Capitalism in Chile is undergoing a major threat. Chile has long been the model for capitalism and economic development in South America ever since the overthrown of Salvador Allende in 1973, and the resulting military dictatorship of Augusto Pinochet. The economy of Chile grew robustly during the tenure of President Pinochet whose rule ended in 1990, when democracy returned to the country. The period of junta control and that of Pinochet will remain controversial for years to come. The trampling of civil rights and repression of the opposition are seen by many, as a stain on the modern political development of Chile.
The economy of Chile in the early 1970’s was in serious difficulty and under siege. The GDP (Gross Domestic Product) was in rapid decline. Inflation was running at a whopping annual rate of 1,000% and there were no foreign reserves left. The tiered exchange rate distorted the market and was compounded by a industrial policy of protectionism, which left the economy in dire straits. Economic sanctions imposed by the American President Nixon, as a result of the Chilean government expropriation of 600 businesses many of them foreign owned, brought the economy to a standstill.
By mid-1975, the government under Pinochet decided that a return to free market capitalism was the way to best combat inflation, and the ongoing economic collapse. The Chilean government returned ownership of confiscated property and businesses to their previous owners. Wages were cut and social spending was slashed substantially. Although business rebounded, there was also a period of speculation that followed. This era was of great benefit to the financial conglomerates and the foreign multinational corporations. Foreign debt also increased dramatically during this time period, rising 300% from the years 1974 to 1988.
GDP growth soon returned and the economy expanded rapidly, under these market based reforms. The capitalist effort introduced by the government was quite successful in stabilizing inflation, the privatizing of state owned companies, and economic liberalization. In 1985, a second round of reforms began that included more privatization, tariff and monetary revisions.
In 1990, a national vote that had been held two years before, ended the rule of Pinochet, but the economic policies of his administration would continue under his successor Patricio Aylwin. The reforms enacted henceforth, would be more political.
It was during these years as Chile was turning wholeheartedly towards capitalism, that the privatizing of the national pension system (social security) took place. If maintained, this will dramatically reduce the liabilities of the nation in the years to come.
In education, the country enacted a school voucher system. This allowed free market principles to become part of the reform movement as well.
Many leading economists and financiers considered Chile a miracle, during the last decades of the 20th century and the beginning of the 21st century. For a generation the country made economic freedom and maintaining a civil society, the two all important goals. A country of just 17 million people had created a GDP of close to $300 billion USD (United States Dollar). Chile was also able to reduce poverty rates from 60% to 9% during those years. The level is now among the lowest in Latin America. The country became the most successful economy in the region.
Chile has made great strides in welcoming foreign investment and enacting government incentives to welcome entrepreneurs from around the world.
Enter Michelle Bachelet, the new socialist president of Chile elected in March of this year. She had previously been elected president of Chile from 2006 to 2010. This time around President Bachelet is enacting even more economic changes that many businessmen and some analysts claim, will undo the Chilean Miracle. She has put in place some 70 reforms this year alone, that will have a far reaching impact on some aspects of the Chilean economy and society. She is promising an in depth transformation of the country.
President Bachelet has put through a $8 billion USD tax increase. The money will be used to help undo market incentives in state funded education. In addition, students will no longer be able to use vouchers to attend for profit schools. There is a push to attempt the same in the health system as well. She also wants to end the privatized retirement system, and return it to a pay as you go system. The President has stated her goal is to balance prosperity with the inequality that exists in the country. Chile has some of the highest unequal income distribution rates in Latin America.
The move away from more market orientated capitalism, to greater state support and involvement in the economy, has become controversial in Chile and elsewhere. These policies are in contrast to the policies of the previous president, Sebastian Pinera. As a billionaire businessman, he mostly championed the dynamic free market system, that Chile had followed for the last 30 years. It must be noted though, that it was the former president who started the rise in corporate taxes to a rate of 20%.
To be fair to President Bachelet, she so far intends that the country will pay for many of the proposed reforms. Corporate tax rates have essentially been increased from 20% to 27% recently. However, the changing tax code along with higher rates, will result in lower rates of investment and business expansion in many sectors of the economy.
Most citizens of Chile will support the idea of spending more on education. It will help the country to make the final transition, to a developed nation status. A campaign pledge for example, is her promise to provide fully subsidized tuition, at the institutes of higher learning for incoming students. Although the idea of free education is popular in many circles, the question is how will it be paid for? How all these transformational ideas can be financed, has become more problematic in the last few months.
This is because of the number of economic issues that have become more pressing. The world commodity boom has ended, at least for now. Copper which comprises half of all Chilean exports, has experienced a decline in price of 12%. A year ago the economy of Chile was expanding at a yearly 5% rate. In the third business quarter of this year, growth had shrunk to just 0.8%. Investment in Chile has also shrunk by some 10% this year and is still dropping. Business confidence is falling precipitously. This is not a good sign for future economic activity.
Minimum wage increases have already exceeded overall productivity growth in recent years.
As the economy worsens, it reduces public support for the president and her policies. Her New Majority will not hold together if the economy continues to stagnate. In June, President Bachelet had a public approval rating of 58%. In just a matter a few months it has plunged to 42%. Under these circumstances, it is likely that the decline in the presidential popularity will lead to many of her reforms to be short circuited by the Congress.
Although Chile has taken some major hits this year, it is still one of the best places in Latin America to invest. Overall tax revenue still amounts to less the 20% of GDP. Government expenditures remain below 25% of GDP. Public debt is still about 11% of the economy, but under the present economic conditions could well rise. Foreign investment is still welcomed and there is still efficient access to financing. Tariffs have remained low at an average rate of 4%. Chile for now, still maintains a good credit rating and sufficient foreign reserves, to ride out the world economic downturn. The 1980 constitution severely limits the ability of political leaders, to alter the fundamentals of the Chilean economic model. It is these very constraints that have allowed the Chilean economy to grow and prosper.
As a candidate President Bachelet wanted to modify the 1980 constitution. Even if that meant using methods, that the document itself forbids. Her proposal along with that of her advisers, was to change what they regarded as an unjust constitution. Her goal would be to create a new welfare state, that would provide numerous benefits to the citizenry. She wanted to replace the market as the main engine of economic growth, with government led industrialization. That would mean the end of capitalism in Chile, as it has come to be known for.
Under present conditions, it is becoming more unlikely that President Bachelet will be able to achieve a number of her goals. There will be too many Chileans that will be fearful that radical change will undo much of the prosperity, that has been enjoyed over the past few decades. Many of her policy positions have been tried elsewhere, and in Chile itself from the 1940’s to the 1970’s. These experiments have all largely failed. She will increasingly find more resistance and backlash, as she attempts to put in place policies that dismantle the Chilean economic model.
She was a moderate politician during her first term, and will most likely find that returning to the political center, will preserve her power and creditability during the next few years. She may have campaigned for a totally new Chile, but the ghosts from the past have created limitations of their own, on what the public will tolerate.