Wednesday, June 12, 2013

Lo que hicieron bien en Chile

Mistakes were made.  They always are.  But after eliminating the lamented, by most Chileans, Allende administration, the military junta led by Augusto Pinochet did a lot of things right too.  As can be seen from James Rolph Edwards Painful Birth: How Chile Became a Free and Prosperous Society.

The major inherited problem being the high--several hundred percent per year--inflation that had been created by expanding the money supply to pay for the government's huge deficit.  Itself the result of nationalizations of private firms and farms that increased government spending to pay for the losses those inefficient, newly-public entities were producing.  Keep in mind that money losing businesses also don't pay taxes, so the effect on the government's budget was a double whammy; affecting both revenue and expenditure. The other big problem being the black market that had arisen thanks to the price controls instituted by the Allende regime.

Without any prodding from the Chicago Boys the military junta quickly abolished the price controls; goods once again became available in Chile's stores, the black market disappeared.  This seemed, according to Prof. Edwards, to have had a positive psychological effect on the people.

Also obviously required, the junta began to dismantle the socialized economy by returning nationalized businesses to private ownership.  Which returned proper profit and loss incentives to the economy, reversing the double whammy of revenue shortfalls and high subsidies due to unprofitable firms. Along with tax changes (replacing a national sales tax with a 20% VAT) they managed to reduce the budget deficit of 30% in 1973 to 5% in '74. By 1976 the budget was in surplus.

Trade was liberalized.  Tariffs drastically reduced, the artificially high Escudo was devalued. Interest rates were decontrolled. Required reserves for banks were lowered. But, in one crucial aspect the military's timing was very unfortunate. In the wake of the Arab-Israeli war, OPEC had begun to restrict the world's supply of oil and drive up its price, throwing the world into recession.  As an oil importer Chile wasn't spared.  Worse, world demand for Chilean copper dropped drastically. Real GDP declined 13% in 1975.

Not that this can be blamed on the Chicago Boys, as they weren't yet in positions of power when it started, and anyway it originated outside Chile. What could be attributed to Chicago economics was the more stringent monetary policy designed to quickly wring inflation out of the economy.  Combined with the previous (non-Chicago inspired) law requiring Chilean businesses to index wages they paid to the previous year's inflation rate, Chile got a shock treatment; unemployment rose rapidly and stayed high for far too long.

Had the Chicago Boys actually had a mandate to introduce a pure free market economy, they would have eliminated the law that had indexed wages to prior (higher) rates of inflation, eliminated the minimum wage law, and cut taxes (they had in fact been raised by the junta's first economic team). Still, Chile recovered from the '75 recession, and prospered; real GDP averaged almost 7% for six years.

More good news to follow.

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