed food products are the United States, Brazil, Germany, United Kingdom, Holland, and Japan. The highest demand for canned and preserved products comes from Mexico, Venezuela, Argentina, Brazil and Japan. Chilean juices flow mostly into the United States, Japan, Canada, Mexico, and Argentina. Such a diverse array of buyers, from Japan to Germany, necessitate a low cost of shipping to maximize the profits from exports. The location of Chile between the major markets of Europe and Asia prove advantageous in its trade-oriented economy.
With a population of approximately 13 million, Chile’s abundance in natural resources exceeds its domestic needs and naturally emphasizes an economic strategy grounded in foreign trade. With a market-oriented economy much of Chile’s policy is structured in maximizing its participation and integration into the international trade market. One example of this emphasis is in the production of copper, of which Chile is the world’s largest producer and exporter.[4] Chile produces 24 percent of world output of copper ore and CODELCO, the state-owned copper corporation, holds about 20 percent of the world's known copper reserves.[5] In 1998, copper exportation accounted for about 40% of Chile’s Gross Domestic Product (GDP).[6] Although Chile has a small percentage of its land available for farming, with 2.65% of its land available for cultivation, surprisingly, its second most important export is fresh fruit. Chile has favourable climates year round and is well-suited to an agricultural emphasis on the production of fruit. During the 1990’s, profits from the exports of fruit were roughly at a median of 1.2 billion U.S. dollars.[7] In addition to fresh fruit, a third major export of Chile is wine. The Chilean vineyards are world-renowned for their distinctive flavour and varieties. The primary markets for Chilean wine are the United States, England, Canada, Denmark, Germany and Japan. This major export has grown to command a sizeable portion of Chilean profits, growing from 14 million liters in 1987 to 348.5 million liters in 2002. Such a voluminous increase in the aggregate profits of wine, the sizeable rewards from copper and fresh fruti exports all give testimony to the burgeoning foreign trade in Chile’s economy.
The shift in exports through the development of Chile has been remarkable. In 1970 Chile exported $US 33 million in agricultural, forestry, and fishing products, and by 1991 this figure was at an impressive US$1.2 billion.(Figure excludes manufactured goods based on products of the agriculutural, livestock, and forestry sectors).[8] With a growing emphasis on foreign trade, successive policies to provide infrastructure and development of these industries helped to facilitate increase in foreign trade. This rising trend of increased exports continued into the 1990s. For example in 1999, exports inreased from$18.3 billion from $15.6 billion, and imports increased to $16.9 billion from $14 billion in the previous year.[9] Exports accounted for 25% of GDP.
These exports are crucial to the booming economy of Chile, for much of its economic strategy maximizes the prospect of international trade. As the trend shows Chile’s government actively promotes a policy of exportation. Exports represented about 35% of GDP in 1990 and represented about 29% of GDP in 1999[10]. While there is a decreased percentage of exports as a constitution of GDP this does not necessarily reflect exports decreasing in this time period. Rather, they are subject to other changes in the countries economy, such as the change in the ratio of FDI as a component of the country’s GDP. With almost 1/3 of its annual GDP dependent on exports, this is a crucial area for Chile to fortify and diversify for future success. Although such a large investment of GDP in foreign trade can be dangerous, because of foreign shocks such as drops in prices of their goods, for the time being, Chile is limited in what areas it can generate substantial income in. Much of this is a result of the skill level of the workforce, and the education level of its citizens, which Chile can divert funds to improve upon. This is a crucial aspect for Chile, for which it can build upon with profits from foreign trade channelled to the areas of education.
Imports in Chile have also shown a rising trend in the decade of the 1990s. Increases in population and shifting trends in demand for products are both factors that affect the quantity of annual imports. Although increasing importation is not ideal in terms of profit for a country, this is necessary to cope with changes in productivity, and to maximize areas of which there is a comparative advantage. For example, if Chile has a comparative advantage in the production of copper, to reduce the production of lumber in efforts to divert resources to the more efficient practice of copper manufacturing, is a sound business practice. However this will turn cause the demand for lumber imports to increase as a result of less lumber being produced domestically. Ideally, Chile strives for a favourable a balance of trade, which entails a greater export to import ratio to maximize governmental revenue. Balance of trade is the most important figure in the calculation of the balance of payments, which is defined as:
“An accounting record of all transactions made by a country over a certain time period, comparing the amount of foreign currency taken in to the amount of domestic currency paid out.”.[11]
A propitious balance of payments is a safeguard against high rates of governmental debt, which seems to be a deep-rooted and unyielding affliction to South American economies.
In 1990, imports represented about 31% of Chile’s GDP and in 1999 comprised about 27% of Chile’s GDP[12]. An aggressive foreign trade policy has created a salutary climate for the expansion and development of Chile’s economy in the decade of the 1990s. The administrations of the 1990s vigorously sought liberalizing trade agreements. Chile signed trade agreements with Mexico, Canada, and Latin America. Preferential trade agreements with Venezuela, Columbia, and Ecuador were also enacted. An association agreement with Mercosur (Argentina, Uruguay, Paraguay, and Brazil) was signed in 1996. In addition to the trade liberalization policies, the Chilean governments of Eduardo Frei and Patricio Aylwin also implemented trade liberalization policies of which the unilateral trade reductions (1991 from 15% to 11%, and in 1998, from 11% to 6% over five years) were most noteworthy. Championing the causes of an open economy that was conducive to trade, and principal trade agreements were hallmarks of this period. These strides in accumulating and promoting foreign trade give credence to the importance of foreign trade in Chile’s economy in the 1990s.
II.Prudent Fiscal Policy
Neighbouring countries strive to emulate the exemplary economic growth of Chile that is grounded in prudent fiscal policy. This fiscal policy was another essential constituent in its outstanding performance during the 1990s. A prudent fiscal policy is key in minimizing government debt and creating an environment conducive to high public revenue. Chronic problems with government debt have been problematic for many developing Latin American countries. Outperforming Mexico, Uruguay, and Costa Rica, Chile’s public sector boasted revenues of more than 30% of its Gross Domestic Product (GDP), according to the UN Economic Commission for Latin America (ECLAC)[13]. This statistic is reflective of the burgeoning local businesses in Chile that are important in generating jobs, creating infrastructure, and the long-term economic development of Chile. However, another element of the high public revenue is due to the high value-added tax rate at 19%. In addition, the CODELCO, the world leader in copper production, is a state-owned enterprise that also yields considerable profits to public revenue.
Chile’s success is also attributable to its efforts at reducing debt and programs to create a sustained fiscal surplus during the 1990s. From about 1987-1997 the annual budget had consecutive years of a surplus and reduction in government debt.[14] Chile also boasts the highest domestic savings rate in Latin America.[15] The Chilean national surplus had systematically increased from 4.9 % of the GDP in 1993 to 5.5% in 1997.[16] From an international viewpoint, Chile is seen as a lucrative sector for foreign investment with a steady decreasing government debt. This gives confidence to investors and shows an independence and deviation from the trend of many growing countries to have an unhealthy dependence on institutions such as the IMF and World Bank to help resuscitate their economies from lamentable economic policies. After 1997 the deficit has not been more than 2.5% of GDP, and at times has been a surplus.[17] Prudent management of the national debt permits economies to grow and flourish in the long-term outlook of their economic future.
This performance of maintaining the national debt has displayed better management than the US and a majority of countries in the European Union. According to the World Bank, the Chilean-established Copper Stabilization Fund has been key in reducing the impact of external shocks on fiscal revenues. These shocks can cause adverse effects in the economies they influence. Avoiding external shocks is key to maintaining steady rates of inflation, also important in Chile’s success, which will be discussed further. An astute fiscal policy, with the hallmarks of low national debt, high public revenue, and years of a fiscal surplus are all critical factors in the role of Chile’s remarkable progress during the decade of the 1990s.
- Targeting Inflation; Central Bank Key Role.
In the 1990s, Chile’s success can also be attributed to the inflation-targeting policies of the independent Central Bank of Chile. The Central Bank strove to provide counsel on economic policies that would avoid the incidence of external shocks. The Central Bank notes how harmful policies have the potential to create inertia in inflationary shocks that make it difficult to lower inflation to acceptable levels. They continue with the example of a transitory shock in the price of petroleum is able to generate prolonged devastation in the objective of their inflation targets.[18]
A cautious approach of maintaining a reasonable inflation rate is important for several reasons. First, a low inflation rate is a result of having low currency appreciation. Low currency appreciation is important to the Chilean economy because their economy has a market-oriented scheme with an emphasis on foreign trade. If they have a high rate of currency appreciation, their currency will lose value in respect to other major mediums, such as the dollar, and investors will not be as inclined to invest in the Chilean economy because of the weakness of the peso in relation to other currencies. Additionally, their exports will lose value in the international market -which in turn will have detrimental effects on the Chilean economy. The success in initiating a decline in inflation during the 1990s was a pivotal factor in the success of the Chilean economy.
To place this statistic in context, Muñoz asserts, “The rate of annual inflation from 1984-1989 was about 20%, while on average, between1990-1998 it was less than 12%.[19] Remarkably in 1999, the rate of inflation had decreased to less than 4%.[20] Inflation rates had peaks of 21% and 25% in each of these periods respectively”.[21] This trend represents a decreasing rate of inflation from 23.7% to a rate of less than 4.5% in the 1990s. The steady decline of in the rate of inflation had several beneficial aspects for the Chilean economy. The Central Bank of Chile notes how a decreased rate of inflation contributes to a healthy environment for the materialization of investments, promotes the general development of the country, provides incentives for the generation of jobs, and increases the productivity of businesses.[22] Naturally, a low inflation rate also allows nascent business to grow without shouldering the burden of a weak currency from which to build a foundation from. This facilitates the integration of their products into the international economy, which will provide jobs and attract investment. The judicious management of the inflation rate in by the Central Bank of Chile constitutes an important element in their growth in the period of the 1990s.
II. Effects of FDI in Chile’s Growth.
The booming economy of Chile during the 1990s was largely successful for a number of reasons. One of the key factors in the economy’s success was the influx of foreign direct investment (FDI) during the 1990s. Aside from the initial macroeconomic stimulus, FDI has many beneficial effects on a Chile’s economy. FDI facilitates developing countries’ access to international markets and technology, provides resources to develop infrastructure, contributes to international trade integration, helps create a more competitive business environment and enhances enterprise development.[23] Benefits such as increases in total factor productivity and a more efficient use of resources have also been noted. Considering Chile’s market-oriented economy, and its reliance on foreign trade, FDI strengthens Chile’s prospects for increased trade. According to a report from the OECD:
The main trade-related benefit of FDI for developing countries lies in its long-term contribution to integrating the host economy more closely into the world economy in a process likely to include higher imports as well as exports. In other words, trade and investment are increasingly recognized as mutually reinforcing channels for cross-border activities.[24]
With the Chilean economy’s reliance on trade, an increase of FDI allows more opportunities for exchange in the international market. During the 1990s, FDI gross inflows represented an annual average 6.4% of Chile’s GDP, rising to an annual average of 8% between 1995 and 2000.[25]
As the graph shows, FDI in Chile rose steadily to peak at a level of US$9.9 billion record high in 1999.[2] The significant decline in of FDI in the subsequent years was a trend seen on an international scale, with the exception of China. The decline was attributed mainly to a slowdown of world economic growth (1.3%, as compared with 4.0% in 2000) and to a decrease in cross-border mergers and acquisitions (M&As).[3] The relatively low level of 1990 in comparison to 1989 was due to a decline in FDI due to the Gulf War crisis of 1990-91.
The Chilean FDI committee noted that in recent years figures of FDI have been distorted because of a growing tendency of foreign investors to use the Chilean local capital market. Foreign investors are lured by low interest rates and the high liquidity of the financial sector of Chile. Although this may create a slightly inaccurate picture of FDI, these facts tend to attract potential investors in the Chilean market. Despite distorted figures of FDI, with an annual average of nearly 6% of GDP during the 1990s, FDI is an important factor in the growth and foreign trade aspects of Chile’s economy. The large influx of FDI in Chile was a critical factor in the remarkable annual growth rate of 7% in Chile’s economy during the 1990s.