Tuesday, June 11, 2013

Ignoring Milton's advice in Chile

In his very useful book Painful Birth: How Chile Became a Free and Prosperous Society, James Rolph Edwards gives Augusto Pinochet a great deal of credit for transforming Chile into the peaceful prosperous country it is today. And it is certain unusual for a career military man--since the age of 15--who takes power in a coup to move a country to a liberal democracy.  Much less one with a free market economy.

Restoring feudalism has been more common in Latin America, and also more in line with traditional military thinking; command and control from above.  Rank hath its privileges. So it is remarkable that Pinochet, almost from the beginning, seems to have been determined to not only eliminate the Marxism that Salvador Allende had unconstitutionally (the Chilean Supreme Court and Chamber of Deputies' judgments) imposed on the Chilean people, but to distance Chile from its social democratic past--it was the Eduardo Frei Christian Democrat party that had begun the wave of partial nationalization of agriculture and industry in the 1960s.

Even before the Chicago Boys economists were appointed to positions in the Chilean government, before Pinochet met with Milton Friedman for forty minutes in March 1975, the direction was clear.  As Pinochet wrote to Friedman in a letter dated May 16, 1975, thanking him for his letter from the previous month detailing the steps Friedman advocated for Chile; The valuable approaches and appraisals drawn from an analysis of the text of your letter coincide for the most part with the National Recovery Plan proposed by the Secretary of the Treasury, Mr. Jorge Cauas. The plan is being fully applied at the present time--a plan for which we have the high expectations of advancing the Chilean economy.

Jorge Cauas, a Christian Democrat, studied economics at Columbia, not the University of Chicago, and had been in the government since July 1974.  One of Cauas' policies though, was in direct contradiction to advice that Friedman gave in his letter--the elimination of wage controls, which Friedman called one of the worst parts of the disease. And Cauas idea--the legal imposition on Chile's businesses of an obligation to index wages to the previous years's inflation rate--had huge negative effects for Chile.

With an inflation rate of several hundred percent per year, that meant something far worse than sticky wages failing to adjust downwards in the recession that inevitably follows a slow down in the rate of money creation by the central bank. It meant that wages were legally mandated to rise in a recession. One hardly needs to be a Chicago Boy to see what is wrong with that.

That one concession--for the most part, as Pinochet put it--to organized labor in Chile produced a persistently high unemployment rate well above what would have occurred had Milton Friedman's advice been taken.  A rate that gave an opening to left-wing critics of Pinochet and the Chicago Boys that was exploited for years by them, and still is by the likes of Naomi Klein.  Had Pinochet actually taken Friedman's advice for shock treatment, he would have had an easier time explaining the benefits of his National Recovery Plan.

Fortunately, other aspects of that plan were better thought out.  As we shall see.

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