Miracle of Chile
|Economic history of Chile|
The “Miracle of Chile” was a term used by Nobel laureate economist Milton Friedman to describe the neoliberal and free market reorientation of the economy of Chile in the 1980s and the benefits of economic liberalism. He said the “Chilean economy did very well, but more important, in the end the central government, the military junta, was replaced by a democratic society. So the really important thing about the Chilean business is that free markets did work their way in bringing about a free society.” The junta to which Friedman refers was a military government that came to power in a 1973 coup d'état, ending 48 years of democratic rule.
Other economists (such as Nobel laureate Amartya Sen) have argued that the experience of Chile in this period rather demonstrate the failure of Friedman-style economic liberalism, claiming that there was little net economic growth from 1975 to 1982 (during the “pure Monetarist experiment”). After the catastrophic banking crisis of 1982 the state controlled more of the economy than it had under the democratic regime that preceded the military dictator General Pinochet, and sustained economic growth only came after these later reforms, while social indicators remained poor. Pinochet’s military dictatorship made the unpopular economic reorientation possible by repressing opposition to it. Rather than a triumph of the free market, the OECD economist Javier Santiso described this reorientation as “combining neo-liberal sutures and interventionist cures”. By the time of sustained growth, the Chilean government had “cooled its neo-liberal ideological fever” and “controlled its exposure to world financial markets and maintained its efficient copper company in public hands”.
In the early 1970s, Chile experienced chronic inflation reaching highs of 140 percent per annum, at a time when the country, under high protectionist barriers, had no foreign reserves, and GDP was falling. The economic reforms were originally drafted by Chilean economists known as the “Chicago Boys” because many of them had studied at the University of Chicago. The plan had three main objectives: economic liberalization, privatization of state-owned companies, and stabilization of inflation. The first reforms were implemented in three rounds – 1974–1983, 1985, and 1990. The reforms were continued and strengthened after 1990. However, the democratic centre-left governments of the 1990s also made a strong commitment to poverty reduction. In 1988, 48% of Chileans lived below the poverty line. By 2000 this had been reduced to 20%. This was achieved through a 17% increase in the minimum wage, a 210% increase in social spending targeted at the low income sectors of the population, and across the board tax increases, reversing the Pinochet tax cuts of 1988 and bringing in a further 3% of GDP in tax revenue. Overall, social spending and redistribution accounted for 40% of the poverty reduction, with economic growth doing the rest.
Hernán Büchi, Minister of Finance under President Augusto Pinochet between 1985 and 1989, wrote a book detailing the implementation process of the economic reforms during his tenure. Successive governments have continued these policies. In 2002 Chile signed an association agreement with the European Union (comprising free trade and political and cultural agreements), in 2003, an extensive free trade agreement with the United States, and in 2004 with South Korea, expecting a boom in import and export of local produce and becoming a regional trade-hub. Continuing the coalition’s free-trade strategy, in August 2006 President Bachelet promulgated a free trade agreement with the People's Republic of China (signed under the previous administration of Ricardo Lagos), the first Chinese free-trade agreement with a Latin American nation; similar deals with Japan and India were promulgated in August 2007. In 2010, Chile was the first nation in South America to win membership in the Organization of Economic Cooperation and Development, an organization restricted to the world’s richest countries.
In 1972, Chile’s inflation was at 150%. According to Hernán Büchi, several factors such as expropriations, price controls, and protectionism caused these economic problems. The Central Bank increased the money supply to pay for the increasing deficit. Büchi states that this increase was the primary cause for inflation.
United States government documents report an antagonistic foreign economic policy toward the Allende government that was "articulated at the highest levels" during this time.:33 Shortly after Salvador Allende was elected president, but before he assumed office, then-CIA-director Richard Helms met with President Richard Nixon and discussed the situation in Chile. Helms' notes from his September 15, 1970 meeting contain the indication: "Make the economy scream." A week later Ambassador Edward Korry reported telling outgoing Chilean president Eduardo Frei Montalva, through his Defense Minister, that "not a nut or bolt would be allowed to reach Chile under Allende." By late 1972, the Chilean Ministry of the Economy estimated that almost one-third of the diesel trucks at Chuquicamata Copper Mine, 30 percent of the privately owned city buses, 21 percent of all taxis, and 33 percent of state-owned buses in Chile could not operate because of the lack of spare parts or tires. In overall terms, the value of United States machinery and transport equipment exported to Chile by U.S. firms declined from $152.6 million in 1970 to $110 million in 1971.:33
Immediately following the Chilean coup of 1973, Augusto Pinochet was made aware of a confidential economic plan known as El ladrillo (literally, “the brick”), so called because the report was “as thick as a brick”. The plan had been quietly prepared in May 1973  by economists who opposed Salvador Allende’s government, with the help from a group of economists the press were calling the Chicago Boys, because they were predominantly alumni of the University of Chicago. The document contained the backbone of what would later on become the Chilean economic policy. According to the 1975 report of a United States Senate Intelligence Committee investigation, the Chilean economic plan was prepared in collaboration with the CIA.:40
The plan recommended a set of economic reforms that included deregulation and privatization. Among others reforms, they made the central bank independent, cut tariffs, privatized the state-controlled pension system, state industries, and banks, and reduced taxes. Pinochet’s stated aim was to “make Chile not a nation of proletarians, but a nation of entrepreneurs”.
The first reforms were implemented in three rounds – 1974–1983, 1985, and 1990.
The government welcomed foreign investment and eliminated protectionist trade barriers, forcing Chilean businesses to compete with imports on an equal footing, or else go out of business. The main copper company, Codelco, remained in government hands due the nationalization of copper completed by Salvador Allende, however, private companies were allowed to explore and develop new mines. Copper resources were, however, declared “inalienable” by the 1980 Constitution.
Minister of Finance Sergio de Castro, departing from Friedman’s support for free floating exchange rates, decided on a pegged exchange rate of 39 pesos per dollar in June 1979, under the rationale of bringing Chile’s rampant inflation to heel. The result, however, was that a serious balance-of-trade problem arose. Since Chilean peso inflation continued to outpace U.S. dollar inflation, every year Chilean buying power of foreign goods increased, . When the bubble finally burst in late 1982, Chile slid into a severe recession that lasted more than two years.
This deep economic recession of 1982–1983 was Chile's second in eight years. (In 1975, when GDP fell by 13 percent, industrial production plunged by 27 percent and unemployment increased to 20 percent). During the 1982-1983 recession, real economic output declined by 19%, with most of the recovery and subsequent growth taking place after Pinochet left office, when market-oriented economic policies were additionally strengthened.
In his Memoirs (“Chapter 24: Chile”, 1998), Milton Friedman criticized De Castro and the fixed exchange rate.
Starting in 1985, with Hernán Büchi as Minister of Finance, the focus of economic policies shifted toward financial solvency and economic growth. Exports grew rapidly and unemployment went down, however, poverty still represented a significant problem, with 45 percent of Chile’s population below the poverty line in 1987. Büchi wrote about his experience during this period in his book La transformación económica de Chile: el modelo del progreso. In 1990, the newly elected Patricio Aylwin government undertook a program of “growth with equity”, emphasizing both continued economic liberalization and poverty reduction. Between 1990 and 2000, poverty was reduced from 40 percent of the population to 20 percent. 60 percent of this reduction can be attributed to GDP growth, with the remaining 40 percent attributable social policies.
Free trade agreements
Successive Chilean governments have actively pursued trade-liberalizing agreements. The process began in the 1970s, when Pinochet cut tariffs on imports to 10%. Prior to that, Chile had been one of the most protectionist economies in the world, ranking 71 out 72 in a 1975 Cato Institute and Fraser Institute annual report. During the 1990s, Chile signed free trade agreements (FTA) with Canada, Mexico, and Central America. Chile also concluded preferential trade agreements with Venezuela, Colombia, and Ecuador. An association agreement with Mercosur—Argentina, Brazil, Paraguay, and Uruguay—went into effect in October 1996. Continuing its export-oriented development strategy, Chile completed landmark free trade agreements in 2002 with the European Union and South Korea. Chile, as a member of the Asia-Pacific Economic Cooperation (APEC) organization, is seeking to boost commercial ties to Asian markets. To that end, it has signed trade agreements in recent years with New Zealand, Singapore, Brunei, India, China, and most recently Japan. In 2007, Chile held trade negotiations with Australia, Thailand, Malaysia, and China. In 2008, Chile hopes to conclude an FTA with Australia, and finalize an expanded agreement (covering trade in services and investment) with China. The P4 (Chile, Singapore, New Zealand, and Brunei) also plan to expand ties through adding a finance and investment chapter to the existing P4 agreement. Chile’s trade talks with Malaysia and Thailand are also scheduled to continue in 2008.
Amartya Sen, in his book Hunger and Public Action examines the performance of Chile in various economic and social indicators. He finds, from a survey of the literature on the field:
The so-called "monetarist experiment" which lasted until 1982 in its pure form, has been the object of much controversy, but few have claimed it to be a success...The most conspicuous feature of the post 1973 period is that of considerable instability...no firm and consistent upward trend (to say the least).
Nobel laureate and economist Gary Becker states that “Chile’s annual growth in per capita real income from 1985 to 1996 averaged a remarkable 5 percent, far above the rest of Latin America.” Since then the economy has averaged 3% annual growth in GDP.
Developments were very positive with regards to infant mortality and life expectancy—infant mortality rate fell so much that Chile achieved the lowest level of infant mortality in Latin America in the 1980s. Infant mortality rate in Chile fell from 76.1 per 1000 to 22.6 per 1000 from 1970 to 1985. In 1988, the military government passed a law making all abortion illegal, and the law remains in place today.
However, Sen claims that this improvement was not because of “free-market” policies but because of active public and state intervention. Chile had a very long tradition of public action for the improvement of childcare, which were largely maintained after the Pinochet coup:
... there is little disagreement as to what caused the observed improvement in the area of child health and nutrition...It would be hard to attribute the impressively steady decline in infant mortality ... (despite several major economic recessions) ... to anything else than the maintenance of extensive public support measures
Milton Friedman gave some lectures advocating free market economic policies in La Universidad Católica de Chile. In 1975, two years after the coup, he met with Pinochet for 45 minutes, where the general “indicated very little indeed about his own or the government’s feeling” and the president asked Friedman to write him a letter laying out what he thought Chile’s economic policies should be, which he also did. To stop inflation, Friedman proposed reduction of government deficits that had increased in the past years and a flat commitment by government that after six months it will no longer finance government spending by creating money. He proposed relief of cases of real hardship among poorest classes. In October 1975 the New York Times columnist Anthony Lewis declared that “the Chilean junta’s economic policy is based on the ideas of Milton Friedman…and his Chicago School”.
Friedman has wondered why some have attacked him for giving a lecture in Chile: “I must say, it’s such a wonderful example of a double standard, because I had spent time in Yugoslavia, which was a communist country. I later gave a series of lectures in China. When I came back from communist China, I wrote a letter to the Stanford Daily newspaper in which I said, 'It's curious. I gave exactly the same lectures in China that I gave in Chile. I have had many demonstrations against me for what I said in Chile. Nobody has made any objections to what I said in China. How come?'” He points out that his visit was unrelated to the political side of the regime and that during his visit to Chile he even stated that following his economic liberalization advice would help bring political freedom and the downfall of the regime.
Commenting on his statement about the “Miracle”, Friedman says that “the emphasis of that talk was that free markets would undermine political centralization and political control.” Friedman stated that “The real miracle in Chile was not that those economic reforms worked so well, but because that’s what Adam Smith said they would do. Chile is by all odds the best economic success story in Latin America today. The real miracle is that a military junta was willing to let them do it.” Friedman said the “Chilean economy did very well, but more important, in the end the central government, the military junta, was replaced by a democratic society. So the really important thing about the Chilean business is that free markets did work their way in bringing about a free society.” The term Miracle of Chile is also commonly[by whom?] used to refer to the favorable economic results of economic liberalization in that economy.
According to the Chilean scholars Javier Martínez and Alvaro Díaz it is a fallacy that the return to democracy in Chile was the result of free market reforms. Contrary to that argument the return of democracy required the defeat of the Pinochet regime that had been fundamental in saving capitalism against the elected president Allende. Democracy has actually a long tradition in Chile. The essential contribution came from profound mass rebellions and finally old party elites using institutional mechanisms to bring back democracy.
Current Chilean economy
According to the 2010 Index of Economic Freedom (of the Heritage Foundation, Fraser Institute and WSJ), Chile's economy is the 10th freest. Chile is ranked 3rd out of 29 countries in the Americas and has been a regional leader for over a decade. Chile's annual GDP growth was 3.2% in 2008 and had averaged 4.8% from 2004 to 2008.
The percent of total income earned by the richest 20% of the Chilean population in 2006 was 56.8%, while the percent of total income earned by the poorest 20% of the Chilean population was 4.1%. Chile's Gini index (measure of income distribution) of 52.0 in 2006, compared to 24.7 of Denmark (most equally distributed) and 74.3 of Namibia (most unequally distributed).
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This article incorporates public domain material from the Select Committee to Study Governmental Operations with Respect to Intelligence Activities, United States Senate document "Covert Action in Chile 1963—197".