The Economic Transformation of Chile:

A Personal Account

The Economic Transformation of Chile: A Personal Account Copyright © 2010 by HACER.org All rights reserved. No part of this book may be reproduced or transmitted in any form or by any means without written permission from the author. ISBN 978-0-557-15966-6 Printed in USA

The Economic Transformation of Chile:

A Personal Account __________

Hernán Büchi

Contents Prologue .......................................................................... vii

Introduction .................................................................... xiii

1. Summer of 1975 ................................................................. 1

2. Of Miracles and Programs ............................................... 15

3. The First Dilemmas .......................................................... 31

4. The Real Modernizations ..................................................51

5. Work, Capital and Freedom ............................................. 89

6. Opting for Human Capital ............................................. 115

7. Reform Becomes Law .................................................... 141

8. Time of Crisis ................................................................ 151

9. How to Get the Economy Back on its Feet .................... 165

10. After the Battle ............................................................... 185

11. The Model Endures ........................................................ 195

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Prologue

During the preparation of the English-language edition of this book, the world experienced the global financial crisis in September 2008, of which the bankruptcy of the investment bank Lehman Brothers is the best known symbol.

It is interesting to note the ways in which the events of the current crisis—economic collapse, weak bank balances, loss of confidence in the financial system, drying up of credit, and further deterioration of the economy—are similar to those of the system-wide crisis experienced by Chile in the early 1980s at the halfway point of that country’s economic reform process. While the scale of the crises may be different, their dynamics are similar, because both deal with phenomena that affect the behavior of economic actors.

Even more remarkable is the fact that the political issues at stake today—whether or when the central bank should intervene, whether or when the government should use public resources, how much moral hazard there is in bailing out lenders, the best tools to use, how to get the financial system going again, and what a future regulatory framework should look like—are also similar to those debated in Chile back then.

Moreover, while the world has not seen a crisis of this magnitude since the Great Depression of the 1930s, financial crises have been common around the world in recent decades. These have common features, and have affected developed countries, like Sweden, as well as developing countries, like Chile. The crisis suffered by the latter during the early 1980s has features that make it worth studying.

The economic collapse and the costs assumed by the Chilean government in order to restructure the financial system in the 1980s place that country’s crisis among the most significant relative to the size of the country’s GDP. Nevertheless, the subsequent recovery was rapid, and the long-term growth and economic reforms that followed were extraordinary and without precedent in the country’s history.

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It is impossible at this time to redirect the bulk of this volume to deal with the current global financial crisis. That is a task better left for other analyses. However, it is worth highlighting certain common features and lessons learned, in the following pages, given that this edition is nearing publication as the most serious financial crisis since the Great Depression unfolded.

The first feature is the facility with which an economic problem can lead to a financial crisis and recession of unprecedented magnitude. A small rolling rock can create a devastating avalanche when a vicious cycle is allowed to develop. It begins with the loss of confidence in the financial system, followed by a drying up of credit, which then leads to more serious economic problems.

The lesson is clear. Action must be decisive and timely, carried out with the instruments at hand to prevent a chain reaction. But this is easier said than done, especially if at the beginning of an apparent crisis it is not clear whether the problem is systemic or restricted to a few institutions or individuals. Moreover, economic crises are difficult to understand, for both policymakers and the general public.

The main problem lies in the role and structure of the financial system. Economies function on the basis of trust. This is especially true in the case of banks, which are the nerve center of economic activity. Unfortunately, the way in which these wealth-creating institutions have evolved places them in a precarious position relative to a generalized loss of public confidence. Their obligations are mostly of a short-term nature, and are in liquid capital of fixed nominal value. Their assets, on the other hand, are not, even when they appear to be.

Short-term credit granted to a company ceases during a general liquidity crisis, because it becomes difficult for the company, regardless of its solvency, to pay it back. A bond with wide marketability before the wholesale loss of confidence loses its liquidity and quickly loses much of its value when the crisis lets loose. In the past, depositors would make a run for cash. Today, developing countries make a run for hard currencies,

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and in the current crisis, depositors around the world have sought refuge in U.S. Treasury bills.

Because governments have given their central banks a monopoly on the issuing of currency, they are the only entities that can act in crises like the current one, providing the instruments that the public and business sectors then begin to demand in greater measure. And because such events are infrequent, laws and regulations lag behind events. This aggravates the crisis by making the policy decision process more difficult. For example, it is not unusual for the market to have given rise to institutions that are essentially banks, but which the law does not recognize as such. This creates a situation that makes the central bank’s role as lenders a last resort more difficult.

Without a doubt, indecision by policy makers was exacerbated in Chile, and similar indecision has exacerbated the current global crisis. In some ways, the job of central banks is more difficult in developing countries, where, when a loss of confidence occurs, economic actors flee toward hard currencies, usually the U.S. dollar, which local central banks are unable to provide. In the current crisis, the run was toward U.S. Treasury bills, the value of which is determined by the American government.

In the case of Chile, two major factors in unleashing the crisis were the collapse of the terms of exchange and a violent shift in external financing.

In Chile, once the crisis was overcome, laws governing banks and other financial institutions were restructured in order to create more efficient mechanisms to address future insolvency crises. Loans coming due at the time were given priority of payment. An expedited process was created whereby other creditors could approve or reject capitalization agreements with their debtors, thus making the different institutions’ liabilities less rigid. At the same time, banks were required to maintain cash reserves equal to their deposits with priority of payment.

This was all done with the intention of making the central bank’s job easier, by not subjecting it to the dilemma of providing liquidity while at

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the same time using public funds to bail out lenders. The latter occurred in Chile with external credit and other deposits, either through the granting of government guarantees over such contracts or through the direct infusion of capital by the government into the most seriously affected institutions.

During the current crisis, the policy proposals that have been put forth in various countries have been varied, but they all share increased capital requirements as a major feature. Another common proposal has been that of preventing institutions from becoming too big. In reality, this latter proposal is debatable, because problems are equally difficult to overcome whether they affect a few large institutions or a lot of large ones at the same time.

Reforming the regulatory framework, as is being considered today, was also a priority during the Chilean crisis in the early 1980s, when the aforementioned framework was modified and improved. However, Chile’s situation was different. The crisis then occurred in an emerging market, without a strong regulatory and business culture, while today we face a globalized world rich in traditions and a wide network of state regulatory institutions. It is doubtful, as was in the Chilean case, that the current crisis can be attributed mainly to a lack of regulation, so we need to be careful and precise in enacting future reforms.

Finally, in Chile, a very important part of the recovery process consisted of identifying mechanisms by which to restore the solvency of banks and other financial institutions. This was not easy in a country suffering from a significant loss of wealth and lacking a developed capital market. Moreover, it was important to accomplish this without running the risk of nationalizing aforesaid institutions for an extended period of time.

Various mechanisms were tried, such as the purchase of bad assets by the Central Bank that were under an agreement of concrete provisions. When the government provided capital, it allowed taxpayers to acquire shares long term, allowing them to pay for them from future

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tax payments. Tax levies were also modified in order to allow banks to retain a greater part of its cash flow.

Additionally, the government aided bank debtors whom it considered economically viable, partially freeing them from the risk of the depreciating peso in the case of debt in foreign currencies—which, as noted, had been taken on when the country had a fixed exchange rate that had to be abandoned during the crisis. The government also restructured loans, mainly home and small business loans, to include more convenient payment periods and interest rates in both local and foreign currencies. These policies provided rapid relief to debtors and prevented a huge number of bankruptcies and the consequent costly liquidation of foreclosed and repossessed assets. It allowed individuals and businesses to renew their normal activities and attend to their financial obligations. This led to a better rate of recovery by creditor banks.

The external debt did not experience a cutback of capital, but it did have an extension of payment periods. This gave some creditors the opportunity to sell off debt at market prices, a process that was enabled by securing debt by both foreign and Chilean investors, under titles XVIII and XIX of the Chilean Central Bank’s new exchange rules. Major companies saw their capital increased and their owners change through this process. This launched a new awakening of the country’s entrepreneurial spirit.

Recently, we have seen several developed countries adopt multiple policies with the purposes described above. Some are similar to those implemented in Chile in the 1980s, and many are not. Hopefully, as happened in Chile, in the near future we will be able to say that confidence has been restored, the economy has recovered and grown as never before, and capital markets emerged strengthened.

However, to achieve all of this, the required policies need to be implemented today. Most of the world still does not understand what happened to the global financial system, or how a problem in an important but relatively small sector—real estate, particularly subprime mortgages—launched a collapse of the world economy.

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We are bound to see many studies and doctoral dissertations on this topic, perhaps even a Nobel Prize. However, well before that time, policymakers must act today to help overcome the crisis and resume the rapid growth of previous years. In Chile, during the 1980s, looking back at historical precedent proved very useful. Surely, for policymakers today, it will prove just as effective.

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Introduction It has been fourteen years since the first edition of this book was published, so we thought it was important to issue this revised edition.

It has not been our intention to write a new book, but to complement the first edition’s analysis with the insight gained by the intervening years. In that spirit, we have avoided making substantial modifications and have simply provided a context for the events described in the original document from the viewpoint afforded by the passing of time. By the same token, we have decided to mention a few subsequent events that were difficult to ignore, given their relevance to the contents of the book. Consequently, the book should be read with the context of the nineties in mind (except for the situations that needed updating, as previously explained).

Specifically, Chapters 1 and 2 have been modified to provide historical context for readers who were not there or who do not remember the actual events. This was not necessary during the early nineties, when we published the first edition, since facts and their circumstances were then vivid in people’s memories. Moreover, proximity in time would have made it impossible to try to approach these events from a historical vantage point.

In the chapters that describe major reforms in detail, the changes are intended to update or include facts both relevant to the account and necessary to understand subsequent events (although this update is neither complete nor exhaustive).

A new final chapter has also been added, to analyze the evolution of the reforms between 1990 and today, the dates of which correspond to when the Concertación, a coalition of political parties, took office and still holds executive power today. Once again, it is meant to be a broad, rather than detailed analysis, since this issue in itself would probably warrant a book of its own. The most outstanding aspect in this enquiry is the causal relation between the significant and comprehensive reforms

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designed and carried out during the seventies and eighties, and the progress that Chile has experienced—which was remarkably rapid until 1997 and more tempered after that.

The influence of the reforms that crystallized in the second half of the eighties is decisive in all of the areas in which progress is observed after the nineties. For example, the definitive moderation of inflation can be explained by, among other reasons, the financial discipline shown both by the Treasury and by public enterprises—a process that took time and effort—and by the Central Bank, whose final structure was established in 1989 and is still operative today. The beginning of rapid economic growth can be traced to the countless reforms in different sectors that made possible spectacular growth in areas as diverse as copper mining and forest exploitation. The rapid economic growth that was enabled by these reforms, combined with a great number of social policies that were already beginning to bear fruit in the early nineties, resulted in improved social indicators.

The slackening in economic and social progress over the last ten years cannot be ascribed to the fact that the level of well-being reached in Chile makes it difficult to maintain rapid growth rates. This, unfortunately, is not the case. Empirical evidence shows that some countries have experienced spectacular changes in their development levels over the last forty years. Countries that have managed to leave poverty behind and increase their level of well-being have done so by maintaining high growth rates during at least three decades.

The explanation for this waning in Chile’s growth rate lies mainly in the weaker conviction toward providing the necessary conditions for generating wealth and employment shown by successive governments after 1990. Despite this—and perhaps despite governments themselves—the optimistic aspect that I can highlight is that citizens who have profited from the country’s progress by gaining access to a job, to a decent home, and to better health and education for their families instinctively recognize the conditions that benefit them. Therefore, this population is the critical mass that makes it easier to get back on course

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if national leaders finally lay aside obsolete ideological visions and provide them with the conditions necessary for development.

After revising this book fourteen years later, it is striking to find it still relevant today. However, this relevance has both an upside and a downside. The upside is that the general principles that inspired the great reforms accomplished are applicable to countries that are just setting out on reform or have yet to do so. The downside is that in many areas—for instance, labor—arguments that should have been moot long ago are still being brought up in opposition to reform. Behind reality lies the explanation for the gradual decrease in growth rates seen over the last ten years.

This fresh reading reminds me of an important lesson: in order for policies to be successful and long lasting, they must be comprehensive and sufficiently deep, and they must tackle the fundamental economic questions. Given these conditions, reforms take on a life of their own, thus becoming harder to modify in the future, when the excess of ideology interferes with development.

This experience can be verified across different areas. In areas where reforms were more comprehensive, they have endured (or have been more difficult to change). On the other hand, in areas where they were weaker or incomplete, backsliding has been significant. For example, if we look at areas such as health or pensions, we find that the former has come to a standstill and has had to overcome countless obstacles in recent years—leading to worse results. Reform in the pension system, on the other hand, has remained strong and it is only in the last year that proposals for modifications have been made. These proposals maintain the foundations of the system while adding universal benefits more appropriate to a welfare-state model and their effects remain to be seen. The inertia of policies, both good and bad, lasts much longer than a single presidential term.

Critics of Chile’s social and economic transformation, who in the early nineties still questioned the benefits of the reforms carried out by the military government, never imagined the results that the reforms

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would bring about in decreasing poverty, lowering child mortality, increasing access to higher education, and making advancement available to all Chileans. Yet these results are real today.

Transforming a country’s economy, thus enabling its population to reach higher standards of living, requires awareness that reform is not owned by any specific group or by any political party—or even by the government that accomplished it. Effective public policies belong to the people and are an integral part of the country that implemented them. When this concept takes root, people rationally defend the policies rather than seek to undermine them through the political process. Ideally, good policy will become an integral part of a country’s culture. Unfortunately, Chile has not managed to incorporate all of the elements that foster development into its values and culture. It has embraced some, but not all. And that explains some of the backsliding.

CHAPTER ONE

Summer of 1975

It all began for me in the summer of 1975, while I waited for a bus on a hot street in Santiago. I had recently returned from the United States, after taking a two-year post-graduate course at Columbia University in New York, and was still feeling a bit of a stranger in my own hometown. I was planning to work at a consulting firm with a group of friends and eventually set up a construction company.

Our plans were already underway and were most likely on my mind when an old classmate turned up at the bus stop. That encounter changed my plans completely. My friend told me that he was working for the government National Planning Bureau, known as Odeplán (Oficina de Planificación Nacional), which at the time was committed to carrying out an economic restructuring and recovery program, and was in need of a large number of young, qualified people to work in the Economy and Treasury ministries.

A year and a half had passed since the onset of the military government headed by General Augusto Pinochet Ugarte. By then the foundations for the transformation of the Chilean economy—which by the mid-nineties had become known as an “economic miracle”—had already been laid down. Although the military had managed to impose order at the top, the imbalances and distortions effected by decades of state control still endured. The performance of state enterprises had improved, but these companies were still generating astronomical losses. The state was disproportionately large, and the allocation of resources escaped all notion of efficiency. Scope for action in the private sector was very limited, and capital flight of companies was a widespread phenomenon. Furthermore, Chile was still locked in a closed economy model. A scant fifteen months into the military government, the situation was difficult—difficult due to international hostility, difficult in the aftermath of the oil crisis that put an end to Chile’s best decade in terms

2 Summer of 1975

of trade in a long time (1964–1974), and difficult because unsolved structural management problems were weighing down the economy.

My friend explained that the first priority, then, was to straighten out the management of public enterprises, which accounted for no less than half of the government’s deficit. In his opinion, things were being handled competently and seriously, with the long term in mind.

“Why not consider the possibility of cooperating in this task, even if it were just for a short time?” he asked me point blank.

I did, and my time in the government—fifteen years in all—was not short. Between 1975 and 1990, I contributed in various areas, working toward the transformation of the country: first as an adviser for the Economy Ministry, later as Undersecretary of the same ministry (1979–1980), Undersecretary of the Health Ministry (1980–1983), National Planning Minister (1983–1984), Banks and Financial Institutions Superintendent (1984–1985), and Minister of the Treasury (1985–1989). This process involved the effort of many people for whom I later had a chance to speak as their candidate for the presidential election of December 1989.

I witnessed how, amid failures and victories large and small, Chile underwent a truly revolutionary liberalization process. I also saw the country successfully overcome the abrupt fall in its terms of trade that it experienced in 1974. Later on, the country was also successful in defeating the external debt crisis during the eighties, before any other country in the region did so. I was part of a team that prevailed over the challenges posed by that crisis, which affected the global financial system and forced us to restructure banks, among other things. None of these challenges was free of difficulties.

Despite all of the difficulties and challenges, this proved to be the most important period in my professional life. It was an exciting time, during which it was my responsibility to become engaged in numerous action fronts in the modernization program carried out by the Chilean military government.

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Deep down, I think that this group, this government, and the circumstances that Chile was going through in those years gave me great opportunities to strengthen my interest in the country’s development and to draw on my ability to put principles and concepts into practice, applying them to the cause of creating opportunities for the country’s poorest. This possibility of translating scientific abstractions into action—significantly affecting the lives of people and of society—was what truly captivated me and kept me in government longer than I ever would have imagined.

When I joined in 1975, the outlook might have been ominous, but the pervading spirit at the economy ministry was optimistic and full of confidence.

The Mark of Messianic Socialism

The first two years of Salvador Allende’s socialist government (elected in 1970 with 36.2 percent of the vote) showed me what the rest of the world found out after the fall of the Berlin Wall: that socialist rhetoric is one thing, but its leaders’ and promoters’ behavior is, unfortunately, another. I realized then that individuals, whatever their ideology or political leanings may be, all behave in much the same way. This being the case, socialism’s alleged identification with the poorer strata of society could be a simple façade set up by socialists to reap personal or group advantages They used the same logic and the same dynamics as the loathsome monopolistic privileges they denounced and sought to dismantle. As a Russian citizen remarked many years later, theirs was also a market system, only instead of operating through a market economy, it operated through a market bureaucracy.

It was precisely that bureaucracy that left in its wake a legacy of poverty and deracinated institutions, as well as a society fragmented by bitter social and political divisions. In 1972, Chile’s economic growth ranked second-to-last in Latin America. By the time Allende’s

4 Summer of 1975

government fell, the country’s annual inflation rate was 286 percent, and it reached 508 percent three months later, after a few distortions created by fixed-price policies had been amended. External accounts were out of control and the government’s deficit exceeded 25 percent of GDP. In just three years, the socialist government increased the country’s foreign debt by 23 percent. With the benefit of hindsight, and bearing in mind that while all this was happening the country was still profiting from the high price of copper, it becomes even easier to understand how misguided that government’s ideology was.

By the end of Allende’s administration, savings and gross domestic investment, at 6 percent and 7.9 percent respectively, were at their lowest since the early sixties. Since 1970, the economy had been registering successive and significant balance-of-payments deficits. The state was gradually taking control of means of production, through nationalizations, expropriations, confiscations, and interventions. As a result, the direct managerial participation of the state in the economic output of all sectors rose to over 73 percent in 1973, except in manufacturing, where it rose to 40 percent. There were price controls on most essential goods, under the excuse that fixing prices was needed for lower income citizens to have access to those goods. Protectionist levies were such that a 105 percent average nominal import tariff was in effect at the end of 1973 (with maximums ranging between 220 percent and 750 percent), as well as a variety of non-tariff restrictions, to all intents and purposes precluding the import of qualified goods in over 3,000 of a total of 5,125 existing tariff positions.

During the Allende government’s last year, 1973, the country was practically paralyzed by workers’ strikes. Violence ruled the streets. The General Secretary of the Socialist Party suggested “setting up a people’s tribunal made up of the workers’ trade union federation (Central Unitaria de Trabajadores, or CUT), ‘industrial associations,’ and other groups, in order to judge the political and economical delinquents who are directly responsible for the state of sedition promoted by

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reactionaries...”1 Chaos reigned. Although it is not essential to this account, it must be emphasized that this chaos was not only economic but, fundamentally, also social and political. The imprint of socialist ideology was also clearly visible in the political area, as was its intention to monopolize political power completely, even when it meant disregarding the rule of law. Therefore, the Chamber of Deputies voted on August 22, 1973, stating that, “the present Government of the Republic has, from the start, attempted to gain complete power, with the obvious purpose of subjecting all individuals to the strictest state control, both economic and political, and thus establish a totalitarian system.” In turn, several months into the military government, Patricio Aylwin, president of the Christian Democratic party (and later my opponent and the winner in the 1989 presidential elections), fully justified military intervention. He said that “the economic crisis, the attempt by Unidad Popular to monopolize power by any means, the moral chaos, and the institutional destruction to which Mr. Allende’s government has led the country, have caused the level of collective despair and anguish in most Chileans that precipitated the Armed Forces’ uprising”

Essentially, the failure of Salvador Allende’s project is connected to the irrational faith shown by Chilean socialism that life and society could change, and in fact would change, as a result of top-down institutional measures that would presumably be able to change black into white. This same top-down, command-and-control approach justified the use of any means to achieve those ends.

I have always felt deep mistrust for such hubris. Socialism tried to clothe itself in scientific robes, using extremely complicated formulas and relatively high-sounding terminology, but at its core, it was nothing but a crude utopia, supported by feet of clay. As an ideology, socialism was nothing more than messianic belief based on principles such as the following: that people could improve their lot without sacrifice and personal effort, that the right to private property goes hand in hand with

1 Telephone interview July 14 1973. Qué Pasa magazine anniversary issue.

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injustice, and that the only important issue is not how to produce more wealth but rather how to distribute it. In reality, however, these are nothing but crude and foolish fantasies.

It seemed to me, at the beginning of the seventies, that this kind of system could never work, and the proof provided by Allende’s government in Chile was categorical and conclusive. It anticipated the failure that would become manifest on a worldwide scale only two decades later. Socialism was doomed to failure. On analyzing the outcome, I think that we should be surprised not so much at its downfall, but at the fact that it survived for as long as it did. The only explanation for this is the brutal degree of control that it imposed on entire societies through propaganda, the manipulation of intermediate organizations, political control, police repression, and expropriation of all potential expressions of free life in society.

In addition to the harsh methods, which socialist governments used to monopolize power and control in the former Soviet bloc, socialist doctrine effectively capitalized on the idealism of Western intellectuals to gain a foothold in the West. My generation—and many others—were captivated by the rhetoric of state control and the panaceas it offered. Socialism did not offer a solution—for it was not a solution—but rather the hope that the situation of the underprivileged would improve, and based its legitimacy on this faith.

Time proved this promise and this belief to be irrational. Latin American history did not follow Fidel Castro’s lead, as every progressive voice raised in the seventies had claimed it would. At the end of the day, not only did socialism fail to live up to the expectations around the world that it had fed on for years, but it also revealed a sordid side—especially in the Eastern bloc countries—in terms of injustice, privilege, arbitrariness, oppression, corruption, terrorism, jails, clinics, control systems, and repressive mechanisms of refined cruelty. Glimpses of this had already been seen during the socialist government years in Chile. Two decades later, following the dissolution of the Soviet Union and the fall of Honecker and the Ceausescus, much more would become known.

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Once again—even though it means stretching beyond the scope of this document—we cannot avoid reflecting on how good intentions and promises of hope can lead entire countries down the road of disastrous policies that only sow poverty and conflict. Socialism and communism are not unique in this respect. This could prove an important area for historical and sociological analysis: to identify clearly the institutional and cultural elements that prevent societies from embarking on ventures of this type, which lead to such colossal costs, especially for society’s poorest.

Socialism Was in Chile before Allende

As surprising as many people might find this, what the socialist government carried out in Chile was not entirely different from the country’s political history since the thirties. The Unidad Popular government may have taken practices and tendencies to an extreme, no doubt, but the paths taken to nationalize, confiscate, expropriate, and restrain the private sector had been cleared a long time ago.

Moreover, these practices and tendencies were not exclusive to Chile. One way or another, they were part of the predominant experience and thinking in all of Latin America at the time. Chile simply went farther down this road, because—among other reasons—observance of laws and regulations in this country was objectively much stricter than in others. This compounded the problem.

In the sixties, labor and foreign trade laws, to name two examples, were probably just as interventionist in Chile as in Peru, Brazil, or Venezuela, but in those countries, the relative impunity with which these laws could be infringed provided some degree of relief and made it possible for their economies to neutralize the damage that they caused to some extent. In Chile there was no such flexibility.

8 Summer of 1975

Commitment by the Government: The Roadmap

It was General Augusto Pinochet, hardly an eloquent but certainly a very tenacious military man, who dared to challenge voguish myths and put the country’s economic transformation into effect. The most important decision made by the new government in the early seventies was to follow the path prescribed by reality rather than by ideology, opening the economy to the world at a time when global trends pointed in the opposite direction: national economies under firm state control.

Long before Margaret Thatcher (1979–1990) liberalized the economy in Great Britain or Ronald Reagan (1981–1989) led the conservative revolution in the United States, Chile carried out a number of privatizations and deep structural economic reforms. By becoming one of the most open economies in the world, the country became a pioneer in privatizing inefficient state companies and in promoting private enterprise. Twenty-five years before the European Union made balance of fiscal accounts a membership requirement, the military government included it among its economic objectives.

In October 1973, the government lifted price controls on almost all goods. The prices of only about 30 articles remained fixed, while over 3,000 were freed up. However, not all of the signals sent out by the government at the time were encouraging. There were serious and urgent needs in all areas. Not only did the Central Bank lack reserves, but the country faced a $400 million deficit. Additionally, there was not full consensus within the government’s economic team as to what path to take. “Murmurs, alarmist voices, and attempts to prove that the economic team was leading the government and the country to ruin, constantly reached the governing Junta,” is Chilean writer Arturo Fontaine A.’s2 recollection of those days. The government undertook unpopular but necessary measures to straighten out the country’s accounts. Liberalization of prices was accompanied by a strong devaluation. Prices

2Arturo Fontaine A., Los economistas y el presidente Pinochet, p. 53

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skyrocketed, and the direction of the country’s economic policy was increasingly called into question by all sides.

This is what makes politics so complicated. Political options are hardly ever black and white. There are gray areas, conflicts between one value and another and, quite often, serious internal contradictions. No group is free of philosophical misunderstandings and personality conflicts.

Deeply immersed in this social, economic, and political milieu, the two main architects of these transformations—Minister of the Treasury Jorge Cauas, and Minister of Economy Sergio de Castro—prepared a recovery program. In April 1975, Law Decree 966 was enacted, naming Jorge Cauas “Superminister” and granting him the greatest economic policy-making power that anybody ever had in Chile in the twentieth century. His designation was an attempt to correct the existing lack of coordination and to establish homogeneity in an area in which undisciplined strongholds made commitment to a uniform and consistent policy implementation plan difficult. The plan reaffirmed the goal of implementing the principles of a market economy. Concretely, it meant applying shock treatment by reducing government spending by 20 percent, dismissing 30 percent of public employees, and privatizing most state enterprises.

It is important to note that, in addition to the disaster bequeathed by Allende’s government, at that time the Chilean economy faced a dramatic change in external conditions—from the surging price of oil to the falling price of copper—that would never again reach the levels it had during the decade of 1964–1974. Even without the depredations left behind by Allende’s socialist policies, these factors alone would have made management of the country’s economy a difficult task.

What persuaded me to work for the government, given such challenging and adverse circumstances? First, it was my belief that this time things were being done differently. I felt that economic policymaking was in the hands of a remarkable group of extremely responsible and technically qualified people. I believed not only in their

10 Summer of 1975

optimistic new vision for Chile, but also—and this is always important—that they were working without regard to partisan interests, both individually and as a group. I saw no hidden agendas, which had frustrated the good intentions of many governments in the past. Finally, I was impressed by the steadfast vision that the team shared with General Pinochet of a free, developed Chile, ready to offer equal opportunity to all of its citizens.

The roadmap that guided the economic liberalization was a document that became known as El Ladrillo (The Brick), drawn up by a group of young professionals between the ages of twenty-six and thirty-five. Concerned by the direction that the country was taking during the socialist government, they met on a weekly basis and discussed liberalization of prices, tariffs, real property, and banks. This group—formed largely under the auspices of a joint program run by the Universidad Católica de Chile’s School of Economics and the University of Chicago—worked conscientiously to develop a dispassionate diagnosis of the Chilean economy. The task took a long-term view and was implemented outside the scope of political parties—although some of the economists on the team were active in rightist and center groups. It seemed a quixotic endeavor. Everything was done with great discretion.

As far as documents go, El Ladrillo is neither very long nor very comprehensive when compared to what was actually done, but it reflects the development process of a different critical and intellectual consciousness by people who were tired of being asked to believe in implausible, farfetched promises. Eschewing the alarmist rhetoric and socialist triumphalism prevalent at the time, they made a very important contribution toward changing Chile’s reality and destiny.

El Ladrillo, which placed individual freedom at the center of economic activity, reached military circles and became the guiding economic policy document for the duration of the military regime. Barely three weeks into the new government, over 200 copies of El Ladrillo had been distributed among the new authorities.

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The team that drew up this plan shared not only a desire to leave economic stagnation and state control behind, but they also had another important common denominator: they all had absorbed free market theory at the University of Chicago. They set to work in 1973, and their ideas became so important to the course that the country was taking that they became known as the “Chicago Boys.”

Although by education I did not strictly fit the “Chicago Boy” profile, I never felt like an outsider. On the contrary, I found respect, acceptance, loyalty to teamwork, a genuine disposition to service, and openness. I believe that the military rendered a decisive and fundamental service to the country, which not only changed Chile’s history for the better, but also steered it toward an unexpected future of reconciliation and prosperity.

The costs exacted on Chile by decades of socialist policies, and carried to extremes during Allende’s government, is beyond measure, both in terms of poverty and deterioration in standards of living. It took a leap in progress, sustained over decades, to overcome the past difficulties and leave them behind. Strangely enough, many Chileans are still not sufficiently aware of the reasons for the price paid or of who were truly responsible for it.

Can the Model Be Replicated?

When asked whether the Chilean experience can be replicated in other countries, I invariably answer yes. Yes, insofar as its principles are concerned, it can be reproduced, because they are equally true and effective everywhere. However, specifics—how things should be done, the pace of the liberalization process, the order in which things should be done, and, just as importantly, the group of people who will carry out the reforms—all vary from country to country. No matter how successful an experience has been, it is never completely reproducible, and that is where the creativity of both experts and politicians enters.

12 Summer of 1975

As far as I witnessed, General Pinochet never rejected the reforms proposed by his ministers, as long as they were appropriately presented and defended, yet he never agreed to them easily. He listened and insisted on hearing different opinions. Various groups holding conflicting positions coexisted within the government. Reform projects were subjected to the harsh scrutiny of different parties. There were those who defended the government’s political stability and refused to support measures that might seem to contribute to further deterioration of the population’s economic situation. There were also economists who placed their bets on long-term benefits.

The President moderated, arbitrated, persuaded, and, in the end, either made the decisions or presented them to—and defended them before—the government Junta. Behind each decision lay a web of debate, research, conflict, pressure, consensus, and struggle. This is true of any government task, even in an authoritarian regime. Restricted as they may have been, the levels of participation in General Pinochet’s government were much more sensitive to public opinion than is thought to have been the case. Not even a government as strong as General Pinochet’s could function in opposition to a whole country—in the long run, no government can, especially when it is broadening individual freedoms.

Economic liberalization in Chile had to overcome tremendous adversity: generalized international hostility toward the military government and negative external conditions for the prices of the country’s exports, coupled with financial difficulties. However, these same circumstances held one great advantage: rejection and isolation killed any illusions about any alternative models for development. Such alternative models have been the death of many other Latin American governments, which were confident—as seems to have been the case in Raúl Alfonsín’s administration in Argentina (1983–1989)—that they could solve their economic problems based on the sympathies of world public opinion and international “solidarity.” Such internationalist utopian dreams turned out to be groundless and foolish. Dependency on

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international economic aid and handouts from rich nations is not only humiliating, but also fundamentally unproductive. However generous, international aid can never compensate or correct structural distortions in an economy. In the end, aid can become a dangerous anesthetic. Even if populist politicians reject the idea, aid never exonerates governments from the compelling need to restructure, adjust, and modernize their economies.

I believe it is best to be realistic when facing this responsibility. In general, I reject fundamentalist beliefs, even liberal ones. Modernizing our countries is not a task for gurus or preachers of messianic liberalism. On the contrary, I consider it a challenge befitting sensible politicians and reasonable experts—public servants with keen insights not necessarily acquired from books, but from experience, and who can apply those insights to their work. In this area, unyielding commitment to consistency, unbounded doctrinal zeal, and dogged ideological determination often cause more harm than good. After all, achieving liberal reform is not as difficult these days. Being an authority on the subject is not a requirement. It is simpler than that. All one need do is notice which economies have been successful and which have not. All one need do is compare and draw a few conclusions. But one cannot just stop at this point, as theorists tend to do. It is important to act on these conclusions, realistically and imaginatively.

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CHAPTER TWO

Of Miracles and Programs

Chile’s economic transformation over the last thirty years is a story of success. From the mid-eighties until the Asian crisis in 1997, the country’s economy grew at a 7.2 percent average annual rate, followed by a 3.5 percent growth rate between 1998 and 2005. But what has become known as Chile’s economic miracle was anything but that. It was a program. Miracles are heaven-sent gifts outside the sphere of human agency. Programs, on the other hand, are temporal and must be painstakingly implemented by human beings. They also carry another inherent earthly trait: the risk of failure.

The project conceived in Chile translated into a program that was pragmatic and unflinchingly realistic. There was nothing supernatural about it. It was based on opening the Chilean economy to the world and revitalizing a languishing private sector. A single import-tariff system was set. State enterprises were privatized. The list of initiatives adopted is extremely long. There must be a check on inflation, creation of an autonomous Central Bank, balancing of fiscal accounts, opening of space for the private sector, creation of a new pension system, decentralization of education, development of a social safety net for the poor with an emphasis on human capital, and more. Numerous considerations were kept in mind during the development of this program, which entailed a huge effort to deliver a comprehensive, consistent, and coordinated answer to the country’s main problems.

Precedents: Who Invented the Wheel?

The Program was not an especially original creation, at least regarding its confidence in the market and in private enterprise. From the late sixties

16 Of Miracles and Programs

and through the mid seventies, the model of the Asian countries was clearly observable to anybody who cared to analyze it.

During the fifties and sixties, John Cowperthwaite, a devotee of Adam Smith (and fellow Scotsman), implemented free market economic policies in Hong Kong, transforming the poverty-stricken peninsula into a world-leading example of sustained growth. In Taiwan, multi-year plans to strengthen industry and increase exports peaked during those years. Much the same happened in South Korea. Singapore also has shown how to transition from the Third World into the First in one generation.

In the late seventies, on the other hand, Brazil was heading into a slump, which it cannot be said to have completely left behind, despite the fact that during the sixties, Brazil’s liberalization experience led to almost twenty years of spectacular economic growth, with 9 percent GDP growth rates. Going farther back, we find Germany and Japan as precedents, rising on the basis of market incentives and the dynamism of private enterprise.

Chile did not invent the wheel: the true road to development had been known for many years. The originality of the Chilean experience was not to be found in the contents of the economic program as much as in the courage it took to set out on a lonesome and difficult path at a time when the rest of Latin America was going in the opposite direction. It was also to be found in the decision to advance toward a free economy even though the country had set out on the path toward state control and socialism long ago, well before Allende’s time.

This is what makes the Chilean experience remarkable: to have embarked on a process to reform and revive the economy that went against programmatic illusions then prevailing throughout the region. From socialism to populism, these illusions all shared a strong belief in state intervention and in the revitalizing effect of expansionary monetary policies—both of which went against all historical evidence.

Particularly laudable was the recognition—despite the difficulties ahead—that the way out of the long, dark tunnel in which Chile found

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itself lay in the opposite direction from that in which the country had been headed for decades. Credit is also due to the transformations having been carried out realistically and seen through successfully to completion.

At the time, defending the free market was no easy task. Not among supporters of the new regime could one find agreement on the advantages of economic liberalization. In that context, persuading the population of the benefits of the free market was a tough sell. The idea of the paternalist state was too deeply embedded in the national mindset to be removed overnight. Minister of Economy Sergio de Castro, in a book on his role in the reforms, describes the mental obstacles that he faced in how exhausting it was to convince people. He points out:

I don’t think we were fully aware at the time of the mental restrictions we faced, because all military men reacted that way. It’s true that we found the same response from priests, trade unions, businessmen, civil servants, CEPAL [United Nations Economic Commission for Latin America and the Caribbean] economists, engineers, professors, etc. The thing is that our basic postulate, that is, giving individuals absolute freedom to do whatever they wanted in economic matters, seemed inconceivable to a vast majority of the people who had been educated in a different viewpoint and thought that this viewpoint only needed corrections.1

We also faced constant and brutal criticism from the military government’s opponents. We were attacked in a particularly vicious and uncharitable way. There was not a single criticism that we did not hear: that our project was not only technically misguided, but also socially genocidal and politically reactionary; that the development model was tailored to suit the interests of a repressive and illegitimate dictatorship; that it did not address Chile’s needs; and that nothing we did would last,

1 Patricia Arancibia C and Francisco Balart. El Arquitecto del Modelo Económico, p. 189.

18 Of Miracles and Programs

because it was doomed to disappear along with the political regime that had promoted it.

The Two Phases

The Chilean economic revolution comprised two major phases: stabilization and modernization.

The first phase was based on the view that keeping accounts in order is preferable to having unbalanced accounts. This seems like a truism today, but it was not that evident at the time. The hierarchy of the socialist government was oblivious to basic macroeconomic equilibriums, which is an attitude that would be ridiculed today. In the late 1960s and for quite some time after, economic thought held that a small amount of imbalance was not necessarily bad, and that growth was well worth a certain amount of price instability. After all, what difference did it make?

The question at the time was how much inflation could be tolerated. The combined effects of the model promoted by U.N. Economic Commission for Latin America and the Caribbean (Comisión Económica para América Latina y el Caribe, or CEPAL) and macroeconomic instability were taken to ridiculous extremes by Allende’s government (as Raúl Prebisch, one of the main supporters of autarkic growth, points out). This anticipated the disastrous economic populist policies that would exacerbate problems throughout the region over the next few years. Examples of such disasters include the governments of Alan García in Peru (1985–1990, but after being reelected in 2006 he has been a convert to economic liberalism); Raúl Alfonsín in Argentina, to a lesser degree (1983–1989), and José Sarney in Brazil (1985–1990). It was like a contagion that spread to devastating effect to the economies of the region.

General Pinochet’s government adopted a reform and modernization program that firmly rejected that approach. It blamed government

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distortions for the extremely damaging consequences that had thwarted the country’s development for decades.

To balance accounts, especially when external conditions for Chile were worsening, meant above all to stabilize the economy and restore some conditions of rationality that were essential to productivity. However, in Chile the military regime intended to go quite a bit farther.

There was an urgent problem that had to be dealt with immediately: putting out the fires that were consuming every sector of the Chilean economy. But the fundamental question was how the country would embark on a modernization process that would address the structural dysfunctions and distortions throughout the economy.

The government acted simultaneously on both fronts. It did not tackle modernization once the economy had been stabilized. The campaigns for stabilization and modernization were concurrent. From the outset, the emphasis was on addressing the chaos prevalent in the country in September 1973. As soon as the economy was brought under control, the government set out to work on its longer-term objectives.

The difficulties during this process appeared to be never-ending. The price of copper—about which Allende had complained so much because during his government it was lower than during that of his predecessor, Eduardo Frei Montalva (1964–1970)—began to drop at an alarming rate. If Pinochet had enjoyed the higher real prices for copper that Allende’s government had, the challenge of stabilizing the economy would have been far less overwhelming. As we have already mentioned, the price of copper from 1964 to 1974, when seen in historical context, were exceptional. They would not reach comparable values again until 2005.

The transformation of the Chilean economy was launched in the midst of a chaotic state of affairs. In October 1973, the same month in which prices were freed and some measure of stability was attained, the OPEC oil embargo struck, causing a dramatic deterioration in Chile’s terms of trade. By the next year, Chile was paying four times more for oil and selling copper at half the price.

20 Of Miracles and Programs

In 1975, Minister Jorge Cauas’s recovery program was implemented, marking the beginning of a period of great hardship. Cauas—a serious, meticulous, brave man, and one of the driving forces behind the transformation—imposed a strict check on spending on the public sector. This was intended to address an extremely critical fiscal deficit. This period, which became known as the “shock policy years,” was tough because the country’s margin for action had been reduced to pathetic levels. The Cauas plan reflected the courage to acknowledge this reality and then dealt with it creatively by means of the severest austerity plan possible. There was no choice but to thoroughly reform a public sector—including government agencies plus state companies—that was evidently oversized. Consequences were felt immediately. GDP fell by 12 percent and unemployment skyrocketed to 16 percent. An active social policy focusing on the needier sectors was established in an effort to reduce the impact of the shock as much as possible. The Minimum Employment Program (PEN) was financed by the central government and administered by local city councils. These numbers are dramatic, but should not be seen in isolation of their context. Imagine Chile today with the price of copper at $3–$4 per pound for the last three years. Now also imagine that this situation has gone on for ten years, that savings are nil, and that monetary policy has degraded the currency to absurd extremes. Let us also suppose that all incentives to save, employ, and invest have been destroyed and that peace is hard to maintain. Let us consider what would happen in this hypothetical country if its external conditions were to change abruptly and if it were to see the price of copper drop below the dollar barrier. That is the reality, only worse, which Jorge Cauas’ plan had to confront

At that time, Chile faced the darkest hour of its twin crises. After that, the situation slowly began to improve. It was during Ministers Cauas’ and de Castro’s terms in government (1974–1976 and 1976–1983, respectively) that the first plans for reform were drawn and implemented—liberalization of trade, the financial sector and prices, and a comprehensive overhaul of the tax system—over a period that lasted

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until the debt crisis in 1982. That year the global financial crisis, with interest rates of over 16 percent, hit all developing countries, including Chile.

At the time that the crisis hit, the country began a new phase of reform, which lasted from 1982 to 1985. This period was full of uncertainty and doubt, but all things considered, the country kept on track on the essentials.

And so it began, in 1985, the last period of the Chilean economic revolution, which was my responsibility to lead as Minister of the Treasury. During these years, the country managed to recover from the debt crisis, reformulated the principles priorities of a market economy, and intensified several modernizations. All in all, this reform period came through the restoration of democracy with the government of President Patricio Aylwin (1990–1994) unscathed, and has continued—give or take a few adjustments—to the present day.

The Ingredients of Success

The success of Chile’s economic liberalization process rested on at least three key factors. First is the political will to reestablish a viable economy that would be responsive to the Chileans’ aspirations to greater well-being. This political will, sustained with great tenacity by General Pinochet, never faltered and was the element that gave continuity to the process. At several critical moments, General Pinochet stayed the course, despite difficulties and pressures. This happened in 1975, when he backed the Economic Recovery Plan designed by Cauas’s team. Even when a new economic team took over—when Luis Escobar Cerda was sworn in as Minister of the Treasury (1984–1985)—the main guidelines were maintained. Moreover, when the new minister stepped in, the government was also joined by professional staff that played a decisive role during my subsequent period in that same office. Chile had six ministers of the treasury between March 1982 and February 1985, which

22 Of Miracles and Programs

shows how turbulent a period this was—although, fortunately, the ultimate course was not changed.

When analyzing these years, the question frequently comes up as to why Pinochet and the government Junta, despite the difficulties, stuck to their decision to back the opening-up and modernization of the economy. There are those who believe that he had acquired a deep understanding of the economic proposals in El Ladrillo, while others think he placed his trust in his advisers’ technical capacity. But also, apparently, General Pinochet had decided to be the promoter of a true revolution for the country.

Even so, the President’s support of the economic team’s work was never a blank check. Far from it. The team was under permanent scrutiny, from a distance. During my time as Minister, I do not think I ever felt safe in my position. I knew that I could be dismissed from the government at any moment. At the end of the year, when General Pinochet would make changes in his team, every minister had to be ready to look for a job elsewhere. In that respect, our own situation was extremely vulnerable.

The second factor, which, in my view, explains the success of the reform, is that the economic reform development project was in the hands of a competent professional team. As in any large project, the successful implementation of the economic reforms does not depend on one man alone, but rather on hundreds, or even thousands of people working toward the same goal. When the challenge is this great, just as in the rebuilding of a country following an earthquake or other natural disaster, it is important to tackle the problem from all sides. This requires not only experts in macroeconomics, but also people who can handle the situation in other areas and cope with sensitive issues such as education and health.

Miguel Kast, an economist with a degree from the Universidad Católica who took post-graduate courses at the University of Chicago, played a fundamental role in the recruiting of young professionals. He was a born leader who—despite his premature death at age thirty-three—

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occupied two ministries and the presidency of the Central Bank and, despite the sense of urgency of the moment, managed to put together teams that generated the changes needed to carry out the reforms.

The third factor was a belief in what we were doing that was strong enough to transcend our individual interests. One way or another, we were all part of and agents for a greater whole, which was not the economic team or even the military regime, but the idea of Chile finally being rescued from mediocrity in order to be able to take advantage of the immense potential of its resources and—more importantly—of its people.

Our background was mainly academic and, on the whole, we were rather clumsy as far as profitable activities went. Any parallel business would have been considered not only suspicious but scandalous. It is a known fact that salaries were extraordinarily modest, and austerity within the ministries, even in leadership posts, reached puritanical levels.

This idea translated into a mistrust of anybody making any personal gain out of his or her position in government. The alliance between the government, the banking system, and industry—which had apparently gone unhindered in countries such as Japan and Korea, and which generated collusion and complicity between ministers and managers, between companies and government institutions—became unthinkable in Chile. If General Pinochet and the military accepted the economic model, it was because, among other things, it preempted discretionary measures. The tight relationship between governments and companies, which during the eighties was considered peculiar to the Asian Tigers—resulting in major concentration, favored export sectors being arbitrarily chosen, and industrial policies being forged on the basis of exemptions and privileges. This situation, in which the state places its bets on specific economic sectors, would never have worked under the military government.

This not only guaranteed greater economic efficiency, but also created a cleaner and more transparent public administration. Chile was probably able to optimize its investments efforts because, to a great

24 Of Miracles and Programs

extent, it was the market that determined the competitive advantages of different sectors. It is true that Southeast Asian countries did very well, but it is also true that, in certain areas, they have done very badly, to the detriment on the return of their high investment rates. For example, in the early eighties, South Koreans paid the price for the failure of industries that their government had decided to favor a few years before. They favored interventionism and the state placed its bets on the development of certain industries. In the end, this policy backfired.

Being wary of state control does not mean that constant care must not be taken to strengthen the private sector, but this was done in Chile as a general policy, not to favor one sector, industry, or individual.

Change and Consensus

The presence of political backing and a sound transformation program, as well as a team that was qualified and motivated to carry it out, was one thing; whether the changes were implemented effectively was another. It is important to make this distinction, because the Chilean economic revolution was not done by the book. The recurrent accusation that we faced from reform opponents that we were some kind of fanatic gang, determined to apply standardized University of Chicago recipes come what may and whatever the cost, could not have been more wrong—because there were no recipes in Chile. Had there been, perhaps everything would have been easier for us.

The successful completion of a transformation requires more than that it be properly conceived from a technical point of view. Sometimes governments—in fact, almost all governments—have good ideas that go awry because they never get past the sphere of theory, ideals, and speculation. Therefore, something more than good ideas is required. A certain skill in generating consensus is also needed—not just at the top levels, which was the kind of consensus the Chilean opposition was

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interested in at the time—but especially at the grassroots level, among ordinary people.

That is a fact: transformations cannot be carried out when the whole country is against them or when the initiatives are not accepted by the citizens. It will not work, even, as I have noted, in an authoritarian government such as General Pinochet’s.

What we learned is that the approval level for reforms can always be increased as long as the team promoting the changes has a detailed knowledge of the problems that it is trying to solve. Knowledge is essential regarding theory and practice, the broad lines and the detail, the historical background of problems and of the current situation.

It is a thorough knowledge of things—of the specific tax system applied in a given activity, of the cargo dispatch system used in sea transport, of the way companies that generate electricity and those that distribute it operate, or of how public transportation in Santiago actually works, to name a few examples—that makes it possible to move the discussion from the ideological sphere to the practical one and find in-depth solutions, using creativity and common sense.

None of this was easy, of course. Talking about liberalization is not the same today as it was fifteen or thirty years ago. The international climate today is much more receptive toward free market solutions than it was then. In the wake of socialist bankruptcy, the crisis of CEPAL models, and the huge economic and political fraud played out in the eighties by Latin American populism in its various styles, the convergence of viewpoints is much greater. For example, the mention of the word privatization is no longer scandalous.

From Words to Action

A member of a delegation of Russian economists who visited the Libertad y Desarrollo (Freedom and Development Institute) in 1991 got

26 Of Miracles and Programs

it right, I think, when he pointed out that the originality and significance of the Chilean case lay in its practitioners knowing how to apply universally valid economic principles to the specific circumstances of our country. That was probably the secret. The merit in the initiatives themselves, such as the trade opening-up and tariff relief program, the tax and pension systems reforms, or the privatizations, is that they were not tied to the principles—which are universal and known to anyone—but to the practical stages and mechanisms that these modernization steps involved. The greatness of an economic policy is always measured in the smaller details—the “hows” far outweigh the “whats.”

In this respect—in its details, its fine-tuning, and patient artisanship—the Chilean revolution cannot be exported as a whole. The successful pension system reform carried out in Chile, its operative structure, and transition mechanisms will not necessarily be applicable for Mexico or for the Russian Federation. The principles will work just as well wherever they are applied, but methods will no doubt need to be different. Circumstances and conditions will almost certainly not be the same. The Chilean model cannot be transplanted from one setting to another in its pure form.

The lesson to be learned from Chile points firmly in another direction—to the fact that no problem is insurmountable and that the solution to a society’s chronic troubles does not lie in third countries or in foreign aid, and definitely not in a hypothetical “international solidarity.” It depends exclusively on the effort that each country makes to correct its own imbalances and overcome its own adversities.

Chile had plenty of both. The country, which the military government took over, was in a shambles. Where did Chile find the energy to leave this predicament behind? From delving down into its own reserves, and nowhere else. As contradictory as it may sound, Chile was able to break free because it had reached rock bottom. Unconsciously, the country had been heading toward a dead end for years. There came a point when, given the population’s despair and the

Hernán Büchi 27 

new government’s sense of urgency, conditions were ripe for a drastic change of course.

A Few Observations

The catastrophic panorama in Chile in 1973 calls for a few qualitative observations:

• This was a homemade crisis. Unlike other crises that the country experienced later on, which were induced by external factors—the first oil crisis in October 1973 and the debt crisis in 1982—the crisis during Allende’s last year was brought on solely by irresponsible economic policies. One need only remember that, when confronted by the concern expressed by vast sections of public opinion over the excessive growth of the money supply (119 percent in 1971, 139 percent in 1972, and 337 percent in 1973), the president of the Central Bank at the time remarked that this was a bourgeois variable, and irrelevant to the construction of Chilean-style socialism.

• The lack of control in the Chilean economy between 1970 and 1973 was a radicalized expression of the Keynesian panaceas so widely practiced and recommended in the sixties. It was a period of accelerated expansion, but it was also a period of recklessness. In fact, world growth rates were very high during those years, except in Chile, because even during the 1960s boom, the country was bogged down by state controls. Between 1950 and 1970, the yearly GDP growth rate in Chile was only 1.4 percent, whereas in developed countries with comparable income levels it averaged 3.1 percent.2

• Governments at the time thought they had found the philosopher’s stone of prosperity and wealth. At the first sign of economic fatigue or contraction, they resorted to expansionary monetary policies, which began turning the wheels of growth again. At first the

2 World Bank 1980. Chile: An Economy in Transition.

28 Of Miracles and Programs

formula seemed effective, but in time, it took a heavy toll. Gradually, the medicine lost its effectiveness, and the pressure of inflation, which would spin out of control during the next decade, was set in motion. The world paid the price during the seventies.

• If Chile is often seen today as a model for economic recovery through reliance on the energy of the market, it should also be kept in mind that it was once also a leader in state control and public sector hypertrophy. By 1973, 85 percent of the country’s mining production was connected to state-controlled enterprises, while 70 percent of transport and 40 percent of industry was linked to the state3. To a certain extent, the country turned back from centralized state control earlier than any other Latin American economy, because it already had gone farther down that road. In 1975, twenty-four months into the new government, there was still a lot to be done. Fifteen of the twenty largest companies in Chile were state controlled.4

• It could be argued in good faith that the Chilean economy in 1973 was dysfunctional and inefficient, but that this was nevertheless acceptable from an ethical point of view, insofar as it had been organized in terms of the requirements and needs of the poorest sectors of society. But this was not the case. Quite the contrary, social policies in Chile at the time were not only indifferent to 20 percent of the population that survived in extreme poverty, but were also clearly regressive in nature. On issues such as housing, health, and education, the poor—voguish speeches and political rhetoric notwithstanding—invariably held the short end of the stick. For many reasons—because they had no political power, were not part of any pressure group, and were never invited to take part when state wealth was distributed— the poorest, who lacked access even to basic education, could do nothing but look on helplessly when slogans such as “university for all” were bandied about.

• The Chilean economy in 1973 was not only in ruins, it was also a reflection of a disillusioned society that had lost all self-confidence.

3 C. Larroulet. Reflexiones entorno al Estado Empresario en Chile, p. 184. 4 Las cien mayores empresas de Chile en 1975, Informe Económico 1975–1976

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The entrepreneurial spirit had practically died out. The best that a student could hope for was to find a job in the public sector or in one of the companies controlled by the state. Complex cultural, historical, and anthropological hypotheses were posited both at the university level and in conservative circles regarding Chileans’ lack of drive and disinclination for business and hard work. Why were our people not as disciplined as the Germans? Why were we not as hardworking as the Japanese? In the search for answers to these questions within the “national soul”—in the collective unconscious resulting from an ill-fated cross between the natives (allegedly rather lazy) and the Spanish (allegedly good warriors but bad producers)—no one stopped to think that this, more than a racial limitation or defect, was a problem of incentives, of an oversized state, and of a suffocated private sector. Nobody stopped to wonder why South Koreans, for example—Asian “spirituality” notwithstanding—were at the time achieving economic growth rates that even the most developed countries in the world would have wished for.

The Questions

Was the reorganizing and adjustment process of the Chilean economy botched? Could things have been done differently? Which costs can be ascribed to the Cauas plan and which must, on the contrary, be put down to the socialist experience and the oil crisis? How manageable were the problems that the economy began showing in 1982? How much progress had been made since then? Did the 1982–1984 crisis mean that a fresh start had to be made? To what extent can it be argued that the model was unresponsive to social issues?

This book is an attempt to answer these and other questions. The following chapters move in that direction. But explanations, counter-explanations, details, and clarifications aside, the basic facts need be kept in mind: the facts of a country whose decisions during the seventies went

30 Of Miracles and Programs

against the tide; of a region that during the eighties and despite prevailing problems, on the whole made good choices. Because whereas in the thirties, after the Great Depression, Latin America misguidedly chose the path that led to state interventionism, the crisis in the eighties did at least help the region come to terms with the market. For a few years, at least.

CHAPTER THREE

The First Dilemmas

When one is faced with the reality of a stagnant economy and the intention is to revive it with a liberalizing spirit and with the long term in mind, the dilemma posed is nearly always the same. The challenge lies, on the one hand, in stabilizing the existing situation, and on the other, in carrying out the structural reforms needed to modernize the productive sectors and the economic structure of the country.

Put in these terms, it seems simple enough. There appear to be two independent management processes. Actually, however, there is no such independence. Both areas are intimately connected. Consequently, initiatives made in one direction will have an impact on the other—and often, they will even conflict. But this is not the only problem that an economic reform team must solve in the initial phase of its efforts.

In all likelihood, the approach to the need to stabilize and modernize will be set within a scale of priorities. Where do you begin? Would it be better to stabilize first, and only then, once a certain basic balance has been reached, move on to the structural reform stage? Or, the other way around—would it be a better idea to fix the underlying problems in the economy immediately, since the situation is out of control anyway, and could hardly grow any worse, and public opinion shows a passive resignation toward the future? These questions came up again and again during the first two years of military government in Chile. It is true that there was an initial agreement that the most urgent task facing the new administration was regaining control of tax, monetary, and exchange policies, which were completely out of hand when Allende’s government fell. These preliminary assignments were associated with stabilization; that is undeniable. But even so, there was still a broad scope within which to set priorities, deciding between measures designed to fix things quickly and measures designed to introduce changes.

At the end of the day, a simultaneous two-pronged approach was decided on, because the need for deep structural changes in the economy

32 The First Dilemmas

met with intellectual support in Chile. Talk of structural and even revolutionary change had been going on in Chile for a long time. But the changes that liberal economists had in mind were of a different kind. They were serious, not rhetorical, changes, oriented in a totally different direction from the one proposed by the Left—which was embodied in Chile by a radical faction of the Christian Democratic party. This party subscribed to a mixture of economic illiteracy and political euphemism known as “the non-capitalist road to development,” a supposed “third way” between socialism and the free market.

Liberal Consciousness and Criticism

As mentioned in previous chapters, these changes were crystallized into a program in 1972 and 1973 in a document known as El Ladrillo, produced after extensive research and discussion by a large group of professionals. This group was convinced that Allende’s government, far from representing a detour in the evolution of Chilean economy, was simply the final step in a way of thinking that had taken over the management of the economy long before—several decades before.

While the country headed toward a grave crisis, perhaps nothing was as decisive to the course that the country would take as that group’s seemingly Byzantine discussions. Again, as noted, El Ladrillo reflects the process that shaped a critical and intellectual consciousness in people who were tired of being asked to believe in fantasies. These people—distancing themselves from the alarmist rhetoric of those years and from the socialist triumphalism then prevalent—made a vital contribution toward changing Chile’s reality and destiny.

If not for the determination of a group of Chileans to drastically change the country’s destiny—an objective shared by General Pinochet—the military government would probably have confined its efforts to stabilizing the economy over a period of one or two years, as far as it could be done by that point, and returning it to the structures in

Hernán Büchi 33 

force prior to 1970. There is no doubt that if that had happened, Chile would have simply continued marching through the miasma of ideology and underdevelopment, much like Venezuela or Argentina, whose GDP per capita in the fifties exceeded that of many European countries, are still doing.

Where Was Shock Therapy Applied?

There were many other dilemmas and tensions during the first stages in the modernization of Chilean economy, apart from the one already discussed. One of the recurring dilemmas in any liberalization process is deciding whether it is preferable to opt for shock therapy or to make reforms more gradual. Some believed that if measures were taken gradually, their effects on the population would be less severe, while if they were taken abruptly and without preparation, political consequences could be serious. One of Pinochet’s main advisers once remarked that “The Chicago Boys’ policy was like feeding a baby fried egg.” Admiral Lorenzo Gotuzzo, who was Minister of the Treasury at the time, would respond to these criticisms with a metaphor: “A certain man loved his pet cat so much that when the cat’s tail became gangrenous and had to be cut off, instead of doing it and getting it over with, he sliced a little bit off every day.”1

If my ideas on this issue may seem extreme, my personal experience is conclusive. In light of what I witnessed, even when rigorous shock policies were adopted, their implementation will always or nearly always be gradual in practice. On the other hand, if the intention from the outset is to introduce change gradually, then chances are that nothing will actually get done in the end, or that the progress made will not be sufficient. Cases in point are Argentina, Brazil, and Mexico, which,

1 Patricia Arancibia Clavel, El Arquitecto del Modelo Económico Chileno, p. 219.

34 The First Dilemmas

despite all their efforts, still have not been able to achieve high, sustained growth that is unrelated to recovery from previous downturns.

Generally, at the heart of the controversy between gradualists and non-gradualists lies a conflict between those who support change and those who resist it. The central dilemma is not whether things should be done slower or faster. The real dilemma is whether to do them or not.

Tariff reduction, for example, which in Chile is presented as emblematic of shock therapy, was far from being a rash measure. Quite the contrary, in retrospect, it seems very gradualistic.

The final objective of the tariff reform, which at the start was closely connected to the objective of dispelling the prevailing economic chaos and achieving stabilization, was to open up the country’s economy, to put an end to international isolation, and to reach a structure of low, uniform tariffs as soon as possible. These tariffs had to be low in order to make full integration of the Chilean economy into the world economy easier, and uniform to avoid the discriminatory distortions that a differentiated tariff structure inevitably entails.

Trade liberalization was intended not only to enable the country to profit from its comparative advantages, but also to strengthen domestic producers by making them more competitive, even as the process of price liberalization was beginning.

This process, in which I took part, was also very gradual. In 1973, most prices were fixed by the authorities. The Industry and Commerce Office (Dirinco, Dirección de Industria y Comercio) was one of the most dreaded public agencies in Chile. It was actually the only “company” that worked efficiently in its mission to make it impossible for producers to operate and flourish. In 1979, six years into the military government, there were still some controlled prices in Chile. The last two to be liberalized were the prices of bread and public bus fares.

The liberalization of prices was unavoidable, but even in this area the dilemmas were critical, because if the government was really determined to achieve stabilization, it could not afford to liberalize every single price overnight. Three price areas were initially created: free prices, informed

Hernán Büchi 35 

prices, and fixed prices. The process was as much political as it was economic, and it took several years to reach full liberalization.

External Opening-Up

The first stage in tariff reduction took place in 1974 and comprised three general reductions. Tariffs ranging between 220 percent and 750 percent dropped to a single 160 percent rate; those between 35 and 215 percent were cut to between 5 and 65 percent, and tariffs below 30 percent were not modified. But there were other adjustments that year. In June, the maximum tariff was reduced further, but the lower tariffs were increased to take them to desired levels. It is estimated that during 1974, the average tariff dropped from 105 percent to 57 percent. The statistically most frequent tariff dropped from 90 to 55 percent.

In August 1975, the second stage of the external opening-up program set a 10–35 percent tariff structure as its objective. A reduction schedule was drawn up to this end; some steps were accomplished ahead of time, and the goal was reached ahead of schedule, in August 1977.

The announcement of the goal of a uniform 10 percent tariff launched the third stage, on December 2, 1977; a new reduction schedule was set up for the following eighteen months and, as a result, the single tariff did not become fully effective until June 1979.

Thus, it took five years and three months in all to complete the Chilean tariff reform. It is difficult to characterize this today as a devastatingly short period. It seems an extremely reasonable time frame—assuming that the objective was to actually open up the economy, not to leave it as closed as it always had been. In any case, we must not forget that later on, during the debt crisis in 1983 and 1984, tariffs increased again to 35 percent, but were very soon back to 15 percent, and to 11 percent a few years later. These fluctuations reflected moments of doubt between keeping on track and returning to the past.

36 The First Dilemmas

Finally, trade liberalization was carried out with the long term in mind and in the spirit of permanently rectifying the Chilean economy’s structural problems.

Now, the opening-up strategy was developed while the government simultaneously set up a framework that was more receptive to the exchange of goods. This was articulated in the tariff reduction policy and in an open-door policy for foreign capital and services. In 1974, Law Decree 600, which in 1974 set up rules for foreign investors, was part of the major structural reforms carried out by the regime. These initial reforms radically challenged the prejudices that socialism had managed to instill in the public with remarkable success. The prevailing doctrine prescribed that economies should be closed in order to avoid being devoured by rapacious transnational capitalists, who were always ready to strangle unsuspecting economies and subject them to their domination. In 1976, Chile even had to withdraw from the Andean Pact—a trade agreement comprising Bolivia, Colombia, Ecuador, and Peru that was intended to promote regional integration—to avoid the traps of these outdated, empty concepts.

It might not raise eyebrows today, but at the time that DL600 was passed, it went against the prevalent orthodoxy. Foreign investment generated panic, even among those who were not devoted to socialism. It was thought that any remotely liberal policy in this area would mean that, sooner than later, the country and all of its companies would wake up one day to new owners.

This was sheer political superstition and economic ignorance. Capital does not move in overnight. Countries are not “invaded” by foreign investors, as caricatured by Marxist economic thought. Quite the contrary, it is extremely difficult to attract investment, especially long-term investment, as the Third World, China, and Fidel Castro have found out. Large flows of foreign investment did not reach Chile until many years after DL600 was passed.

The problem is that if there is no foreign investment, problems become exacerbated, because in order to finance new investments, the

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country either must make titanic efforts to increase its internal savings or resign itself to falling into debt—with all of the risks that this entails and which Latin America suffered firsthand in the eighties. The huge irony in all of this is that in the end, an oversized external debt compromises national sovereignty much more than foreign investment does. In fact, Latin American treasury ministers spent the entire decade of the eighties negotiating and renegotiating their foreign debts—hardly an edifying spectacle. This anxiety could have been avoided if the debt resources had been obtained through foreign investment. In that case, the investors, not the authorities, would have had to deal with the problem.

The central idea behind the whole opening-up effort was that Chile would develop only if it managed to become part of the world economy. The provincial concept of socialist development had to be defeated once and for all. The fear that underdeveloped countries would never be able to improve their situation and would remain forever condemned to exploitation at the hands of industrialized nations turned out to be completely groundless. In practice, quite the opposite proved true. Poor countries can afford to grow more rapidly than rich countries. It took England, the leader of the Industrial Revolution, eighty years to double its gross domestic product. It took the United States only forty. It took Japan considerably less, and China reached this duplication in just seven years. The reason for this global acceleration of growth is the fact that the path to development had already been opened and did not need to be discovered all over again. The logic of development has its mysteries. Relatively underdeveloped countries become prosperous gradually and achieve their first successes through labor-intensive industries. There was a time when nothing was held in lower regard than Japanese toys and other products. South Korea started out in manufacturing with products that were quite inferior. There are many more examples. Countries have to start somewhere. The important thing is to open up to world economy in the process.

The belief that economies must be closed or, at best, form part of closed regional blocs, is a mistake. This explains why Latin America’s

38 The First Dilemmas

much-vaunted regional integration has never been more than a rhetorical cliché. The whole of Latin America—including Brazil, Argentina, and Mexico, the giants in the region—accounts for less than 4 or 5 percent of world GDP. The Andean Pact project was even more insignificant, and therein lay the trap. Integrating into 1 percent or 2 percent part of the world economy may seem comforting to some minds, but what can eventually be gained from this integration is worthless compared to the opportunities that are lost as a consequence of close-minded regional or sub-regional trade agreements. Not that regional integration is useless. It can in fact be very helpful, as long as it does not stop countries, either individually or in groups, from being part of the world that is, at the end of the day, the big market.

Exchange Policy

A large dose of realism, combined with the imperative need to introduce deep, long-term counteractive measures, was the main characteristic of Chilean exchange policy at the beginning of the military government. In this field as well, the socialist administration had managed to do away with the exchange market by means of multiple prohibitions, absurd discriminations, and obstacles galore. This muddle of interventions naturally projected numerous distortions over the country’s productive sectors. Exchange arbitrariness was largely responsible for Chile manufacturing many products in which it had no comparative advantage whatsoever and neglecting the exploitation of areas and resources in which it did. The foreign exchange market had been completely dismantled and the dollar rate oscillated between the 25 escudos fixed by the Central Bank for certain imports and its black-market exchange rate at 1000 escudos.

Thus, the task was arduous. The function of the exchange rate as an adequate standard by which to allocate resources needed to be restored. Consequently, the first decision was to abolish the socialist government’s

Hernán Büchi 39 

multiple-rate system and correct the overvaluation of the peso, which was changed from the escudo to the peso in 1975, and had accumulated over the previous years. A 229 percent devaluation was implemented in 1973, and it is estimated that for food and raw material imports the devaluation meant an increase exceeding 1,000 percent, because this area benefited from formal access to a preferential dollar exchange rate.

Overall, the exchange system was restored, and a fluctuating exchange rate was maintained until 1979. This rate varied in terms of domestic and world inflation, and the level of reserves accumulated the reduction of nominal tariffs and stabilization objectives. Adjustments exceeded inflation when the price of copper fell (1975), when tariffs were reduced (August 1974 and December 1977), and when the fixed dollar was announced (June 1979) in order to establish a better correlation between internal and international inflation.

Exchange rates readjustments were smaller when the combination of fiscal, monetary and exchange policies resulted in a spectacular turn in the balance of payments in 1975. The expected deficit had been reduced by 80 percent, and foreign currency reserves were increasing at an accelerated rate, surpassing all predictions. In the first few months of 1976 alone, reserves increased by $250 million.

In June 1979, the government announced a fixed exchange rate, which remained in place until mid-1982. This exchange policy was highly controversial, especially toward the end of the period. (Further reference to this point will be made in the discussion of the 1982 crisis.) Since 1985, exchange policy has been similar to the policy maintained until 1979 in that rates were adjusted in terms of domestic and world inflation, international reserves, and the general international payments situation. The objective explicitly introduced in this period was to maintain an exchange rate that would be consistent with a long-term balance of payments and at the same time high enough to promote an increase in exports—the only way to solve the external debt problem for good—which would lead the way to future growth for Chilean economy. The idea was that the real exchange rate should be high for structural and

40 The First Dilemmas

not artificial reasons. Toward that end, domestic spending had to be adjusted in order to adapt the ratio between the prices of tradable and non-tradable goods, increasing the relative price of the former. Other measures aimed at making a higher real exchange rate possible were the reduction of tariffs and of other taxes on foreign trade. Simultaneously, investment in state infrastructure was focused more intensively on support projects for exporters, and this, along with an accelerated deregulation process, improved the country’s competitiveness.

Monetary Redemption

Priorities in monetary management were clear from the start. The effectiveness and credibility of national currency as a payment method needed to be restored, after having been seriously compromised by the socialist government. What else could be expected of an irresponsible monetary policy in which all that the Central Bank did was to simply keep track of the substantial amounts of money that it transferred on a daily basis, following political orders, to financial firms and companies, which had been intervened into by the state? For several years, monetary management had been nothing but a system to finance the treasury.

The phase that the country was beginning, however, would require a responsible monetary and financial policy that was capable of offering efficient incentives to saving and expeditious channels through which these savings could be geared toward credit for investment. This necessarily entailed redefining the role of the Central Bank by orienting it toward conducting monetary policy. It also implied the need to generate a capital market that would have some degree of development and independence. The increased scope for activity that was gradually allowed to intermediary agents played an important role in the liberalization process, including the perfecting of the indexation mechanism created in 1968 by Frei’s government, the Unidad de Fomento (UF), to ensure that interest rates were real, since inflation was

Hernán Büchi 41 

still high. Without the UF, a unit of account that reflects variations in the consumer price index in Chile, the currency would inevitably have had to be pegged to the dollar, or rely on other less efficient mechanisms in order to continue functioning into the long term.

The high interest rates prevalent in Chile during most of this phase reflect not only the high cost of capital in a country that was extremely de-capitalized at the beginning of this period, but also the difficulty in creating a capital market in the country.

Government Revenues and Spending

Fiscal policy solutions were also drastic. For government revenue, the initial objective was to sort out the tax system and separate the ultimately perverse correlation between income and expenditure, since Chile was riddled with special laws taxing specific acts or activities for very specific ends, even at a local level. The cornerstone of tax reorganization was, in any case, the introduction of the value-added tax (VAT) to avoid market distortions, given its advantages in terms of performance, control efficiency, and neutrality. Later on, in the eighties, the tax system included an incentive to reinvestment in companies, which had an extremely positive impact in strengthening the investment rate. It is impossible to describe this in just a few words, but it is nevertheless important to point out that the process leading to a tax system with few, efficient, and neutral taxes that did not seriously affect savings, investment, or the development of exports, was a long process requiring many years’ work—even though it was begun early and forcefully.

There was also some margin for cutting spending, by either eliminating or drastically reducing agencies and programs that the previous government had enlarged or created solely for political reasons—including the Agrarian Reform Corporation (Corporación de la Reforma Agraria) and the Agricultural Development Institute (Instituto de Desarrollo Agropecuario), both connected with the agricultural

42 The First Dilemmas

reform that Chile had undergone in previous governments, as well as Dirinco, in charge of price control. By 1975, due to the fall in the price of copper and the exchange crisis, Minister Cauas was forced to apply a 20 percent reduction on all government spending—including wages and spending in both local and foreign currency. However, cutting spending is one thing, but restructuring the public sector and, more importantly, the public enterprises, is another.

It is true that in most cases, deficits in these enterprises were the consequence of distorted tax rates that had been set with openly demagogical intentions. But the solution was not simply a question of adjusting rates. In most cases, it involved a complete reorganization. All of this took time; it took so much time, in fact, that it was not until 1980, seven years after reform was launched, that the first phase of the restructuring and rationalization of the Chilean public sector and fiscal enterprises could be said to have been completed.

It is estimated that approximately half of the government’s deficit was generated by state companies. The task in this area was difficult, as I know firsthand, since it was on this that I first worked when I joined the government. In general, solutions were designed on a case-by-case basis. Some companies were privatized immediately or returned to their rightful owners. Attempts were made, as part of a long-term plan, to reorganize others, correcting distortions both in their pricing systems and in their productive processes. Generally speaking, the problem with state enterprises is that there is confusion regarding their objectives. On the one hand, they define efficiency objectives, as they should. On the other, they feel compelled to fulfill social service goals. They operate between these two extremes, which is almost always a problem when it comes to trying to hold them accountable. One day they justify their shortcomings by claiming to be fulfilling social objectives, then the next day they reject the idea of giving their activity meaningful social content, claiming that they cannot afford to work at a loss. You cannot win. As I learned from my experience, restoring these companies’ objectives is very difficult. It is exceedingly difficult to get their administrators to

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understand that state enterprises must be, first and foremost, enterprises, and as such, they are under an obligation to make a profit. If the government or the community wants the railway company to reach a remote little town or the price of kerosene to be less than its market value, well then, that means the government or the community will have to provide the required subsidies. But it is not a state company’s role to assume, in very questionable ways, social service missions that have been poorly evaluated and often achieve nothing. Accordingly, it is essential to define roles so that no one can claim to have been misled. In my experience, solving problems begins with an awareness of the need to not confuse the interests of the company with the potential interests of society.

As in other areas, here too the economic team had to act innovatively to make sure that independent public enterprises did not stray from the economic program’s general guidelines. The idea of setting up a holding company to control them was never carried out. At times, the economic team lacked the political weight to even appoint members to boards of directors. Resorting to extremes, a decree was issued preventing public companies from incurring any extra expenses or any debt above a certain amount without the Treasury’s approval. It was a seemingly drastic solution, but there was no other way to keep the situation under control in a moment of crisis.

Today there is much discussion in countries around the world about what should be done first: restructure state enterprises prior to privatizing them or privatize them immediately, just as they are, leaving it up to the private sector to reorganize and modernize them. It is worth noting that the Chilean experience in this area produced rather hybrid solutions. They are not solutions that can be distilled into any general rule, much less be followed as a recipe. Every country must determine a strategy and draw up a schedule to suit its needs. In Chile, the only enterprises that were privatized immediately were productive units that were very small or that had been taken over illegally by the socialist government, via

44 The First Dilemmas

legal loopholes2 (resquicios legales) that made a mockery of the spirit of the law and of basic concepts of political morality.

In the case of most other state enterprises, the decision was to reorganize them first, for several reasons. Foremost among them was the question of economic and political opportunities. After Allende, the private sector was undercapitalized and had essentially no purchasing power. Politically, also, calls for bids by investors would have been much more strongly resisted in the seventies than we can imagine today. Socialism was still a very dominant trend in that decade.

The Totalitarian Script

The economy picture at the end of 1973 was one of devastation. The price system was no longer relevant to economic decision making. Isolation had practically cut the Chilean economy off from the world’s international connections. In addition to a burdensome, protectionist tariff policy, an elaborate system of quantitative restrictions and absolute prohibitions complicated the problems, affecting international trade even further. Chile’s fiendish customs regulations were enough to make even the most tenacious and enthusiastic importers and exporters run out of patience.

Every important economic activity depended directly or indirectly on the state, through either direct control, the appointment of interlocutors, or price controls. Enterprises that were controlled or taken by the government were granted access to limitless open credit with the Central Bank. Large issues of paper money devoured the currency’s purchasing power—during the last stages, in a matter of days. Inflation in 1973 was

2 Legal loopholes (resquicios legales) was the name given to the government’s practice of searching through legislation that was dated or had been issued in different contexts, in order to apply it and attain an objective which was not authorized by law; for example, expropriating a company by using a long forgotten law passed in the thirties.

Hernán Büchi 45 

just over 500 percent, but in the months prior to military intervention, the speed at which destabilization was increasing implied much higher annualized rates.

All this only seemed to be chaotic and the result of local improvisation. In fact, the same script that had been followed in all true socialism regimes, from Czechoslovakia to Cuba, from Poland to Nicaragua, was being followed here too, to the letter. The strategy, quite sinister in essence, was the same—to strengthen and magnify the political power of the state system, come what may, to control companies immediately either by direct expropriation or intervention, to destroy the price system via outrageous inflation and subsequent price controls—all with the sole purpose of weakening property rights. The end goal is to confiscate, nationalize, and control everything—not just the economy, not just things, but people as well.

This totalitarian logic has been always the same, give or take a couple of variations. And so it will remain. For totalitarianism, the concentration of power is an ever-present, overarching goal. The threat from Soviet Communism may have disappeared, but it would not be at all surprising if other totalitarian systems were to appear in the future. Several could crop up, for example, from radical environmentalism, which today provides a pretext to attack private enterprise and the market economy and to gain power over people, including those of us who are genuinely concerned about nature. Their weapons will always be the same. If the market is destroyed, all other freedoms become nominal. Economic control gives political control teeth. That the process in Chile was quite advanced is reflected in the fact that a political distribution channel had begun to operate through the Committees of Supplies and Prices (JAP, Juntas de Abastecimientos y Precios,), a source of so many bad memories.

It seems strange that none of this was perceived as having been premeditated, even by people in Chile who experienced this process firsthand. The problems, beginning with rampant inflation, were perceived as the consequence of ineptitude on the part of economic

46 The First Dilemmas

policy makers. But behind this apparent bungling, there lay in fact a more sordid plot, and the coldest minds in the regime—as well as the Soviet Communist Party of course—knew this.

The People Behind the Numbers

The crisis that was overcome had a decisive financial dimension to it, but it also presented a delicate double human dimension. On the one hand, any measure taken affected both private individuals and government officials, and things needed to be done in a way that would minimize the pain. On the other hand, it was essential to have competent professionals that could accomplish the tasks at hand. Fortunately, in this respect, not all was lost. There were still some reserves of professionalism to be found, to varying degrees, both in government administration and in state enterprises—responsible officials, technicians who knew their job, and decent people with good intentions on whom the new government could rely for support in the restructuring and modernization process.

Even so, however consistent the market-based development strategy, and however firm its intellectual grounding, at the outset of the government’s administration, nobody could be certain how much of this strategy—or any other consistent strategy—would be enforceable or in what sort of time frame it could work. In many respects, the initial phases of the Chilean economic revolution felt like groping in the dark, given the country’s situation after Allende’s thousand days in office. The country faced not only a massive inflation crisis, but also a crisis in its balance of payments that nobody really knew how to solve.

Obviously, when inflation crisis coincides with an external crisis—as it did in Peru, for example, after Alberto Fujimori took over the government from Alan García—the government’s scope for action to stabilize and liberalize the economy is much more limited and the challenge much greater.

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Lessons from the Chilean Experience

Chile is proof that it is possible to move from an inefficient economic model to a market economy. But it is also proof of three other concepts. First, there are no easy ways out. Second, transition processes take a long time, longer than one would wish. And third, there is no such thing as a universally valid formula, especially regarding the details of implementation. What worked in Chile may not necessarily work in Peru. What Guatemala does will not necessarily be applicable in the Russian Federation.

The Chilean process was too adversely affected by the external crisis. Chile went from Unidad Popular straight into the oil crisis and then into the debt crisis—two of the main economic convulsions of the twentieth century. It was like having providentially survived a fierce fire with serious bruises, only to be run over in the street twice.

There is another lesson in all this. One cannot face a crisis and expect its effects to go unnoticed. There is evidence that this is the worst option. It is what Alan García’s shameless populism did in Peru (1985–1990) and what other Latin American presidents have done. There is also evidence as to how much good it did them. The anesthesia of populism wears off after a few weeks. Afterward, returning to reality can be much more violent. In Argentina in 2001, people ended up raiding supermarkets.

It seems strange that in most common citizens’ perception, truly serious stabilization and economic reform programs are associated with dramatic social costs. More than strange, it seems unfair, because these costs are not a product of the programs themselves but of prior distortions. A country’s accounts do not improve simply by returning to economic rationality. It is to be expected that they will continue to deteriorate for some time because of time lags in this area, which can be quite protracted. One government’s mistakes are often paid for by the

48 The First Dilemmas

next. Chile is a clear example of how the mistakes made by one generation can end up dragging down the fate of the next.

By the same token, one must be cautious when making comparisons, not only for the sake of intellectual rigor, but also of political decency. Advocates of the social market economy in Chile would point out that the purchasing power of wages in the first years of Allende’s government was substantially higher than it was during the military government. But that was a fallacy, not simply because the numbers for both stages had been doctored, although it is possible to find many distortions, but because both realities were extremely dynamic in very different senses. While the purchasing power in Allende’s time led to a precipice, because the country was firmly headed toward disaster, during the military government it was the starting point—tough, brutal and whatever else one might want to say about it—of a much more sustained long-term recovery process.

The phase comprising the reorganization and the first structural reforms during the Chilean military regime was a long process. Not everything was done immediately and simultaneously. But in a way, it was all interconnected. Tariff reduction affected fiscal revenue. The adjustment in the exchange rate was a key factor in external opening-up and in the new development strategy. The value-added tax was decisive in making it possible for exporters to compete internationally, since it exempted them from the cascade of taxes under the previous system. It never would have been possible to reimburse them for paid taxes otherwise.

After only three or four years’ time, the Chilean business structure opened up to a vast transformation process. Businesses began to lose their fear of exporting. Even more revealing is the fact that they began to stand on their own two feet. Before then, they were extremely dependent on—and requested everything from—the government. Now they know how to compete not only in Chile but also globally. After having strongly resisted opening up, the fact is that they showed remarkable adaptation skills in the face of new circumstances. Non-traditional exports grew in

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importance, especially after 1977. The only year in which exports did not increase was 1981, but at that time, the country was facing a huge crisis, although we Chileans were not yet fully aware of it. It was not businessmen who were to blame, but rather the imbalances about which they could do nothing.

This process yielded important lessons, which proved valuable when it came to perfecting the system. Many times tariff reduction is blamed for problems brought on by the exchange rate. Businessmen’s recollection of the dramatic impact of the opening-up process is more closely related to the undervaluation of the dollar in 1981 than to tariff reduction per se. The country did indeed swing between extreme options. It was of course unthinkable that the exchange rate in Chile in 1981 could remain as high as it had been three years before—but it was also unreasonable for the country to function with the dollar as cheap as it was that year. It is undeniable that those variations, which today seem extreme, were accompanied by incredibly sudden changes in the availability of foreign investment and in the prices of the products that the country imported and exported.

Between 1973 and 1980, the Chilean economy showed unmistakable and vigorous signs of recovery. After the sharp 12.9 percent drop in GDP in 1975, the economy’s growth rate increased. The government chalked up major successes in stabilization, although inflation was still quite high. The balance of payments was increasingly favorable. The rate of investment became steadier. Non-traditional exports reacted with surprising dynamism. All of these factors contributed toward creating a scenario of favorable perspectives. Granted, there remained some unsolved problems, such as a low level of internal savings and an alarmingly high interest rate, but by 1980 the country reflected barely a shadow of the economic shambles in which it had been seven years before.

This was the process headed by the first stabilization measures and the first great structural reforms of the military regime. That is where it

50 The First Dilemmas

all started. Without them, Chile would never have become what it is today.

CHAPTER FOUR

The Real Modernizations

As all textbooks teach and as anybody who has watched economic forums on television knows, macroeconomic stability is decisive in preserving the stability required for an economy to function.

But we cannot forget that this stability does not in itself guarantee the modernization of an economy. Opening up an economy by reducing tariffs and setting up a realistic exchange rate will be of little use if, for example, at the same time port operations are not liberalized or customs and civil service legislation—which are the source of the real walls of para-tariff measures that obstruct trade—are not reformed as well.

For the same reason, along with major monetary, exchange, and fiscal reforms, every economic liberalization project must envision sectoral restructuring in terms of ideas and objectives that rarely find their way into economics textbooks or televised debates. Any economic structure needs consistency in order to function properly, and the principles that make up its foundation must be present at the top, too. In Chile, in order to make sure that the economic project was consistently applied, thousands of professionals who advocated free market ideas were placed across different ministries. This made it possible for the different ministries to work in coordination, tearing down barriers and working toward the same objective. Hence, the most significant progress was made precisely in the areas where there were people who supported reform. This was not “a miracle,” but the natural response to coordinated work.

Among the numerous lessons from the Chilean experience is the realization that reforming the Constitution is insufficient if regulations remain unchanged. Cleaning up the superstructure is insufficient if, as far as workers’ everyday experiences are concerned, the weeds of state control continue to grow. The ruler who never leaves the realm of principles and grand political guidelines will gain little if he does not

52 The Real Modernizations

come down to the ground level, where people are really in touch with the nation’s problems.

In this respect, economic liberalization and reform require tremendous hard work. Thousands and thousands of rules, procedures, and operational mechanisms in the public sector must be synchronized. This entails not only arduous work but also the task of getting large, generally very heterogeneous, groups of people to agree on a course of action.

State control dynamics are always all-embracing, and go beyond simply closing the economy or imposing price controls. State control pervades all areas, large and small—from the design and management of policies to the systems administration models and the criteria used to interpret regulations. Change must therefore be exhaustive and reach all sectors, labor, and capital markets. That is precisely where the epic aspect of the economic transformation led by General Pinochet lies. The main guidelines—the macro part—were set out at the same time as the details that made it possible for the transformation to be carried out were developed. All of this was done in an adverse milieu, in which international criticism offered no respite and internal opposition groups never relented in their antagonism.

Regulations and Property: The Pillars of the Market

The guiding idea in the reform program was that markets should operate in as natural a way as possible. For this to happen, at least two important requirements must be met. One is that property rights in the different sectors must be well defined. The other is that regulations must be compatible with the principles, the mechanics, and the flexibility inherent to a market economy.

Put this way, reform seems a simple task, but carrying it out is not easy, because it entails—even for the staunchest liberal—going against

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numerous myths and impulses molded by decades of state interventionism. That is when the connection between statism and people’s legitimate aspirations for prosperity and security becomes evident.

Guaranteed Success?

State interventionism takes advantage of those aspirations. The security that things will not change for the worse, that nobody will lose his job, that no inefficient factories will be forced to close, that no foreign competitors will be allowed in, that nobody will be allowed to sell at cheaper prices, that pensions will be generous and available for everyone, are all held out as enticement. State control is a straitjacket that binds and immobilizes the future, deactivates risks, slows down technological change, and evades the challenges of innovation. For example, Chile’s vineyard law, issued in 1967, forbade planting new vineyards, thus ensuring a perfect monopoly to established vintners, on the grounds that this was part of the battle against alcoholism1. Nothing could be worse than this, if the objective is to generate wealth. Wealth does not spring from rigidity but from flexibility. It is not the fruit of conservation but of change. It is not born of a rejection of the future but of the ability of each society to meet future challenges and opportunities. It does not come from a tendency to repeat the same thing day after day, but from the challenge to innovate. An economy in which everyone wants guaranteed success will be inert, stagnant, and regressive. It is the worst possible scenario, because rigidity and stagnation lead to ossification. This means that the rich will continue to be rich, even if they make mistakes in their business deals, while the poor will continue to be poor, however much effort they make to improve their lot in life.

1 Joaquín Lavin I. El Enriquecimiento de las Personas en Chile, p. 21.

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For want of a better name, the task of reforming an economy, sector by sector, by moving from state control to a market model is often referred to as deregulation. The name could hardly be more unsatisfactory because the task at hand is not to end regulations, but to do away with interventionist regulations, to generate rules that recognize property rights in each sector and to solve the conflicts in each sector efficiently.

The most successful societies in history have not been the ones that rejected change, but those that remained open to the future. They are also the ones in which strong institutional safeguards ensured the full exercise of property rights.

Most people do not find it hard to envision the scope of property rights in agriculture or in industry, because in these sectors, some ancient traditions regarding the protection and transfer of these rights have been internalized by nearly all civilizations. But when it comes to conferring property in areas such as mining, telecommunications, or water, many people become confused and succumb to fallacious reasoning.

Technological innovation has begun to open up new fields to the notion of property. For example, airspace, as either flight routes or the electromagnetic spectrum, has only begun to acquire economic value during the twentieth century. Previously it had never been a scarce and finite good. It lacked utility. It was the development of aviation, radio broadcasting, and telecommunications that endowed it with economic value. Unfortunately, this occurred at a time of worldwide predominance of state interventionism. Consequently, in this sector, the state became the key agent, and this prevented the consolidation of property rights, which should have followed naturally.

In Chile it was necessary to sweep across all sectors of the economy in order to remove the weeds of state control. This is what made the Chilean economic revolution so extensive and deep-rooted. The struggle in every sector was dramatic. This was not only because of the reaction of many groups whose vested interests were threatened or because the regulations in force were invariably long-standing as a result of political

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and intellectual tendencies enforced in the thirties. It was also because the most acknowledged “experts” in many specialized areas with traditionally weak legal or cultural links to the concept of property—such as ports, telecommunications, or transport, to name a few—had internalized an interventionist mindset.

The sweep was almost exhaustive. However, some areas went practically untouched. For example, absolutely no substantial initiative was taken in relation to the workmen’s compensation system, for several reasons. The system contained, and still contains, some reasonable features. It works well and receives substantial support from the private sector. On the other hand, at the time when social legislation was revised, the system had yet to mature. The law creating it had been recently passed. The system was not fully operational and the contingent of workers it was to finance over the next decades had not reached retirement age. A large part of the system’s technical reserves were invested in hospitals, and its books were satisfactory. But none of these factors was enough to ensure that maximum benefits were being obtained at minimum cost, as would have been the case in a competitive system open to the participation of private administrators ready to provide the same services. In spite of this, the effort required to embark on a comprehensive reform was not worthwhile at that point in time, given other priorities pending on the agenda.

If there is any general conclusion to be drawn from the modernization that the military regime carried out in various sectors, it is that the greater the degree of state intervention, the poorer the performance of the area and, consequently, the easier the recovery. The effort required was much greater in areas that had still not hit bottom or in those whose performance, albeit not optimal, was at least somewhat adequate.

In addition to regulations and institutions, it was also necessary to reform thinking. Entire agencies would need to adapt to new objectives. For example, a customs service or a bank regulator does not operate in the same way under a socialist government as in a market economy. The

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focus needs to be completely different. But in some cases, the problem was not just a matter of focus. In fact, several agencies, such as the price control office (Dirinco), had completely lost their raison d’etre. Not long after the beginning of the military government, the person who took over the management of this organization handed in his resignation, realizing that there was little that he could contribute within the new scheme of things, in which the first measure taken was the liberalization of prices.

In looking at each of the sectors and areas modernized by the military government, the observer finds, alongside realities that are exclusive to Chile, problems and experiences that may prove valuable in liberalization programs in other parts of the world. The following list cannot be exhaustive nor can it reflect all of the significance and the complexity of the changes accomplished. I have tried, however, to deliver a fair portrayal of the reforms that were undertaken.

Agriculture

According to United Nations Food and Agriculture Organization statistics, 5.7 percent of Chile’s land is arable.2 This land became the scene of one of the most violent episodes during Allende’s socialist government.

The scandal of land reform centered on the fact that land had been taken from its owners—via an expropriation process that did not include adequate compensation—and not handed over to anybody. Allende’s Minister of Agriculture himself warned that any estate exceeding 80 hectares would be expropriated. By the end of 1972, this threat had been carried out in full.3 By 1973, over 4,400 properties totaling 6.4 million hectares had been seized. The beneficiaries—including settlements and CORA cooperatives (Corporación de la Reforma Agraria—Agrarian

2 United Nations Food and Agriculture Organization, 1990. Production Yearbook, Vol. 44, 1991. 3 Simon Collier and William F Sater. A History of Chile, p. 337.

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Reform Corporation)—were nothing but political pasturing herds and legal nonentities, or in some cases shell entities invented in order to invalidate the right to property.

The agricultural sector inherited by the military government was in chaos, not only because of the land reform but also because of a systematic lack of incentives to national producers that was decades old. Nevertheless, Chile’s agricultural sector retained a substantial moral reservoir of natural notions of land property, which socialism, despite its best efforts, had managed to wound but not kill.

The advantage that the military government had in this field was that legislation regarding farm property rights had existed from time immemorial. Regulations were very clear and were part of the Civil Code. No new legislation was required. For this reason, the government’s task consisted in reestablishing the notion of property to wherever it had disappeared. The problem was serious, since more than 50 percent of the land with productive value had already been expropriated. Not that the rest had escaped. Far from it; a high proportion of the remaining arable land belonged to smallholders who in turn created other types of inertia in the country’s agricultural development. Nothing else can account for the fact that in 1973, the country’s agricultural production was comparable to its production in 19364.

The restitution of agricultural property was carried out among high political tensions. The way in which the agrarian reform was applied and the situation it created in the rural sector was one of the Allende’s government’s most critical fronts.

The attitude with which the urban middle class observed the disintegration of rural society was strange and often contradictory. On the one hand, the vast majority thought it unfair that the land should be taken from its owners by means of the broad discretion that the agrarian reform plan bestowed on officials. On the other hand, many believed that the owners of large estates were largely responsible for the country not

4 James Whelan. Out of the Ashes, p. 565.

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making progress. It was assumed that large landowners, secretly allied with foreign capital, which was by nature exploitative, were conspiring to prevent the estates from thriving. Given that the country was being exploited externally by transnational companies and internally by the wealthy, the agrarian reform could, to many naïve people, appear to be a good solution.

In this setting of social turmoil, expropriations, and violence, very few people considered that agriculture was simply not profitable because price levels were fixed by the government. Hardly anybody noticed the fact that, of all the economic sectors, agriculture was the most punished by the country’s economic isolation. Protectionist measures were adopted in the name of national industry, with no regard for agriculture.

Since there was absolutely no awareness of our country’s true competitive advantages, the entire economic system revolved around industrialization. “Behind industrialization lay economic interests and votes to be won. The powerful industrial labor unions, the workers’ unions, and the business lobbies benefited from policies that favored the industrial sector.”5 With prices fixed and wages increased, it was inevitable that agricultural production would be expected to pay the cost. In 1972, the country was spending 52 percent of its export profits on importing food.6

For the same reason, clearly the process of property restitution in the sector needed to go hand in hand with the gradual liberalization of agricultural prices. Acknowledging property rights and establishing the conditions to make agricultural production viable were both necessary in order for the market to function. It was a complicated and huge task. The agricultural sector’s operations were completely distorted, so it was hard to know where to start. When the government controlled the prices of products, it also openly subsidized seeds and fertilizers. This gave it the pretext to interfere in the rest of the chain of production. In a way, almost

5 Juan Andrés Fontaine. Transición Económica y Política de Chile, p. 5.

6 Collier and Sater, p. 340

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the entire productive cycle in agriculture was a lie, from the economics point of view. None of the prices reflected what things were really worth.

Regularizing farm property rights took many years. The land reform gave rise to an enormous amount of lawsuits, many of which were still unresolved in the mid-eighties. There was even a law that offered people who sued the government the option of trading their claims for shares in the companies that were privatized during my time as Minister of the Treasury. Only then was the cycle of wealth transfers, which the reform had set in motion, completed. Generating alternative channels for buying supplies and restructuring the price system and the marketing mechanisms of agricultural production also took a long time. The government went on granting grain loans much longer than it would have preferred to do. The idea was that the state should withdraw from the sector as soon as possible, but in the case of some products this took quite some time. Price bands, which to this day trigger so much debate, reflect this gradual process of introducing market mechanisms into the sector—and are far more respectful of market principles than of price fixing.

Nevertheless, these bands were a solution worth considering. They were applied to wheat, sugar, and oil, with the purpose not of fixing prices but of protecting producers from the relatively violent fluctuations in the international market. These fluctuations were generated in most cases by other countries’ subsidy programs, which entailed unfair competition.

The first challenge that the implementation of price bands had to overcome arose from Cartesian reasoning: if all products are subject to price fluctuations, then why not have specific bands for each one? Obviously, this line of reasoning could lead to the worst-case scenario: trying to provide stability for everyone, which ultimately would mean providing it for no one, as socialism ended up confirming. Nothing can be more vulnerable than forced stability. Therefore, if price bands were established for some products, it was only for political reasons. The products involved had great impact on national agricultural production;

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they were exposed to the pressures of very volatile external markets and were part of a chain of broad effects, especially in a political sense. In comparison with the support that European countries and even the United States give to their farmers—granting subsidies worth up to 2 percent of gross national product—price bands may seem insignificant, but they played a very important role in stabilization. On the other hand, to try to emulate developed economies’ agricultural policies would have placed an intolerable burden on a country striving to leave economic stagnation behind.

The real objective of price bands is—for producers’ peace of mind—to minimize fluctuations between sowing and harvest seasons as much as possible, especially when they are caused by political decisions made by other governments. Bands were set by analyzing the movement of prices throughout the previous five years, and they had to be flexible enough at both ends to reflect both rises and falls in international prices when these variations are not purely circumstantial.

The military regime inherited a prostrate, unviable agricultural sector, and left it in a positively dynamic state for the following government. The prices of products, supplies, credit, and marketing channels were completely liberalized. The only exception—in addition to the loans designed for small producers due to political considerations—was the aforementioned price bands policy, which presented only minor problems for products in which the country is not self-sufficient. However, when there is a surplus, or a tendency toward a surplus of a product, the situation becomes more complicated because it forces the government to buy the surplus and become involved in the marketing process. The problem—as countries like Germany or the United States can attest—can take on very serious proportions when seasons of abundant harvest not only cover domestic consumption needs but also leave a large enough surplus for export.

The liberalization of agriculture caused apprehension, rather than opposition, among farmers. Many perceived that their situation would deteriorate by transitioning to a free and open system. They assigned

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more importance to the benefits that they stood to lose—cheap supplies and easy credit—than to the opportunities they would gain—greater competitiveness, freedom to set their own prices, and access to external markets. Other problems added to this apprehension, such as the deterioration in the exchange rate between mid-1980 and mid-1982. The agrarian reform, in fact, had brought about a huge transfer of wealth from the sector affected by expropriation to the Treasury. By design, only the state had stood to gain in the process, since it paid less than market value for the land that it expropriated and sold—at higher prices, one would assume—to the parceleros (smallholders). For those affected, the reform had been an act of plunder that robbed the agricultural sector of capital. This problem weighed heavily on the economy for a long time. It became necessary to pass laws forgiving part of the parceleros’ debt. Meanwhile, the farmers who kept the land to which the law authorized them found to their dismay that it was very difficult to keep up the standard of living that they had enjoyed when they owned the entire property.

The compensation conditions established by the agrarian reform were clearly unjust, and this injustice had been abetted by the law. The farmer concerned received a small down payment for part of his land with the rest paid in bonds that were indexed at only a percentage of the inflation rate. It was clearly a case of state exploitation.

But this was not the only plunder occurring in Chile during those years. The pension system was subjected to a similar fraud. Retirement pensions were an average of the wages earned over the last five years, of which only the first three were increased due to inflation. In a country with the inflation rates that Chile had at the time explains why very soon all Social Security Service pensioners had been reduced to minimum pensions.

In the agricultural sector, the military government decided to respect the situation that had been created by the application of the agrarian reform in cases in which it had been applied according to law. In cases in which the expropriations or interventions had been illegal, the lands were restituted without delay. For the farmers grouped in cooperatives or in

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settlements—and consistent with its decision to create property rights—the government parceled the land and, if the property was too large or indivisible, called for bids.

Sale of parceled land was conditional on a clause that prohibited the transfer of the property, which had little effect. People always managed to find loopholes to transfer their property, whether to their neighbor next door or across the road or to a businessman in the city. There was nothing wrong with this. These transfers are a key part of a dynamic economy. To a great extent, this was an important way in which fresh capital made its way into the agricultural sector to support the beginnings of the fruit sector in Chile.

Based on the fruit industry’s success, there are those who claim today that the agrarian reform was a key factor in the fruit-growing boom in the eighties. That is pure demagogy mixed with science fiction. Following that same logic, it could be held that the Third Reich was a key factor in postwar Germany’s economic prosperity. Former landowners would have had to be very obtuse indeed, which they were not, to have not taken advantage of the incentives to growing fruit crops if those incentives had always been there. Those incentives had never existed before; when they did appear, farmers took advantage of them.

In my opinion, the aim of the agrarian reform was never economic. It was political. By the time the government took over, the country’s far Left had already done a great deal toward setting workers against employers and businesses. Politicization of the industrial unions was the result of patient, long-drawn-out, coordinated effort. The manipulation of these organizations successfully drove a sharp wedge into the relations of authority, leadership, commitment, and affinity that should have existed between businessmen and workers. This marked the beginning of the breakdown of the natural socioeconomic ties in urban Chilean society.

In rural areas, this disruptive process began later. In the sixties, rural society still responded to the traditional model, which was not perfect, but was at least free of ideological class warfare. Rural areas were much more conservative than the cities. At its core, the agrarian reform was

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intended to sever the traditional connections between agricultural employers and workers. In this, it was undeniably successful.

It was not agrarian reform that modernized the Chilean countryside. Modernization came about entirely and exclusively as the result of confidence in market mechanisms, the re-establishment of property rights, and the work of a farsighted government that did all that it could—in relation to ports, transport, health policy, export incentives—to facilitate Chilean agriculture’s entry into new markets. The change in relative prices in agriculture opened up new economic and mental horizons in the sector. Rural areas became industrialized. Change was swift and it relegated to the past experiences that had been common during Allende’s time—such as, for example, the price of a television being equivalent to the price of several cows. This situation was soon reversed. Today it is not unusual for a small agricultural producer to own a car. Today, cars can be found in rural areas, and they do not belong only to the employers. Rural workers no longer wear the once-common ojotas-improvised footwear made out of tire rubber—and can frequently be seen riding bicycles, as they do in Argentina, a fact that impressed me the first time I visited that country.

The military government incorporated agriculture into the VAT general tax system. This sector is also subject to a land tax that finances the cost of the legal system for property protection. These contributions help remind landowners that real estate has a social cost. This tax benefits local municipalities. The sector is also subject to an income tax, although in certain cases farmers are allowed to opt for a presumed income tax, designed to save taxpayers from the costs of a full accountancy.

In terms of results, the country recovered its agricultural production capacity quite swiftly. Food imports, which had reached $511 million in 1973, decreased to $361 million two years later. Everything happened very quickly. The transformation of agriculture took much longer, and encompassed the emergence of the fruit and forestry businesses, which definitively changed the profile of Chilean agriculture. In 1992, fruit

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exports were worth $982 million, compared to $18 million in 1973. Forestry exports reached $420 million in 1992, while the cellulose and paper industry contributed a further $685 million. By contrast, in 1973, forestry exports were barely $6 million and cellulose and paper contributed $30 million.

Mining

Mining is one of the Chilean economy’s most important sectors. For many years, copper was the main export, and Codelco, the state company that controlled the main copper deposits, was the largest company in Chile.

In the Chilean mining sector, state control had gone quite far; its roots went all the way back to colonial times, when legislation had an openly centralizing and legalistic bias. Although the Mining Code, issued in the thirties, welcomed private participation in the sector reasonably well, it was by no means isolated from the socialist intellectual currents being voiced in the public arena at the time. Later on, the situation gradually became even more radicalized. By the late sixties, the dominant opinion was that mining was far too important to be left in the hands of private enterprise.

The numbers underscore the sector’s importance. Known as “Chile’s salary,” in 1970 the copper industry represented 70 percent of the country’s trade. Many believed that the $120 million yearly revenue that it brought belonged to the state and should benefit the whole population7.

Therefore, some sectors argued, the state itself should be in direct charge of the country’s most important deposits. And so, in 1971, all of the parties represented in the Chilean Congress endorsed the constitutional amendment that nationalized the country’s main copper mines, which today are run by North American companies.

7 Simon Collier and William Sater, p. 334.

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The 1980 Constitution did nothing to improve this state of affairs. The five clauses on mining—undoubtedly too many—under article 19, subsection 24 of the Constitution, which guarantees the right to property right, are better suited to a set of rules and regulations than to a constitution. Their wording does not exactly endorse the market or private enterprise. Statism comes across in the text and between the lines. Property seems to have been reduced to a system of administrative concessions, subject to the moods of government bureaucrats, and as vulnerable as everything that can be given or taken away by the state.

But that is not all. In some working drafts of the constitutional text, state intervention and interference in the sector were even stronger. Fortunately, internal debate managed to lower the state’s profile somewhat. My impression of this preliminary wording was very unfavorable. At my first opportunity, I discussed the issue with Sergio de Castro. It is important to note that in addition to the Chilean public opinion of the sixties and seventies, many military officers, who were in charge of running Codelco, saw mining activities as inextricably linked with national security.

The military regime, in a stark exception to its own reform efforts, going against everything that it had done in other areas, came very close to establishing more state control in mining than had existed in 1973. There was even a moment in 1980 when it was feared that in this area things would not only remain unchanged, but would actually backslide. Fortunately, cooler heads later prevailed, and important amendments were made to the original text. But even so, the final result was far from optimal.

The situation began to improve when, during José Piñera’s term in office as Minister of Mines, the Mining Law (1981) was passed, which rose to the level of constitutional amendments, finally achieving what the Constitution had not: complete recognition of property rights in the sector. The new Mining Code, issued at a later date, completed the framework that would guarantee the participation of private companies. In this sector, as in others, property is fundamental. There was general

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consensus regarding the fact that mining required a different legal regime from the one applied on land in order to, among other things, encourage dynamism in the sector. If the owner of the mines should also own the land on which the mines lie, the sector tends to greater inertia and the incentive to explore diminishes—a serious problem in a country in which mining wealth is not within easy reach. As small-scale miners know, it is not just a matter of picking wealth off the ground.

The Mining Law and the Code that followed had other worthy qualities. They defined and clarified the concept of eminent domain, created a system for protecting property, and practically reduced the margin of bureaucratic discretionary control in the allocation of concessions to zero, since concessions were now to be allocated not by the administrative authority but by judicial power. This is not to say that this path was free of conflict, but at least it guaranteed more equitable and reasonable channels through which to resolve disputes.

Naturally, all of this upset many people’s preconceived notions. Most people find it hard to understand that private property—here and in any other field—is the best way that a society and an economy can optimize the use of natural resources, whether renewable or non-renewable, real or apparent, scarce or relatively abundant. Nothing advances the common good and public utility better than the system of private property. Judging by its inaction and lack of incentive to exploit its mines, the state is the worst mining entrepreneur in Chile.

Codelco, increased its number of workers by 43 percent between 1969 and 1973, while production decreased by 19 percent during the same period. Between 2001 and 2006, the production cost per pound of copper increased by 83 percent. At present, a large part of the mining sector is in the hands of private investors who produce much more and at lower costs than Codelco.

In addition, most of Codelco’s deposits are not being exploited. They are a buried wealth that benefits no one and whose economic value is by no means indefinitely guaranteed.

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Another triumph for modernization in this area was the integration of mining activities into the general tax system, mainly by means of the value-added tax and the income tax. There were those who, in view of the solidity that had been conferred on mining property, suggested that it would be convenient to establish a royalty on what was considered national wealth. On the basis of these arguments, a royalty on mining companies was set up in Chile in 2005, which in my opinion, was a step back in the country’s economic liberalization. A clear decision is crucial regarding whether we want to move toward clearly defined rights or open up the arena to collective discussions that will end up eroding the concept of property rights.

Experience shows that this kind of tax has deplorable distorting effects. Mining in Argentina has developed at a slower pace than would have been expected due to the effect of these taxes, among other reasons, which vary from province to province.

The Argentine case is not an exception. Royalties is a major topic in mining policy around the world. The United States Congress has discussed proposals to introduce such a system, which could eventually make that industry competitive.

Other institutional changes were also important in the development of mining in Chile in the eighties. For example, water rights regulations played a decisive role, especially in the northern regions of the country.

In short, the main accomplishments in the sector were to guarantee property rights; to deregulate, so that everyone could produce freely; to open up the sector along with the entire economy to foreign investment; and to liberate prices, supplies, and the entire mining ancillary support structure. This was enough for the sector to achieve unprecedented and spectacular growth. Huge investments have been made in the Chilean mining sector; mining operations occur in conditions that would have been unimaginable before the reforms. Private enterprise has reached places that previously no one thought could be reached.

At El Indio and La Coipa, gold was extracted at an altitude of 4,000 meters. At La Escondida, copper that had never risen to the surface is

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being extracted. Oddly enough, in those areas where the state retained a higher proportion of property rights—as it has in lithium, for example—development has been much slower and more complicated, to say the least.

A different strategy regarding property issues was adopted for crude oil and natural gas, about which I was never too happy. Chile is poor in “black gold” and, within this poverty, opts for a state-control model. I doubt that creating a structure more receptive to private investment would have changed Chilean geology for the better and led to the discovery of more deposits, but I have no doubt that it would have helped our industries to capitalize on their opportunities more efficiently.

Argentina, in President Carlos Menem’s time, for example, decided on a more aggressive option involving the direct sale of the areas in which it had varying degrees of information regarding oil deposits. It was clear that the country would benefit from this arrangement. In fact, viewed from today’s perspective, the nineties brought rapid development in investment and in the discovery of natural gas and oil in the trans-Andean region. When this strategy was modified after the crisis in 2001, progressive deterioration ensued, which will exact heavy tolls in the future due to the lack of investment for the discovery of new deposits. The buyers paid a certain price and committed to a certain royalty. There is no doubt in my mind that if the oil system in Chile had decidedly accepted private investment, Chileans would have participated in the Argentine oil industry, for a time at least, as they did in the electricity field.

In oil-related matters, in any case, a great majority of countries remains tied to concession-based schemes. Exceptions are very rare: the United States, where the owner of the land also owns the oil below the ground, is one. Yet, even there, the problem crops up in state or federal lands.

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Energy

The energy sector became extremely important shortly after the military government took over. This was during the oil crisis, when the international market registered a jump in the oil price that seriously threatened the large Western economies. The main mechanism applied to address this crisis was the price system. After much discussion, the alternative of an emergency program to force the substitution of one fuel for another was abandoned. Instead, the government opted for a policy to allow the price of oil-derived fuels to reach levels that would reflect the real cost of fuel. This comprised several factors: the cost of importing the product (Chile is a net importer), the real costs of distribution, the value-added tax, and specific taxes applied on gasoline and diesel, to pay for use of the transport infrastructure.

Completing this structural reform took time. The Chilean fuel market had previously included a vast amount of cross-subsidies. For example, subsidies to reduce the price of kerosene meant an increase in the price of premium gasoline. This set a correlation, which, contrary to the conventional wisdom, benefited wealthier people, since it offered them cheaper fuel with which to heat their homes, and in the long run was detrimental to the maintenance of the country’s car fleet. Subsidies also favored inhospitable and remote regions. During an intermediate stage, great care was taken to calculate, as precisely as possible, the subsidies that, when deducted from the price of different products, allowed the National Oil Company (Empresa Nacional de Petróleo) to sell some products at reduced prices in certain regions.

The idea of organizing the market in these terms was not born of an obsession with accounting rules. Clearly, until the price system had been allowed to function, it had been very difficult for private individuals to import products. Argentina understood this and achieved stabilization in a very short period, notwithstanding the backsliding that took place after 2000. In Peru and in other countries, the process has gone along at its own pace.

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It was extremely interesting to notice the effect that prices exerted on energy consumption. Indeed, consumption of gasoline dropped. On the other hand, the use of coal, electricity, and firewood increased. It was, in practice, a textbook case: how the price system is capable of creating equilibrium in a crisis situation. The country broke its previous trend toward an increase in oil consumption. Kerosene, a type of fuel theoretically intended for the poor but in fact very commonly used by the wealthy, gradually became less popular.

At first sight, this establishment of a price system seems relatively easy due to its application to a tradable product such as oil, which enjoys the reference of international prices. But it turned out to be far from easy, owing to the lack of transparency in the subsidies and the way in which the state enterprise established prices.

In the area of electricity, where competition is hard to achieve, the task of establishing prices was much more difficult. In this, Chile was a pioneer. The system created even predates the one implemented in England to reform the sector in the eighties.

The challenge consisted in coming up with a price system and a way to organize the electrical grid, so that rates would function as if competition existed. This required great intellectual creativity, which created a model that was later applied to reform the telecommunications and the potable water systems. It is probably far from perfect, but it did lay a good foundation, open to the sector’s dynamism and to future improvements.

The electricity rates reform got the market working right from the start, as far as this could be done. In Chile, at least for large consumers, there is freedom of prices and in service contracting. A large mining enterprise can, for example, contract with different energy suppliers and then have the energy sent to its industrial plant—via easement—even through the transmission networks may have been built by a losing bidder.

For smaller consumers, the system features an evaluation carried out on a regular basis, which estimates the alternative distribution costs of a

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well-functioning company. This estimation is binding on the distributor during a certain number of years, after which the evaluation is repeated. Energy production costs of the energy, on the other hand, are calculated through a much more complex mathematical model, based on marginal cost.

This approach received no end of criticism. Why use a system, some people asked, that is so complicated and hard to understand? That was a strange reaction. Since when do consumers need to “understand” the means by which the goods and services they purchase are priced? Whoever wishes to analyze this can do so, but to argue that “understanding” of prices must precede usage or consumption is absurd. Must one understand how the electrical grid and a light bulb work in order to turn a light on or off?

By implementing the new rates system, the government attained much higher energy efficiency levels. Each individual and every company knows better than any bureaucrat when and at what time it is convenient to consume more electricity, as well as where, how, and at what time it is convenient to save.

But the government went farther than simply rationalizing prices. It also reformed the sector’s corporate structure. In order to make the system better reflect market reality, some companies were divided into generators, transmitters, and distributors. The reorganization was far from perfect, because political problems cropped up in the interim. Endesa, the large electric company, was never broken up. It merely spun off a few small distribution companies. But Chilectra (Compañía Chilena de Electricidad), which is the private enterprise that distributes electric energy, was divided into generation and distribution. Distribution, in turn, was subdivided geographically. All of this work greatly simplified the subsequent privatization of these enterprises. That was the aim of the sector’s restructuring process, which made it possible to put an end to the arbitrariness that forced companies to charge higher industrial rates in order to compensate for lower residential rates. The intent behind these rate subsidies had been to benefit the poor, but it was the wealthiest who

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benefited more in the end. It is not the poor who consume the most energy, yet they are hit the hardest when the economy stalls.

The work that we carried out in the electrical sector was very gratifying. It was intellectually creative and managerially efficient. The market reacted very favorably. Large consumers found that, practically overnight, they had been granted the power to negotiate with companies that previously were monopolies. Entire neighborhoods changed their electricity consumption habits. Decade-long trends were reversed. Many people reacted very negatively to the new “winter rate,” which was in fact sound, since the excessive electricity consumption during the winter months—and especially after twilight—made it necessary to install power stations to reinforce the system during peak hours. These rates were a way of telling consumers—obviously not the poorest—that because they were turning on their electric appliances during these hours, the company was forced to incur additional costs and that it was not fair to pass on these costs to people whose consumption during those hours was more frugal. Power consumption in wealthier neighborhoods decreased considerably. To waste energy became costly. Importantly, the additional charge was linked to a cost factor and not to a tax. Energy in Chile, aside from VAT levies, cannot bear any further taxes, and this prevents distortions in the allocation of resources.

Coal was a distinct and problematic case. Problematic because, in spite of the energy crisis in the seventies and the high prices in force in the sector, a large part of the exploitation of the Lota and Schwager mines was still unprofitable. Major restructuring was necessary at both mines. In addition, privatizing Schwager, the poorer of the deposits whose layers were becoming increasingly thin, helped the process.

In the meantime, new deposits were discovered in the far south, where, although the coal is of lesser calorific quality, the mines are easier to exploit, and therefore extraction costs are lower. It was a special case, because a serious effort was made to integrate coal into the general mining system. Since in fact the most important assets were controlled by Corfo, it was necessary to find investors who were not only interested

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in exploiting this resource, but who also believed in the stability of the policies announced by the authorities.

Of course, the market cannot fix everything overnight, and enabling and liberalizing markets is no easy task. In fact, the task is still incomplete. The end of the story has yet to be written. There are still issues pending, for instance, in the electricity sector. The government has an important task ahead, not only to make the development of the economy viable, but also to reinforce the credibility of the associated institutional framework.

There has been significant backsliding in this area. Beginning in the late nineties, the government began intervening unnecessarily in the price system and in electric contracts. These interventions, still unresolved, are at the root of the problems that the country faces today, which are exacerbated by the ill-conceived interventions in the Argentine natural gas market and by the global rise in the price of oil.

Forestry

The development of forestry during the military government is a very good example of how implementation of the right policies allows a country’s comparative advantages to emerge. Law Decree 701, issued during the first years of the military government, set up a forestation subsidy that was important in helping the development of the sector. However, the key factor was the comparative advantage that the country enjoyed in its forest industry, but that had been repressed by state regulation. The subsidy was based on compensating for the difference between the amount received by a private enterprise and the amount received by the government, vis-à-vis the decision whether or not to reforest. The level of public assets committed to this program was sufficiently low as to make it justifiable as an incentive to employment.

Several of the arguments that initially surrounded the development of policies in this sector can still be heard today in other countries. Was

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exporting logs acceptable? Should the government have required the export of products with greater added value?

At the end of the day, confidence in the greatest possible liberalization and in the market resolved these dilemmas. The market performed extraordinarily well and there were periods during which more than 100,000 hectares were planted in a year. The added-value dynamics gradually prevailed, unaided by government—sawmills, pulp mills, paper manufacturing plants, and lumber mills thrived.

In some countries, the exportation of raw wood is forbidden. For example, Paraguay has issued regulations to this effect. The rationale behind such export bans is to favor the development of domestic industry, but this mechanism—which can be legitimate in certain contexts as a means to promote industrialization—is just as misguided as is imposing high tariffs.

The impatience expressed by many people at seeing faster development of the country’s basic industries than in newer, value-added industries, such as the computer manufacturing plants they would like to see in Rancagua or Chiloé, stems from serious misunderstandings. How does one determine nowadays what a basic industry is? Where is more technology applied: in manufacturing athletic shoes or auto parts, or in hiring teams of scientists to determine which pine species are the most suitable for foresting a region? The evidence is irrefutable. When all is said and done, a country that exports only lumber can be just as technologically advanced as a country that exports paper or forest-derived chemical products.

It is the market and entrepreneurs—through thousands of everyday individual decisions—that determine the routes to development. This is what Chile did, and everything indicates that it was done well.

The charge that forestry policies did not adequately safeguard the integrity of the country’s forests is unfair. Unfair because these resources were previously exploited indiscriminately. Unfair because thanks to the military government’s policies, Chile actually began reforesting at an impressive rate and recovering land that was suffering erosion. Unfair

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because, within the existing budget constraints, the administration did an excellent job in the national parks through the National Forestry Corporation (Conaf). Unfair because in order to protect the native forest effectively, adequate incentives needed to be created. If citizens or the government want to create forest reserves, there is nothing stopping them, but naturally they must pay for them. People’s appreciation of the native forest should not work to the detriment of property rights.

Unfortunately, today the environmental movement has provided a new home for opponents of the free market. Environmental protection itself is a laudable goal, and there are people who have been advancing it honestly for years. The world of nature is, by the way, one that I know well, and few people can teach me anything in this area. I mention this because these days too many recent converts to environmentalism appear to have shifted from red to green with suspicious ease. These are advocates of formulas that have failed in every place that they have been tried, and who see in environmental ideology their last chance to gain power in order to impose central planning. The Rio “Earth Summit” (1992) was a sorry spectacle in this regard. When faced with evidence of the planet’s environmental degradation, the last thing the environmental “experts” will propose is to implement rules, regulations, and mechanisms to make ecological recovery compatible with the market. The same standards that were raised by the Chilean government in many areas—creating clear property rights and deregulating wisely—could be used today to gain ground in this area, which has been beset by state control and statist rhetoric. In this field, socialism has also been a failure: environmental problems in the former Eastern bloc are far more serious than those in the West. By the same token, it is not true that development is the main culprit behind ecological degradation. Ultimately, the problem turns up whenever incentives are distorted. It makes no sense for environmental activists to ask for more state intervention to protect the araucaria (monkey puzzle tree, national tree of Chile) or the pudú (South American deer), while turning a blind eye to the serious environmental problems in Santiago and Valparaiso, which are derived

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from the poor sewage system and related to underdevelopment. State enterprises or the treasury itself, it must be said, were responsible for these problems.

Environmental protection is the area in which some of the most serious institutional backsliding has occurred during the nineties and the beginning of this century. We are all concerned about the environment, but it is unreasonable that environmental protection should be at the expense of prosperity. There is no worse environmental disaster than poverty. The most polluted countries on the planet are, invariably, poor. Today, a movement is gaining ground in Chile that sees development as the problem. This movement focuses only on the possible negative externalities of economic growth—whether real or imagined—while ignoring the increased well-being and countless other benefits of progress—via increased employment and improvements in health and education. Unfortunately, the global discourse on this issue is not very helpful. If we are unable to set up mechanisms that are more balanced, respect private property, and be less prone to irresponsible demagogy, the future of the country will be very much threatened.

Water Management

Government action in water management was guided by the same principles as in forestry: to create solid property rights, not on the water itself but on its use, and to make it feasible by all means at our disposal for the market to operate in an orderly way.

The regulations issued made the distinction between consumptive rights and non-consumptive rights. Consumptive rights apply to water that is consumed and is therefore permanently extracted from the natural water supply. Non-consumptive rights apply to water that is used but is then returned to its source, in the way that hydroelectric plants function, for example.

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The water issue suffered at the time from the same inertia that hindered the development of mining. It faced the same arguments: that water should be a public good that belongs to everyone, and one that the state should be in charge of administering. Such rhetoric leads only to squandering and underuse of resources. Where is the benefit for a farmer who installs drip irrigation if he cannot then sell the water that he would save with this system to a third party?

A full understanding of free market principles and mechanisms was not easy to introduce in this field, either. Introducing these principles was hard work, so much so that in 1992 the Chamber of Deputies reverted reforms. These changes became law during President Lagos’s administration. The law establishes that the right to use water lapses if it is not exercised for a five-year period. This cause for lapse seems reasonable, but it reflects the same kind of motivation that in darker times led to expropriations, whenever some government official considered that the land was not being properly exploited. Again, the same old story: the cause for lapse is based on the belief that government officials know better than the market. This hubris has been proven a failure the world over. Why would a government official’s reasons benefit the community more? If someone is not exercising his right of use, it is because he is waiting for a better opportunity, which may ultimately benefit the community more.

The debate on the use of water is relevant in many parts of the world. In Mexico, several reforms were carried out in this area during the nineties. In California, during the drought just before winter 1992, the debate on local water rights did not even consider the private ownerships of the rights to exploit this resource. The outcome of collective water rights schemes is waste of water and a lack of incentives to invest. For example, farmers end up sowing alfalfa, which uses up great amounts of water, and discarding crops that could optimize the resource. The facts are undeniable. The problem will persist until the market is allowed to function. For this to happen, a full acknowledgment of property rights

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and of the rules is essential. That is the bottom line, even if in many fields private property remains anathema to some.

The military government itself did not refer to property rights directly. It referred to property of a concession, not to property of the mine. It referred to property of water use rights, not property of water itself. This reticence was absurd. Property is by far the best system for safeguarding the social utility and correct allocation of resources. In areas with strong institutional roots and a stronger tradition in favor of privatization, this is widely accepted. But it is resisted in areas in which the state has stronger influence. The less tradition, the greater the state control. The electromagnetic spectrum, which was discovered at the end of the nineteenth century, is illustrative. In this field, the only option considered is the concession system. The state owns everything and only grants concessions for use for a time and conditionally.

Fishing

In the fishing sector, the military government met only partial success. The market was set in motion, products were diversified, a climate of great competitiveness prevailed, and fishing companies took advantage of liberalization to expand their business internationally. They exported sea products in various forms for approximately $1.3 billion in 1992, compared to only $15 million in 1973. But—and herein lies the problem—property rights were never satisfactorily defined. When goods are relatively abundant, this may not cause serious problems. But when the resources are at risk of depletion—as is the case with some fish species—the problem can become very serious.

I am convinced that if the government had found a way to define fishing property clearly and solidly, the country would not have had to ban fishing of abalone, due to overexploitation. The Fishing Law issued during the final years of the military regime—and modified, after much debate by the following government—was a belated attempt to amend

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the omission, but it was far from perfect and did not address the real problem.

It is true that it property rights of fishing resources are a difficult concept to convey. However, the Spanish conquistadores found it even harder to define property rights over the waters of the Mapocho River, as currents change constantly, and yet they finally managed to do so. The challenge still stands. A system based on bans leads to distortions and overexploitation. As soon as the ban is lifted, everyone rushes to extract as much as possible before anyone else does. From overinvestment in larger boats to industrial capture technologies, this is a very dangerous and destructive zero-sum game. What I win, others lose—what others win, I lose.

If the military government was only partially successful in defining property rights in fishing, it was not only because this was a complex task, but because a major mistake was made. The first efforts did not acknowledge the participation and preference of those who were already engaged in the fishing industry and had a track record to show for it. When property rights are first defined in an area where they did not previously exist, it is important to assign some value to the experience and expertise of those already in the business. One cannot start from scratch, and a basic sense of justice should make one wary of any statute that treats someone who has been in the business for many years the same way that it treats a newcomer. This was not fair, and it made political consensus more difficult, thwarting better and more modern regulations.

Telecommunications

The greatest difficulty in this area was setting the market in motion. One would think that the challenge was relatively simple, having accomplished what we did in the electricity sector. But here the issue is more complex, because the country had fallen behind in this area—its

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technology was obsolete and its equipment antiquated. If the sector was known for anything, it was for excessive regulations, prohibitions, and cross-subsidies. This was the price that the country paid for state intervention—through price control policies—and for the Allende government’s nationalizations, which left Chile a laggard in the technological development of telephony and telecommunications, looking on while the developed world raced ahead.

There was another political problem of telecommunications being considered as an area of high strategic national security value. Making all parties interested in the sector— including the military—understand that it was preferable, in terms of the country’s sovereignty, to have telecommunications that were good, free, and modern rather than bad, obsolete, and state controlled, was not a straightforward, instantaneous process.

Although visualizing property rights in this sector was not that difficult, the fact is that very little was done. In the case of cable communication, things seem relatively simple. Introducing property rights is harder, although not impossible, for communications requiring use of the electromagnetic spectrum, as in television and radio broadcasting. I have no doubt that as soon as the government auctions off the spectrum to private owners—property right included—the technology required to split those bands into three, four, or even twenty frequencies will appear, and the net asset value of that right will multiply. But as long as property rights are not recognized in this field—everywhere, not just in Chile—there will be little incentive for such innovation.

Television, which is privately run in most of Latin America, was born in Chile under a state or para-state control model—through universities that receive public funds—and only in very recent years has it incorporated private participation. In truth, its programs—give or take a couple of local idiosyncrasies—are hardly different from programs in the rest of the region. In radio, on the other hand, the country has always

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had a strong private industry. Chile appears to be one of the countries with the widest variety in radio programming, especially on FM.

The basic instruments used to modernize Chilean telecommunications were the rates system and the regulations regarding interconnection. These regulations succeeded in breaking the vicious circle that made every natural monopoly into a legal monopoly. This logic was the key step to liberalize the sector, open the telephone market, create competition between companies, and, above all, recover the legal concept of easements, which enabled a company interested in providing services to use another company’s infrastructure.

The problems arising from competition and from the overlap of companies in the same geographic area are not easy to solve. It is much simpler to have just one company. But I am convinced that competition works even through simple presence. The government’s role is to make sure that the market works despite the difficulties involved. A natural monopoly need not necessarily become a legal monopoly. On the contrary, competition, even if only potential, should be the policy maker’s main concern. The effort is absolutely worthwhile. The incentives to deliver good service at lower costs are incomparably greater in a market scenario.

In Chile, the telephone system used to be very inefficient. Waiting lists to get a line installed were as long as the phone book. Just the fact that the telephone market needed to be opened describes the absurdity of the situation. If the state phone company had worked well, installing telephone lines should have imposed practically no costs on consumers, since companies profit from the use of the lines, not from any inability to cover the demand.

There was constant pressure on the government to back out of all of this. Until 1993, CTC and Entel—one company delivered local telephone service and the other long-distance service—each refused to let the other compete on its own turf. This made no sense; multi-carrier technology allows multiple long-distance providers to operate simultaneously. It is up to users to choose the supplier that they prefer. Companies have no

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right to make the choice for them. It must be noted, however, that the method and timing chosen to do this created a series of difficulties.

The modernization of telecommunications—the restructuring of rates and dismantling of subsidies, both overt and hidden, paved the way for the privatization of the telephone system. It was a pioneering move in Latin America, which speaks highly of the military government, not only because of the content of the policy, but because of the strategic implications that it had for the military. It required great political will. Privatization was unavoidable, because considerable investment was needed and the state was in no condition to provide it.

At one point, it looked as though the entire privatization effort could fall apart, because CTC was awarded to the Australian group headed by the Australian entrepreneur Allan Bond. Not only was his offer the best, but it also promised new investment, instead of external debt promissory notes. The problem was that Bond, who founded his empire on credit, hit hard times internationally and had to liquidate his investment in Chile. Fortunately, the whole affair did not entail major consequences for Chile. During the time that the group ran the company, a huge investment program to modernize the sector and increase the number of lines was launched. Getting a phone line was no longer a nightmare. Subsequently, Telefónica Española, the runner-up in the bidding, took control of CTC. On this foundation, Chile became the leader of cellular telephone development in the region.

Transportation

In all areas—sea, land, local, long-haul, freight, and passenger—transport was an overregulated sector in which the state had accumulated an increasing amount of power, led by bureaucrats who thought they knew how to safeguard the interests of the public better than the market. There was another problem: the constant pressure from transport unions for more power. Fortunately, since the notion of property was quite a bit

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stronger here than in other fields, the government’s first concern was to get the market to function. Ports were the only area in which private property was unheard of.

After selling the assets of the State Public Transport Company (Empresa de Transportes Colectivos del Estado) in the government’s early days, and repeatedly postponing the total privatization of the State Railway Company (Empresa de Ferrocarriles del Estado)—which was finally never carried through, perhaps because Chile’s geography makes railways less critical than in other places—the task consisted of revising regulations to make them market friendly. This was not hard to do, because fortunately the sector was quite competitive by nature. However, convincing the unions that competition, which they feared, would benefit everyone in the long run was more difficult. Few union leaders could understand that public transport working with competitive prices would not be the end of the world. Older people remembered a time when Chile’s government had come very close to collapsing as a result of a rise in the public transport fare to one chaucha (a 20 cent coin, in the old peso currency).

In the end, competition worked. It worked well in freight transport and in long-distance passenger transport. Local public transit, while not optimal and inferior in quality compared to that of developed countries, saw definite improvements in relation to what it had been twenty years before. I say this because today there are those who cite deregulation of public transport in Santiago as proof of the failure of free market policies. One needs to have traveled on a bus the way most Chileans did in the sixties and seventies in order to know what a disaster the system was back then. The experience was almost degrading—an obsolete and inadequate bus fleet, vehicles that were dangerous to travel in, insufficient routes, infrequent scheduling, terrible service. I have no patience with nostalgia for the past in this area. I, like most Chileans, experienced the public transport disaster firsthand. I spent all of my youth hanging on to the steps of buses trying to get to school and later to the university on time.

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What the military government did not do, admittedly, was to bring the market into the use of urban space. Santiago is a city afflicted by traffic jams. The military government made no serious effort to improve the traffic situation. This was partly due to political pressure, and partly because the logical way to have gone about this was to start with private vehicles, then move on to taxis, and finally on to public transport, following a scale based on social utility.

In the last few years, the Concertación government decided to “improve” public transport, by intervening in individual decisions expressed through the markets. The outcome was Transantiago, a recently launched public transport system that establishes that the government—not the market—will design urban bus routes. In addition to burying the small private transport companies that served the public years ago, and requiring millions in state investment in infrastructure, the project has been disastrous and has not managed to satisfy people’s basic transport needs. Workers, who often wait for hours to get to their jobs, are the worst hit by this statist experiment.

On the maritime front, deregulation overcame difficult obstacles. Often, monopolies are external, determined by treaties that impose various freight restrictions. But nevertheless, the government reduced their room for action to a minimum. Various adjustments were made in order to establish competition in as many areas as possible. This was done with consideration of the position of those in the sector who argued that their real competition was with the rest of the world, but never to the point of allowing monopolies that might eventually prevent our cargo from leaving our ports. In the past, both imports and exports had to follow a strict cargo reservation system and could only operate with Chilean companies. That is no longer the case, although they must comply with certain procedures, which to a certain extent are a compromise with global reality. Shipping is affected by protectionism and overly strict regulations the world over. In any case, cabotage remained restricted to national companies.

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The most important problem that the military government met in ports was labor related, and it translated into very high rates and anti-competitive regulations. For example, the rates system resulted in a situation in which it made no difference to a ship owner whether he used his own ship’s crane boom or that of the port to load and unload cargo. I first discovered this absurdity when I joined the government in 1975. The ship owners chose to use the port cranes, which were obviously insufficient to serve all of the ships within an adequate time frame. This circumstance created an urgent need to invest in equipment; I remember how vehemently government port officials demanded it. The sector was riddled with distortions of this kind. Behind each such distortion there were always favors being handed out to the detriment of the majority, while benefiting a specific person or group. Showing great resolve, a government team headed by Miguel Kast ended the labor monopoly in the ports and incorporated the port labor system into the one for all Chilean workers.

Despite all of the reforms introduced in the sector, despite all the improvements achieved in operations, considering that trade increased five-fold in this period, and in spite of the important reforms introduced in the sector’s labor legislation—a subject that will be taken up later on—the military government was unable to create property rights or privatize state-run ports. This final step was simply not taken.

Air transport went through a similar process as that of maritime shipping, which in addition coincided with deregulation in the sector.

Industrial property and intellectual property faced a similar situation, but in these areas the conflicts tended to be fewer and less intense compared to those in other sectors. Consequently, the government’s critical mission was to deregulate. Quotas purported to prevent industry overcapacity were scrapped. Chilean industrial legislation was overrun with socialistic laws and regulations, many dating from the thirties. The content of the regulations was openly interventionist, and it was my responsibility, as sub secretary of Economy, to take advantage of the passing of several miscellaneous laws and to advance toward their being

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revoked. Otherwise, the multi-target laws that were absolutely instrumental would still be in force today, given the chance to eliminate them without provoking too much political resistance. Those regulations were potentially dangerous. In unscrupulous hands, they could have been a death sentence for Chilean industry.

When the economy was centrally planned, when almost all prices were controlled by the state, when the authorities decided who could import and who could not, when the state owned countless enterprises, the Economy Ministry was a colossal source of power. All of this was dismantled, beginning with the unconscionable prerogatives bestowed on the Industry and Commerce Office (Dirinco), the agency in charge of price control, and with the complicated regulations that strangled foreign trade. Some criticized the government for not having an industrial policy, but that criticism could not have been more mistaken. Everything that the government did in this area was geared toward a different industrial policy, one that was non-interventionist and designed with a view to exploiting the country’s comparative advantages. In my long personal experience in the pharmaceutical, capital goods and transport equipment areas, among many others, careful, painstaking effort was made in all of them to keep either the tax system or the tariff system from preventing the development of activities at which Chilean businesses could excel.

This was not coarse work. It involved much fine-tuning. It was not just a question of eliminating controls, but also of correcting distortions. These included, for example, the tax regulation that made it more profitable for a businessman to import a machine than to buy the technology needed to build it in Chile, or the tax rebates on supplies and capital goods for exporting manufacturers who bought from local suppliers. These support industries are very important. Underestimating them is a mistake, because such carelessness can transform a well-devised industrial policy into an anti-industrial policy with obstructive, harmful implications. From my point of view, they are a necessary complement to the industrial development framework, which tariff and exchange policies that favor opening-up provide naturally.

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Government Reform On reviewing the modernizations introduced into the state’s

provision of infrastructure and public works, the importance of having a system by which to evaluate public investment projects stands out. The military government, through Odeplan, in collaboration with the Economics Faculty of the Universidad Católica and especially with professor Ernesto Fontaine, created a complete system for the economic evaluation of projects that, because they were financed and run by the government, were not subject to the automatic profitability control that surrounds private projects.

Thousands of government officials, from a wide range of agencies, were trained in project preparation and evaluation techniques. This was done so successfully that to this day it is not the government’s specialized agency that evaluates projects, but the officials of the public institutions who themselves facilitated the investments, with Odeplan acting solely as inspector and regulator. This model has been transferred to other Latin American countries through state-financed courses run by the Universidad Católica and through the work of international entities like the United Nations Development Program and the Latin American Institute for Economic and Social Planning, which finance the training of public officials from various countries in these techniques, with the participation of Chilean consultants. A framework for private financing of public infrastructure projects exists in Chile today, thanks to the approval of a concessions law—a positive move made by President Aylwin’s government that emerged from this task.

In this same area, regionalization, which began through studies carried out by the State Administrative Reform Commission (CONARA), was an important step toward decentralizing government activities. This brought people closer to governing institutions by creating regional governments. An essential complement to this was the redefinition of the role of municipalities, which were provided with greater financial resources at the expense of central government, to

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enable them to carry out the new tasks assigned to them. In addition, the decentralization in health and education farther down the road would hand them new responsibilities and new resources.

But the reform of the state went even farther. It is a huge task that is never done. Multiple administrative reforms were carried out in all sectors. They affected diverse areas, from tax administration to the civil registry system, from defense and security to certain aspects of justice administration, from the management of public enterprises to the way in which state assets were made available to the private sector during the privatization process. In some areas, such as justice, the task has only just begun, but that does not make the efforts already made any less remarkable. A complete account that adequately acknowledges the contributions made by all of those who took part in Chile’s government reform process requires a whole book.

CHAPTER FIVE

Work, Capital and Freedom

Each of the reforms carried out during the country’s modernization phase were part of a program whose goal was to lead Chile toward development through a market economy. But these reforms also arose out of opportunities, circumstances, and special situations that no one could foresee.

Just as in the lives of individuals, there is a time for each initiative and each experience. Little is gained by attempting to do things ahead of their time. On the other hand, it is hard to make up for things not done at the right time when it is too late.

In this respect, circumstances have a huge influence. Could there have been reform in the former Soviet bloc before Lech Walesa in Poland, and others in the rest of Eastern Europe denounced their leaders as not representing their interests⎯if those governments had not faced international pressure? Could property rights have been established in mining if the Constitution had been slightly less biased toward the state on this issue? Was this not, in fact, the factor that created a general awareness among government officials that the situation was unsustainable over time? Would modernization of the ports have been possible had freight and landing costs not reached the unmanageable levels that they did, bottlenecking the external opening-up policy?

It is therefore not so strange that the government should have achieved sustained modernizations, starting out from the points previously described. Every reform has its time, and it is up to policy makers to perceive when this time has arrived. This is what overly conservative and bureaucratic governments never notice, because they are unduly averse to change and innovation.

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The Labor Market

Airplanes remain airborne because they reach a certain speed. If they lose enough velocity, they fall out of the air. This is one of the first lessons that pilots in training learn. However, when an aircraft loses speed and altitude, people’s natural instinct is to try to lift the plane, putting all their effort into getting it to climb. This reaction is catastrophic, because if the plane is falling steadily, what one actually needs to do is not try to lift it, but make it fall even harder so that the increased speed allows it to recover lost altitude quickly. Needless to say, this requires having some margin for action. If there is none because the plane is too low, perhaps the best that one can do is to say a quick prayer while looking for a spot to make an emergency landing—at that point, the pilot’s life is in God’s hands more than in his own. This lesson should be mandatory not only for aviators, but also for social and political leaders, especially in the field of labor.

Many labor leaders believe that wages will rise higher the more they battle against employers. This is like the pilot who, when his airplane is in free fall, tries to point it toward the sky⎯when he is not even certain where the sky actually is⎯as if this were enough to stop the fall. It is just as misguided as the belief that wages can be improved as much as one wants with the backing of a generous law coupled with strict enforcement. Some honestly believe that workers are better off renouncing their individual freedom in order to negotiate en bloc and face employers from a much stronger position.

None of this is true, however. Confrontational war with a company yields not better, but worse wages. Real wage increases come about not because of laws mandating them but from increased worker productivity. It is highly improbable that a worker will win anything by resigning his freedom. In fact, there is a good chance that he will lose, because salaries negotiated by a union will tend to reflect the company’s mean productivity, which means that all those above this level will have to

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settle for less. This is the best way to kill any incentive to improve and the best way to neutralize the motivation for individual creativity.

The dogmas of trade unionism⎯the unity of workers against employers at all costs, the loss of individual freedom for the benefit of the group, and the maximization of the political power of labor unions to improve their negotiating capacity⎯derive from a combination of errors, distortions and myths. Nearly all of those who shaped labor legislation during the twentieth century have subscribed to these grave errors to varying degrees. It is no accident that these distortions are cultivated with devotion by Marxism.

Truth lies precisely in the opposite direction. Workers will do well only if the company does well, if the economy is growing, and if new work opportunities arise on a permanent basis.

For this to happen, freedom and flexibility are fundamental. Without freedom and flexibility, economic growth is impossible. The security and stability that people seek will yield to stagnation and instability when those goals are sought through coercive and collectivist means. The attempt to nail down the wheel of fortune only leads to nailing the country down to economic prostration and poverty.

This being the case, what labor legislation must safeguard is the freedom and flexibility to adapt to changes in the market, since this is the way—the only way—in which workers’ interests are effectively protected. It has been proven that measures whose primary goal is to give workers greater stability always end up harming them.

Labor legislation should be limited to fulfilling the objective to which all laws adhere: to preserve as much as possible of the tradition, the natural sense, and common practice of social and economic activities, while establishing mechanisms to address future conflicts that may arise. This is what sets the path for progress. The laws themselves need not be progressive, only functional and fair. The energy that drives progress comes from the people, not the laws.

Regulations that undermine job mobility or make it mandatory to belong to a certain union are completely counterproductive, both for the

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workers and for the union organization. Freedom of association should be a non-negotiable principle in the world of labor policy. The union may represent its members in good standing, but only insofar as they have adhered freely to it, rationally weighing the freedom of action that they give up against the material benefits that they can gain. In this aspect, nominal freedom is not enough. In several Latin American countries, the law stipulates that admission to and membership in a union are free decisions to be made by each worker. But what good are such laws if, for example, access to company pension programs and other benefits remain tied to union structures? In many countries in the region, freedom of association remains an illusion, because of the collusion of politically powerful union and business leaders.

Compulsory unionization is harmful, both to economic performance and social welfare. In the American experience, which is often invoked in favor of openly interventionist labor laws, economic growth has shifted from the states that are overregulated in labor matters to those in which there is greater freedom in this field. A federal country can afford this and ultimately has this escape valve. It is true that in some American states a large part of labor legislation is permeated by inflexibility, but these states should not be considered a model for anybody. The outcome of these experiences many times lies in that, despite the regulations, those states have managed to succeed because of the dynamism of a federal economy, with the scarcity of labor – like what happened in European countries for an extended period – or for other reasons unrelated to labor legislation.

Reform of the Chilean labor market was carried out based on three principles: full freedom to work, ample freedom of association, and collective negotiation within the company. Union leaders resisted the three principles vehemently, because all three threatened their political power. There was also a threat of an international boycott in 1978, which would have meant, among other things, the refusal of port workers around the world to load or unload merchandise to and from Chile. In the

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long run, this threat benefited the government, inasmuch as it made the need to liberalize the labor market more urgent.

The effect of the extensive labor reforms introduced into legislation was soon felt in the market⎯individual work contracts, collective contracts, trade unions, use of contractors and subcontractors, collective bargaining, and the right to strike⎯were secured. However this was done at company level and without restricting the employer’s right to continue operating his company with third parties if necessary. Until 1973, employment in Chile grew basically as a function of the growth of the public sector. The economic liberalization launched in 1974 marked the beginning of change in the nature of the workforce. Later changes brought about by the liberalization of the labor market were beyond what anybody could have imagined. Chile, at the time that I left for the United States for my post-graduate studies, was a rigid country, where the only major employer was the state, and university-educated professionals’ positions were virtually guaranteed. In the country I had helped to change, these things already belonged to the past by the time I returned.

Another problem was caused by the 1982–1984 debt crisis, which led to high unemployment throughout Latin America. Wages fell as well. But in the medium term, they fell less in Chile than in Mexico and other countries in the region. Contrary to what some demagogic critics suggested, the situation had not been brought on by liberalization. By 1985, when the opposition held that Chile would not be able to leave two-digit unemployment behind, the facts quickly proved them wrong. By 1989, the country had a 5 percent unemployment rate. This recovery would never have taken place under rigid socialistic labor legislation.

The stubbornness of the opposition on this matter was enormous. When, as a presidential candidate in 1989, I put forward the goal of creating a million jobs in four years, my opponents said there would not be enough Chileans to fill those jobs. Between 1985 and 1989 an average of 239,000 jobs were created annually, which was unprecedented at the time. One million new jobs in four years were certainly achievable. However, plenty of people remain out of work, and there are thousands

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of Chileans who should be joining the ranks of the labor force. The country’s active working population⎯currently around 35 percent⎯needs to continue to grow in the coming years until it represents at least 45 percent of the population. Greater flexibility and vision are still needed in order to advance in this direction. What matters is not just the people who are working today, but also those who could join the labor force in the future. Rather than set up obstacles that interfere with employment in export agriculture, which is largely temporary, ways should be found to enable more people⎯mainly women and young people⎯to participate in these tasks, in order to bolster the country’s competitiveness. Why not, for example, consider a change in school holidays to suit local needs?

Within the labor reforms accomplished during the military regime, the ports reform⎯carried out by Miguel Kast⎯was critically important. A monopoly of scandalous measure had prevailed for years in this state-run infrastructure, favoring workers who were licensed to work in ports. The conditions and benefits that they had obtained were so favorable that many actually hired other people to do their work for a fraction of their wages, which was still an attractive option to them. There were exceptions, of course, but not enough to alter the big picture, because the overall situation was undoubtedly scandalous. It was enabled by state control, since the ports belonged to the state, and by the economy’s apparent insensitivity to the costs of this absurd labor structure. Essentially, the people who paid the cost of these labor privileges were the farmers and agricultural workers whose products became much harder and costlier to export because they could not negotiate with the port workers. The negotiation was done by the shipping agent, who in turn passed on the costs to the exporter or importer. The costs were so high that it was impossible for ports to work a third shift, which meant that a third of the country’s port capacity remained idle.

This was the situation in Chile, and it is a situation that still exists in many other countries. This is why the ports reform issue should be on the agenda of all governments committed to economic liberalization. Above

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and beyond the content of the political decision, the dismantling of union privileges in Chile’s shipping industry included compensation for those affected. This cost the country around $50 million, but the expense was worth it. However, the matter did not end there. Old habits die hard, and so many privileges remain entrenched today.

After moving in one direction for decades, turning in the opposite direction is not easy. It is not easy to internalize that yesterday’s truths and core concepts were mistaken. I remember a question asked by a Chilean labor lawyer to a government official in Hong Kong during a visit by a Chilean government and business mission to that country in the late seventies. They showed us impressive evidence of the economy’s dynamism, and the lawyer asked, “Yes, that’s all very well, but what is the minimum wage and where are the laws protecting workers?” The official, without batting an eyelid, answered with another question: “Do you want us to suffer unemployment? With the enormous amount of Chinese immigrants that we have annually, and the terrible poverty conditions in which they come to our country, our challenge is to expand employment, not obstruct it.”

Even though I cannot help but believe that many union leaders will eventually come around, I am not particularly optimistic regarding the future of labor reform in Chile. The foundations have already been undermined in some fields; for example, today it is possible to have sector-side collective bargaining, which in a small and open economy such as that of Chile can be very damaging.

On the other hand, some projects presented in Congress during the Concertación government give cause for apprehension, as do the actions of labor authorities, based on certain potentially damaging administrative interpretations. Unfortunately, the tendency to grant by law benefits that only economic growth can provide remains deeply ingrained in the country’s political class. Today, pressure groups remain very powerful and have extraordinarily effective weapons⎯their organizational capacity and the public perception of them as representatives of the downtrodden, which is far from true.

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Against the labor leader who knows only how to maneuver his people politically, a new, kind labor leader is often at a disadvantage. It is difficult to get the rank and file to understand that conditions have changed and that wages depend not on ideological slogans, but on training, increased work productivity, expertise, and the contributions that workers as a whole make to the company.

However, the evolution of industrial activity⎯its increasing degree of technological specialization⎯is transforming work throughout the world into an increasingly individualized experience. Collectivist labor systems are on the way out. This explains the decline of unionism worldwide. Companies do not maintain collectivist relationships with their workers. Therefore, the times have bypassed the old union models that are supported by the Marxist idea of class struggle. In the new scenario, the company’s relationship with its people is increasingly sensitive to the individual skills, professionalism, character, and motivation of each individual.

The sole aim of the liberalization of the labor market was to open it up to the responsible decisions of individuals. Finally, the direct agreements made between workers and managers began to matter and to influence the inner workings of companies, the natural space for labor relations to play out. Both parties became independent, free agents. Collectivist labor arrangements fell, and relationships evolved from rigid to flexible.

If this change was important socially because it took labor relationships to an individual level, economically it was critical. Chile would not have been able to become what it is with the privileges and rigidities that used to prevail in this field. The reforms invested Chilean companies with a competitive spirit. This is precisely what an open economy implies⎯openness, plurality, competition, non-discrimination, and freedom of choice in the widest sense.

The inflexibilities, artificial barriers, safeguards, and privileges not only limited the freedom to contract and the freedom to work, but also became breeding grounds for inefficiency and lagging productivity. This

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concept was very hard to advance politically, because it meant transferring power from the union leadership to the people, while it also involved dismantling the false “social gains” obtained at the cost of inequities and disadvantages imposed on the least powerful and the poorest.

Labor reform vindicated the freedom to work in a comprehensive sense. The changes in labor legislation were complemented with resolutions to further freedom of association and to do away with mandatory association as a requirement for employment, giving shape to a set of regulations appropriate to a truly free society and a truly open economy. The right to work was reinforced by eliminating the number of registrations, identification cards, and licenses established by political pressure over the course of many years. The task was neither simple nor well understood, but it benefited millions who found a job. The backsliding in this area, which has occurred gradually throughout the nineties and this decade, partly explains the reduced dynamism in the Chilean economy after 1997. This is why, in spite of economic growth, the proportion of the population that is active in the labor force has not increased as it would have if the pro-employment vision had been sustained. This has serious negative consequences, especially for the younger, lower-income population and for women.

Pension Reform

The pension reform, launched in 1980, is related to both labor reform on the one hand, and to the capital market on the other. In Chile, the pension system had so drastically severed the connection between work and benefits that retirement contributions had become a tax on work. In some cases, contributions were as high as 60 percent of wages.1 In theory, this correlation gap should have advanced the social welfare goal of

1 Cheyre, Hernán. La Previsión en Chile: Ayer y hoy.

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benefiting those in greatest need, but that was not what happened. The workers in the worst situation were precisely the poorest, and were also the Social Security Service contributors. These workers represented 65 percent of the contributors and, while other groups were entitled to retire at 42, the workers who performed the heaviest physical tasks could not retire until they were 65—and in addition received a sum that was below the taxable income2.

The people who benefited the most were those with the greatest political clout, beginning with⎯no surprise here⎯members of Congress. The inequity of the system, in addition to shameful discriminations and privileges, showed up also in terms of a financial shortfall, which meant an inequity between generations. A consequence of this was a sustained increase in pension contributions, reaching 60 percent of a worker’s income in the case of private employees, with very serious consequences on the level of formal employment.

The military government decided to tackle the matter at its roots, and started out by correcting the most obvious deficiencies, inequities, and distortions. This preliminary cleanup was necessary in order to reorganize the system as much as possible and neutralize the pressure of organized groups attempting to obtain privileges, a race in which everyone took part, even while aware that it was materially impossible for everybody to succeed.

Even though the pension provision situation was similar to that in the rest of Latin America, in Chile things had reached an apex in terms of state control, irrationality, and injustice. The system was unsustainable owing to the number and the magnitude of perverse incentives that it contained. These incentives yielded effects⎯understated income tax returns, constant pressure to obtain benefits at the expense of others, depletion of the system’s technical reserves on homes sold to a lucky few, long-term plans with no readjustment clause⎯that would ultimately lead the system to ruin. For each pensioner there were only two-and-a-

2 Luís Larraín. Soluciones Privadas a Problemas Públicos, p. 16.

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half active workers. This ration, combined with other deficiencies in the system, inevitably meant that the vast majority of workers were retiring on very low pensions. In a population whose life expectancy was increasing, there were ever fewer active workers financing each beneficiary’s pension. While in 1995 there were 12.2 active workers for every pensioner, in 1979 only 2.5 active workers financed each pensioner.3

Politically, that may have been the hardest part of pension reform, because what people thought of as the root of the crisis⎯the miserable level of pensions⎯was not really the root but the consequence of the problem, and therefore very difficult to solve for current pensioners. To begin with, it had nothing to do with a pension reform, because pension reform simply means devising a system free of perverse incentives that could jeopardize it in the future. To fix problems in the old system, policy makers have no room for action outside the political and tax expenditure decisions they make, based on the tax resources generated by economic growth.

In addition to discouraging saving and considerably raising the cost of labor, the old pension system also weakened the private measures that people would take to anticipate possible emergencies and times of need. In the end, the magnitude of pension contributions reduced workers’ savings capacity even more, and the system ended up nationalizing most private savings. But the problem did not end there, because everything was set up for the state to transform those savings into spending.

The route chosen by the military government to carry out the pension reform had three major elements.

The first consisted in introducing some rationality into the old system. For example, equitable age requirements for retirement were established and privileges were eliminated. A case in point are the pensions known as perseguidoras (“chasers”), which granted some lucky

3 Estudio de la Reforma Previsional: Previsión Social Chilena

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pensioners the income and the adjustments corresponding to his former position, as if he were still actively employed.

In exchange, all retirees gained a permanent, general adjustability mechanism, which had previously been lacking, and which restored the purchasing power of pensions when inflation exceeded a certain range. A decade after the reform’s implementation, the numbers confirmed that the new pension system paid a higher average pension than did the old system. The relative factors were 1.4 in old-age pensions, 2.2 in disability pensions, 1.5 in widow’s pensions, and 1.4 in orphan’s pensions.4

It is ironic that precisely the same government that to this day is attacked for not having granted a 10.6 percent adjustment in 1985⎯which by the way nobody received, neither the public sector nor the military nor any other sector, and which the same government later compensated for with automatic adjustments for the poorest pensioners⎯was the one that created the automatic adjustment system for retirement pensions in Chile. This system did not exist before then. It was created, not by any one of the governments that made shallow promises about redistributing wealth, or that proclaimed themselves saviors of the poor. It was created by the military government. So it is asinine that the same political factions that wreaked havoc with pensions and whose inflationary policies relegated the vast majority of Chilean pensioners to minimum pension levels should continue to present themselves as advocates of pensioners. Not only did they never defend the pension system, but they were responsible for the miserable state in which it ended up.

I remember an especially unpleasant incident just before the 1989 presidential campaign. I was on a bicycle and was accosted by an elderly retired man who reproached me for his problem with that 10.6 percent readjustment. He had just argued with his wife, he said, over money. He looked not only irritable but also bitter. But he refused to listen to reason.

4Boletín Estadístico Mensual S.A.F.P.

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He hardly even let me speak. An impoverished old age can be a very sad experience, which the old Chilean pension system imparted with no compassion whatsoever. It was not the government during the eighties that was to blame for the situation, but rather its predecessors.

The second component involved the government gradually reducing the tax on work that was implicit in pension contributions. Benefits were no longer financed by pension funds but by general tax revenues from the national government. Employment benefited from these changes. Naturally, in order to make them, first the tax and collection systems had to be improved and government spending cut.

The third element arrived at the comprehensive solution: a top-to-bottom structural overhaul of the pension system. The government’s first victory was its ability to separate benefits for old age, disability, and family group survival from the rest of the social security program—including health, workman’s compensation, welfare, death benefits, and personal loans. Mixing different systems—for example, using pension funds to finance health benefits or to provide workers with credit to buy their own homes—can lead to nothing good.

The new pension system, with freedom as its guiding principle, is founded on the individual responsibility of each worker, reflected in his own savings capacity and his own individual account, and in the private administration of the funds by properly regulated companies, known in Chile as AFPs. At the time, banks were expressly barred from managing pension funds for reasons related to their vulnerability in the early eighties.

Initially the investment portfolios managed by the AFPs were restricted by wariness toward the management of pensions by private companies. However, over time, the investment of pension funds in the more firmly consolidated companies’ stock was authorized. Therefore, in the long run, the increase in the price of stock benefited all of the Chilean workers, through high returns on their retirement funds. Currently, the AFPs are authorized to invest abroad—with certain limitations—both in stock and in other financial products.

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The system, on the other hand, provides a social safety net. The state supports it by guaranteeing to supplement workers’ savings in order that pension holders who have not managed to accumulate sufficient resources in their accounts but comply with certain basic requisites concerning years of contribution, will collect a minimum pension at least. This minimum pension is completely unrelated to the pension granted by the State to pensionless elderly people on the verge of indigence.

The system provides adequate incentives for exercising individual responsibility. If a person wants to retire before reaching the required age—60 for women and 65 for men—he or she will need to save up more money. If his job involves heavy labor, the worker can make arrangements with his employer for a higher pension contribution. Also, individual pensioners are entitled to choose the AFP that provides them the best terms and service. Competition between institutions is a key factor to ensure that they aim at greater efficiency in their administration of the funds.

On the whole, the new system redirects decisions that until then had been political into the individual sphere, which was precisely one of its objectives.

As a Russian economist who was visiting Chile some time ago pointed out to me, in a perfectly libertarian society, there would be no need for a government-imposed retirement system, since there would be no reason for the state to interfere in people’s private decisions. How he or she wants to face old age would be up to each individual. Some may prefer to start from a very early age and save much more than 10 percent of their monthly income. Others might be less apprehensive about the future. There may be a point in this argument, but not within current political reality. Today, for better or worse, people have already removed these matters from their realm of decision and believe that creating a good retirement system is a government responsibility. This is an undeniable political fact that every government must deal with. Things

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may be different in the future, but in the meantime, utopian libertarian scenarios are bound to remain just that.

The military government did not impose reform by force. Granted, the law creating the new system was enacted in the same way that all laws were generated during that period, but joining the system was voluntary. It must be noted that the incentive to transition into the new system was very strong—namely through an increase in liquid salary owing to the changes in retirement contributions and a bonus that recognized the contributions made into the old system. The efficiency of the new system made these things possible.

With the reform, the government completed its efforts to reduce pension contributions in the old system to a reasonable level, at which they were no longer a tax but an equitable contribution in relation to the benefits that they guaranteed. Besides, in both the old system and the new, contributions were now paid from the worker’s wages, and to this end, gross remunerations were increased. The cost for the employer, however, was still basically the same. The change was important in allowing the worker to feel that it was his own money that he was saving.

The interesting thing about the reform is that, in addition to introducing efficiency, rationality, and justice in an area sensitive to a society’s welfare, it also helped create a substantial private capital market.

The system, as noted, became more flexible over time. At the beginning, the range of investment options for pension funds was very limited. Later on, these options became more varied. During his whole working life, the worker saves into his AFP individual account—which he can transfer from one company to another as often as he wants to—and at the end, among other alternatives, he can opt for a lifelong annuity to be paid by an insurance company. Management by insurers was suggested early on, but the idea was dropped, mainly because the scope of this participation is not the same in a compulsory savings system as it is in a retirement system. It seemed crucial to safeguard people’s

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freedom, anticipating that hasty decisions made while they were young could be very costly in their old age.

In countries in which private and compulsory pension funds already exist, initiating a reform similar to the one carried out in Chile may of course create some complications. But it is not hard to visualize good formulas for adjustment and coexistence in terms of each country’s circumstances. This is what countries such as Mexico, Argentina, and Peru did in the nineties.

The Chilean pension reform has completely fulfilled its objective, especially regarding incentives, which today are well structured. The fears that pension funds would become easy prey to rapacious capitalists were completely laid to rest. In the case of embezzlement, there is no comparison between the new system and the old, which was a constant source of scandal and allowed fraudsters ample leeway for impunity. Doing away with the tax on work revitalized employment. In addition, the system created an ample market for savings, close to 35 percent of GDP in 1993. It is true that the Central Bank, for macroeconomic reasons, absorbs a significant part of these resources, but the difference is that it now absorbs them in a competitive system. The issuing institution must now compete for these resources.

The foundations of the system are perfectly applicable in any country, as long as the role of individual responsibility is recognized and as long as the retirement system remains independent of politics. Every nation can adjust the system to its own circumstances and development level, but the basic structure is universally valid.

Strangely enough, certain institutions, such as the International Monetary Fund (IMF), were somewhat skeptical of the Chilean pension reform. It is to be expected that the implementation of a reform this size will generate a greater fiscal deficit. In effect, when workers transfer their funds to the private sector, the Treasury loses part of its income, which was anathema for the IMF. The real problem arises when the long term is not considered, and when the truly important variable is not taken into account: that domestic saving should not drop, so therefore

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incentives should be created to make it increase. This can be achieved through increased private savings, even at the expense of somewhat greater fiscal deficit, because the treasury can still resort to the capital market to obtain the resources that it forfeits.

Chile’s decision was different. The idea was to modernize the savings market and privatize it—that is, to make it responsive to the individual decisions. At the same time, to maintain and even improve the level of domestic saving, the level of government spending was cut. In economic terms, what the Chilean government did was to create private savings and to fully neutralize the increase in the fiscal deficit by restricting state expenditure. The purpose behind this was to increase private domestic saving. Depending on the specific situation of the economies adopting this strategy, the compensation that was necessary in Chile may not be necessary or may be only partly necessary elsewhere.

The military and the security services were not incorporated into the new system. The reform always met opposition from the military, mainly for two reasons. The first is that military institutions need to operate under strict secrecy, because they are exposed to special risks—including combat—and have different promotion and retirement systems. It is true that their situation is not the same as that of civilians, but there is nothing to stop the development of adequate mechanisms that would ensure that the system could handle these particular circumstances. For example, there is nothing to prevent the creation of a special bonus to supplement the funds of someone who retires early from the military. The second reason, which was the one that led to deciding against further attempts at persuasion on this issue, was related to certain barriers of distrust that added to the pressure from multilateral lending organizations against generating a larger deficit. In retrospect, this imbalance was handled well, but it seemed advisable at the time to be prudent in the face of uncertainty and to take all of the necessary precautions to avoid exacerbating the potential conflicts. In the end, the military continued to operate within the old system and to that degree, they are today more

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vulnerable to governments’ political decisions than is the reformed sector.

The effects of the pension system reform are still developing. Within the next two or three decades, the structure of Chilean social expenditure should vary substantially. The country will have greater leeway to allocate resources to the needier sectors. Because the pensions from the old system, which today are by far the largest item in the country’s social spending budget, will gradually disappear. There will always be pressures from retirees, but they will not be as important or as urgent as they are today.

The pension reform, led by Labor Minister José Piñera who had previously led labor law reform, was not conceived with the idea of building a rigid, fixed structure. The reform was intended as the starting point of a modernization process that would be open over time to successive developments. Full development of the pension system will take time. It behooves the government to gradually adjust it to the development of the domestic capital market and to its increasing integration into the international market. There is still much to be done toward achieving this, while consistently preserving the basics of this important modernization. The day may come when individual responsibility will be so deeply rooted in the population that, as the Russian economist believed, compulsory pension provision will no longer make sense. Unfortunately, since 2006, proposals have been introduced that would undermine the very heart of the system of incentives for retirement savings. Should these ever be adopted, they will create long-lasting harm down the road.

The Capital Market

The capital market plays a crucial role in the allocation of the economy’s resources. It transfers savings into investment and enables the flow of many people’s capital into large-scale financing programs.

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For obvious reasons, both roles have traditionally been very dear to the political class. The capital market, like the labor market, can be a huge source of power that socialists firmly believe should be controlled by the state. They mistrust individual freedom, assuming that individual interest is at odds with the common good, and instead place their faith in political leaders.

It is no coincidence that one of the Allende government’s first tasks was to impose state control over banks (nor is it a coincidence, incredible though it may seem today that the nationalization of the banking system in France was one of earliest decisions made by Francois Mitterrand’s government, 1981–1995).

Expropriation and nationalization are not the only ways to control the banking system. Government can also yoke it though onerous regulations or by nationalizing savings. This had happened in Chile long before Allende came to power. Savings existed, but they were not private. Banks existed, but they were little more than cashier windows for the Central Bank. The issuing institution granted them financial backing and instructed them on where to allocate resources and what interest rates to apply. More often than not, these rates would be negative in real terms.

Inflation, on the other hand, also obstructed any possibility of developing a significant capital market. This is the problem that many Latin American countries with a long history of monetary instability are facing today. High inflation rates are the death of any capital market, and there are only three ways to fix the problem: by eliminating inflation entirely, with people being convinced that this has been achieved; through indexation, as Chile did; or by full dollarization, as Argentina did under Finance Minister Domingo Cavallo, and as other countries, such as Peru, have also done.

To rebuild the Chilean capital market, the government acted on three fronts. It privatized everything that the socialist government had managed to expropriate or control, thus reestablishing clear property rights in the financial sector. It shifted control of savings from

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predominantly public to predominantly private. Finally, it encouraged competition by amending regulations that restricted financial institutions’ operational spheres to absurdly narrow extremes, which prevented financial institutions from attracting investment in a competitive manner, from paying and charging real interest rates, and from allocating credit based on risk and profitability.

The deregulation of the Chilean financial sector ran parallel to the implementation of new modernizing regulations, and comprised several stages.

The initial stage involved complete liberalization, and there were even some informal financial companies in operation. The first monetization of the economy took place during these years. People who previously bought a car or an apartment as a way of protecting their savings from inflation now took their money to the bank in order to be paid interest and readjustments. However, in 1975 and 1976, the crisis in Sinap became unsustainable. Sinap was the National Savings and Loan system whose structure was similar to the Savings and Loans system in the United States, which had enjoyed the monopoly of readjustable fund raising, then lost it, encountering subsequent liquidity problems. These institutions offered long-term home loans, but operated on short-term investments. The fall of the Banco Osorno, in 1978, was another such incident. And so the sector continued until January 13, 1983, when in the middle of the debt crisis, the state liquidated or intervened into a large part of the banking system in order to protect depositors.

This period has been subjected to many criticisms—including lax regulation, extremely high interest rates, deficient controls, and institutions’ inadequate capacity to adapt to the changing economic conditions. At the same time, other events were taking place within the capital market during those years. The rules for the insurance industry and for corporations were also changing. The stock market was already operating under new guidelines and, toward the end of this period, AFPs were beginning to function. There were several reforms underway simultaneously.

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The second stage took place during the debt crisis, between 1983 and 1985, when many observers would have concluded, in view of the intervention into a large part of the banking system, that reform had failed.

The third stage began in 1986, when the country gradually found its way to a capital market whose degree of development was comparable to that in industrialized countries, as shown in the increase in financial liabilities expressed as a percentage of GDP from 60.3 percent in 1983 to 94.4 percent in 1988. It was also shown in the level and stability of real interest rates and in the increased length in average loan periods (the long-term debt in 1983 represented 59 percent of the total debt; in 1991 this percentage had increased to 69).

It is true that the military government’s experience in financial matters took its toll. But after the early stumbles and falls, the mistakes and corrections, a capital market that had not existed before was finally opened—a capital market whose development had been prevented by the political class that had appropriated its power. I do not want to go into a lengthy interpretation at this point of the difficulties in and the price paid for the restructuring process. Getting all the pieces of the puzzle into place was a long and arduous task. Transferring domestic savings to the capital market was very difficult. Several countries in the region are now taking their first steps in this direction and with this experience as an example, it is to be hoped that they will be able to make quicker progress than Chile did.

If at the end of the day the system worked well, it was because three factors converged simultaneously: institutions were properly regulated; operational rules and procedures were properly grounded in the market; and people’s savings were channeled through the financial market, which was also a key factor in the pension reform. Only when these three factors converged did Chile achieve a relatively stable market, reasonable interest rates, and wider operational horizons.

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A Diagnosis on the 1983 Crisis

My personal observations and diagnoses regarding the crisis that the Chilean financial system went through are very different from the views prevailing in nearly all circles of opinion. I do not believe that the 1983 crisis was mainly a consequence only of lax regulation or of lack of control. Before the debacle, it was common knowledge around the world that banks were granting interconnected loans. In some countries, such as Germany and Japan, this had posed no major problem. It caused difficulties in Chile, because the external crisis was too strong and there came a point when the solution could only be political. Hence the intervention, to protect not bank shareholders—who ended up losing everything—but depositors, especially checking account holders. One way out would have been, following the interventions, to declare the banks’ bankruptcy. Leaving aside the fact that rules regulating bankruptcy were weak and inadequate, this would have meant exacerbating the economic crisis even further. Once this option was discarded, public funds—from CORFO—were used to capitalize the institutions in order to sell the stock to private investors, with special incentives. Why the incentives? Because losses were only partially capitalized. The portfolio resale program was set up to eliminate the burden of unproductive assets. Through this program, the Central Bank bought troubled assets from banks, under the condition that they would buy them back later on. In essence, a special tax on banks was set up, until the time that they had returned the backing received from the Central Bank—again, not to benefit shareholders, but to answer to checking account holders and creditors.

Politically speaking, capitalizing the total sum that was needed at the time was very difficult. How were the banks to be sold afterward? In all probability, an institution that had been capitalized at 100 would sell for less than 50, in which case, it seemed more tolerable that the bank should sell portfolio worth 60, that it should capitalize 40 and then be sold off at

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that value or slightly less. Also, the exact loss in each specific case was not really clear.

Generally speaking, I have always thought that the main problem with financial systems is that they do not make it sufficiently clear what is to be done when institutions go bankrupt. This is a fact. And it is also a fact that banks in small countries tend to go bankrupt more frequently than in larger countries, because small countries often have more pronounced and more frequent ups and downs. Economic adjustments make equity capital adjustments inevitable. When things are going well this is not a problem, but when the economy slows down problems arise: people’s net worth diminishes, and debtors cannot make their payments. The structure of banks with small assets and large liabilities is very vulnerable. What happens when debtors fail to pay and depositors want their money back? This is a problem in all countries.

The dilemma becomes even more complicated because all financial systems tend to confuse a business that is to a large extent risk related—granting loans—with the function of providing means of payment within an economy. The issue is made more complicated by the overlap between these two roles. I do not think that a greater or lesser degree of control would solve the problem completely. The root of the problem is that no financial system can endure a really serious crisis unless the laws specify that in these cases people will not be able to recover their deposits in full. The laws much also provide a practical mechanism to make this happen, without this resulting in many wages and bills going unpaid in many companies for a long period of time.

Would it have been possible to force the institutions that had been intervened into in 1983 into bankruptcy? Was Chile’s legal system equal to the task of sharing out losses between the banks’ creditors, with a reasonable degree of equity? Was the economy adequately equipped to restrain or to obstruct means of payment indefinitely in the way that bankruptcy does? The answer was clearly no.

Later, an effort was made to establish legal mechanisms regulating these issues, while the new Law of Banks was being discussed. Besides

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optimizing controls, systems were added to ensure a certain degree of separation between operations pertaining to the banking business itself—mediating resources, granting loans, and taking in savings— and operations connected solely to the handling of payment methods within the banking system—mainly checking accounts.

Chile has legislation in force related to this issue, which is an important factor in crisis contingency. To me, the worst scenario would be for the government to not have a legal system that would make sure that if crisis struck again, the losses would be paid by whoever was responsible for them, and to have to intervene once again in order to answer to checking account holders. The regulations to address this now exist, not just for the banking system but also for mutual funds, insurance companies, and the financial sector in general. But the fact that they exist is not enough. They need to be in operation, they need to be remembered—crisis drill exercises need to be carried out, to make sure that the system is properly responsive to and familiarized with existing mechanisms. I would like to be certain that this is being done. Today, not all deposits are guaranteed to the same extent. Depositors need to be aware of this and responsibly assess the risks they are taking.

I think that, ultimately, financial systems are not flexible enough to make equity capital adjustments—sooner or later, they become an unmanageable source of loss of confidence and instability for the state. The German and Japanese financial systems can probably afford to be less flexible, because their economies are very powerful and very stable. Crises are less recurrent and less dramatic, but even so, they have still caused problems.

As for lessons, there were several that Chile learned from its financial crisis. As I pointed out earlier, regulations for insurance companies and other intermediate agents in the capital market now contemplate the possibility of companies going bankrupt. The law provides a solution that is not necessarily traumatic and protects users, on the one hand, from the uncertainty associated with any bankruptcy, and the state, on the other, from having to assume the burden of heavy losses.

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In the case of insurers, these regulations are crucial because pensions are at stake.

There is, one might say, something epic about the creation of the Chilean capital market. The country went through with the venture and achieved its objective. It opened up a space in which institutions in the financial sector can operate relatively freely. Practices that made it possible to work with different maturities were forged, a matter in which the inflation adjusted unit of account (unidad de fomento) as an indexed currency played a fundamental role. Savings became a part of the market. The pension system reform and the experience of popular capitalism created an ownership society. This whole process shaped a very complex and enriching reality. In early 1993, the Central Bank set up a tender for twenty-year promissory notes. A true victory, this would have been unthinkable in the old Chile. Today it is easy to see that the Chilean financial modernization went far beyond the question of whether control over the banking system failed or not. Relative to the crux of the matter, this argument is almost incidental.

Having said this, it should not be inferred from this that financial reform focused only on the banking system. Albeit less dramatically, the development of spheres of activity for other financial market actors—corporations, insurers, mutual funds, foreign investment funds, stock markets—followed their own paths to prosperity. In these sectors, too, the scope of liquidations and of bankruptcy was properly defined. In short, it was the convergence of reforms from different fronts that shaped a capital market whose standard, considering the size and the degree of development of the Chilean economy, is practically unequalled.

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CHAPTER SIX

Opting for Human Capital

In the realm of social policy, the Chilean experience leaves absolutely no doubt that development is the only way to improve living standards for the most vulnerable members of society. This point is crucial. To argue that growth is at odds with the redistribution of resources is not only wrongheaded; it is a leftover of discarded ideologies. Economic growth has never precluded an equitable distribution, and furthermore, the only sustainable and reasonable path to redistribution is through growth. In general, comprehensive solutions to the most acute social problems—minimum sustenance for families, medical care for the indigent, decent homes in outlying villages—require economic growth. Equitable distribution can only become a reality in the context of economic development. The age-old conflict between growth and equality was therefore completely pointless.

Perhaps because this concept was so clear to the military government, its social policies were closely coordinated with its economic policies. The economic team, in this case headed by the economist Miguel Kast, spent long, sleepless hours designing the social policies that would effectively end the vicious circle of poverty in Chile. The first steps were taken through Odeplan in collaboration with the Economics Faculty of the Universidad Católica, where Sergio Molina (later to become President Patricio Aylwin’s Odeplan minister) took part by drawing up the Extreme Poverty Map, which determined for the first time that 21 percent of Chile’s population in 1970—1,916,000 Chileans—lived in extreme poverty. There was much talk about poverty in Chile, but no government had ever made any serious effort to describe or study the problem in order to determine where the poor were to be found and what were their most pressing needs. It was discovered, for example, that over 40 percent of children from poor families did not attend school, despite the fact that the country had had tuition-free

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education for a long time. This and other such data led to the creation of social programs designed to address the real needs of the poor. Before then, it had been common for the assistance from social programs to reach the middle classes, but not the poorest. The reason for this was that, generally, the old programs focused on wage workers, who were not among the poorest.

Many of the social programs in education, health, and other areas designed to benefit the poorest were developed through Odeplan. The professionals who worked there also took part in the free-market economic reforms. There was consequently no divorce between the economic team and the social programs, as is often the case in many governments in Latin America. During the debt crisis, when people began to look on Odeplan with some mistrust as the source of government teams promoting the economic reforms, social work moved to a new organization created for that purpose. Under the leadership of the outstanding sociologist Patricia Matte, the Social Development and Assistance Bureau, subordinate to Office of the President, continued to work effectively toward directing state social assistance to the country’s poorest.

This experience also confirmed that all of the sociological, economic, and intellectual exercises carried out during the sixties to allegedly prove that a small segment of the population controlled a huge percentage of the country’s wealth, or that a very small number of landowners controlled 80 to 90 percent of the country’s arable land, were deceptive and led nowhere ... except to socialism. The only thing this kind of research achieved was to mislead people into thinking that problems could be solved by seizing wealth from these minorities and distributing it among everybody else. Nothing could be farther from the truth. These calculations were terribly precarious technically. Their true purpose was to show that the small elite groups were hijacking the country’s wealth, to keep it all to themselves and not share it with anybody. The fact that these people were running companies and

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farms—productive enterprises that invested and grew, where thousands of people worked and earned their living—was never taken into account.

It is precisely because of this close correlation between growth and redistribution that social policies that go against growth cannot be healthy. At the very least, they need to do no harm to growth. For example, a program that involves setting up very low interest rates in order to create easy loan terms will not only not benefit the poorest, but will depress savings and drive investors out of the country; the poorest will lose out and, naturally, so will the country. A better alternative—in keeping with the same example—would be to establish a program to subsidize the purchase of houses, financed through general taxes such as a VAT, because the distorting effects will be considerably less. Any tax interferes with the economic process, it is true. No tax is harmless. A VAT, for example, affects consumption and encourages tax evasion. But a VAT at least, because of its higher degree of neutrality, has the advantage of not encouraging the consumption of noodles at the expense of bread. Neither does it force a company into vertical integration or into carrying out activities for which it has no competitive advantage.

Therefore, social policies that interfere with, restrict, or obstruct economic development can only lead to disaster and ultimately will harm the people whom they are intended to benefit. Relevant examples abound: unrealistic minimum wages, preferential exchange rates for certain products, politically fixed prices for wheat and bread, and an assortment of price controls.

The second point is related to a delicate issue that we have already outlined in regard to the social work carried out through Odeplan. Often, owing to political pressure, the benefits of social programs do not reach the poorest. By definition, the basic purpose of all of these programs is to help the poor. It is worth keeping in mind that this was Allende’s intention when his government promised university education for all. What could be better than a young person from an underprivileged background making it to the university? But what happened? Universities began to use up 40 percent of education expenditure, even

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though universities are not where the country’s poorest were to be found. Whom did “free university for all” ultimately benefit? Certainly not the poor, except for a few isolated individuals who reached the university level and who were already relegated to achieving only a basic education because of access to minimal resources. In the end, the beneficiaries were those who got tuition-free education even though they were in comparatively better social conditions to pay for it.

The third important point is that social programs should include gradual measures to incentivize individual effort to encourage people to take responsibility for their own destinies. Nothing is more tragic than social programs that foster dependence or the growth of a pliable, rent-seeking client constituency. The goal should be for the poor to someday no longer be poor.

The fourth point is a word of caution: although it is usually government that designs social programs, implements them, and determines their content, ideally these programs should not be administrated or operated by the government. If, for example, the State wants to provide more and better opportunities in education, then it should subsidize good quality elementary and secondary schools, even if they are privately run. But it should not make the mistake of monopolizing the school administration.

It is no coincidence that the principles displayed in these four observations should elicit very little enthusiasm from the political class, because they reduce its power. A politician always has more to gain from favoring not the neediest but whoever shouts the loudest and controls the most votes. I was almost killed by students from the Universidad de Concepción a few days before the 1988 plebiscite, but that would not have happened with students from an elementary school in a working class neighborhood. Usually the sectors that are better organized politically are not the poor.

There is a perverse feedback effect between certain bad political habits and the cycles of dependency and poverty. This is the case at many levels. Education ministries in Latin America have long been a

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kind of public relations service for the teachers’ unions. The truly important decisions that they make do not cater to the contents of educational plans; they cater to wage increases every two or three years due to inflation, or to issues that took up most of the minister’s time and energy—issues which, while important, should not be the only ones or the priorities in an education policy.

The government was harshly criticized during the seventies and eighties for its alleged social insensitivity and social policies that were supposedly inadequate to the problems that they were meant to address. There is no doubt that the government prioritized growth. To do so was a question of social responsibility. But even as it defined this priority, it also defined the boundaries for a field of action for supporting programs to develop human capital as well as welfare programs—to provide basic assistance to people who could no longer fend for themselves. That was indispensable, for it was development that set people free from the captivity of sickness, ignorance, and poverty.

On both of these fronts —welfare programs and programs to develop human capital—the Chilean government showed impressive results and numbers. The accusation that the government was insensitive because it reduced university budgets is, therefore, nonsense. That was not an oversight. It was a deliberate decision based on social spending priorities and was made at a time when resources were very scarce.

Meanwhile an addition problem was the fact that assets had become scarcer as a consequence of the external crisis. When the topic of the number of poor people in Chile comes up, people forget what happened with the number of poor people in Latin America. It is because Chile pursued the economic policies that it did, from which the country, unfortunately, has strayed in recent years. Otherwise, the number would still be increasing, as in fact it is in many other countries in the region.

In terms of schooling, libraries, basic literacy, elementary education coverage, child nutrition and mortality, care for pregnant mothers, morbidity rate, medical care, and other indicators—including UN indicators—Chile experienced an authentic social revolution and became

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one of the top ten nations in the world in terms of social achievements between 1975 and 1990.

Housing and the Market The military government’s achievements in housing were governed

by sensitivity and social reality. The key decision was to allow the market to operate at its full potential by withdrawing the state from the direct administration of housing programs. At this level too, government action had been disastrous. When the new government took over in 1973, approximately ten independent agencies connected to the government through the housing ministry directly carried out projects, building roads and houses and employing over 50,000 workers. There was an incredible number of projects—planned, interrupted, underway, abandoned, taken over, or half finished. It was the usual chaos.

While the middle and wealthier classes received state subsidies, there was no policy aimed at solving the housing problems of the poor. This did not become evident until 1974, after the extreme poverty map was drawn up.

In the context of free interest rates and of a developed capital market, among other factors, housing policies began to subsidize buyers and became an example for targeted social spending. For the first time in a long time, state resources allocated to housing actually mainly reached the needier groups, rather than the groups with greater pressure power. The housing subsidies system achieved a good balance between individual and family savings, and state aid, enabling a greater number of Chileans to become owners.

For the sectors with no savings capacity, on the other hand, basic social housing programs were a good solution within the existing economic limitations. The idea was to de-bureaucratize the system as much as possible and to give increasing decision-making power to municipalities in the allocation of houses. In matters like these, local

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governments generally make better informed decisions than does the central government.

One of the most recurrent accusations made against the military government was that the development agency (unidad de fomento), specifically the readjustability system applied on mortgage loans, was responsible for the impoverishment of the middle class between 1975 and 1985. Therefore, it is worth analyzing in detail the plight of many homeowners who were unable to make their mortgage payments and whose homes were auctioned off by the banks.

At the core of the problem was the debt crisis that hit the country between 1982 and 1984, which made Chile and all of the countries in the region objectively poorer.

A second factor involves a basic concept of justice. Justice is served when a person buying a home pays what it is really worth, within a certain time limit. Adjustable rate loans, which are beneficial to a fortunate few, are disastrous to society as a whole, because it de-incentivizes saving and the accumulation of housing resources, thus harming families that do not own a home. In theory at least, one of the benefits provided by the Private Employees Fund, an institution belonging to the old pension system, was the granting of home loans at a nominal interest rate below inflation. This was very convenient for the debtor, who was practically being handed a gift when inflation rates were high. The problem was that only 1 percent of the Fund’s contributors received this benefit, and in most cases, they were selected because of connections and influence rather than because of actual need.

A third factor in the analysis leads to the recognition that in Chile the indexation mechanisms made it possible to restructure the housing and capital markets, but they jeopardized a vast sector of the population that had contracted long-term debt to purchase homes during the boom, before the 1982–1984 debt crisis. Some people had bought houses that they could not afford, and to make things worse, in some cases the debts involved both the mortgage and a second shorter-term loan that had been taken out to make the down payment. While the economy was growing,

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there was no problem. But things fell apart with the first setbacks caused by the crisis—income contraction and unemployment—which created a delicate and protracted social problem.

The best rebuttal to the criticisms made against the housing policy, and especially against the UF (unidad de fomento) as a readjustability mechanism, is the fact that the country has continued to operate—give or take a few adjustments—within the same framework. Successive Concertación governments—even though they had more resources available to them—have not been able to come up with anything truly new in this area.

Santiago, which used to be full of shantytowns with no running water or electricity, gradually changed. Anybody who has driven through the city thirty years ago and then again today can see the difference, although there is still much to be done. Between 1970 and 1992, according to census data, 1/4 million rural families acquired decent housing. This is unprecedented in Chilean history.

Education

The government, in its approach to reforming education, recognized two levels from the outset. One comprised preschool, elementary, and secondary education, which the vast majority of the population goes through. The other involved higher education, which only a very small percentage of the population attains.

Establishing priorities was easy and required little thought. Yet many still cannot forgive the military government for turning its back on the university-for-all utopia. Perhaps the reason why they cannot forgive the government is that it revealed the fact that most of the education budget was being spent on minority populations—and in very uncompetitive conditions, to boot. Higher education circles still exerted the greatest pressure on the education budget, even though it comprised only minority segments of the population.

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The government policy for the allocation of fiscal resources to the university system was to steer it toward a financing structure that would be less direct and less dependent on fiscal decisions to create incentives for competition and quality. The idea, on the one hand, was to gradually equip universities, using their own assets. On the other hand, special funds were created, or strengthened, to support university programs in a more competitive framework—including a science and technology fund, money contributions based on better results, and student loan programs. The objective was to detach the state from the university system’s requirements, as far as this could be done. It was reasonable to think that these resources, added to students’ contributions, would allow universities to finance themselves and reduce their dependency on the state education budget.

Some critics decried the concept of paid and self-financed universities as unfair, because it allegedly excludes the lower classes from university education. This meant that a loan and scholarship system needed to be set up in order to overcome this barrier. However, not all college degrees guarantee an income that will be sufficient for a graduate to cover adjustable loan installments. This means then that the government will have to direct its efforts to awarding education grants for disciplines, if and when they are deemed socially valuable.

The government’s favorite verb in education-related issues was “to target.” Adequate targeting of social spending is a must, for the sake both of efficiency and civic responsibility, and in consideration of the principle of equal opportunities. The undertaking took years, and it is not finished: for example, a student loans system was never properly consolidated. Pressure to turn back in this area was extremely strong. I would have liked, for example, to consolidate an endowment-type system, with rotating funds managed by the universities themselves, to finance the loan and scholarship systems. Such a system would provide a sounder operating structure and produce greater commitment from the universities both in the allocation of resources to students—resources that are supposedly recoverable—and in the creation of new degree

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programs. It would have disadvantages, certainly, because it would not allow transfers from one university to another, but it is better in many ways. Other policies do nothing but prompt students and university administrators to gang up against the government. The competitive funds solution also proved innovative in the areas of scientific research and cultural creation, where it was actually possible to consolidate systems of work that were later used by the successor government.

The challenge in this area, in any case, was to channel resources to the needier sectors, which were not in higher education. But an effort was made to link higher education to a properly oriented system of incentives, grounded on basic principles: that students should be aware of and, if at all possible, assume the cost of their education; that there should be some degree of competition in the allocation of resources for research; that having a university degree should not necessarily obligate the state to provide the graduate with a job; and that there should be some kind of incentive to promote quality.

This idea of incentives was the goal behind what some people called la marraqueta (loaf of bread), a fiscal contribution made to universities based on their success in attracting students with the highest scores on academic aptitude tests. It is a good idea, but it needs perfecting. The important thing is not just rewarding the universities that draw the best first-year students; it is also important for the schools to make sure that these students stay on and eventually graduate.

In a way, which is yet to be analyzed in depth, the Chilean modernization process weakened the universities’ role as cultural arbiters and as the “critical conscience of the nation,” to use an expression in vogue during the sixties. Indeed, several universities faded into the background. Others, on the other hand, which were more receptive to the value of academic quality, increased their prestige. What happened was that, as a result of de-bureaucratization, society itself became more receptive to knowledge, but less enthusiastic about professional degrees. The correlation between education and development became more complex. Professional diplomas were no longer seen as evidence or as

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public employees’ ticket to a highly respected albeit ill-paid position in the community. The society and economy became more sensitive to skills that did not necessarily need to be certified by a university degree. In short, there was greater social mobility. The country of old, which was scared to death of competition, was gradually left behind. In essence, that conservative, hierarchical, bureaucratic, and somewhat provincial social structure—the “liberal” professions at its apex—that had been so typical of the country for many years, began to fade.

Another priority in higher education was private universities—which were looked down on at first, but have in several cases become more prestigious than many traditional universities—and initiatives aimed at diversifying alternatives for post-secondary, non-university training. This resulted in the burgeoning of technical and vocational schools. The idea was to open this field in as transparent a way as possible to the individual responsibility of students and the private initiative of schools. There is a tendency to underestimate the quality of the instruction that these institutions provide; however, strictly speaking, only those who sign up for this training are qualified to judge whether it is useful or not. People are perfectly capable of discerning what their own needs are. They do not need tutors for this, as some state-control advocates believe. Neither is there any need for planners to make projections and forecast the exact number of technicians or professionals that the country will need in ten or twenty years’ time. Although they are valuable as reference points and should be made available to young people for their consideration, these estimates are almost always speculative and should not interfere in people’s decisions. If someone, knowing that there is an oversupply of professionals in a certain specialization area, insists on registering for and assuming the costs of that same degree, he or she has every right to do so.

In the field of preschool, elementary, and secondary education, the government had to confront the commitments made by the two preceding administrations. The law stated that everyone should receive an education, but what the law mandates is one thing; having the

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administrative and financial means to do it is quite another. Frei Montalva’s government (1964–1970) had extended basic education from six to eight years. After that, Allende promised “university for all.” However, the numbers reflected a very different reality. By 1970, the average Chilean had 4.5 years of schooling. In addition, 43 percent of school-age children living in extreme poverty did not attend school.1

The government’s experience in this area proved interesting, because it was faced with the task of carrying out the promises made by other administrations. In fact, during the military government’s term in office, indicators gave evidence of spectacular improvements. In secondary education, the rate of schooling increased from 37.4 percent in 1970 to 52 percent in 1980 and 74.8 percent in 1988.2 The average years of schooling in Chile practically doubled, reaching 8.7 in 1987.

That was not all. The government’s greatest triumph in this area was its ability to make the distinction between its orienting and regulating role—defining curricular contents and standards—and its financing and administrative roles.

The first role belonged exclusively to the state, whose responsibility it was to define a basic curriculum that met wide social approval, by its respecting the nation’s identity and values. The risk at this point is to try to put the cart before the horse by using education to change or manipulate the society’s values. The government that took office in 1990 has done quite a bit of this kind of social engineering. The idea of including “human rights” in the basic curriculum requirements points in this direction. The initiative seems worthy of consideration from the perspective of civics, but only insofar as it does not go beyond the consensus within Chilean society as to when, how and why such issues arose. Many people will argue that the origin of the serious problems that the country lived through in this area lies in socialism, in the Machiavellian political morality that it fostered through its rejection of democracy and “bourgeois institutionalism” and its efforts to reshape

1 Extreme Poverty Map, Odeplán, U Católica, 1974. 2 Chile Central Bank, Social and Economic Indicators, 1960, 1988.

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society by means of political coercion, by force or through the use of legal loopholes. That being the case, would this mean that the basic curriculum should include lessons on the failure of socialism throughout the world?

Having established that the government’s role in education was mainly to set curriculum content and standards, a system of financing laws was also enacted. The focus was now on the students, rather than on the schools. Consequently, financing consisted in providing schools with a subvention for each child in the school. This was an important and unprecedented step forward. It was the first time that central government, the proprietor of schools that had always been financed according to a traditional government budget, introduced the principle of decentralization and competition in the sector. As soon as school administrators realized that in order to receive more resources they would need more students, the stage was set for municipalities to take over the administration of the schools and for new private schools to open. Very peculiar things happened as a result of this liberalization. Some municipalities resisted the idea of new private schools opening, for fear of the competition to which they would be exposed.

This conflict, in any case, still has not been resolved. There is an abundance of news stories on the excesses, fraud, abuse, and irregularities that have taken place in private schools. Strangely, irregularities in the state sector do not receive the same kind of attention. Yet, in spite of so much scandal and so many attempts to discredit private schools, thousands upon thousands of parents still prefer privately run schools for their children’s education. According to national Education Quality Measurement System (Simce) tests, achievement levels in private schools are higher than in schools under municipal administration—and people had become aware of this even before the test results had been published. I remember, in the early eighties, speaking to a man selling dusters and brooms at the door of a supermarket, who told me that he worked, among other things, in order to be able to send his children to a state-subsidized school in which

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parents were asked to pay a monthly fee collected by the parents’ association. He was glad to do it and knew that he was making a good investment toward his family’s future.

In the case of technical and vocational education, these schools were transferred to private companies. On the whole—there are always exceptions—it was a satisfactory experience, but I tend to think that this kind of education needs careful and fundamental rethinking. The idea that young people should master some trade skills by the time they complete their schooling, in order to enter the workforce early and with a head start, is attractive, but it involves considerable risks for two reasons. First, the equipment required to provide this type of education is very expensive. Second, the trades that are taught are highly vulnerable to obsolescence. Technological change is accelerating and it is highly improbable that schools will manage to stay ahead of it. The only way to close this gap is to strengthen the links between schools and businesses, but determining how to make this connection enriching for both parties is not easy.

The decentralization of education was accomplished quite creatively. The biggest problem that it faced was that its progress was affected by the economic crisis during the eighties. This made it impossible to increase subventions as much as initially planned. The objective was to substantially improve the quality of education and ensure a smooth transition, because the transfer of state schools to municipalities or to private operators would necessarily entail replacing less competent teachers with better qualified staff. The political problem that would ensue was foreseeable, but the government believed that other teachers and the community at large would appreciate the improvement that this change would bring about for everyone, and that this would neutralize the conflict.

However, this did not happen. In teachers’ perceptions, the change would always be associated with layoffs, uncertainty, and economic restrictions that were as great as or greater than before. The effect that the crisis had on the deterioration of the situation was completely

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ignored. The truth of the matter is that no more progress was made. One unrealized goal was to entrust the administration of municipal schools to organizations made up of teachers or of parents and trustees, in order to decentralize the system even further. Also on the agenda was the idea of moving toward a system that would integrate, in addition to the state subvention, contributions from parents themselves, if and when the population’s real income began to improve.

The task, therefore, went unfinished. Although the process succeeded in engaging municipalities in the development of education, it did not take root, mainly because subventions remained too small. The backsliding after 1990 demonstrates that the system is still vulnerable to statist pressures. That backsliding has been largely caused by the restoration of direct allocations to schools run by municipalities, which meant discarding the subsidy-per-student financing system. That is a sure way to increase schools’ dependency on the discretionary decisions made by the central government and to distort the competition between municipal and state-subsidized schools.

Among other initiatives, the decentralization process in education included a general instrument for assessment—a nationwide test, strongly resisted by the same teachers’ union leaders who rejected municipalization in the name of quality in education—that is intended to help guide parents’ decisions and their involvement in their children’s education. To the extent that the results of these tests are publicly released and published, the system will have incorporated a key measure for competitiveness and selection.

On another level, the modernization of education also opened up ways to deliver food to the student body more productively and efficiently. These ancillary services were outsourced to private companies operating according to previously determined guidelines, which identify schools in the poorest areas as well as the most vulnerable ages in children. These and other initiatives in this area contributed substantially to the human capital development efforts carried out by the government between 1973 and 1990.

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It is always possible to turn back, and in fact this is what successive Concertación governments have done. For example, universities are once again favored, to the detriment of preschool, elementary, and secondary education, as the trend in government education spending seems to indicate. The idea that the infrastructure of state schools should be financed through direct resource allocations and not through a subvention per student is gradually becoming accepted. This entails a form of discrimination against private schools—which still achieve better results. The modifications made to the Teachers’ Statute to a certain extent involved the government in the issue of teachers’ wages again. Centralization has reared its head once more. Another issue that has been called into question, creating strong nationwide controversy, is whether private schools that receive a subvention from the government should be non-profit organizations, which is the politically convenient way of rejecting free enterprise in this area for fear of the comparison of results, among other things. While the total education budget has increased by 29 percent between 1990 and 1993, subsidies made to devolved schools have increased only by 8.8 percent. On the other hand, expenditure on staff in this ministry has increased by 44 percent in this same period, without this reflecting an improvement in the quality of education.

Health Freedom

At the time changes were made in the cabinet in 1980, the stage had been set for me to be named Undersecretary of Health. At the last minute, however, the President let me know that he would prefer that I assume the position of Undersecretary of Economy. The following year, exactly the opposite happened: I thought I would be staying on at Economy, but at the last minute, the President asked me to take over as Undersecretary of Health. This move was actually decisive in my survival in the government, since I did not belong to any of the teams that were blamed for the 1982–1984 crisis. I was working elsewhere at the time. What had

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appeared to be a position that would force me into the spotlight, because at the time health was the most controversial sector, turned out to be a refuge in the midst of an economic storm.

If the field of education is complex, the field of health is even more so. In education, at least it is possible to get society to agree on the standards and the minimum curriculum requirements that elementary and secondary school students should comply with or master. Establishing the range of health care that a person should receive is much more difficult. The difficulty lies in the fact that no one aspires to anything less than top quality, yet no system can guarantee that level of care for everybody.

The other controversial point in this area is that, when human lives are at stake, any standard that one defines as satisfactory or reasonable can be highly controversial. The reason is simple, but there is quite a bit of demagogy surrounding all this. Any standard implies leaving some people without coverage, which entails a question of life and death—and therefore a huge political and ethical problem. In fact, there is not a single health care system that does not put human life on the line in its everyday decisions.

This harsh and undeniable reality is the reason why all state health care systems, to some degree, avoid the dilemma and prefer to face it indirectly. They prefer to offer the highest standards, letting the fulfillment of their promise be contingent on their ability to actually deliver them. Rationing is not explicit, yet it is made manifest in delays, postponements, and waiting lists and other rationing practices. The state system will be successful to the extent that it manages to line sick people up in a queue without their ever realizing it.

The situation is different in private health care systems. The limits are set right from the start. A company, after setting a higher fee for higher risk candidates, will be able to control its costs by setting limits on the expenses incurred through a given illness or service, or even by not covering some illnesses. This refusal will no doubt lead to conflict. However, once interpretation-related issues are out of the way—for

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better or worse from the patient’s perspective—that is the end of the discussion and it is quite clear what the beneficiary is and is not entitled to.

There tends to be quite a bit of hypocrisy involved in the discussion of this topic. People become indignant when a private company denies coverage for some clinical treatment or recovery program and claim that it is unfair to leave someone unprotected in such a predicament. Hence, many people infer that it is more convenient to have a health care system that will grant everyone the same coverage. But those critics fail to understand that this does not do away with the problems. In fact, they will exist all the same, because a one-size-fits-all system will still have to ration its services through queues or waiting lists. The difference is that in one case, the decision is controversial and transparent; in the other it is not controversial but it is obscured and opaque because it depends, ultimately, on each patient’s luck—good or bad—with the medical bureaucracy.

Now then, it stands to reason that endless comparisons between one system and the other are pointless, insofar as they obscure the truly important issues—that people should feel motivated to look after their health and lead a healthy lifestyle; that reality should not be disguised in the name of a deceptive egalitarian ideal; and that the system should not hide its limitations or shortcomings, allowing everyone to keep them in mind when making decisions on how to maximize their own well-being. In short, that the fees paid by the users of the health care system should be precisely that—fees for a service—and not a tax.

The military government had to sort out several questions before arriving at the health care system that it finally adopted. Should assistance be public, private, or a combination of the two? Should care be comprehensive or differentiated by specialty, as it is in insurance coverage? But perhaps the most important decision was whether to favor primary care or more complex health care services.

Chile’s infant mortality rate in 1973 was 68 per 1,000—that is, 68 out of every 1,000 children died within the first year. This was a high

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rate even by Latin American standards, so it is paradoxical that medicine schools in Chile were prestigious and received many students from other Latin American countries in which public health issues were better addressed. The explanation is that at certain stages of development, public health problems are not related mainly to medical care in hospitals or other sophisticated institutions, but to the provision of basic sanitary infrastructure and of primary care in rural areas. Thus, once again the military government faced a decision and, in my opinion, made the right choice in deciding to favor the weakest, namely, the children of poor families. This also implied a decision regarding resources, which led to the strengthening of primary care through rural clinics and doctors’ offices that were built or reinforced throughout Chile, and supplemented with diverse special programs designed for vulnerable groups, such as mothers and children. PNAC, the supplementary nutrition program, was one of these programs. As a result, Chile today has one of the lowest infant mortality rates in Latin America. This means that approximately 30,000 children a year survive, in circumstances in which they formerly would have died before their first birthday. The infant mortality rate in 2006 was 7.8 per 1,000.

The health care system was organized along the following criteria: • The state guarantees a minimum provision of health care for all of

the population. The public system covers everyone, regardless of whether they have health insurance or not, and whether they are employed or not. Traditionally, this system’s coverage has been very broad.

• Workers must be responsible for their health and are required to belong to a health care system.

• The public system is financed by direct contributions from the state and through the contributions made by the workers in the system. The worker’s contribution is set at a percentage of salary, with a certain taxable maximum limit. This percentage is in itself a mistake, because low-wage workers—who fall ill as often as or more often than workers who are better paid—do not cover their

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costs. Yet, however flawed, there seems to be no other solution available, at least from a political standpoint.

• The system makes every provision to allow people who want to migrate from the state system to the private system to do so. In turn, private providers are also given maximum flexibility conditions within which to operate. The most obvious candidates to transfer between systems were, of course, higher income groups, which caused some consternation among people who believed that high-income people migrating out of the system would be depriving the system of resources. Those who felt this way essentially thought of the health care contribution as a tax—which it was never intended to be. Those critics also ignored the fact that having the wealthy stay on in the public system does more damage to the poor in the long run, because the wealthy add to the congestion of the system and have greater political clout to be able to jump the queue for medical care and to direct the system toward satisfying their own needs. In fact, the most expensive treatments in the public system, which required a co-payment, were given to higher income people. Within the health care institution regulations, the provisions made to ensure a smooth transition between systems included new opportunities for private providers to participate in the health care market, provided that they could guarantee compliance with the commitments they made to their users, mainly through reserve requirement regulations. In time (not at the outset), some measures were taken to shift health care contracts toward open-ended or lifetime agreements, with a view to gradually generate contracts that could encompass different life cycles.

Another important feature that made the system viable was the state’s commitment to provide supplementary support for the public system, based on the consideration that it would be the lower income workers, whose contributions were not enough to cover costs, who would remain in this system. This was done through state payments from the general fund.

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One proposal that was never carried out—although it had been part of the original plan—was to create a supplementary subsidy, equivalent to what the state spent on each beneficiary and along the lines of what had been done in education, it order to allow people with lower incomes to also be able to migrate to the private system.

What thwarted this last step? Basically, it was the impossibility of finding viable policies—both administrative and operational—that could effectively decentralize the system. Transferring a school to a municipality or to a private educational organization is not very difficult—students continue attending the same school—but the health care system is more complex and more interconnected. People do not always go to see the same doctor. They go from their primary care physician to the hospital, and from there they might be referred to specialist or group of doctors for further evaluation, and then to another hospital. All of this is complicated.

One hypothesis was that, by granting this subsidy, a large number of people in the public system would transfer to the private system. This would mean that from then on, public clinics and hospitals would charge a fee for the care they provided, financed by the government subsidy. Undoubtedly, this would not be easy. But there was an additional problem: the supplementary subsidy would, in any case, ultimately entail a substantial increase in health care spending. The reason is simple: assuming that a significant part of the public health care system beneficiaries—say, one third or one half—transferred to the private system, taking their subsidy with them, it seemed highly improbable that an equivalent reduction could be made in the public system’s expenditures. In all probability, spending would remain at the same level, but the system would be providing care for a—theoretically—substantially smaller number of people, albeit in better health condition. Taking on this increased cost may perhaps be worthwhile, for the sake of decentralizing the health care sector, but in the eighties, resource restrictions were dramatic enough to postpone the implementation of this proposal. At the time, public expenditure was affected by increased

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costs, caused by the pension system reform and by educational decentralization, and adding a new pressure front would have been irresponsible.

To that extent then, modernization did not go all the way and therefore remained unfinished. Two major difficulties complicated the effort, one political, the other financial. The financial solution is absolutely feasible. The challenge boils down to encouraging workers to join a health care institution, to which end the state would supplement their contributions up to a certain limit.

It is reasonable to expect that putting this operational structure into effect in the health care sector would require a reasonable transition period, and that it would generate certain costs that are inevitable in any learning process. What the government plans is one thing and what actually happens when the measures are carried out is another. The normal approach in this field is to work with estimates and to sort out thousands of unforeseen details. For instance, the military government had initially set the health care contribution at 4 percent of a worker’s taxable salary, but soon realized that it had fallen short. The percentage was later increased to 7 percent.

Alongside this reorganization, the government carried out many other initiatives in the health care sector. The state health care system was reorganized, moving from a centralized model to a decentralized model. The municipalization process was not always as comprehensive as it had been in education, although it was partially implemented through primary care and rural clinics. Here, too, municipalization gave rise to conflicts, because the tendency in the Health Ministry was to finance these services through municipal corporations and to increasingly reduce the resources assigned to them. Of course it is easy to argue, citing these problems that municipalization is a bad idea and that it does not address people’s needs. That controversy has still not been resolved.

The fact of the matter is that more sophisticated hospitals remained in the state system, which did succeed in eliminating the differences that existed in the past, when there had been one healthcare plan for white

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collar employees and another for blue collar employees (National Health Care). The hospitals managed by the central government were then administered by local governments.

I know that the military government’s health care policies have been criticized very harshly. Yet people often miss the central point of the debate—they miss the forest for the trees. In this controversy, the government needs to have a clear idea as to how much money can be spent in this area and how it can be spent most efficiently. What the government responsible for modernization in Chile tried to do was to give people more freedom so that they could decide how much to spend and how they wanted to spend it.

Obviously, keeping a sense of proportion in all of this is important. The shortcomings in the public health care system are often compared with those in highly developed countries. This type of comparison makes no sense. Per capita health care spending in the United States is approximately equal to or higher than the per capita income of Chile. In order to have a similar system, Chileans would need to spend practically all of the country’s GDP on health care alone, which is, of course, impossible.

Health policy is such a complex issue that even as the system improves, new needs and demands arise in the process. When authorities, for example, shift emphasis to prioritize the early detection of a certain illness, many sufferers who otherwise would have died from the illness are made aware of it and thus seek medical treatment. Although in the long run, prevention preempts future demand, in the short term it almost always generates greater demand for care and more people lining up in the queue.

It bears repeating that the most important effort made by the military government centered on social expenditure on health care. This effort favored, above all, preventions and care for the neediest and most vulnerable groups in society. The program to reduce mother and infant mortality included protective measures for pregnant women, special nutrition for children in their first year, distribution of milk and

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nutritional supplements, vaccinations, and other medical assistance. Many such programs were developed, opening new opportunities for state action. Through these initiatives—in conjunction with basic sanitation policies in towns and villages and development programs for rural communities—Chilean society began to incorporate commitments to long-term health care strategies. Essentially, it was about choosing for the people, which did not always coincide with what its potential beneficiaries wanted. But this is where the state comes in, since it can to a certain degree force individual decisions in the interest of the common good. For example, a mother might prefer to not have her child vaccinated for fear that he will contract the illness that the vaccine prevents. The risk is plausible, albeit remote. That is where the state comes in and mandates vaccination to be compulsory. The risk of a child contracting a disease and even dying may still exist, but the state assumes the risk of one child dying versus thousands, hundreds of thousands, being saved. This is what the government and its authorities need to be involved in—not in how much doctors should be paid.

Chile was extremely efficient in fulfilling some of its objectives. Many health indicators showed spectacular improvement. Chile’s infant mortality rate, which had not been among the lowest in the region, dropped into the lower ranges. It could be argued that in Cuba it is even lower, but it must be kept in mind that in 1958, in Batista’s time, the island already had one of the lowest infant mortality rates in Latin America. In any case, mortality and morbidity levels drew very close to those in developed countries. Several illnesses were successfully eradicated, but the situation regarding typhus and hepatitis is still precarious. Both are related to deficiencies in sewage treatment by state enterprises responsible for this service.

Bearing in mind that on health-related matters, nobody settles for less than optimal quality, and given that technological development contributes to making medicine increasingly specialized and costly, this is one area where it is very easy for the state to become bogged down. The solution to this increasing tension is not for the state to spend more,

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because this leads to destructive distortions, but rather to have people assume more responsibility in this area, in line with rises in income. It is part of the logic of development that health issues will constitute an ever higher proportion of spending. And it is a historical fact that countries in which the state has made increased spending commitments end up in trouble, because the degree of public satisfaction does not increase in proportion to the increase in spending, and because public systems contain pernicious incentives that impair efficiency—including that of the controlling political system.

The experience of the Concertación governments is telling. Thanks to the growth generated on the foundations of a healthy economy, more resources have become available to the system, which now cater to a smaller number of beneficiaries. But, in spite of this, the overall perception is that medical care has not improved, and some of the government’s major internal political crises have been precisely in this area. In my view, the reforms introduced by these governments have only succeeded in creating more confusion and less efficiency in the structure of the system.

There Was More to the Social Safety Net In addition to the reforms in housing, education, and health care described above, the government took other measures to strengthen the structure of the social safety net—which fall outside the scope of this discussion—encompassing such areas as assisting homeless children, supplementing the income of the unemployed, and providing custody for abandoned children. It also covers areas such as providing pension assistance to people with no access to pension coverage, providing a uniform subsidy for poor families and temporary workers, and many other programs intended to cover basic needs, without undermining the foundations of social and economic development. Each one of these programs has its own history, its own conflicts and tensions, and its own

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heroes. The effort was so comprehensive and complete, that eighteen years after the end of the military government, it is still the basic support framework for the neediest in Chile today.

CHAPTER SEVEN

Reform Becomes Law

The Chilean economic reform process involved not only multiple sector reforms, but also a serious attempt to modify the criteria by which the public would assess policies, and to educate society. This intention—which would have scandalized F.A. Hayek, a sworn enemy of government intervention in intellectual matters—was never articulated in terms of the social engineering that the author of The Road to Serfdom so feared. The military regime helped transform Chile’s political culture and led a true revolution in its social and economic institutions, in the orientation of its development, and in people’s perceptions. But it was a different kind of revolution because it was accomplished in the name of freedom. This revolution was carried out not in order to build walls—as many revolutions did in the twentieth century—but to tear them down.

The changes also affected the combination of regulations, institutions, and customs, starting with the Constitution itself, that determine both how a society works and how its government is to be structured. The government’s aim was to give economic liberalization proper backing at the highest institutional level and to lay the foundations for a democracy based on checks and balances that would have good prospects for stability over time.

My perspective on this point is rather unorthodox. I believe that the proper conclusion to a reform process is popular acceptance of the reforms, independently of what is written in legal texts and constitutions—which tend to be worse the more detailed and full of regulations that they are, anyway. Excessive meticulousness in these matters is often indicative of a lack of consensus.

For this reason also, it would be a mistake to analyze the Chilean process only in light of the military government’s construction of the new institutional superstructure. In fact, this task marked a culmination of an accomplishment rather than a starting point. This speaks well of the authorities of that time. One of the most baleful features of Latin

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American politics is the persistent belief that reality can be changed by simply changing the laws and that a country’s greatness is not forged through work, through education, and through people’s creativity, but through drawing up a constitution.

Perverse Legislation

It is often the case with laws and regulations that the intended meaning of the laws at the time that they were drafted is not always the sense that prevails when they are applied. I had the chance to follow a series of trials closely—on agrarian reform, on pension system issues, among other matters—and was very often surprised by the court’s interpretation of regulations whose meaning, at least to me, seemed unequivocal. But clearly they were open to other interpretations.

Although I have always understood that legislating meant establishing the rules of the game so that everyone knew where they stood in the future, it became very clear to me early on that to politicians and legislators redistributing wealth today, it presents a more appealing option for gaining voter support. For example, in the case of legislators working on a rental contracts law, the incentive to set a maximum rent or to freeze rental payments now—and earn renters’ approval—is much stronger than it is to lay down guidelines for future rental contracts. The problem with this behavior is that these regulations become a hindrance to the people who hope to make a reasonable profit out of buying houses and renting them, and consequently reduce the supply of this service, which means that rental properties in the future will be fewer and more expensive. It is, of course, a perverse incentive, which in a way explains—especially in the case of laws regulating economic issues—the gradual intrusion of legislation into areas that previously had been left to the parties involved.

If legislators were made to forget the present and look toward the future, their perspective would necessarily change. No one would want to

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promote a misguided labor law if he knew beforehand that it would hurt employment in the future. Legislators tend to write faulty laws because they think it will benefit people who are working today. They either neglect or underestimate the effect that such a law will have on people who will need jobs tomorrow.

On the other hand, laws and constitutions will be ineffectual if their text contradicts the prevalent perceptions and beliefs of a society. Were that to happen, courts would end up interpreting regulations in order to suit the preferences and priorities of the society in question.

In times of prevalent belief in state control, then, no pro-market legislation will ever be strong enough. Therefore, the goal should not be to pass laws in favor of the private sector. This may be useful, but what is truly worthwhile is to convince the greater society that the market advances the common good better than does state interventionism.

Even so, drawing up the 1980 Constitution was an important milestone in the military regime’s reform process. The government’s resolve to submit to regulations of a higher order had been made clear through the passing of constitutional acts between January and September 1976, and through diverse general legal regulations.

The Constitution represented a serious effort to provide a backbone, within a greater institutional framework, for the reforms that the regime had implemented or intended to implement in the country’s political, social, and economic institutions.

Simple Truths and General Principles

Personally, I feel disappointed by our inability to draw up a Constitution that was simpler and less regulation-oriented than the 1980 Constitution. Its major faults are its neglect of principles and excess of detail, especially on the regulation of economic matters. I am not sure to what extent such meticulousness works as an effective barrier against distorted interpretations of the regulations. There will always be loopholes, and a

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Constitution that has been drawn up with the obsession of closing them, come what may, is off to a bad start.

It is important to note that by 1973, our country’s institutional framework had been broken not by a coup, but by a long series of small transgressions that eroded and undermined the rule of law. It was a long process that started well before Allende’s government. However, Allende took it to its logical conclusion—to such an extreme, that the Minister of Justice proclaimed that “the revolution would keep within the boundaries of the law as long as the law did not attempt to curb the revolution.” Meanwhile, the general secretary of the governing party publicly congratulated the “workers who would not submit to a legal order.”

Perhaps we lacked the courage to present the country with a constitution that would reflect only basic principles, in as distilled a form as possible. We lacked confidence that this—a handful of simple truths and very general principles—could provide the foundation and a set of guideposts for the entire institutional structure. As a consequence of the traumatic experience in 1970–1973, the government feared the creation of loopholes (resquicios), but we failed to keep in mind that these would arise anyway, because the political manipulation of institutions and regulations is ultimately unavoidable.

For example, the rule establishing that the Central Bank cannot finance the Treasury seems to be, in principle, a good guarantee against uncontrolled monetary expansion, which as we know always leads to inflation. But what about the National Bank? Can it or can it not make loans to the Treasury? And if not to the Treasury, can it make loans to a state enterprise? And what about Corfo (Chilean Economic Development Agency), which was created in 1939? In each of these cases, it is possible to come up with numerous legal gimmicks that, while not betraying the letter of the Constitution, would be going against the civic principles that inspired it.

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Other Times

At the time that the government tried to build an institutional framework for the economy that would be consistent with the reforms—both those already carried out or on the agenda—the intellectual climate and public opinion were very different from what they are today. Even in the eighties, the social market economy was a project still in its developmental stages. Its scope was still very much open to debate even within the government.

The most revealing testament to the internal contradictions of that time is the Constitution itself. Skimming through it is enough to discover that several of its ordinances reflect contradictory orientations. Although it is openly statist on mining issues, it could not be more committed to the market economy when it comes to outlining property rights. The Constitution would probably have been even more biased toward state control had it been drawn up after the 1982–1984 crisis. After all, 1978–1980 were bonanza years for the country. The economy, diverse worrying symptoms notwithstanding, was flourishing.

In Chile, expropriation is out of the question except by law, with compensation to be paid in cash. This Constitution leaves no room for another wave of forced dispossession similar to the one brought about by the agrarian reform. Now there are different loopholes: for example, the municipal zoning ordinances entail serious restrictions on property rights, and the same is true, to an ever increasing extent, in the process for environmental approval of projects.

The Constitution’s most important contribution is perhaps its ample and vigorous recognition of economic freedoms. Behind this lies the idea that individual rights and political rights that are normally recognized by a constitution become a dead letter if they do not go hand in hand with economic rights.

This correlation is essential. Anyone who studies socialism will understand why this ideology makes a distinction between “formal” and “real” liberties. Socialist criticism of bourgeois democracies makes a lot

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of noise about the proliferation of formal rights in constitutions when there are people in those democracies who are undernourished because they do not have enough to eat.

Socialism has always been adroit at confusing the ends with the means. The objective behind any institutional legislation is to make it possible for people to fulfill their needs. Obviously, a constitution cannot guarantee fulfillment of those needs, although many constitutions—as a result of pressure from socialist factions, no doubt—in addition to personal, political, and economic freedoms, guarantee so-called social rights, such as the right to eat, the right to social security, the right to a job, the right to pleasant summer holidays, and so on. This reflects huge misconceptions. What a constitution can guarantee is opportunity, not concrete results.

The Chilean Constitution is not immune to these distortions. Parts of it feature idealistic or programmatic statements. In almost all of its articles, the tension between the liberal positions and dirigiste positions is evident. These tensions are often dealt with by including exceptions in one direction and then the other—which are not few. The resulting amount of detail undermines the quality of the laws. The wording of the great constitutional principles should have been much simpler and briefer—not enough constitution, too many rules—but perhaps this was the best we could have done.

Isolated Observations

One of the most long-lasting contributions made by the Constitution on the economic plane is undoubtedly the cash compensation, in the absence of an agreement between the parties, in cases of expropriation. This obligation was also in force under the old 1925 Constitution, but the indemnity could be paid in installments subject to undefined adjustability mechanisms. In a country with the rates of inflation that Chile had, this would make a mockery of the payment.

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On education, labor, and health issues as well, solutions provided by the Constitution were also rather hybrid. On reading the text, for example, one might wonder to what extent the municipalization of education complies with the constitutional requirement that the state finance a system of basic, compulsory, tuition-free education. Under this prescription, would it ever be possible to transfer municipalized schools to be managed by organizations comprising of teachers or parents, as some of us had envisioned? Would it be possible for parents—when a rise in their wages made it feasible—to also start paying toward financing schools? How meaningful would an explicit reference to basic education be in a hundred years’ time?

In many of the constitutional regulations, it is possible to discern traces of the traditional distrust that our legislation has always had of customary practice—a distrust that may be rooted in the Spanish colonial legacy. In Chile, contrary to the legal tradition in Anglo-Saxon countries, the law comes first and, supposedly, customary practice will follow. Supposedly, if the constitution guarantees the right to health or to education, then the problem has been solved: all Chileans will automatically have good health and an education because the state says so.

The Constitution recognized the importance of private property to a social market economy. However, it made a clear distinction between property rights and the right to property. The former would protect those who already owned property; the latter those who hoped to one day own property. The result, however, was an overly long property rights law. Perhaps it would have sufficed to include a short statement to the effect that the constitution recognizes private property rights, period. It should be incumbent on other laws to establish the scope of this principle in mining, waters, telecommunications, intellectual and industrial property, and other areas. The mere fact that the Constitution included so much detail speaks volumes of the internal tensions that prevailed.

A few safeguards were adopted on issues related to public enterprises. Certain requirements were set up—mainly qualified quorum

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laws—regarding the State’s participation in business activities, establishing that these would be subject to common legislation applicable to private individuals.

The debate over the Central Bank’s independence proved interesting. Apart from guaranteeing the issuing institution’s independence, the Constitution limited its operations severely. In fact, it can now only operate with financial institutions, both public and private, but cannot purchase documents issued by the state or finance public spending as it used to do. The Constitution envisaged this institution fulfilling a technical role, since that was the only way that it could function as the backbone of monetary policy. But it was a long process. The Constitution stating that the Central Bank is independent is not enough to make this a reality. It gradually became a reality because the military government created opportunities for the development of a capital market in Chile. Without this market, the Central Bank would never have been able to leave behind its role as a direct lender to the Treasury and to specific industries. The Central Bank had basically been a fiscal policy agent. Its autonomy was realized during the later years of the military government, after a political agreement had been reached, taking representatives of the opposition on board as counselors. This fact is important because it shows how autonomy was legitimized. Otherwise, the bank’s autonomy would still be questioned today. With independence realized, it was essential that the Bank act independently and confine its activities to its basic task: currency stability.

I am inclined to believe that, given the existing problems and the country’s perceptions at the time, the 1980 Constitution was the best one possible. At least the pivotal definitions of economic institutional organization were taken seriously. At least we left behind the endless discussion of whether the Constitution should allow the president to run for reelection—which at times completely overtakes any constitutional debate in Latin America to the detriment of important provisions that will have a significant effect on the country.

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Several aspects in the 1980 Constitution are essential and have been dealt with reasonably well. For instance, time has shown that the two-party electoral system that it incorporates has benefited political stability. Fortunately, it has so far survived the attempts at modification promoted by the political convenience and fashion. The rules on budgeting and on presidential authority on this matter have resulted in a favorable regime of fiscal discipline that has put a check on the tendency toward arbitrary and inefficient allocation of state resources.

But there is no doubt that countries are not defined by their constitutions. Some, even, are what they are in spite of them. And others fall far short of the high-minded constitutional prose laid down by their national leaders.

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CHAPTER EIGHT

Times of Crisis

The eighties began with a world in upheaval. In the United States, Ronald Reagan was launching his conservative revolution and was to find his strongest ally in Margaret Thatcher.

Chile, in turn, was experiencing an economic boom. Growth rates were close to 8 percent, real wages were up 9 percent, and everything seemed to confirm that General Pinochet had made the right decision in 1973 when he adopted the principles of economic liberalization articulated in El Ladrillo. The country’s first shopping mall and first private university were both about to open, and the private health care system institutions were beginning to operate.

Storm clouds began to gather on the economic horizon in 1981. Pressure on the exchange rate, which had been frozen at 39 pesos to the dollar in mid-1979, was strong, because during two consecutive years, inflation—though it was decreasing—had caused domestic production costs to increase. In this context, exporters’ returns were becoming less and less attractive.

Many Latin American economies have gone through this predicament. Applying exchange policy as an instrument toward stabilization is more common than people in Chile think—examples include Argentina during President Carlos Menem and Minister Domingo Cavallo’s time, and Mexico during President Carlos Salinas de Gortari’s time in office. In both countries, the exchange rate was used as an anchor mechanism to slow inflationary momentum (although that was in the context of the early nineties, not the late seventies).

In 1981, in any case, debate over the exchange rate gathered momentum in Chile. Nobody could say that there was no awareness of the behavior of this crucial economic variable, or that it was not being analyzed.

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There are two aspects of the economic situation at the time that should be kept in mind. One is that 1981 was atypical: it was the only year since 1975 in which Chile’s export volume did not increase. The other is that foreign borrowing had never been as high in Chile as during that year.

Nonetheless, there was significant growth both in 1980 and in 1981. It is true that the rhythm of activity began to slow during the second half of 1981, but before that, the economy behaved relatively well.

Dollar Inflows

The economic situation that the country faced in 1982 was less reassuring. That year was marked by strong and intense debate—both within and outside the government—over the advisability of devaluating against the dollar, which was being kept at 39 pesos, or reducing salaries directly. The crisis hit rock bottom when the decision was made to devaluate by 18 percent.

On the one hand, there were evidently problems in the private sector, especially for commodities, because the government was resorting to the exchange rate to stabilize the economy. The idea was to eradicate inflation, and this is not easy, especially in a country in which wages are adjusted by inflation. On the other hand, the government was working in the context of a large amount of foreign investment that did not go into the Treasury—the Treasury actually had a surplus—but into the private sector, especially the financial sector. The authorities did not foresee any major problem with this because, in the event of credit flow coming to an end, the problem would be between foreign and domestic private parties.

As it turned out, the situation was not that easy. The problem of stabilizing the financial system in order for it to be able to answer to depositors was not a matter of importance to private individuals only; it concerned the state as well. Therefore, when credit inflows came to an end in 1982, the problem, which had been private, became public. The

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situation was even more difficult because at the time, the financial system did not feature legal mechanisms enabling the adjustment of potential imbalances by prorating losses between depositors.

What Went Wrong?

There is ample room to attempt to explain this episode. One proffered explanation maintains that the problem would not have become as serious as it did had there been fewer loans between banks or through interrelated companies, and that the situation would not have arisen had the country been able to resort to more efficient mechanisms to control the financial system.

Although the Superintendence for Banks and Financial Institutions in time did become more efficient, it was only halfway there at the time. The country had already been through one banking crisis in 1978. But the fact that private economic actors went into debt the way that they did was not clearly perceived as a problem. Why should an organization structure that worked quite well for the German and Japanese financial systems, where the banks own enterprises, be unacceptable in Chile?

The main diagnostic error was to think that it would be possible to keep the state out of the problem that was developing. Private parties were unable to make the changes that the situation demanded, because they were not equipped to do so and because there were no laws or regulations stipulating how to cope with this contingency. Essentially, bankruptcy in the banking context was not clearly defined.

The other element of the crisis was economic rigidity. When foreign investment stopped flowing in, the logical reaction would have been for the economy to change relative prices. With a fixed dollar, this would necessarily have meant reducing internal prices, especially wages. In theory, this would have solved the crisis, but in practice, prices were fairly inflexible downward, and wages particularly so. Politically, wage reduction was too high a hurdle to jump, even for the military

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government, which today many people regard as headstrong and determined. In fact, the government did not even come close to imposing wage reductions of the magnitude that the economy required. Ironically, a decision so avoided and postponed, so feared and exorcised, was finally forced by circumstances anyway, when the economy adjusted on its own—between 1982 and 1984, wages fell by 10.7 percent in real terms. This was an important component in the adjustment. The other component was paid for by an increase in unemployment, which in 1984 climbed to approximately 23.5 percent of the workforce, if we include among the unemployed the people working in emergency employment programs created by the government. In any case, although these numbers seem astounding, this was the experience of many Latin American countries’ labor markets, if we look at the combination of wages and unemployment that prevailed during those years.

It is unlikely that the economy would have adjusted unaided, without the 1982 devaluation, which took care of generating inflation, reducing the purchasing power of wages, and changing the structure of relative prices. In Chile, the wage system was indexed and the collective bargaining law set the previous contract’s wage level and adjusted for inflation, as the floor for new union contracts. It could not have been more inflexible. The government in turn reproduced these same dynamics in its own wage policies and in the labor law that applied to non-union private sector employees. In fact, in order to make the adjustment via devaluation effective, the convergence of a pronounced recession and legal changes making labor indexation more flexible was a necessary precondition.

Two Factors

The two main factors that explain the Chilean crisis are, first, a very strong external shock and, second, the interaction of this external shock with the fixed exchange rate mechanism. When Mexican Minister of the

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Treasury Jesús Silva Herzog called the banks in New York to let them know that his country would be unable to pay them and would default, all of Latin America was dragged into the hardships of the decade of the debt crisis, which became known as the “lost decade.”

The external situation became especially grim. The Mexican default coincided with the effects of the policies that U.S. Federal Reserve Chairman Paul Volcker had implemented in order to curb the inflation rate inherited from President Jimmy Carter’s administration (1977–1981), during which inflation had reached a yearly 11 percent rate. As a result, interest rates during President Ronald Reagan’s time soared to unforeseen levels: between 16 percent and 17 percent for nominal rates, between 4 percent and 5 percent for real rates.

In addition to this, there was the fall in terms of trade to consider. They had deteriorated between 1970 and 1980, but the decline between 1980 and 1985 made the situation even more dramatic.

There can be no doubt that the external shock was underestimated in Chile in 1982. Critics of the official policies hardly took it into account as a variable in their analyses. The authorities, in turn, never could have imagined the depth and duration of the crisis.

In the end, events turned out to be much more serious than had been indicated by either the diagnoses made by economists, the criticism from government opponents, or the government’s own working assumptions. Latin American countries fell one by one, victims of the violent international recession. The situation made evident the fact that the Chilean contraction was a consequence not just of the fixed exchange rate system, as critics maintained. The change in the external variable was crucial. Latin American countries, each with different policies, were just as affected as Chile was, if not more so.

No doubt, the delay in the decision to make the exchange rate more flexible was a problem, especially given the new external conditions. But it was not the whole problem, as some suggested. It was evident—one had to be blind not to recognize this—that Chilean exports had been losing competitiveness. This was disturbing, given the country’s

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development strategy, even though the conditions required by the exchange rate as an instrument were being adequately complied with. The situation was in itself serious without the external shock, but the external crisis intensified the problem. Perhaps it might have been possible, once inflationary momentum had been arrested, to correct the exchange rate lag through other instruments within the system, or by means of milder traumas than the ones that were finally applied to check the external crisis. But something had to be done. The imbalance would not correct itself. Furthermore, the way to development is through export competitiveness. If it is a question of erring on any one side, a high exchange rate and an undervalued currency are by far preferable to an exchange structure that makes exporting unviable.

Using the exchange rate to stabilize the economy is a legitimate policy and can be very effective in certain contexts. This strategy proved useful to Argentine Finance Minister Cavallo in controlling rampant inflation in 1991, at a time when his country had been through several shocks. This is what happened in Chile. The exchange rate lag could perhaps have been overcome, but not the lag in conjunction with the debt crisis and international recession. That was too much.

Unanswered Questions

The Chilean economic crisis during those years raises many questions. How was it that the authorities did not react in time? Why did the measures to face the emergency take so long to implement? On the other hand, it is only fair to recognize that there was no easy way out. Devaluation, which seemed such a sensible measure and was finally adopted, entailed huge costs. The rise in the exchange rate made the situation of debtors in the financial system more critical and brought to question the health of practically the entire banking system.

That there was no easy way out was made very clear not only in Chile, but throughout Latin America, and violently so. Chilean GDP fell

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by a whopping 14.1 percent in 1982. However, in retrospect, Chile reacted better in the end than did any other country in the region, especially in comparison to Mexico, Peru, and Argentina. Between 1981 and 1992, Chile’s per capita growth was the highest in Latin America, according to CEPAL data— higher even than Colombia’s, even though that country largely escaped the debt crisis. The only exceptions were a few small countries in the Caribbean.

Handling the situation was extremely difficult as the economic crisis threatened to turn into a major political crisis. For example, between 1982 and 1984, Chile had five treasury ministers—Sergio de Castro, Sergio de la Cuadra, Rolf Lüders, Carlos Cáceres, and Luis Escobar. I was appointed in February 1985.

As controversial and painful as it was, devaluation did at least fulfill its basic objective: it made it possible to change relative prices. The crisis, on the other hand, made it possible to modify the law that indexed workers’ wages, making the Chilean labor market more flexible.

The final point here is that in Chile’s experience, two factors converged that were impossible to resist in conjunction: a major external shock and a fixed exchange rate as a weapon against the inflationary trend, in an economy where there was strong indexation, not only by law, but in practice and by popular custom.

I do not think it would have been possible at the time to stabilize the economy via nominal wages. This option is not part of our economic policy toolbox and has not been internalized either by the authorities or by workers.

A Rift in the Team

Aside from its huge economic costs, the crisis introduced a serious rupture in the liberal consciousness of the team of professionals and economists on which the government had relied to plan the country’s economic transformation. The climate of great unity, the certainty of

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having taken the right path, and the collaboration of previous years yielded to an atmosphere of struggle, conflict, and ill feeling. This could not have come at a worse time, given the situation that the country and the government were going through. The administration was pushing for substantive reforms that required not only imagination and hard work but also deep personal commitment, in order to carry them through.

Politically, the government was sailing through rough waters, and these divisions did not help face criticism from detractors. The newspaper El Mercurio, through its editorials, questioned the path taken by the government economists, arguing that “things were being handled with the clumsiness of the inexperienced.” Political opposition also became more intense. National protest days began to occur, and eventually turned into massive anti-government demonstrations.

On April 22, 1982, Minister of the Treasure, Sergio de Castro—one of the main promoters of the reforms from the outset of the government—resigned. The crisis, the shattering of consensus, and the course of events were crushing blows to the Chilean reform project. The decision to devaluate was taken by General Pinochet at the same time that he refused to reduce nominal wages.

It is possible that in the handling of the crisis, many people saw signs of intellectual arrogance that may have contributed to a hardening in positions. But it is important to recognize that the economic authorities were in a very difficult position. Any evidence of doubt or hesitation would inevitably have worked against the economic team’s efforts, so political sensitivity was a luxury that we could not afford. The fixed exchange-rate policy is precisely a no-regrets policy that requires mental toughness in order to implement it.

If things had happened the way they do in textbooks or in laboratory experiments, there first would have been an automatic unaided adjustment in wages and internal relative prices. Second, private debts would have been transformed into private equity, and foreign creditor banks would have capitalized the loans that they had made to their clients in Chile—most of them in the financial sector. Third, depositors in some

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troubled banks would have had to assume the loss of varying proportions of their credit balance.

None of this happened, however. The first point was very difficult, and the country was not ready to carry it through. As for the second and third points, there was no clear system of regulations establishing the mechanism by which equity adjustments were to be made effective. Some of these points began to take shape, in fact, when indexation was made more flexible, especially after 1985, as a result of the changes introduced in financial market legislation. However, the direct equity adjustment in 1982 was confined to the owners of the unstable banks, because they had lost practically everything.

In practice, foreign bankers also lost. They ended up selling Chilean external debt promissory notes substantially below their nominal values, which ended up benefiting the country to a great extent. However, this process was not immediate. It took time and did not take definite shape until 1985.

To sum it up, the change in relative prices was never as significant as an automatic adjustment would have required. Besides, the proposal to pass a law to reduce wages by a percentage that would not have exceeded 10 percent eventually yielded to a law that reduced only a small fraction of the higher wages in public administration. In view of the magnitude of the imbalances at stake, this was insignificant and, inevitably, the problem exploded in the form of a recession. Some critics argue that the devaluation merely added fuel to the flames of recession but that in fact the recession was coming anyway; it had been gathering force during all of 1981 and became visible at the beginning of 1982. External conditions rendered it inevitable.

In Chile, the outcome of the eighties crisis was especially bitter: devaluation, recession, and state intervention into the financial system. Aside from this, the state had to take responsibility for the debts contracted by private parties. This was for the purpose of answering not to bank owners—as has often been claimed—but rather to depositors and creditors.

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Fatal Convergence

Many were the factors that converged in 1982, in Chile’s second worst economic crisis of the twentieth century. The economic authorities were stuck in a fixed exchange-rate policy. Nobody could predict how long or how intense the crisis would be. The regime lacked the political ability to provide relief through wages. The legal system was imprecise and rather ineffective as a means to induce the equity adjustments that the crisis called for. There was also a misguided perception that the indebtedness of the private sector did not concern the public sector. In addition to this, one more factor failed: the solidity of the financial system and of the Chilean private sector in general. It is true that the private sector had grown in comparison to its situation in 1973, but this expansion had taken place through debt. There was little capital in Chile. The decapitalization of the private sector after decades of interventionism and of the Allende period of outright Marxism was real. It took years to overcome this problem, which exacted a heavy price during the crisis. Debts are always too inflexible to cope with times of crisis.

Undercapitalization in economies trying to transition from socialism to a market economy is a serious problem, because there can be no free economy when the private sector’s equity situation is unstable. Transition from one system to the other, as Eastern European countries discovered, requires mechanisms and incentives to strengthen the private sector, and this can only happen via reduced taxes or via direct equity transfers. Such transfers could take place via privatizations through popular capitalism, the sale of enterprises to their employees at favorable prices, or the voucher system that was used in the Czech Republic and in Russia.

Despite the intensity of the crisis in Chile, the country showed an amazing capacity for recovery. The country’s trade deficit in 1981 had become a surplus by 1983. This transformation involved almost a 15 percent GDP movement, which is significant. Now, the downsides in this situation were the dramatic fall in GDP, increased unemployment, and

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reduced wages—although some sectors such as Codelco, where wages were not reduced, escaped the fall that affected even the salaries of central government staff and the military. This means that the reduction was necessarily steeper in other areas, to compensate for the privileged few who went through the crisis unscathed.

The crisis also changed the fiscal situation, which prior to the crisis had shown a surplus. Clearly, if there was one thing that could not be done to address the new needs and spending, it was to raise taxes. Increasing the tax burden on a depressed private sector would have made things worse. Therefore, there was no choice but to cut spending and adjust public sector wages and the government agency budgets, applying an adjustment factor below the rate of inflation.

The Government’s Actions on Other Economic Agents

The accusation that some of the means the government used to overcome the crisis were arbitrary—especially the intervention into the banks—will always linger. Why were some debtors affected while others were not? Why were depositors helped? Why was the assistance offered to some people not offered to others?

These are legitimate questions, but so are the priorities that guided the actions of the government. The government decided not to help the owners of the banks, but did help debtors, especially small and medium debtors, through mechanisms such as a preferential dollar exchange rate, successive renegotiations, refinancing operations with the Central Bank, and de-dollarization, among others.

In practice, the question of who could be rescued and who could not depended on how extensive these mechanisms were and on each group’s credit position. Ultimately, the groups and the banks that fell were the ones that had assumed greater obligations in a risky bet. If things went well, they stood to gain a great deal, both through the bank and through the company that had received the money. If the system locked down,

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their only hope was that the problem would be so massive that in one way or another the government would come to their rescue. But this did not happen and these groups disappeared. Later, in 1984, several economic groups made that same gamble and things turned out well for them, because the country was doing well, but there was a radical difference this time: the assets on which they were gambling were mainly their own, not those of other people. The government had changed its strategy to make this possible. Taxes were modified, and a series of measures enabled greater capitalization of the private sector.

The outcome of the crisis was not only painful and dramatic, but paradoxical: after six or seven years of a social market economy, the banking system and a significant part of the private sector in Chile returned to the state. The country perceived this development in two conflicting ways: while the market purists thought that state intervention had gone too far, the opposition held that it had not gone far enough and that money was being given away to the bankers.

The truth was at neither of these extremes. Intervention was not spurred by a dogmatic eagerness to vindictively liquidate the private sector, as some people maintained, and neither were bankers favored. Depositors and savers were favored foremost, with small debtors second. This explains the entry of new investors and owners into the banking industry, even in the case of institutions into which intervention was not a factor.

Would it have been possible to negotiate with the economic groups of enterprises that fell into bankruptcy? In other words, was there an intermediate solution, more assertive than doing nothing but less drastic than intervention? Of course it was not up to the state to present the solution. The government always expected greater negotiating potential from the main economic groups, especially with their foreign creditors; however, they lacked this potential, and they failed in this. Perhaps they did not even consider the possibility, but the securitization of debts by foreign banks would have been not only a solution for the country, it would also have meant the salvation of the banks. Paradoxically, this was

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considered to a great extent several days later, when the crisis was over. It was too late, of course.

Today, some people argue that all of these companies and banks could have gotten back on their feet had they been given time. That is true, in view of the development of the Chilean economy since 1984. But what would have happened if the country had not recovered? Recovery at that point was not guaranteed—it was actually so uncertain that foreign banks were prepared to take losses of up to 40 percent and 50 percent of their credit, in an effort to liquidate Chilean external debt promissory notes.

Everyone lost out in the crisis—the government, bankers, workers, businessmen, pensioners, and foreign banks. Strictly speaking, nobody won. What did happen later was that recovery in some activities was swifter than in others. During the second half of the eighties, there was great mobility. A large number of small and medium-sized businesses expanded. Those in a better position were able to capitalize on the benefits of recovery more advantageously.

Reflections from a Distance

My own experience at the time of the crisis was unique. I lived through the culmination of the process, not within the economic policy community, but as Undersecretary of Health. After this, I moved to the National Planning Bureau (Odeplan) and later to the Superintendence for Banks and Financial Institutions. In a sense, this saved me; in another way, it tied me inexorably to the appointment awaiting me farther ahead. In the Health Ministry, I never felt involved with or committed to either the unshakeable truth of the fixed exchange rate or the harsh criticism directed at De Castro at the time.

In retrospect, the crisis was a time of great conflicts and crucial decisions. The country came to within a short step of abandoning the social market economy for good. Had it turned back on the experience

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then, history’s verdict would have been that the model had failed and was therefore abandoned. Where would we be now? In Brazil’s situation in 1992? Facing the same problems as Venezuela in 1993? Would we be looking for a Chilean version of Menem or Salinas de Gortari? Going even farther, where would Latin America stand now? Would the Mexican, Argentine, or Peruvian experiences have occurred, if not for the Chilean experience? Would it have been possible if the country had only gone halfway?

The year 1983 marked the peak of political risk for the market-based development model in Chile. There were several cabinet changes, each new minister having to face a tough and thankless task, until the appointment of Minister Escobar Cerda. He clearly belonged to a different school of economic thought, but the merit of his tenure was the confirmation of the fact that there were no easy and painless solutions to the problem. The country began to recover in 1984, but it was clear to everyone, given the trend reflected in the indicators, that the recovery would be short lived. That year, the balance of payments current account deficit increased by $1 billion. So short lived did the recovery turn out to be that the Minister, at the end of his short term in office, had to devaluate once again and increase tariffs.

This experience proved useful when I was appointed Minister of the Treasury. There were no easy solutions. Therefore, the task the country needed to undertake was to retake the initiative on behalf of a free economy, which required perseverance and hard work. It was not a question of moving just one economic variable. All of the variables had to be dealt with simultaneously and in coordination in order to put the country back on the path of sustained and sustainable development.

CHAPTER NINE

How to Get the Country Back on Its Feet

The year 1984 in Chile proved that solving the economic crisis that the country was going through was not easy and that the tough times were not simply a consequence of the former economic team’s obstinacy. Nor was it a question, as many people believed, of the need for greater skills in negotiating with the International Monetary Fund. It is true that for a few months, public opinion was that things were improving. There was, in fact, a certain degree of relief and greater growth, but the downside was the worsening external crisis at a moment in which the world showed absolutely no interest in financing Chile or Latin America, and in which the prices of our products were falling. This situation could later generate significant inflation as well, if the economy was not stabilized quickly and soundly. Greater growth translated into successive increases in imports at a pace that was unsustainable in the long term, as evidenced by the fact that the current account deficit was taking on dangerous proportions.

Minister Luis Escobar Cerda’s objective in devaluating by approximately 24 percent and raising tariffs from 20 to 35 percent in September 1984 was to reduce domestic spending, moderate people’s consumption, and reorient the economy toward exports. But these measures also meant that real wages had to be restrained; otherwise the economy would once again be caught up in the inflationary spiral caused by continuous movements of both exchange rates and wages.

This was the situation at the end of 1984. Things were not going well for the country, and during the latter months of the year, rumors of a new cabinet change began to circulate. After many years, I had decided to take a long family vacation, especially to spend time with my oldest daughter who would soon be leaving childhood behind to become an adolescent; this would probably be the last holiday that I would be able to spend with her. But the President, just as I was beginning my vacation,

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announced a cabinet change that was to be made at the beginning of February, which was rather late, given his habit of making cabinet changes at the end of the year. In short, this announcement obliged me to cut short the trip I had planned and postponed several times as I had come to occupy different positions: Undersecretary of Economy, Undersecretary of Health, Directing Minister of Odeplan, and, finally, Superintendent for Banks and Financial Institutions. In fact, I had to be tracked down in a place in the south of Chile by the Carabineros (Chilean national police), who took me immediately to La Moneda by Air Force plane for an interview with General Pinochet.

On February 12, the President confirmed my appointment as Minister of the Treasury. It was not the most optimistic of times. Different proposals to solve the crisis all seemed to have been exhausted. Almost two and a half years had passed since economic indicators had begun to decline and, after all this time, the country was still very disoriented. Some colleagues on whom I called to share the work ahead have reminded me that at the time they joined the team, they knew that the work presented to them would be very interesting, but also very precarious in terms of job security. The high turnover of officials who had preceded us in the economic policy team led us to place bets, only half jokingly, as to how long we would last in our positions. The average bet was of about two months.

The Diagnosis

The challenge that I faced was complex and the responsibility enormous. We had made great progress in matters related to structural reforms. We had transformed the economy into something entirely new. We were also facing a new social situation, and were making significant reforms to help the poor. But, in the short term, we faced a major crisis, the end of which no one in Latin America could foresee. The Chilean economy’s terms of trade continued to deteriorate. The numbers for 1985 show

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Chile’s terms of trade at dramatically low levels. In October 1984, the price of copper fell to 57 U.S. cents per pound.

There was another, more serious problem: the gradual divorce of the government from the social market economy model. The Minister of the Treasury and his team’s work, to all intents and purposes, renounced the development model that the government had embarked on in 1973. Many felt that the strategy had failed and therefore should be abandoned. The government had placed its bets on expansionary and protectionist measures that would help improvement in the long run. The challenge in front of me was to a great extent political: to prove that this path led nowhere, that any recovery it may achieve would be ephemeral in the best of cases. In short, I needed to persuade the country of the need for a drastic change that would mean a renewed commitment to economic freedom, liberalization, and the market.

I was convinced that the structural policies implemented by the government were the right ones. The problem that the economy was experiencing was a consequence of the loss of wealth caused by the decline in terms of trade, which had translated into an even greater loss in well-being as a result of foreign banks’ refusal to continue granting Chile credit to the extent that they had done in previous years. People’s difficulty in accepting and facing the new situation made things worse.

The right thing to do, from my point of view, was to strengthen structural policies, reinforcing the economy’s orientation toward exports. In view of the shortage of foreign capital, this was more pressing than ever before. The debt-to-product ratio reached its highest historic level in 1985, at 114.1 percent. Interest rates at the time were excessive—the 180-day LIBOR rate was 13.4 percent in 1982 and 11.2 percent in 1985—and the poorer the country became in dollar terms, the greater its foreign obligations became.

Regarding support of exporters, the devaluation implemented by Minister Escobar in September was certainly useful. But it would only be useful insofar as it was not eroded by rises in either government spending or nominal wages, both which proved unlikely due to existing pressures.

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The situation was different in the case of the tariff hike, which took tariffs to 35 percent and headed precisely in the opposite direction as what the country needed. A protected economy always exports less, but lowering this barrier involved greater fiscal discipline, since tariffs are politically expedient tax for the Treasury.

The other critical problem that needed to be dealt with at the time concerned the rate of investment, which the crisis had reduced drastically. It was barely 13.6 percent in 1984; clearly, in the long term, this level of investment would lead the country to a dead end. The task was to determine how to increase this level quickly, but this time without foreign capital, at least in the medium term, since banks had stopped lending to Chile. A steep rise in domestic savings—2.7 percent in 1984—was therefore required. In achieving this end, fiscal savings were key.

A Weak, Broken-Down Engine There remained a more serious problem. The crisis had destroyed the private sector, so building it back up was crucial, as we considered it the true engine of development. It was a strange time because the situation, after several years of market reforms, was somewhat similar to the situation in Eastern Europe, since a good number of enterprises and a significant part of the banking industry were run by the state, to which they had returned when faced with bankruptcy. Clearly, until the private sector was consolidated, the country stood little chance of getting off the ground. The challenge was not to take it back to its pre-crisis situation, but to make it much stronger. This meant moving on quickly to the privatization of the major public enterprises.

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The External Debt Among the tasks aimed at solving the truly pressing problems

concerning unemployment and income in Chile, the handling of the external debt was extremely important. The debt was a constant source of pressure on the economy. The opposition maintained that the strategies that Alan García was implementing in Peru at the time were what this situation called for. The more moderate opposition endorsed the policies applied by Raul Alfonsín in Argentina. They called for outright war against foreign banks. García’s announcement that Peru would pay only for up to 10 percent of its exports was hailed as a model of economic inventiveness and political courage. In the end, the amount Chile finally paid was not far from this percentage, but it was paid in the context of systematic and orderly negotiations that helped increase our exports and our manufacturing. At the time, however, we were criticized for our alleged political meekness. That criticism would not stand up to scrutiny today.

The negotiation of the external debt was an extremely interesting experience for me. It gave me the chance to work with important world economic leaders—such as U.S. Federal Reserve Chairman Paul Volcker, U.S. Secretary of the Treasury James Baker, and his successor, Nicholas Brady. In addition, I worked with Bundesbank President Helmut Schlesinger as well as French chief Jean-Claude Trichet, who is now President of the European Central Bank, and with several leaders of private banks. This was all in a context of great uncertainty in the world economy, caused by the repercussions of the debt crisis. In that context, we Chileans were able to devise and put into practice solutions that would also prove useful to many other countries trying to overcome the global debt crisis. Specifically, this involved debt-equity swaps, which were first set forth in chapter XIX of the Central Bank Regulations Compendium, and restructuring of payment schedules with our creditors. Chile was the first country to apply the Baker plan, before James Baker translated it into a concrete proposal, and came up with a Brady plan

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before Nicholas Brady. However, what comes seems so simple when described in one paragraph was not that simple at all. The myriad difficulties and anxieties caused by delays in the approval of the first structural adjustment loan from the World Bank, due largely to political considerations, seem trivial today, but at the time they were nigh-insurmountable hurdles. The creditor banks were not easy to deal with either. At one point, I even decided to travel to Antarctica for a few days, as a way of getting a reprieve from a negotiation that I found exasperating. The decision helped me—literally—both to cool down the talks and to better fulfill my role as a member of the Antarctic Politics Commission. It also gave me time to go over existing budgetary problems.

The rationale behind this effort was not to adjust macroeconomic figures on paper. It was to solve the tremendous problems that people were living through—mainly unemployment—that would never be solved unless Chile managed to set itself on a stable growth rate that not only would bring bread today but would also thwart the risk of hunger tomorrow.

To Grow, but in Stability

What we were trying to do was to get back on the path of stable growth, with stability as the top priority. A spectacular growth rate one year would be worth nothing if the following year the economy contracted again. That was the only way we would be able to eliminate the dire unemployment situation. It must be kept in mind that at the time, a large segment of the opposition held that the problem was unsolvable. The two state emergency employment programs—the minimum employment program (PEM) and the unemployed heads of household program (POJH)—at one point comprised 500,000 workers, which in a workforce just under 4 million people was a huge proportion. Alongside these numbers, we faced the reality of a 20 percent open unemployment,

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including people employed by the central government through social programs, taking the percentage of population affected by the lack of work close to 30 percent. Our main priority was to create jobs, leaving improvement in wages to be dealt with later. The opposition’s prognosis maintained that the economy would need over twenty years to overcome the scourge of unemployment.

Put in these terms, the recovery program seems a simple matter. In fact, theoretically it is, but it is easier said than done. The difficulty lies in handling several interrelated variables. Talking about implementing a fiscal austerity policy is easy, but actually doing so becomes very complicated in areas such as health or education at a time when, because of the crisis, society is highly vulnerable both economically and politically. The political situation in 1985 and 1986 was still very difficult. Street protests, which began soon after the onset of the crisis, had not only become widespread, but had turned into a ritual whose routine nature did nothing to detract from its violence. The tension and the level of confrontation increased, month after month. I remember venturing out on the streets in a neighborhood where one of the most violent protests had taken place the day before, trying to go unnoticed, to see the damage for myself. This underscored for me the extent of the crisis and strengthened my resolve to work toward overcoming it.

The last straw for my administration was the violent earthquake in March 1985. Damage in the central region was extensive; a significant part of Chile was literally razed to the ground. It was a terrible experience but, in a way, it forced the country to face up to reality. The level of government spending prior to 1984 could no longer be maintained. Agreements that had been signed by Minister Escobar before I took over, regarding budget increases—which were already unfeasible before the earthquake—became impossible to fulfill. A closer watch needed to be kept on government spending, even though after the earthquake the whole country set its eyes on what the state would do to help overcome the emergency in the areas and regions that had been worst hit.

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The disaster helped make people aware that there was no other way out but through hard work and austerity, which entailed moderating wages and cutting government spending. It was in this context that the 10.6 percent adjustment on pensions was not applied, as it should have been according to the automatic readjustment mechanism that General Pinochet’s own government had set up in favor of retirees. It was a tough time; wages in Chile were not being increased at all, so at the time this decision was made, there was no other choice.

The government, showing great resolve, adopted a policy that affected pensions in the defense sector more than in any other. In the case of higher pensions, the loss was substantial. This was not done out of some masochist compulsion: times called for more than just patching things up. Drastic decisions were necessary. Countries that avoided such decisions caused more harm to their needier populations in the long run. In Peru, Argentina, and Brazil, the problem was much more critical, and those countries to this day cannot offer any hope of recovery to their most disadvantaged citizens. Between 1980 and 1987, real wages in civil service and defense underwent a sharp and sustained decline. Much the same thing happened in the private sector. It is worth noting that workers at public enterprises, many of whom did not apply the adjustment or applied it in a milder version, fared quite a bit better.

Government spending, which had reached 30.7 percent of GDP in 1984, was reduced to 20.6 percent in 1989. Fiscal policy was fundamental in creating opportunities for export in backing a high real exchange rate and in promoting increased domestic saving. The latter increased from 2.1 percent of GDP in 1982 to 17.2 percent in 1989. During that same period, investment rose from 11.3 percent of GDP to 20.3 percent. The real exchange rate increased by 80 percent between 1980 and 1988. Without an austerity policy, the government would never have been able to carry through measures such as the tariff reduction. Without lower tariffs, a high exchange rate would have been impossible and exporters would not have been able to recover to the extent that they did.

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The decision to reduce exports costs translated into numerous other measures during this period: rebates on or assistance for VAT payments for exporters; incorporation of the construction sector into the VAT in order to facilitate investment; elimination of all export taxes; and further tariff reductions. Tariff reductions were always resisted, both by some people in government, because it reduced revenues, and by the business community, which feared greater competition from imports.

Every one of these reforms involved a struggle. In fact, the last tariff reduction was carried through only after Chile had been removed from the Generalized System of Preferences, due to political pressure. Success makes consensus easier: this was clearly reflected in the fact that in 1991, Patricio Aylwin’s Christian Democrat government reduced tariffs once again, after a unanimous vote in Congress.

The Authority of Detail

The process of restoring business confidence was slow. The most depressing year was 1985. The specter of the previous year’s increasing balance of payments deficit, which included a current account deficit of11 percent of GDP, lingered over Chile. The dramatic fall in terms of trade, an earthquake in the central region, street protests—wherever one turned, the situation seemed to be a disaster. Things began to improve slowly, but never by chance. Behind every measure and every decision there was a systematic effort to apply a balanced approach to the achievement of many objectives—to restore confidence, encourage recovery, appease public opinion, convince government ministers of the unfeasibility of increased expenditure, uphold General Pinochet’s commitment to the strategy that we were following, and neutralize the opposition’s criticisms.

I think I managed to survive so many problems and so much pressure during this period because I had detailed knowledge of the government’s institutional structure, which allowed me gain the trust of the health

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minister one day, of the manager of a public enterprise the next, and then of the education or defense ministers. I had the advantage of having been involved in practically every area of government. Setting modesty aside, the one thing that no one could tell me was: “You’re new, so you don’t know what I’m talking about.” In fact, I knew quite a bit from the years that I had already spent working in different fields within the government. I doubt that I would have been able to privatize state companies without the knowledge that I had about the problems in the companies that we wanted to transfer to private ownership, about earlier privatizations in the seventies, and about the difficulties faced by banks that had been intervened into. I had to combine and coordinate thousands of decisions and details—while facing over 10 percent of the workforce on minimum employment plans (which were supposed to be temporary) and a large number of unemployed. The challenge lay not only in maintaining these special programs, but in thinking of ways to dismantle them when things improved. Memories lingered of past crises in which, in an effort to bring down unemployment, the government agencies had taken on employees on a temporary basis but then never let them go. In this task, the support of other economic policy agencies was essential. Minister of Economy Modesto Collados (1984–1985) understood from the outset that the path we were suggesting was the right one, and his decision to take the risk and commit to it was important to future accomplishments. Later, Juan Carlos Délano and Manuel Concha, in the same ministry, gave their valuable support, as did all other economic policy officials.

Until 1984, many people believed that Chile’s problem was mainly due to the external debt, which they believed could be addressed through what was known as a “good negotiation” with the IMF. My administration quickly put aside this perception, because the problem lay not with the IMF. The problem was ours. When a business is in a difficult situation because its operations are becoming unsustainable, its main challenge lies not in getting more funds or an extension on financing. The challenge is to sort out the enterprise, in order to achieve

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a positive cash flow, increase its products’ market appeal, and improve its competitive position. Within this perspective, endless renegotiation of debt schedules made no sense unless the country corrected its own imbalances and dysfunctional structures.

The effort to attain stable growth was subject to the condition of keeping inflation within ranges that were reasonable in the Chilean context. Our aim was never a one-digit figure. The goal was to achieve growth that could be sustained over time and to reduce inflation as much as possible, although not eliminate it—that would come later. Our indexation was not just formal, but psychological, and the need to raise the exchange rate made this almost impossible.

The Tools of Recovery

The Treasury played an important central role in strengthening the export sector and in maintaining an attractive exchange rate. Its handling of tax revenue, tariff changes, and pension system reform were key instruments in the recovery of savings levels and in the recapitalization of the private sector. The tariff changes and pension system reform had remarkable exponential effects. In just a few years, domestic saving jumped from 3 percent to 18 percent of GDP. This proved once again that, in the long run, the socialist compulsion to levy taxes on businesses hurts the poor even more than it hurts the businesses themselves. The higher taxes are, the more limited is the private sector’s reinvestment capacity and the fewer are the jobs that businesses can create. This debate is far from over, and it continues not only in Chile but in many other countries as well. The one thing this debate needs to avoid is the pitfall of “short termism,” which is usually reflected in the question: “Why reduce taxes if the economy is working well?” The situation cannot be evaluated based on one year’s results. It needs a wider perspective. Any growth process will generate increased savings capacity, but when development objectives are ambitious, these savings will in all likelihood not suffice

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and more will be required. It is then, looking a little bit beyond next week, that the importance of lower taxes becomes evident. The signals and incentives that citizens perceive will strongly influence their behavior—saving vs. consuming, working harder vs. sitting back, and state support.

Several measures proved to have a crucial role in strengthening private investment, from the fine-tuning of details—such as of the mechanism for collecting VAT on construction projects—to the resumption of financial activity with the rest of the world, privatization, taxes, and the mechanisms devised to attract foreign investment through debt conversion operations. The latter, in addition to helping reduce the country’s external obligations, also helped to put Chile back on the global investment map.

We consistently adhered to the imperative of safeguarding foreign investment. This was clearly a way to escape the debt crisis. We systematically refused to submit to pressure from various constituencies, including the IMF, to include maturities and returns on foreign investment on the list of items to be negotiated with foreign banks. We thought this was a dangerous thing to do. We even increased our advantages for foreign investment in order to attract more investors, especially those interested in strengthening our economy’s export capacity.

The Road to Privatization

Politically, the most critical issue in my administration was perhaps the restructuring and strengthening of the private sector. The very idea roused indignant reactions from many people. “Why build up the private sector when the whole country had just witnessed its fall?” they would argue. In the eyes of many critics, the private sector appeared to be the main culprit. Looking beyond those resentments, to whom could these corporations, which had been driven into state hands by bankruptcy and

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had become known as the “peculiar sector” (área rara) of the economy, possibly be sold?

To whom could the major state enterprises such as the phone company or the electric utilities be sold? The privatization strategy applied to the “peculiar sector” enterprises this time was different from that applied in the seventies. The objective was not to sell, but to build—indeed, rebuild—a solid private sector, through capital flows and through stocks. This had to be done, as had been clear to me since the late seventies. That was the reason why I considered it so important for individuals’ savings to go through the capitals market—which made the pension system reform feasible—and for the government to reduce the tax burden on businesses. Who could ever conceive of a social market economy with a chronically weak and battered private sector?

The strategy for restructuring sought to increase capital flow through the pension system reform and the tax reform. Since their taxes had been reduced, businesses either increased their level of investment or directed their savings into either the financial market or retiring debt. It also sought to increase stock ownership through the mechanisms that allowed nondiscretionary stock transfers, such as popular capitalism, labor capitalism, and advantages granted to public employees and to large groups of people. The idea was to make stock ownership accessible to relatively large groups of people—public administration officials, workers from the privatized enterprises, small savers—using non-conventional procedures such as the use of retirement compensations and reduction of personal taxes if they bought stocks.

The privatization process also attracted foreign investors who came in through the door that had been opened by chapter XIX of the Compendium of Foreign Exchange Regulations. These foreign investors converted external debt into capital. The process also attracted the domestic entrepreneurship that had managed to overcome the crisis. Interesting combinations began to develop, and each case was different. The privatization of the Bank of Chile—given its tradition and what it represented—followed the guidelines to reduce the concentration of

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property ownership. We believed that foreign banks would show interest in the Banco de Santiago, but this did not happen, and the same procedures were applied to its sale. In the case of Banco Concepción, the solution adopted involved the workers, through an agreement with the National Mining Society. The negotiation concerning the Banco Internacional involved Israeli investors. In the cases of the Santa María and AFP Provida, popular capitalism was combined with foreign investment from Aetna and Bankers Trust, respectively. In all of these cases, the challenge lay in privatizing within a competitive environment. In Mexico, for example, it is true that the banking system was privatized, but during the initial phase, it maintained some significant obstacles to foreign competition. In Argentina, telephone companies were granted a period of legal monopoly. In the Chilean privatizations, monopoly was not part of the negotiation.

Copec, a fuel distributor and cellulose exporter, and a “peculiar sector” member, was taken over by the Angelini group through successive share purchases. CCU, a brewery, was taken over by a private entrepreneur, Andrónico Luksic. It was interesting to see the ways in which domestic investors attracted foreign partners for these projects. This was how investors from New Zealand came into Copec. Later CMPC, another paper and cellulose company, interested the Fletcher group, another Kiwi concern. Luksic also attracted German investors.

In the end, not everyone profited to the same extent from these changes. In fact, investors ran considerable risks, which was the reason why, initially, administrators of the pension funds were barred from taking part in the process. Had they been allowed to do so, any losses of workers’ assets at the outset of a new private system would have been politically disastrous. Pension funds would be allowed into privatization later, and then gradually.

When the storm had subsided, some critics portrayed the privatization process as a carve-up, but it was nothing of the sort. Over time, people came to believe that the popular capitalism shares had been given away, because the shares obtained excellent returns as companies

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and banks recovered. But, just as things went well, they could have gone awry. There was no try-before-you-buy policy in privatization.

The privatization of the large state consortia, such as steel, telephones, and electric utilities, came later and was gradual. The makeup of the Chilean economy had changed markedly. The financial sector had been stabilized. Interest rates, for the first time in over a decade, had dropped to normal levels. But privatization faced restrictions and real problems—to begin with, because of the size of companies that were hard to incorporate into a private sector that had only just begun to recover. In addition, when it came to obtaining credit and foreign investment, the global financial community still perceived Latin America as a high-risk region. In fact, in some other countries’ privatizations, such as those of Argentina and Peru many years later, there would not have been enough bidders had it not been for the presence of the Chileans.

One option was to say that conditions were not ripe for the privatization of these consortia and that this had to wait. However, that meant keeping key sectors stagnant. Faced with this alternative, launching the sale of the main electric utility, Endesa, and other companies in the electricity sector, including the telephone company and the steel company CAP, among several others, was infinitely preferable. By doing so, Chile ultimately benefited from a cycle of spectacular growth, which extracted it from the mire of debt and enabled it to lead Latin America in economic recovery. A large part of Endesa’s assets came under the control of public employees through pension funds or through an advance payment on their retirement annuity. The phone company’s capitalization was increased by investment from the Australian business group led by Alan Bond, who at one point controlled 40 percent of the company. Bond’s foreign investments later hit hard times, but the investment that he brought to Chile launched the take-off of investment in telephony, which was later taken over by Telefónica Española, the company that bought the Australian consortium’s shares. As for the steel company, domestic investors, the workers themselves,

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and a Swiss business group entered the scene. Each company’s privatization was a separate case and each was difficult to carry through, but the dynamism that the process generated made it all worthwhile.

However, many tasks were left pending. The oil refineries were not privatized (Argentina would later take the lead in this field). The mining unions’ situation became complicated, and the National Mining Company (Enami) remained antiquated. Banco del Estado remained untouched, after a reasonable attempt to privatize it, giving workers ample participation through dispersed ownership, failed.

This process involved the work of a large team that included both veterans and newcomers; economists, civil servants, and military officers; and academics and practitioners, young and old.

If one were to assess the work carried out, the emphasis would surely have to be on the notion of pragmatism. The task set aside ideologies and preconceived notions. In fact, it can even be said that the general ideas put into practice were few and simple. The details, however, were many and complex, which is probably why I felt so comfortable carrying it out. I consider myself to be detail oriented. I strongly believe that high-sounding statements mean little if they are not grounded in reality. The mere description of how the debt equity swaps were implemented is overwhelming. The process seemed never-ending. The creditor banks originally opposed our plan, because the debt renegotiation contracts prevented us from carrying out the swaps and prevented the sale of state assets. After long negotiations, they accepted the plan, but that was not to be the end of our problems, which were just beginning. How could we guarantee that the different promissory notes would receive equitable treatment? How would we decide on the order in which to accept them? How would we meet the challenge to increase competitivity, as the Japanese did? Details, simply details, but the issue was crucial. Chile reduced its debt level substantially through this process. Banks that got rid of their promissory notes immediately made a bad deal; the more patient ones did better. However, the banks that transformed their debt

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into direct investment, effecting the operation themselves, made out the best.

Outcomes

In the end, our efforts led to a vigorous economic recovery and a healthy growth trend that lasted nearly a decade.

The structure of government expenditures changed. Although they now represent only 20 percent—not 30 percent—of GDP, actual revenues are much greater because there has been spectacular GDP growth.

The improvement in employment was remarkable. At the end of 1989, unemployment stood at 5 percent and emergency jobs programs had completely disappeared. Social spending, on the other hand, was increasing at an unprecedented rate, even as the government began the twin processes of decentralization and regionalization in this area. The flexibility introduced by the labor laws passed in the early eighties was vital in improving the employment situation. As foreseen, the recovery of the purchasing power of wages held back until 1988, but it finally showed, and since then real wages have shown sustained improvement. It became clear that nothing has more damaging consequences for workers than inflexibility. Chile actually needs to go much farther still. Our workforce—around 35 percent of the population—needs to grow. Rates of workforce participation in developed countries are higher. Achieving that requires greater labor market flexibility.

Exporters’ response was equally encouraging. Between 1985 and 1989, Chilean exports jumped from $3.8 billion to $8.1 billion. The projects involving greater production capacity were in the mining, fruit, forestry, and fishing sectors.

What the country experienced starting in 1985 was not a boom, but a process of orderly and gradual recovery. It was a healthy process, grounded in the improvement of savings and investment rates. Without

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this, recovery would have been illusory. In short, manna never rained down from heaven, but things did improve consistently and gradually.

By 1989, the private sector had changed completely. New players appeared on the economic scene. Emerging enterprises became increasingly important, in addition to those that were already established. Not only had businesses’ wounds scarred, but Chilean companies were now ready for far greater development.

The government was also extremely successful in stabilization inflation, which, although it was not reduced to international levels, was kept under control and came close to disappearing.

By 1989, the country had successfully completed its structural reforms. Chile had not only extracted itself from the rut that it had been in, but had also cleared a path for development for many years to come. Personally, I found this process doubly encouraging for two reasons. First, a successful development strategy, which the country had almost given up on between 1983 and 1984, was salvaged. Second, having started out as a simple pawn, I came to the later stages of the reform process holding responsibility and authority over the country’s social and economic policy making and development. I found additional satisfaction in seeing new government officials who had criticized the model when they had been in opposition now applying it with no major changes. In all honesty, I think that they have done so less imaginatively, yet have been rewarded with greater praise, but such is life—what really matters is improving the lot of the poor, not personal recognition.

“Never think of yourself,” I said to myself when I sat down at the Treasury Minister’s desk for the first time. I think I have been loyal to that commitment. I never changed my government car. I did not even dare move the desk from the place where my predecessor had left it. In the public sector, one owns nothing. And in the ministries, the day-to-day hassle or one’s exhausting schedule are not what really matter. What matters is the contribution that one can make for the country. In this case, we left hope for the future—not only for Chile, but also for other developing countries (including other Latin American countries) whose

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economic reform processes would have been much harder to achieve had our experience been cut short.

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CHAPTER TEN

After the Battle

Now is a good time to reflect on issues that were critical in Chile and that have also appeared in other countries whose economies are moving from a state control regime to a liberal model, facing serious stabilization and balance of payments problems in the process. Addressing these problems requires, above all, long-term stable growth—and, one would hope, the greatest possible growth. The content of this chapter may seem too technical to some readers, but I think that the questions it raises come up frequently in every economic liberalization process.

In any case, beyond the conclusions recorded here, my firmest recommendation to those in a position to carry out market reforms is to avoid delay. In the end, the time available to economic policy makers is always short. The task is so vast that there will always be challenges left unresolved, but the important thing is to leave lasting solutions for as many of the country’s challenges as possible. I know of many people who were part of the government and did not make full use of the time that they had—they do not say as much, but their regret is easy to see. The opportunities to modernize, to liberalize, and to clear paths to development come around only once. The following conclusions and suggestions should be read in this spirit:

1. There are no easy ways out. This may be the most important lesson from the Chilean economic experience, and is drawn from diverse situations that the country went through during its modernization process. Chile had long suffered from chronic inflation, and was on the verge of hyperinflation during Allende’s time. Inflation was later brought under control, but it was never eradicated, not even when the behavior of prices seemed very stable and when the peso was pegged to the dollar, as it was in 1980 and 1981.

The price that the country paid to moderate the rise in prices was high in terms of lost competitiveness by exporters and manufacturers as

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well as other adverse effects. Unfortunately, the debt crisis struck in 1982, and this experience was cut short over the next few years. Although inflation was kept under control, eliminating it was not a priority in the face of the urgent need to get development back on course. Once the debt crisis had been overcome in the late eighties, it became possible to make eliminating inflation a priority once again. However, this was interrupted by a change in government. In the meantime, the total indexation in the capital market, by means of the UF, made it possible to live with a moderate level of inflation, while at the same time developing an increasingly sophisticated financial sector. It should be pointed out that the indexation of financial operations does not necessarily lead to the indexation of the goods market or the labor market. The degree of difficulty in eradicating inflation will depend on the degree of segmentation achieved in these markets. Interestingly, other Latin American countries, rather than resort to indexation, have decided to dollarize their financial sectors, which has allowed them to develop a more complex financial market. In any case, it is important to keep in mind that it is not easy to leave instability behind. Once instability rears its head, correcting it always translates into slower growth (which can lead to recession and depression) or into clear deterioration vis-à-vis the external sector. Sometimes both effects occur simultaneously. When this deterioration is only partial, a relatively good external situation can be very helpful. In Minister Cavallo’s time, Argentina provides a good example of a stabilization program sustained by the external sector. The same thing happened in Mexico in the early nineties. In both cases, the effort made during the eighties had corrected the critical external imbalances, and, in Argentina, this had generated a significant commercial surplus. However, this changed quickly when exchange policies were used as stabilization instruments, because this generated increasing trade deficits. The challenge was to maintain price stability and reverse the loss in competitiveness, setting into motion growth based on investment and exports. When the first edition of this book was written in 1993, these challenges were as yet unresolved in

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both Argentina and Mexico, and their subsequent outcomes have both been dramatic, albeit different.

When inflationary instability combines with a serious external disequilibrium—as in Chile in 1974 or Peru in 1990—the situation is more severe, and the margin for action is much narrower. Correcting these disorders can be very difficult unless there is financing for a gradual adjustment in external accounts. Unfortunately, except in some special cases, this option is not available at the height of a crisis.

2. Stability is its own reward. This belief used to be less widespread than it is today. The CEPAL development model, which had taken such deep roots in Latin America, for many years accepted that, in view of the costs of instability, a small amount of inflation was not in itself a bad thing, provided that other economic indicators were sound. The hit-and-miss economic policy approach that Brazil had followed since the late seventies reflects a blatant disregard for stability and illustrates many governments’ cavalier attitude toward inflation. They disregard the fact that when a crisis hits, chronic instability becomes explosive. During the sixties, Brazil and South Korea both stood poised for spectacular growth. One need simply see where each of these countries stands now. South Korea paid attention to inflation. Brazil, unfortunately, did not.

3. There are three key tools. In order to achieve stability, governments can resort to three basic instruments linked to monetary, fiscal, and exchange policy, respectively. Hundreds of theoretical models provide guidelines on how to address instability. Some emphasize the exchange rate—raising it almost to gold standard status—and give monetary policy a passive role. Others advocate a more active monetary policy. Chile adopted several alternatives. In 1974, and after the first devaluations and efforts toward a single exchange rate, a managed exchange rate policy was adopted. Monetary policy was designed around inflation targets, and the currency was revalued against the dollar in order to maintain a real net parity, which was adjusted according to the balance of payments situation. Later a pre-announced dollar table was set up, and finally, in 1979, the exchange rate became fixed. It remained so

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until 1982, when monetary policy became passive, as reserves exceeded the money in circulation in the economy. Between 1982 and 1985, the country went through times of great confusion, including a brief period during which the dollar was free. After 1985, the economy went back to a policy similar to the one applied during the government’s early years, with monetary and exchange targets that were consistent with an inflation range of 10 percent to 20 percent and with a real exchange rate. Personally, I think that in these matters, flexibility was an important principle that was applied during my tenure. This is not to say that what was done during those years should be applied in all situations. Once the crisis has been overcome, eradication of inflation would need to become a priority. Other alternatives may become appropriate, as has been the case in some countries that have reimposed a fixed exchange rate. It is difficult to establish general rules. What works in one case may not in another. At times, a fixed exchange rate is unfeasible. At times, setting targets may not work, because it is very difficult to predict how the demand for money will develop. Underlying the alternatives in the management of monetary and exchange policies is fiscal policy, which is always decisive in a stabilization process.

4. Highly developed capital markets provide valuable help. Almost always, at the outset of a stabilization and reform process, the margin of action in monetary policy is very limited. Central banks are often very restricted in their functions, because they are obliged to finance state enterprises and the Treasury, and because of a lack of capital markets in which to make long-term investments (sometimes not even short-term investments). Because of these things, it is difficult for them to carry out an active monetary policy with any degree of certainty. When capital markets do exist, the Central Bank faces a less complex task; it has some margin in which to neutralize the expansions that the Treasury may create in order to fulfill the commitments required of it through issuing of bonds. Without this, the margin for action is smaller or inexistent. These markets are unlikely to exist when, in the period prior to the reforms, the only capital market institutions to be found are the banks,

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and these operate practically as cashier windows for the Central Bank, as was the case in Chile. In this context, the combination of necessarily strict monetary policies, exchange rate uncertainty, erratic expectations regarding future inflation, certain sectors’ protection from the restrictions through preferential credit, and falling domestic savings due to the crisis result in exorbitant real interest rates. Chile went through that process. The normalization of interest rates to ranges compatible with international rates was not achieved until 1986. By then the Chilean economy had developed a capital market that enjoyed a considerable degree of independence and sophistication, and many of the issues affecting the interest rate had been addressed. Mexico, Argentina, Brazil, Peru, and many other countries went through similar situations involving inordinately high interest rates. Moreover, Brazil, to a certain extent, was still feeling the effect of this phenomenon in 2007.

Changes in monetary policy should be done with great care, because of the inflationary effects that they could create, and because exorbitant interest rates almost inevitably cause defaults by debtors, putting strain on the financial system. Chile also lived through this experience. This is the type of experience that shows that economic policy making is as much an art as a science.

5. Fiscal policy is a key factor, both during stabilization and in subsequent stages. Fiscal stability is neither a whim nor an accident. A treasury that spends above its revenue level is a destabilizing factor that is very difficult to neutralize in economies resembling those in Latin America. Developed countries such as the United States, Germany, or Italy can afford to have significant fiscal deficits without this immediately having an inflationary effect, because they can resort to highly developed capital markets for financing, and because their overall economies are much more stable. The long-term effect of a fall in savings, investment, and growth certainly leaves its mark, and this is part of the controversy going on in some countries today.

But when instability is evident and chronic, and capital markets are not yet fully developed, fiscal policy becomes a key factor for both the

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long and short term. This was a constant in Chile. Public deficits during the seventies, which exceeded 20 percent of GDP, began decreasing gradually. At the beginning of 1980, the country already had a strong surplus. The crisis temporarily put an end to this affluence, which reappeared in 1986, when the country once again showed a surplus. Between 1984 and 1990, government spending fell from 30 percent of GDP to 20 percent, and proved decisive in the increase in domestic saving, which rose from 2 percent to 17 percent of GDP. On the other hand, the fiscal situation can also highlight an important trend. An overspending treasury can be dangerous in the long term even when there is a current surplus. The important goal is not a one-time balance—such as can be caused by a rise in commodity prices, an increase in tariff revenue after an import boom, or new borrowing—but rather a long-lasting, sustainable balance between revenues and spending. Financing the treasury through an onerous tax burden is not the answer either. Higher taxes mean reduced incentives for growth and investment, and reduced investment means less future development, which is the worst thing that can happen to a country. My experience in this matter is that sound fiscal policy is essential both in containing inflation and in achieving adequate levels of savings, investment, and competitiveness.

6. The external sector is not to be fooled with. Chile’s case proves the effectiveness of development strategies based on export growth. As far as I know, no country has reached development in modern times in any other way. A key variable within these strategies is the real exchange rate. As I have already pointed out, I am of the belief that going overboard is preferable to falling short. However, a high real exchange rate, which requires real measures, should not to be confused with a high nominal exchange rate, which can lead to nominal rises and inflation. The development of exports needs an exchange rate that is favorable not only today, but also over the long term. Otherwise, it is unlikely that the exchange policy will be able to incentivize the investment needed to generate growth.

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Undoubtedly, the exchange rate is not the only necessary factor; rather, it must be part of an ensemble of micro and macroeconomic policies geared toward improving competitiveness—including lowering or eliminating export taxes, liberalizing overregulated sectors that have exporting potential, and providing support for entry into foreign markets.

On the other hand, there is talk these days of the world moving toward the configuration of large, outwardly closed trading blocs, and rumors that countries that do not succeed in joining one of these blocs will not fare at all well. This prediction has some very respectable advocates, but I do not subscribe to it. On the contrary, I believe that the world, for the most part, is moving in the direction not of protectionism but of freer trade. There may be backsliding as some countries and markets close up, and there may be whole industries that need to be retooled, but essentially the opportunities that open up always outnumber the ones that close down. In fact, the rate at which international trade has increased exceeds the rate of world product growth. Countries in Eastern Europe, the former Soviet Union, and China, among others, have opened up to trade. Besides, the only choice for small developing economies—Latin America, for instance, represents roughly 5 percent of GWP—is to take the opportunities that the world offers. Locking the region into this 5 percent share—that is, ignoring the opportunities of 95 percent of GWP—has proved a losing strategy for Latin America.

7. Overly rigid positions can be damaging. In setting economic policy, a certain degree of flexibility is not only desirable, but also necessary. The important thing is to have clear objectives. We must not turn things upside down and let the instruments of economic policy become ends unto themselves, because this can generate many distortions and very few benefits. Complete understanding of the circumstances of each sector is extremely useful; theoretical concepts must go hand in hand with a thorough knowledge of concrete reality in order to yield optimal results. Theories on tax rates do no good if one is not familiar with the rules of accountancy that affect those rates. For example, when tax rates in different countries are compared, if the real

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effect of these rates in view of depreciation regulations or exemptions is not allowed, the comparison will have a basic flaw. The same applies in all areas of policy. This is the source of my appreciation for a detailed understanding of real-world circumstances, to ensure flexibility in action.

8. Reasons for and against indexation. In the absence of indexation mechanisms, persistent inflation becomes a serious obstacle to the development of sustainable capital markets, which are indispensable for investment and growth. The predicament for countries such as Venezuela, where stability yielded to several years of double-digit inflations, is more serious than we can imagine. Mexico and all of Central America had enjoyed considerable price stability in the past, but since the eighties they have had to live with high rates of inflation that they have still not erased. The risk in indexing capital markets is that, although it eliminates the problem of inflationary uncertainty, indexation can spread to the market for goods or to the negotiation of wages, making the economy more rigid and difficult to stabilize. In addition, there must be credibility in the index chosen. Some countries have fallen back on dollar indexation, a dollarization that is almost natural in Peru and elsewhere in Central America, or is the result of a strategy, as it was in Argentina. Dollarization, while it can solve the problem of reduced credibility in local currency, can have negative effects if there happen to be strong modifications in terms of trade, since this would rule out the option of solving the problem by simply adjusting the exchange rate. This is a serious problem to which I believe there are no alternatives outside the ones described: paying the price of uncertainty, indexation, or dollarization. Chile generated a general mechanism for indexation, which I think has been positive for the country and can be a useful model for other countries.

9. The important thing is to persevere. A country’s economic transformation is not a one-shot undertaking. It requires many struggles. During the endeavor, there will always be setbacks, be they internal, in which case policy makers have a certain say, or external, in which case they have practically none. In every liberalization process one must

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expect to go through some dark and difficult moments. But the important thing is to send out the right signals to the economy, protect the weakest while assuming the costs of reform, and keep on track, maintaining resolve. This ingredient is essential. Little is achieved without faith and conviction.

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CHAPTER ELEVEN

The Model Endures

Even at the beginning of the nineties, in spite of the winds that were sweeping the world at the time, there were setbacks around the world. Uruguayan voters, for example, rejected in a referendum a privatization program designed to bring the economy up to modern standards. Why this rejection? Was the crisis not strong enough to make a majority of Uruguayans sensitive to the need for the discipline of a reduced role for the state? Was the referendum not properly set up? Did political leaders not explain the advantages of privatization clearly enough? Does this mean that Uruguay chose to fall behind from that point on?

It is not easy for leaders and political parties that have condemned pro-market policies in the past to later embrace them. Many prejudices and reservations still endure, in spite of the market’s capacity to raise living standards, especially for the poorest.

Many are the specters that cause large sectors of public opinion to mistrust the market. It is not easy to accept reality when utopias come crashing down overnight. Development is not about simply transferring wealth; it is about creating it, and certain political factions lack the intellectual repertoire required to meet that challenge. In recent years, Bolivia, Ecuador, and Venezuela have gone back to talking about redistribution, abandoning the goal of wealth creation, and have destroyed existing wealth in the process.

Even now, many people think of the market economy as being about selfishness, consumerism, and the poor becoming poorer. This perception is demonstrably false. In this context, during the nineties, whether Augusto Pinochet’s democratically elected successor would uphold the economic model or overturn the measures taken over the previous seventeen years, taking the country back to the days when the state took a predominant role was a valid question.

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On March 11, 1990, Christian Democrat Patricio Aylwin won the presidency with 55 percent of the vote, leading the transition to democracy. He was backed by the Coalition of Parties for Democracy (Concertación de Partidos para la Democracia)—a coalition that drew together several left-wing parties, all opposed to the economic liberalization model. In fact, several Concertación members had actually worked in close collaboration with Salvador Allende’s government.

President Aylwin himself had stated that he thought the market was cruel, and later, in an interview in a Brazilian newspaper, said that the new Chilean pension system was not completely just, but was probably realistic in that it takes account of human nature. The notion of an open economy makes some sectors in the country so uncomfortable that, in late 2007, members of the Christian Democratic Party were still questioning the free market model and holding it responsible for poverty in Chile.

At that time, during the nineties, wondering how much these statist and retrogressive visions would influence the future of the economy was a valid concern. Was this to be the beginning of a major shift? Would the new government be able to address social demands by handing out money at the expense of fiscal discipline? Would we move backwards again, toward populist policies that would plunge us back into the poverty of the sixties? At the time that Aylwin took office, these questions were yet to be answered and generated uncertainty in many people. The only certainties in 1990 were that Chile was beginning a period of sustained growth, and that there was a 21 percent inflation rate and a 6 percent unemployment rate.

The Guidelines Are Preserved

President Aylwin governed with an opposition that, although it did not have a majority, had significant representation in National Congress. This opposition was resolute in blunting changes that threatened to

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dismantle the economic model. Moreover, in several areas, the reforms that had been launched in previous years were carried on. This not only prevented us from backsliding, but made it possible for Chile to continue growing for several years.

The free trade agreements signed with the United States (2004), the European Union (2003), China (2005), and many other countries are the last links in a chain that began to be forged in 1973, when the country opted for opening its economy to the world. Minister of the Treasury Alejandro Foxley himself (1990–1994) described the path taken by the Christian Democrat government thus: “It was necessary to open up the economy more, reducing country risk and negotiating trade agreements. We needed to take further steps in the international reach of Chilean companies.”1 There is no doubt that this would not have been possible had the economic liberalization not been launched seventeen years before, or if it had been upended during the crisis in the eighties. The same thing happened with foreign private investment: in 1990, it was among the highest of the previous twenty years, and 26 percent higher than the previous year. This was made possible by the guarantees established in the mining law for this type of investment.

Also along these lines, the Central Bank’s independence, which was put into effect in 1990, just after Patricio Aylwin’s government had begun, was fundamental. In addition to establishing the Bank’s independence, the 1980 Constitution restricted the loans made by the Central Bank to the financial sector. One of the main objectives of this measure was to control inflation. Thus, Chile managed in fifteen years to reduce inflation from approximately 30 percent to the current annual 4.8 percent, patiently going through the process of building up trust as well as institutions. The Constitution also restricted government spending. Moreover, creating a state enterprise now requires passing a law to that effect, under special quorum conditions.

1 Alejandro Foxley. La Economía Política de la Transición, p. 7.

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The list of examples of reforms that took shape during the second half of the eighties, and were behind the important advances made in the two subsequent decades, is very long. Actually, behind the control of inflation after the nineties stand not only a revived Central Bank, but also a new regime of fiscal discipline at the Treasury and at state enterprises, and the creation of a strong financial market. Building all of this took a long time, mainly because of the initial chaotic situation. At the beginning of the present decade, President Lagos inaugurated several new modern highways in Santiago and throughout the country. Few people realized that this would have been unthinkable without the convergence of many of the changes implemented in the eighties.

Financing for all of these projects comes from a financial market that was strengthened by the 1980 pension reform. Decreased poverty and improved social indicators after 1990 have gone hand in hand both with the economic growth enabled by the previous changes—which unfortunately have not been reinforced as vigorously as they initially were—and with the social policies designed between 1970 and 1980, which involved a lot of hard work. Undoubtedly, changes have been introduced that have accumulated over time, sometimes with negative effects; on the whole, however, the guidelines have been upheld long enough for them to bear fruit.

Which factors were decisive when it came to upholding the model? Looking back to try to identify the lessons that could be useful in other reform processes, I find two aspects—one, temporal, the other spatial—that stand out as essential.

In the first place, the changes must be comprehensive and go deep enough to make them enduring. In Latin America, there have been numerous attempts at economic reform, but the policies did not go deep enough to make them lasting. Argentina is a case in point. That country, which started off on a strong privatization plan, after a while centered its economic reform on a fixed exchange rate, with a convertibility law establishing that one peso would be equivalent to one dollar. Instead of advancing toward comprehensive reforms, the Argentine government

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made the mistake of turning the exchange policy into the centerpiece of reform, which paved the way to failure. By trying to address the weakness of the country’s political institutions through the convertibility law, the Argentine government was left with the convertibility law as the only enduring legacy of the whole reform process.

The second essential factor for transforming an economy is for reforms to be comprehensive in encompassing as many areas as possible, in order for professionals and experts in areas as diverse as education and health to all work in conjunction toward the same goal. As in all major change, the success of the reforms does not depend on one single person, but on the joint efforts of a large number of men and women working toward the same end.

Two Minds

Although it has maintained the country’s macroeconomic stability, the coalition that has governed Chile since 1990 has exhibited a conflict between two opposing worldviews, in effect two minds—one pragmatic, the other ideological. This conflict has prevented the swift, decisive action required in order to make further progress in the reforms that the country needed. As well as curbing the progress needed to uphold growth, Concertación’s ideological mind has brought into the debate a constant questioning of the pillars of the free market, which has ended up shifting economic policy in the wrong direction. For many public figures in the country, the entrepreneur is an enemy to be distrusted and whose work therefore must be hampered with obstacles, taxes, and mandates. So, entrepreneurs who want to start a new business today face ever-increasing costs, energy shortages, and an increasing number of regulations that increase their costs and make all aspects of running a business more complicated. Fortunately, there are voices within the Concertación that have expressed concern about this trend.

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The proposals for more labor regulations—when what the country needs is more flexibility—and for higher minimum wages are misguided. In the modern world, there is more and more labor flexibility, as more people work from home or on a part-time basis. As for minimum wages, surveys show that the work situation of the poorest—of those who are employed—is precarious, because their jobs are temporary, part time, or informal. In fact, a nationwide social indicator survey indicates that they earn less than the minimum wage, confirming that this type of regulation is ineffective.

In the mid-eighties, a harmonious labor institutional framework that favored competitiveness was finally achieved. After this came a ten-year period, between 1985 and 1995, in which workers’ wages increased at a 7 percent annual average rate, taking into account the increase in employment. This performance is unprecedented in the country’s history. Unfortunately, the situation was affected by a gradual deterioration in the legal framework, resulting in greater adherence to a confrontational worldview, which caused this rate to drop to just 4 percent between 1995 and 2005. Difficulties in finding employment are still critical for low-income young people and for many women. If this spiraling trend continues, it would not come as a surprise if we were to find, in ten years’ time, that workers as a whole have been the most harmed.

It might relieve our consciences to say that we want better wages for everybody. However, imposing on others what they should do—turning a blind eye on the evidence confirming that these impositions curtail progress, employment, and the future of the poor—is unethical. What we desperately need are policies that will accelerate growth and create jobs. Chile has adopted these in the past, and there is no reason why it cannot do so again.

The mark of the ideological vision of some Concertación factions also crops up in the debate on education. Instead of tackling the problem of quality in education and why it has not improved—even as education spending has tripled in recent years—the focus has jumped to issues of equality. Some claim that the goal of equality would be better served

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through direct state provision of education. Others aim at much stronger control of subsidized schools based on the fact that they receive public money, ignoring the fact that the goal of the subsidies is to use the people’s own money to make sure that they get an education.

Parents must have as great a freedom as possible to choose their children’s education. The state has no right to impose any one school on them. We must not forget the lessons of the past, when almost all schools were state run and inequity was huge.

There has been no progress in investment issues either. Getting an investment project approved is becoming increasingly difficult, which has curbed investment growth. We seem to have forgotten that just as investment may have negative externalities, it has positives ones too, and many of them.

Regarding pension reform, although the system has room for improvement and should work toward raising its share of population covered and increasing competitiveness in order to reduce costs, the answer does not lie in greater state intervention. Proposals such as creating a state-run AFP, or private pension fund managers, or granting benefits that are not directly correlated to individual income, are misguided.

It is vital that Concertación’s pragmatic mind—the one that sets ideological visions aside—retake the economic reins of the country. We cannot miss the opportunities that globalization has to offer. We must allow the poor to achieve the prosperity that they deserve. It is to be hoped that the recent dialogue between the government and the opposition on topics such as education and equity will lead to a more practical and less partisan approach.

The worst thing for the country would be for the ideological mind to prevail, and for misguided policies to become legitimized. Today, we answer to an ideological or demagogical viewpoint. At the present, anti-globalization voices, which are becoming ever stronger in the region, seem to reflect that regrettable tendency.

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Part of the Culture

Transforming a country’s economy involves understanding that reforms must not be directed at any specific group, political party, or individual, but rather at all citizens. When this concept has been internalized by citizens and policy makers, it becomes imperative to carry on with the necessary reforms, rather than take them apart in an ideologically charged debate. Ideally, good policies should be a part of a country’s culture.

A 2007 survey revealed that three decades after the liberal reforms were launched, 55 percent of the Chilean population supports the market economy model. In the 18–34 age group, this support is even greater. The survey also shows that this support cuts across political affiliations, from right to left.2

For those of us who helped tackle the challenge of implementing the basic principles of economic liberalism, this is an important triumph for the country, whose population today believes in an economy that is based on individual effort.

However, Chile has not yet taken the last step. I believe that Chileans have not incorporated into their culture all of the elements necessary for the country’s development. They have accepted some of them, but not all.

In my opinion, the concept of opening up to the global economy and being part of a globalized world has been accepted. Unlike in other countries in the region, which have gone down different routes, in Chile there is practically no political space for nationalistic or populist proposals, or for advancing extreme ideologies. The same is true of macroeconomic stability. Most people recognize the importance of controlling inflation and of balancing fiscal accounts.

It is also necessary to shape a culture that will favor growth. Learning to value entrepreneurship is essential. Countries that value,

2 National Survey, La Tercera Survey Center, October 2007

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admire, and encourage their entrepreneurs have made huge strides in becoming competitive internationally. This is precisely where we have failed. We need to understand that local companies that decide to go global face ferocious international competition. To burden them with more taxes and regulations is clearly the quickest way back to underdevelopment. I think a socialist tendency still persists, which ascribes success to the government when the country grows, and blames entrepreneurs for declines in growth and employment. A persisting demagogy keeps repeating that the fate of workers can change by simply passing a law, when it is no secret that only a dynamic economy can create more and better jobs.

Another error that prevails in our country’s culture is the belief that more regulations are the only way to protect consumers. The experience of other countries proves that precisely the opposite is true. Fewer regulations translate into more competition, which ultimately benefits the consumer by offering more products at lower costs.

Two Post-1990 Periods

Based on the country’s growth rate, two post-1990 periods can be defined since the beginning of the Concertación governments.

During the first, between 1990 and 1997, the country experienced a 7.2 percent growth rate, which surpassed the 3.4 percent world average. In 1990, President Aylwin’s economic team believed that they were facing an overheated economy and likely inflationary outbreak. This was not their only diagnostic error. They also thought that the debt crisis had not been overcome and that the country would have trouble accessing external financing. But the country paid a price, which translated into a year of lost growth because of this error in diagnosis—although this probably reaped the benefit of everyone better understanding and accepting the bases of economic policy.

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Since then, when free market policies prevailed, Chile’s growth rate exceeded the world average. During this period, no doubt encouraged by the previous economic reforms, the country’s first free trade agreements were signed and efforts became focused on opening markets for exports. The results are in plain view.

However, during 1998–2007, when the world average growth rate was barely 5 percent and the price of copper was high (toward the end of the period), the average national growth rate slowed down to 3.9 percent. The world in 2007 seemed about to complete a five-year cycle of continuous growth, the likes of which had not been seen in decades, but this bonanza was not seen in Chile. The reason for the slowing of the growth rate lies in the ideological mind of the Concertación governments, when it has prevailed over its pragmatic counterpart. When this happens, it destroys incentives to hire and to invest. The source of progress is private enterprise, so when it becomes more difficult for businesses to operate, the country finds it harder to get ahead in an increasingly competitive world. The negative effects of misguided policies are slow in showing up, but they accumulate, and in the end they curb progress. The effects of economic policies, good and bad, take longer to be felt than is generally recognized, and they extend far beyond politicians’ time horizons. Rarely are the effects felt immediately, as in the case of Transantiago. In pensions, for example, the mistakes that we make today will be felt by the next generation. Slowly at first, but more markedly later, misguided decisions, guided by the ideological mind of the Concertación governments, have begun to accumulate. By now, the obstacles to employment, saving, and investment are such that the dynamic Chile that was once an example of growth and progress for the poor is now a thing of the past.

During 2006, economic growth estimates gradually declined. Paradoxically, while this was happening, external conditions were improving beyond all expectations. The price of copper was almost $4 per pound, while pulp for paper products, fishmeal, and many of our products were thriving.

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Reduced growth during this period coincides with a persistent drop in ranking in global indices measuring competitiveness and transparency. The World Economic Forum competitiveness report ranks the country’s performance in innovation 45th out of 131 countries. The trend repeats in transparency and technological advancement.

For quite some time, external conditions have been very favorable for our country. However, the population has not perceived corresponding improvement. This is not because entrepreneurs or the businesses lack the will or the ability to channel the positive effects to everyone. The real beneficiary this time is the government, which receives the revenues from copper, directly or indirectly. Private companies put up with the higher costs, energy shortages, and increasingly burdensome rules that make all aspects of doing business more densely regulated, more costly, and more complicated. Luck has helped the government. Today, the moral responsibility of the country’s leaders is to determine how to put it to good use in order to promote growth, increase employment, and thus overcome poverty.

The Inertia Is Over

Despite the legacy of the military government—or rather as evidence of its strength—in social policy, the government that took over in 1990 showed little competence in creating new programs. Despite the resources available to it and which, thanks to the growth rate, become more abundant every year, the initiatives turned out by the cabinet ministries in recent years leave much to be desired.

The achievements of recent years are nothing compared to the military government’s efforts to restructure all of the country’s social programs in order to build up a comprehensive and consistent social safety net. The same government that proved capable of coming up with answers and reforming the economy and society to benefit the poorest is

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still denounced as insensitive. Winning the policy battle does not necessarily mean winning the battle for perception.

If Concertación had been able to maintain the 7.9 percent growth rate attained between 1987 and 1996 for another ten years, the poor could have become 40 percent wealthier. The importance of this fact extends beyond its economic value. Eradicating poverty is a profoundly human issue. But the average growth over the last ten years has been only 3.9 percent. The innovative reforms begun in the eighties were not followed through with the same determination and imagination, and that is the real cause of our more modest performance.

I am convinced that Chile has a great opportunity today to accomplish growth-enhancing reforms. It is true that the government coalition, due to its ideological bent, has difficulty in making progress on the issues of employment, investment, and regulation. But fortunately, the country has resources with which to implement policies that promote prosperity, while compensating for theoretical negative effects (which may not be real, but worry some of the current authorities nevertheless).

All opportunities to introduce the right reforms must be seized. Even if their consequences seem trivial, they could lead to increased long-term benefits.

Although it is difficult to say this, I believe there is cause for optimism. The lengthy period of time during which Chileans have experienced a free market economy system has allowed them to appreciate the advantages of progress, or at least get a closer look at them. This is especially important for young people. People who have tried to convince them that it is possible to take shortcuts—that individual responsibility and a job well done are not the main ingredients of success—have lost credibility. Solutions based on greater state intervention and social engineering, such as the public transport reform in Santiago, have been spectacular failures. The evidence is overwhelming; one just needs to look at neighboring countries. Peru is, economically speaking, making better progress than Chile, paradoxically under the leadership of Alan Garcia, who today openly admits that he

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was wrong. Fortunately, on the other hand, our country does not have a strong Chavista discourse —based on the squandering of Venezuela’s oil riches— that can be perceived like an antagonistic model to our own.

That is why, although the country’s political situation today is disappointing to those who would like to speed up the creation of wealth and jobs, there is light at the end of the tunnel. If the pragmatic mind of the coalition government joins the members of the opposition who uphold and value the spirit of free enterprise, and together they help build a new and thriving Chile born from the reforms, then the last step toward development would not prove that difficult. The foundations required to make rapid progress remain firmly rooted in the country’s economic institutions. However, as noted before, taking this step will demand not only clear ideas, but also committed people to carry through the details of the task. The key to success lies in motivating them and providing them with the space that they need.