Chile's Macroeconomic Stability and Income Inequality General Augusto Pinochet's sixteen years in power brought many changes to Chile's economic landscape, some for the better and some for the worse. Arturo was once again in a position to control economic policies sixteen years after the military deposed Chile's last populist administration. Chile had improved after the 1973 military coup. Following a period of economic hardship, the economy rebounded strongly in the late 1980s. Real GDP growth had averaged 6.2 percent per year, unemployment had dropped to 6.3 percent from a high of 30 percent in 1982, and export growth had increased significantly. However, sixteen years of conservative economic policies and authoritarian rule had taken their toll on the working class, with nearly half of the population living in poverty and real incomes remaining 19% lower than in 1970. Inequality had widened, especially in the first decade of Pinochet's presidency, when the poor saw their incomes stagnate as social spending plummeted. In 1990, President Patricio Aylwin, a moderate, is the leader of the "Concertacion," a center-left coalition. While Chileans are pleased with recent economic gains, they are concerned about poverty; in reality, poverty and low income levels were key factors in persuading Pinochet to allow the October 1988 plebiscite that led to the December 1989 Presidential and Congressional elections. As Chile's first democratically elected President in sixteen years, Aylwin has a responsibility to those who have suffered the most during the country's long transition period. He must tread carefully, however, because he has a diverse coalition, the right still holds enough seats in the Senate to obstruct policy reforms, and General Pinochet has refused to relinquish control of the military. As President Aylwin's adviser, Arturo's job is to formulate a plan for quickly reducing income inequality without jeopardizing the military regime's macroeconomic gains. A nation made up entirely of islanders. Chile, a nation that stretches for 2600 miles along South America's Pacific coast, is rich in natural resources. It is the world's largest producer and exporter of copper, producing 24 percent of global copper ore production and holding about 20% of the world's estimated copper reserves through CODELCO, the state-owned copper company. There are also significant nitrate and iron deposits. There is suitable land for the cultivation of fruits, vegetables, and wine, as well as significant forested areas for timber exploitation. With a population of just over 13 million people, the country's resources in these areas have far outstripped domestic requirements. As a result, Chile has been geared toward international trade and markets from the start. "The Chilean people... are in fact islanders," says political scientist Federico Gil. The relative scarcity of crude oil reserves in Chile adds to this foreign reliance. Salvador Allende was elected President of Chile in 1970 on a populist platform. The aim of his Unidad Popular coalition was to transform Chile into a socialist state. Land confiscations, economic mismanagement, and general instability marked the socialist experiment, which ended with Allende's death during the 1973 military takeover led by General Augusto Pinochet. Pinochet liberalized the economy in order to increase the position of competition, and he privatized many of the companies that the Allende government had taken over. After losing a plebiscite in 1989, Pinochet agreed to hold free elections. Patricio Aylwin, a moderate who welcomed the 1973 coup and was a staunch opponent of Allende's socialist policies from the start, was elected President. Aylwin leads a coalition of 15 center-left parties, has members of his cabinet who served in Allende's administration, and understands the importance of including the right in the political process. The Economy of Allende's Period (1970-1973) For Chilean democrats, unequal income distribution is not a new issue; in 1970, Allende's economic advisers ranked it as the country's most important problem. Revolutionary changes, including nationalization of the mining, banking, and agricultural industries, as well as much of the manufacturing sector, were combined with an expansionary aggregate demand strategy. At the time, it was thought that the economy had enough surplus capacity that aggregate demand could be increased without causing inflation. In 1971, wage rises were widespread, money development rates were higher, and government spending was substantially higher. During Allende's presidency, the government's payroll rose at an annual rate of 11.4 percent on average between 1970 and 1972. Unions were extremely strong, with the ability to bargain for whole industries' salaries. During Allende's rule, labor law was extremely protective; it was difficult to fire employees, severance costs were heavy, and strikes could last indefinitely. Wages were also adjusted to inflation at a rate of 100% in most cases. In 1971, populist policies boosted growth: real GDP increased by 7.7%, unemployment dropped to 4%, and real wages increased by 23%. This expansion was only temporary. By 1972, real GDP had fallen, and the fiscal deficit had risen to over 30% in 1973 due to continued huge government spending. The government "sold" loans to Banco Central, which then printed money to cover the massive deficit: Between 1970 and 1972, Banco Central's claims on the central government increased tenfold, allowing inflation to hit 600 percent annually. Price controls and product rationing were widely implemented, resulting in the creation of black markets. In 1972, real wages dropped by 25%, indicating that the working class would face difficult times ahead. Even before Allende nationalized the financial sector, it was heavily regulated by the government. The government effectively regulated interest rates and guided lending. A bank was usually included in family-run grupos, which were conglomerates of relatively conservative business companies, to gain access to scarce loans at negative real interest rates. Opposition parties participated in a national strike in October 1972 in protest of what they saw as erroneous government economic and educational policies. By mid-1973, the opposition parties were demanding President Allende's resignation, and the UP alliance was dissolving. The populist experiment came to an abrupt end on September 11, 1973, when the armed forces launched a coup. The country was politically divided at the time, and the economy was in shambles. Economic changes under Pinochet. General Augusto Pinochet's military government drastically altered policies. The military regime's key economic goals were I economic liberalization to increase the position of markets, (ii) privatization to return businesses to the private sector and restructure the public sector, and (iii) inflation stabilization and prevention of a balance of payments crisis. Import tariffs were lowered from an average of 105 percent to a uniform 10 percent ad valorem rate by 1979, after which most controlled prices were freed in late 1973, followed by sweeping reform of domestic financial markets and the start of comprehensive trade liberalization. The majority of the real properties that had been transferred to the state during the Allende administration were sold as part of the privatization effort. Big, highly leveraged grupos emerged as a result of the privatization process, which differed greatly from the traditional, family-run grupos of the pre-military period. The aim of stabilization was to lower inflation, but the government initially failed to do so, with both annual money growth and inflation remaining about 300 percent. Government macroeconomic policy centered on fixing the balance-of-payments deficit caused by the fall in the world price of copper and the tripling of oil prices at the end of 1974 and during 1975. The Banco Central implemented a contractionary monetary policy in April 1975, and the government reduced government spending to eliminate the fiscal deficit by 1976. In 1975, the policy resulted in a 12.9 percent drop in GDP and a sharp rise in unemployment. Chile's economy began to expand again in 1977, and the annual inflation rate dropped to 84 percent. The fiscal accounts were balanced in early 1978, money growth was low, but inflation persisted at an annual rate of 80%. Chile implemented the re-announcement of the rate of exchange rate devaluation as the primary anti-inflation measure in January 1978. The devaluation was phased out in 1979 and replaced by a fixed exchange rate. General Pinochet said publicly that "not even the devil" could persuade the government to devalue the currency. By suspending collective bargaining and restricting union activity, the Pinochet government weakened workers' bargaining power. The government has mandated wage increases. These changes were made using partial indexation of past inflation in 1974-75 and overall indexation in 1976. The combination of total indexation to past inflation and falling inflation resulted in increasing real wages. In the mid-1970s, employment growth was slow, and the government's key response was a scheme in which the unemployed conducted public works in exchange for lower wages. This was a perplexing period in Chile's economic history, dubbed the "boom" by some Chileans. From 1977 to 1981, annual output growth averaged 7.9%, the supply of imported products increased significantly, and inflation eventually dropped to 9% in 1981. But not everyone in Chile was benefiting from the "boom": unemployment remained stubbornly high at 15%, real incomes were still 27% below 1971 levels, and income inequality was worsening as the richest 20% of the population gained a greater share of the pie. Labor Minister Jose Pinera's Labour Plan of 1979 did nothing to lift the spirits of the working class. The new labor law significantly weakened workers' bargaining power by further suppressing labor unions, limiting collective bargaining to the company level, allowing for termination with no severance pay after 60 days of strike action, and allowing for unfair dismissals. General Pinochet, on the other hand, boasted that the new labor law "guarantees employees a rise in remuneration of at least 100% of the increase in the cost of living" by requiring salary indexation to past inflation. Privatization, the elimination of credit and interest rate caps, and a dramatic reduction in reserve ratios (from 85 percent to 10 percent on demand deposits) began in 1974 and was completed in April 1980 with the removal of restrictions on banks' international borrowing. The large Grupos benefited greatly from government restrictions on private capital mobility because they had access to private foreign financing through their banks. The grupos were able to reap huge arbitrage profits because they were able to borrow at relatively low foreign interest rates and lend at high Chilean lending rates.

1. What was the actual percentage growth difference after 1970?

2. Arturo's task, as President Aylwin's advisor, was to devise a strategy to reduce income inequality rapidly without sacrificing the macroeconomic gains of the military regime.

3. Why was the real GDP declining by 1972 How did he do it?

4. The military regime had three main economic objectives, State them.

5. General Pinochet assured workers an increase in remuneration of at least 100 percent of the increase in the cost of living through its mandatory 100 percent indexation of wages to past inflation. Did it work? How?