Monday, June 17, 2013

Chile in the 80s, and beyond

When last we left our continuing review of James Rolph Edwards' Painful Birth: How Chile Became a Free and Prosperous Society, Chile had recovered from a serious recession in the mid 1970s and was enjoying annual real GDP growth of almost 7%. As we mentioned, Chile's path wasn't always smoothly upward, and a mistaken monetary policy tactic--pegging the Chilean currency to the US dollar in 1979--was a disaster waiting to happen.  Which it did after Paul Volcker slammed on the monetary brakes in the United States in 1981 in order to break the inflationary spiral that had developed in the U.S.

The side effect of the cure for inflation being recession. The higher the inflation, the worse that recessionary side effect. With Chilean monetary policy being determined by the Federal Reserve in the USA, and Chile's inflation rate being much higher than that in Volcker's country, Chile's recession was much more severe than America's. It hit in 1982-83, and was brutal.  GDP dropped over 13%, as once again demand for Chilean copper dropped drastically, as it had in 1975.

The Chilean public was understandably outraged, and Pinochet had to make some changes in his economic team, including sacking the Minister responsible for the currency peg. The Chilean peso was freed from the U.S. dollar, tariffs were again lowered, more corporations were privatized,  double taxation of corporate profits was eliminated and rates were lowered.  Maybe most importantly, the law requiring wages to be indexed to the prior year's inflation was eliminated.

Even more innovative--Chile, like many Latin American nations had borrowed heavily in foreign markets, and many firms were on the brink of default--the Chicago Boys instituted a program of  equity (stock) swaps of that debt.  As Prof. Edwards tells it:
As a policy, it worked extremely well, contrary to the predictions of the critics. In 1982, Chile had a foreign debt burden equivalent to $17.4 billion in U.S. dollars, one of the highest per-capita in the world.  Yet in only four years, 1985-1989, $10.5 billion of this debt was retired, mostly thought various forms of debt-equity swap, and the country had built up $9 billion in foreign exchange reserves. Exports expanded and the country prospered.
Chilean productivity boomed and real GDP grew at a compound rate over 6% for the rest of that decade. In stark contrast to what was happening to all other Latin American nations during this time. Nor, contrary to left wing spin, was the increased prosperity confined to the better off in Chile.

Finally, the last gift from Pinochet to his nation was the restoration of democracy.  Losing a plebiscite in 1988 that would have given him another decade in power, Pinochet stepped down.  Even though in doing so he knew he was going to be opening himself to retaliation by disaffected socialists.  And not just in his own country.  When, elderly, he traveled to the United Kingdom for medical treatment in 1998, a Spanish court issued a warrant for his arrest on the dubious grounds that Spanish citizens had been murdered in Chile when he had been president. Pinochet's last years were spent defending himself from that, and other charges.

But, as it says on the plain marble slab that covers the remains of the architect Christopher Wren in the basement of St. Paul's Cathedral in London, If you need a monument, look around. Chile has been a functioning democracy for about a quarter century now. Even when Socialist governments were elected they didn't attempt to undo the free market reforms of Pinochet and his Chicago Boys--one such Socialist, Ricardo Lagos, still brags that he privatized the Pan American highway!

Chile has a sound (privatized) social security system, school choice for even its poorest students, freedom from the fear of the midnight knock at the door that was the fate of most people who suffered the kind of nightmare that Salvador Allende wanted to impose. Quite a monument if one isn't afraid to look around...and see.

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