Case StudyChile : The Latin American Tiger?

Group 1

"Chile has moved farther, faster than any other nation in South America toward real free-market reform. The payoff is evident to all: seven straight years of economic growth. You deserve your reputation as an economic model for other countries in the region and in the world. Your commitment to market based solutions inspires the hemisphere."

-President George Bush in Chile, 1990

Chile's Profile

Chile was a mineral rich, medium income country.· Chile was located along the western seaboard of South America.· Chile had the world's largest reserves of copper (about one-fifth of the world total) and the second largest reserves of lithium. It also had significant reserves of other minerals such as iron ore, coal, gold, and silver.

· Historical Roots» Chile became a parliamentary democracy in 1891.» Chile seized several mineral-rich provinces in the north,

increasing the size of the country by more than one third and cutting off Bolivia's access to the sea. Chile and Peru continued to argue about the ownership of these provinces into the 1990s.

Chile's Profile

Chile's Profile

· The Chilean People» Chile’s population in 1996 was 14.3 million» Population growth in Chile slowed from an average of 2.1 % per year in 1960-70 to. 1.6% in 1982-92.

· Social Measures» Health standards in Chile were among the highest in Latin America.» Chilean education standards compared well with other countries in Latin America, but were below those in developed countries.

Economic History

Salvador Allende4 Nov 1970 – 11 Sep 1973

Augusto Pinochet17 Dec 1974 – 11 Mar 1990

Post Pinochet The 1990s

Chile Before Pinochet

· Chile began to provide social services in the early 1920's.· A coalition of four groups- Socialists, Communists, Radicals, and Christian Democrats-won a plurality in the 1970 presidential election.

· Allende's program » Pacific transition to socialism» Imposed price control» Nationalized many sector of economy» Tightened exchange controls

Result : - Inflation 473%- Public sector deficit 25% of GDP- Currency reserves depleted

Initial Reforms: 1973-1982

The economic reforms can be divided into 3 categories :

1. Stabilization Policies

2. Structural Reforms

3. Social Policies

Initial Reforms: 1973-1982

1. Stabilization Policies» Balance federal budget, reduce inflation, stabilize currency» Monetary policy tightened» Result : Inflation in triple digits, wage controls imposed» Fixed exchange rate : 39 pesos to $1

2. Structural Reforms» Tariffs Average : 100%, Reduced gradually» Introduced VAT, liberalized domestic capital

Initial Reforms: 1973-1982

3. Social Policies» 1979 : revised labor laws» Privatized social security and health

Initial Effects of ReformThe economy was much stronger in the late 1970'sThe large economic groups used their banking subsidiaries to borrow dollars cheaply in the Euromarkets and lend to other group members in pesos.

The 1982 Crisis• Mexico suspended interest payments on

$80 billion in foreign bank loans, leading to capital flight from Chile.

• The Chilean government Peso was devalued GDP fell by 14% Inflation doubled to 21% Unemployment jumped to 22%

• Counter measures : VAT increased to 20% Import tariffs increased to 35% (from 10%)

Fallout from the 1982 Crisis

The intervention took 3 forms: Promoting foreign direct

investment, Encouraging exports through

management of the exchange rate.

Controlling short-term capital flows.

1

The government employed two tools to manage trade : 1). tariffs 2).the exchange rate.

2

3

Chile after Pinochet

Group 1

The government was aimed at a gradual reduction in inflation to 3% per year; and the nominal exchange rate continued its gradual decline.

Two legislative changes :1). A tax package designed to fund new social program.2). A reform of Pinochet’s labor law.

Chile in the late-1990s

•The mandatory pension program appeared to have contributed to Chile's high savings rate-26% of GDP, the highest in Latin America.

•Chile attracted growing levels of foreign direct investment.

•The labor law allowed collective bargaining by unions at individual companies, but not across entire industries.

Chile's Choice

MERCOSUR

NAFTA1

2

Chile's Choice : NAFTAJoining NAFTA

One strong point was dispute resolution.

NAFTA also offered a much larger market than Mercosur.

May lead to increase in trade of mining industries.

May have cost advantage.NAFTA did not limit Chile's

sovereignty regarding trade with non-member countries.

Chile's Choice : NAFTA

Critics of NAFTA made three arguments.1). They feared the disparity in bargaining power, both

because of the difference in size between Chile and the other members.

2). The environmentalists claimed that the agreement would lock Chile into an unsustainable development strategy.

3). There is no way we can fill a market as large as North America.

Chile's Choice : Mercosur

The Southern Common Market.A common market that would allow

for the free movement of goods and services among its four member countries.

Mercosur members applied a common external tariff (CET) to imports from countries outside the agreement.

Chile sign an association agreement with Mercosur in June 1996.

Chile's Choice : Mercosur Those who advocated Mercosur membership over NAFTA

made several arguments. 1). Mercosur was nearby, increases in trade were expected to be

broad bases. 2). As a relatively rich country in a medium-income trading

block. 3). Financial services, retailing, and infrastructure industries

were expected to benefit most from integration with Mercosur. 4). Chile would have more negotiating leverage with Mercosur

countries than with NAFTA. 5). The rules of origin and other border controls were scheduled

to be phased out.

Chile's Next Step

•Chile’s trade policy was an important part of its development strategy.

•The final option : Bilateral Free Trade Agreements. Uruguay Round.

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