The Unidad Popular and the Pinochet Dictatorship: A Political Economy Analysis

The Unidad Popular and the Pinochet Dictatorship A Political Economy Analysis

Patricio Meller Translated by

Tim Ennis

The Unidad Popular and the Pinochet Dictatorship

Also by Patricio Meller WESTERN HEMISPHERE TRADE INTEGRATION: A Canadian–Latin American Dialogue (co-editor with R. G. Lipsey) ADJUSTMENT AND EQUITY IN CHILE EXTERNAL SHOCKS AND STABILIZATION MECHANISMS (co-editor with Eduardo Engel) THE LATIN AMERICAN DEVELOPMENT DEBATE: Neostructuralism, Monetarism, and Adjustment Processes (editor) DIVERGING PATHS: A Century of Latin American and Scandinavian Economic Development (co-editor with Magnus Blomström)

The Unidad Popular and the Pinochet Dictatorship A Political Economy Analysis Patricio Meller Professor of Economics University of Chile Santiago

Translated by Tim Ennis

First published in Great Britain 2000 by

MACMILLAN PRESS LTD Houndmills, Basingstoke, Hampshire RG21 6XS and London Companies and representatives throughout the world A catalogue record for this book is available from the British Library. ISBN 0–333–80053–2 First published in the United States of America 2000 by ST. MARTIN’S PRESS, LLC, Scholarly and Reference Division, 175 Fifth Avenue, New York, N.Y. 10010 ISBN 0–333–80053–2 Library of Congress Cataloging-in-Publication Data Meller, Patricio. The Unidad Popular and the Pinochet dictatorship : a political economy analysis / Patricio Meller. p. cm. Includes bibliographical references and index. ISBN 0–333–80053–2 1. Chile—Economic conditions—1970–1973. 2. Chile—Economic conditions—1973–1988. 3. Chile—Politics and government—1970–1973. 4. Chile—Politics and government—1973–1988. I. Title. HC192 .M4553 2000 330.981'0646—dc21 00–033294 © Patricio Meller 2000 All rights reserved. No reproduction, copy or transmission of this publication may be made without written permission. No paragraph of this publication may be reproduced, copied or transmitted save with written permission or in accordance with the provisions of the Copyright, Designs and Patents Act 1988, or under the terms of any licence permitting limited copying issued by the Copyright Licensing Agency, 90 Tottenham Court Road, London W1P 0LP. Any person who does any unauthorised act in relation to this publication may be liable to criminal prosecution and civil claims for damages. The author has asserted his right to be identified as the author of this work in accordance with the Copyright, Designs and Patents Act 1988. This book is printed on paper suitable for recycling and made from fully managed and sustained forest sources. 10 09

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Printed and bound in Great Britain by Antony Rowe Ltd, Chippenham, Wiltshire

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Contents List of Tables and Figures

vi

Preface

ix

1

The Road to Socialism of the Unidad Popular Brief review of the social issue Brief review of the political issue The two governments prior to Unidad Popular The Unidad Popular view of the Chilean economy The macroeconomic situation during the Unidad Popular The structural reforms of the Unidad Popular Property rights

1 1 10 21 27 31 47 56

2

The Economic Model of the Military Dictatorship The destruction of Chilean democracy The structural reforms of the 1970s The economic and financial collapse of 1982–83 The adjustment process of the 1980s The structural reforms of the 1980s Economic freedom and political liberty

61 61 75 88 119 141 152

3

A Tentative Synthesis The legacy of the Unidad Popular The legacy of the military dictatorship Human rights and historical memory

158 158 168 182

Notes

186

Bibliography

201

Index

216

v

List of Tables and Figures Tables 1.1 Relative Wages and Living Costs in Chile, Beginning of the Twentieth Century 1.2 Land Ownership in Chile, 1925 and 1965 1.3 Growth and Employment in Chilean Agriculture and GDP, 1940–1970 1.4 Relative Productivity and Prices in the Agriculture Sector, Chile 1940–1970 1.5 Chilean Voters and Population, 1870–1989 1.6 Results of Chilean Parliamentary Elections, 1912–1969 1.7 Results of Three Chilean Presidential Elections: 1938, 1958 and 1970 1.8 Principal Macroeconomic Variables during the Alessandri and Frei Governments, 1958–1970 1.9 Evolution of Unionization in Chile, 1932–1970 1.10 Number of Strikes and Evolution of Real Wages, Chile 1960–1970 1.11 Evolution of the Main Macroeconomic Variables, Chile 1970–1973 1.12 Minimum and Average Real Wages for Blue- and White-Collar Workers, Chile 1970–1973 1.13 Selected Components of the Balance of Payments, Chile 1970–1973 1.14 Consolidated Non-Financial Public Sector, Chile 1970–1973 1.15 Public-sector Employment in Chile, 1970–1973 1.16 Social Expenditure During the Unidad Popular Government, Chile 1970–1973 1.17 Quarterly Evolution of the Official and Parallel Exchange Rate, Chile 1970–1973 1.18 Calculation of Compensation Associated with the Nationalization of Large Copper Mining, 1971 1.19 Agrarian Reform During the Governments of Frei and Allende, 1964–1973 1.20 Productive Enterprises under State Control, by Economic Sector, Chile 1970 and 1973 vi

3 5 6 7 17 18 20 23 25 26 33 34 39 40 41 41 46 49 51 55

List of Tables and Figures vii

2.1 2.2 2.3 2.4 2.5 2.6 2.7 2.8

2.9 2.10 2.11 2.12 2.13 2.14 2.15 2.16 2.17 2.18 2.19 2.20

2.21 2.22 2.23 2.24 2.25

Distribution of New Voters, Chile 1918–1973 Basic Structural Reforms in the Chilean Economy in the 1970s Time Sequence of the Structural Reforms of the 1970s Indicators of the ‘Chilean Economic Miracle’ Indicators of the Import Boom, Chile 1976–1981 Some Indicators of the ‘Chilean Collapse’ Balance of Trade, Current Account Balance and Overall Balance of Payments, Chile 1977–1981 Six-Monthly Inflation Rates in Chile after Implementation of the Fixed Nominal Exchange Rate Policy: June 1979–June 1982 Annual Growth Rates of Chilean Macroeconomic Variables, 1979–1981 Selected Financial Sector Indicators, Chile 1976–1981 Total Net Capital Flows, Chile 1977–1981 Evolution of External Variables Relevant to the Chilean Economy, 1978–1983 First Signs of Severe Economic Problems, Chile 1980-I to 1982-II The Working of the Automatic Mechanism, Chile 1980-I to 1982-II Impact of the Automatic Mechanism on the Real Economy, Chile 1980-I to 1982-II Monthly Evolution of the Nominal and Real Exchange Rate in Chile, 1982 Net Monthly Foreign Currency Sales by the Central Bank, 1982 Daily Rates for the Dollar under the Free Floating and ‘Dirty’ Floating Systems, August–September 1982 Evolution of Monetary and Real Sector During 1982. Chile, Selected Months Selected Chilean Economic Variables Illustrating Existing Imbalances and Successful Adjustment in the 1980s Main Sources of External Financing, Chile 1983–1987 Nominal Devaluation and Inflation, Chile 1981–1988 Real Exchange Rate and Real Wage, Chile 1980–1987 Nominal Tariffs Following the External Debt Shock, Chile 1982–1990 Measure of Real Transfer Abroad, Chile 1982–1988

65 78 79 86 87 89 91

93 95 96 96 99 103 105 107 110 111 113 116

120 123 125 126 127 130

viii List of Tables and Figures

2.26 2.27 2.28

2.29 2.30 2.31 2.32 2.33 2.34 2.35 3.1 3.2 3.3 3.4 3.5

Quasi-fiscal Subsidies Supplied by the Central Bank, Chile 1982–1988 Unemployment and Real Wages, Chile 1980–1989 Structure of Unemployment and Employment by Households of Different Income Levels, Greater Santiago, 1981–1983 Fiscal Deficit, Employment and Wages in the Public Sector, and Social Spending, Chile, 1980–1986 Composition of Social Spending Per Capita, Chile 1980–1987 Milk and Near Substitutes Distributed National Nutrition Program, Chile 1980–1985 The Second Privatization Process, Chile 1984–1987 Privatization of State-Owned Firms, Chile 1980–1987 Evolution of Employment in Selected Privatized Firms, Chile 1970–1990 Number of Exporting Firms by Amount Exported, Chile 1986–1990 Importance of Copper in Chilean Exports, 1960–1990 Export Growth Rates, Chile 1960–1990 Composition of Tax Revenues, Chile 1970–1990 Comparision of the Final Years of the UP and Military Governments Economic and Social Indicators of Four Chilean Governments, 1958–1989

Figures 1.1 Right-wing Voters (Parliamentary Elections), Chile 1918–1969 2.1 Center Voters (Parliamentary Elections), Chile 1918–1973 2.2 Left-Wing Voters (Parliamentary Elections), Chile 1918–1973

132 133

134 136 137 138 143 144 148 150 159 159 163 169 169

19 64 64

Preface Why Allende? Why Pinochet? These two questions are going to trouble several generations of Chileans during the twenty-first century. Is it too soon to start looking for answers? Is a detached assessment of the period between 1970 and 1990 possible? In those 20 years a level of antagonism prevailed that was sufficient to polarize Chilean society. There were two Chiles and two types of Chileans: the good and the bad. The tranquility did not exist to make possible a serene analysis: caricatures abounded – indeed, maybe even the country itself was a caricature. The aim of this book is to look beyond such an exaggerated view of things. Incomprehension of the present is associated with an ignorance of what went before: the past clothes the present with sense and significance.1 The founding characteristics of the ideologies that were predominant in the period 1970–90 were intent on destroying the past and its history. Hence the importance of reconstituting the historical record; for this fulfills a fundamental social role by explaining who we are as a nation, linking the present to our past. For what we are is also what we remember. On the other hand, the ‘objective weight of history’, in the Hegelian sense, needs to be balanced by analytical examination to enable the past to be assumed in a mature fashion.2 Every generation has the duty and the right to ask its own questions of history, or to lay its own particular ghosts and use them as food for reflection and as a source of understanding.3 The same past will be reinterpreted, therefore, by various generations. The traditional historical method uses a sort of backwards projection through time: historians, located in the present, examine all the existing information to try painstakingly to reconstitute the past that they are studying. Ideally, historians would like to have available a kind of time machine that would transport them back through the centuries, to be able to witness directly the events being analyzed; but obviously this is not possible. That being the case, it is worth posing the following question: what comparative advantages would a researcher have in the year 2099 in understanding the events that occurred in the period 1970–90? Assuming progress in the methodology of social science, the analysis in ix

x Preface

2099 would be more sophisticated, more at arm’s length and more systematic than an analysis undertaken in the present. Yet it would also run the risk of confusing the relevance of different factors, and of not experiencing in their full intensity the circumstances in which the events actually occurred. Someone who is closer, someone who is present and sees with their own eyes – someone who is actually there – has information and a perception for which there is no substitute. There is a big difference between living through an experience and hearing or reading about it a hundred years later. No doubt historians of the present are susceptible to bias; they reach impassioned judgements that probably lack overall perspective but, in their analysis, what is relevant is sure to take precedence over what is not. How can one stand back from the present to enhance the objectivity of current analysis? Here again, the ideal would be to have a time machine, which this time would transport the historian into the future. As this is not feasible either, the next best alternative – a close substitute for time travel – would be to travel geographically: a concrete application of the concept of ‘distancing oneself’. There are various, not mutually exclusive, procedures for effecting this geographical displacement. The simplest consists of the social scientist physically installing himself abroad in order to analyze what is happening in his or her own country. A second option starts from the assumption that an underdeveloped country like Chile will, in the long run, acquire a degree of maturity, conscience and capacity for selfcriticism similar to that currently seen in developed countries. In this case displacement is mental, by examining the assessment and processing of recent events in Chile by European and North American analysts, or else imitating their reasoning: implicitly one is assuming that a Chilean analyst at the end of the twenty-first century will have a similar perception. A third possibility involves finding experiences similar to that of Chile in 1970–90 in the past history of developed countries; one then can examine the kind of analysis that was carried out 50 to 100 years later. This book makes a major effort to ‘distance itself’ from recent events, using all the substitutes for a time machine described above, in an attempt to transport the analysis to a middle-of-the-twenty-firstcentury perception. The central aim of the book is not merely to construct an objective reconstruction of what happened; rather, it is to understand and explain why what happened did happen, and to analyze the factors that led to the replacement of one paradigm of knowledge by another,

Preface xi

diametrically opposed one. Over these 20 years (1970–90) drastic changes have taken place in the way the Chilean economy is analyzed, and one is interested in understanding why people reasoned one way during a certain period, and what later influenced them to adopt principles that are so different. Why did people believe what they believed, and why did they change their beliefs? This might make it possible to learn to anticipate changes in current beliefs in the future. Each of the first two chapters is a self-contained unit, where I have used as a basis the prevailing literature of the period under analysis. Chapter 1 covers the government of the Unidad Popular. It examines the historical development of the social and political questions, in search of the historical antecedents of the Unidad Popular platform, recognizing that this did not simply come about spontaneously in 1970. The outlook of the Unidad Popular and the logic of the structural reforms of that period is contrasted with the resulting economic events. Their attitude to private property and property rights constituted one of the most contentious issues of that time. Chapter 2 deals with the military regime. In view of its beginnings, the analysis has to start with the destruction of Chilean democracy. Then the chapter examines the structural economic reforms, distinguishing, unlike other books and articles on this topic, the reforms carried out in the 1970s from those of the 1980s. In addition, there is an innovative methodological examination of the causes of the economic collapse of 1982–83. The question of economic and political freedom is one of the burning issues of that period. In brief, the predominant issues and questions in each period are the elements that condition the structure of each chapter. The relatively intensive use of the literature written in and confined to each period has the aim of identifying the fundamental ideas and the logical structure of the various arguments: it allows an inside view of how the world was perceived in each period. Finally, Chapter 3 proffers a tentative synthesis from the future, looking back. In other words, the same periods already examined are reviewed anew, but now from the standpoint of the next century, rather than through the lens of the period in question. This leads us to the legacies of the Unidad Popular and the military dictatorship. In the historical memory of the twenty-first century, the human rights violations are sure to occupy a special place. This book has been written over a period of four years. In that time, several articles have been presented and discussed in numerous national seminars and international conferences, and these have

xii Preface

constituted important back-up material in the writing of the different chapters. I am grateful for the suggestions and discrepancies of those who took part in these academic events: Jorge Arrate, Sergio Bitar, Magnus Blomström, Vittorio Corbo, Sebastián Edwards, Ricardo Ffrench-Davis, Roberto Frenkel, Oscar Godoy, Alexis Guardia, Felipe Larraín, Rolf Lüders, Mats Lundahl, Cecilia Montero, Oscar Muñoz, Martin Paldam, Gabriel Palma, Aníbal Pinto, Francisco Rosende, Andrés Sanfuentes, Sol Serrano and Bo Sodersten. However, the usual caveats apply, and none of these individuals bears any responsibility for the contents of this book; in many cases, their discrepancies served to moderate certain issues or reinforce others. I want to acknowledge, most especially, the valuable comments and constructive suggestions made by Eduardo Engel, who was kind enough to read carefully the final drafts of the first and second chapters. I also wish to express my gratitude for the great efficiency and constant goodwill of Andrea Repetto, who collaborated in the preparation of the book’s tables and graphs. The environment prevailing in CIEPLAN during these four years has been a huge stimulus for reflection and analysis, and the presence of an outstanding group of young economists and social scientists contributed to this: Andrea Butelmann, Pilar Romaguera, Raúl E. Sáez, Andrés Gómez-Lobo, Rodrigo Valdés, Andrea Repetto, Sergio Lehmann, Bernardita Escobar, Fernando Lefort, Rodrigo Cifuentes, Dante Contreras, Cecilia Montero, Pablo Halpern, Pablo González, Héctor Schamis, Francisco Aracena, Esteban Jadresic, Miguel Basch, Carlos Budnevich, Pilar Campero, the late Edgardo Bousquet, Pablo García, Juan Jiles, Claudio Bonacic, Mauricio Hidalgo, Marcelo Henríquez and Jaime Soto. Their tremendous capacity, cordiality, spirit of learning and eagerness to understand led to undertaking highly ambitious research tasks. To all of them I want to express my most sincere gratitude. The sustained support for CIEPLAN provided by various organizations has been an important factor in undertaking this lengthy research. I would like specifically to thank the Canadian International Development Agency and the International Development Research Center in Canada; the Andrew W. Mellon Foundation and the Ford Foundation in the United States, as well as SAREC in Sweden. Tim Ennis has done the English translation, while Rosa Jaime has shown infinite patience in diligently typing the numerous drafts and painstakingly making the repeated corrections. To both of them many

Preface xiii

thanks. Finally, numerous weekends dedicated to studying and writing were always accepted with great understanding in my family; and as if this were not enough, my wife Clary and my children Ilana, Ariel and Alan had to put up with the repeated readings I subjected them to. For their permanent affection and concern at all times, I wish to express my eternal thanks.

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1 The Road to Socialism of the Unidad Popular

Brief review of the social issue The existence of rich and poor For most of the nineteenth century, Chile’s economy was fundamentally agricultural. Nearly 80 per cent of the population lived in rural areas before 1880, and even as late as 1930 the rural population was greater than the urban. In agriculture the latifundio or estate system predominated, with social relations of a semi-medieval type: on one side of the fence, there was the lord of the manor or latifundista, known as the ‘patrón’, and on the other, the tenants or peasants. The latifundista provided his tenants with a hut and a bit of land, and protected them and looked after them in old age or when they got sick. For their part, the tenants obeyed and revered their ‘patrón’; they lived and died on the land.1 Their standard of living was quite precarious, and they were isolated from urban, cultural, educational and political life; this situation lasted until well into the twentieth century. Social criticism concerning the gap between rich and poor surfaced in Chile in the middle of the nineteenth century:2 The extremely grave disease which keeps the country in the sad state we find it in, is the condition of the people: poverty and degradation among nine tenths of our population … There are rich and poor everywhere, but not everywhere are people as poor as they are in Chile. In Chile to be poor is a condition, a class of people which the Chilean aristocracy refer to as ‘rotos’ … The poor man is not a citizen; the poor have no party, they are neither liberals nor conservatives – they are simply poor.3 1

2 The Unidad Popular and the Pinochet Dictatorship: A Political Analysis

‘Highly visible upper classes have sprung up, and they swim in wealth while the lower classes drown in their misery; the former hold the strings of power while the latter live out a life of servility.’4 The material and work situation at the beginning of the twentieth century was not much better for urban workers. After 1880, rapid urban population growth generated serious housing problems, to which tenement buildings and slum dwellings were part of the solution. In 1910, 25 per cent of Santiago’s population – or around 100 000 people – were accommodated in 25 000 rooms in tenement houses; this gives an average of 4 people per room, but ‘even in 1922 there were tenement houses which gave shelter to up to 10 people per room’.5 These tenement houses were ‘rooms lining both sides of a narrow alleyway like the berths in a steamship; with all their grime, their criminality, their defenselessness against cholera and smallpox; with their dilapidated walls, with their women squatting down in the middle of the street cooking’.6 The infant mortality rate there was as high as 30 per cent, and 35 per cent of births were illegitimate.7 Up to 1920, employment conditions had the following characteristics.8 (a) There was no collective bargaining, all agreements were individual and verbal; written contracts were totally unknown.9 (b) There was no social security for workers, nor compensation for accidents at work, and no hygiene or security standards that were respected, whether in the fields, or the mines or the factories. (c) There was no maximum limit to the working day, which varied between nine and 12 hours. (d) There was no obligatory Sunday rest period: parliament took 14 years to pass a law regulating this. (e) It was not illegal to pay wages in kind, or in vouchers or coupons that were only exchangeable in the patrón’s grocery store known as the ‘pulperia’. (f) Child labor was not regulated and accounted for 8.5 per cent of total employment in 1908.10 On this topic, one writer’s description quoted by Vial is quite eloquent: ‘in a bottle factory, past midnight, I saw a large number of tiny children, some eight years old perhaps, sweating copiously beside the smelting ovens, half naked, their faces stained, their countenances emaciated, their little eyes half asleep, forced to stay at their task … until the new day dawned.’ In 1917, a parliamentary commission that visited the nitrate mines could see children stretching for miles, even including seven or eight year-olds, doing jobs that not only exceeded their strength, but which were extremely dangerous and unhealthy.11

The Road to Socialism of the Unidad Popular 3 Table 1.1 Relative Wages and Living Costs in Chile, Beginning of Twentieth Century (Index: Skilled urban worker = 100) Nitrate worker Skilled urban worker Public employee (mail) Unskilled urban worker Woman or child (urban area) Peasant workera Rental of tenement room (Santiago)

125 100 70 50 25 20 30

Sources: Jobet (1951); Aylwin et al. (1986). Note: a In addition, the peasant would have received food, housing, and land rights. A laborer earned the same wage but without the right to these extra benefits.

Table 1.1 gives figures on relative wages and living costs in the early years of the twentieth century. Considering that rental costs accounted for between 25 and 30 per cent of income, it can be appreciated that most workers were living in extremely precarious economic conditions; this was true even for sectors that could be considered middle class (public employees and skilled workers), since these were probably not living in tenement houses and therefore had to pay higher rents. The table also shows that the peasantry earned a monetary wage inferior to that of a child in the urban area. Vial argues that one should not be too harsh when judging Chilean society of that time. ‘Let us view these failings through the eyes of that time rather than today’s; it was not only Chile: the whole world was like that, and there was no model to copy or adapt.’ 12 However, there was a large wage differential between the Chilean and the Argentine countryside at this time, which shows that not all the world was that way, nor was it obvious that a peasant had to earn less than a child. In fact, this differential stimulated peasant migration to Argentina at the turn of the century. It is worth asking why there was no competition for labor in much of Chilean agriculture; in other words, why did the agrarian sector of that time operate as a sort of monopsony, when there were many large estates belonging to different owners? The explanation probably lies in the existence of a perfectly elastic supply of labor at the subsistence wage. In a poor and underdeveloped economy, levels of saving and investment and the incorporation of technology are low, giving rise to the low productivity levels and therefore low wage levels. At the turn of the twentieth century, Chile’s social classes could be classified as follows: the gentlemen of the aristocracy; the ‘siútico’ or

4 The Unidad Popular and the Pinochet Dictatorship: A Political Analysis

flashy middle class;13 and the common people from the poorest class, referred to as ‘rotos’.14 The social issue only began to be confronted when the middle class acquired a significant share of political power, from around 1920. From this time, thanks to the predominance and consolidation of the middle class, greater concern for marginalized social groups has emerged, and this has led to them being increasingly integrated into society. As result of this, by the end of the twentieth century most of the population considered themselves to be middle class, and political parties tried to position themselves in the center of the political spectrum to capture their votes. The agrarian issue From the time of conquest and colony, Chile’s social structure had been built on agrarian foundations, and this social inheritance molded the Chilean way of life even during much of the twentieth century. A somewhat exaggerated description that gives a view of the predominant structure (for 60 to 70 per cent of the population) up to the beginning of the twentieth century is as follows: There was a landowning aristocracy which controlled national affairs; and, completely separate from this, another lower class which formed the permanent tenancy of rural properties. Whatever a man’s occupation, or wherever he lived (in rural areas), he belonged to one or the other of these two classes: he was either master or servant. The landowners ruled, and it fell to those who had nothing to obey.15 The hacienda or latifundio system ensured the maintenance of this social order. This system contained features of a barter economy and autarchy, which were current even the first half of the present century.16 The working day lasted from dawn to dusk; nearly 70 per cent of peasants’ remuneration was paid in kind rather than in money; contractual agreements were verbal, the patrón’s word was law, and the immutable centuries-old tradition was the Constitution. As mentioned above, the patrón’s grocery store, or ‘pulpería’, was another mechanism which isolated peasants from the market and kept them permanently in debt, thereby preventing them from leaving the estate. Moreover, there were practically no peasant union organizations before 1965, nor was there a legal requirement to keep written accounts in agrarian activities before 1990; taxes were not paid on effective income but on imputed income, in accordance with

The Road to Socialism of the Unidad Popular 5

estimates made by the farmers themselves, without any form of control. The latifundio system retarded economic, social and political development in Chile. In the economic sphere, primitive technologies were used to cultivate the land: given the low level of peasant wages, there was no incentive to introduce modern technology to economize on labor. In the social area, a semi-patriarchal regime prevailed in which a peasant’s highest aspiration was to have a good patrón. In the political field, a small latifundio oligarchy controlled an enormous mass of peasants, enjoying a huge amount of political power for a long time. Table 1.2 illustrates the distribution of land ownership in 1925 and in 1965. In relative terms, it can be seen that fewer than 10 per cent of proprietors owned more than 90 per cent of the land. It could even be inferred that this distribution was even more concentrated in 1965 than in 1925. During this period there was a significant increase in the number of landowning farmers, whose number grew on average by 2.3 per cent per year. But in 1965 nearly 50 per cent of agricultural owners were minifundistas, or smallholders, with properties averaging 1.7 hectares.17 At the start of the second half of the twentieth century, the landownership situation in Chile could be summarized as follows: out of a total of 400 000 families living in the countryside, 5 per cent were owners of large estates (latifundistas), 30 per cent were minifundistas, or smallholders, another 30 per cent were owners of medium-sized estates, and 35 per cent of families owned no land at all (a group

Table 1.2

Land Ownership in Chile, 1925 and 1965

Size of property (hectares) 0–50 51–200 Over 200

Total

No. of owners (% of total) 1925 1965

No. of hectares (thousand) (% of total) 1925 1965

87 464 (79.6) 12 503 (11.4) 9886 (9.0)

216 044 (85.2) 23 959 (9.5) 13 489 (5.3)

836.0 (3.3) 1288.0 (5.1) 23 301 (91.6)

1763 (5.8) 2284 (7.4) 26 602 (86.8)

109 853

253 492

25 425

30 649

Sources: Jobet (1951); Aranda and Martínez (1970).

6 The Unidad Popular and the Pinochet Dictatorship: A Political Analysis

comprised of sharecroppers, journeyman laborers and so on). It should also be noted that highly concentrated land ownership also implied a high concentration of water rights. In the light of these figures, it is hardly surprising that the issue of agrarian reform had already surfaced in Chile by the 1930s. ‘Only a profound agrarian reform can save the country from disaster; Chilean estate owners are faced today (the 1930s) with a choice between voluntarily handing over part of their landholdings, without compensation, or losing them altogether.’18 In the 1938 presidential campaign the winning candidate used the issue of agrarian reform as one of the main planks of his platform. Parties on the left began to explain backwardness and slow economic growth in terms of the predominance of the latifundio system, which was held responsible for the semi-medieval, semi-colonial structure that persisted in the Chilean countryside.19 After 1940, a series of economic indicators showed up the mediocre performance in the agricultural sector (Tables 1.3 and 1.4). (i) The agricultural sector was growing relatively more slowly: while the growth rate in other sectors was 4.3 per cent per year, agriculture was only growing at 1.9 per cent. (ii) The sector had a negative rate of job creation (–0.4 per cent per year), whereas the rest of the economy was generating jobs at a rate of 1.9 per cent per year. (iii) The average productivity of agricultural labor was only 35 per cent of the productivity level in the rest of the economy. (iv) Food imports accounted for nearly 30 per cent of the trade deficit in the 1950s and 1960s, thereby creating balance of payments problems.

Table 1.3 Growth and Employment in Chilean Agriculture and GDP, 1940–1970 (percentages) Annual economic growth Agriculture GDPb

Annual expansion of employmenta Agriculture GDPb

1940–1950 1950–1960 1960–1970

2.2 1.6 1.9

3.4 4.1 5.5

0.4 0.3 –1.8

2.2 1.7 1.8

1940–1970

1.9

4.3

–0.4

1.9

Sources: Central Bank of Chile; Meller and Rahilly (1974); Léniz and Rozas (1974). Notes: a Annual expansion of employment relates to 1940–52 and 1952–60. b Excluding agriculture sector.

The Road to Socialism of the Unidad Popular 7 Table 1.4 Relative Productivity and Prices in the Agriculture Sector, Chile 1940–1970 Average labor productivity (Ch$000/person at 1965 prices) 1940 1950 1960 1970

35.4 42.3 48.4 70.0

Agricultural prices/price non-agricultural GDP

100.0 111.4 139.1 199.0

100.0 106.5 101.7 85.8

Sources: Based on Meller and Rahilly (1974); Léniz and Rozas (1974). Note: To calculate the employment figure for 1950, the annual growth rates of employment between 1940–52 were used.

In the 1950s and 1960s, two different (but not necessary mutually exclusive) explanations for the agriculture sector’s deficient performance took root. The structuralist hypothesis put the emphasis on the structure of land ownership, which was seen as perpetuating an archaic productive system. By contrast, the neoclassical microeconomic hypothesis focused its explanation on the unfavorable trend in relative prices in agriculture, and on the existence of negative incentives: the hypothesis suggested that the maintenance of price controls to keep inflation down, in which food prices played a preponderant role, led to a trend in relative prices that was unfavorable to agriculture; on top of this, there was uncertainty about the level at which prices in the sector would settle in the future. Table 1.4 suggests that this argument was empirically valid only during the 1960s. The preceding discussion of the agrarian issue may have exaggerated the role of agriculture in the evolution of the Chilean economy during the late nineteenth century. From 1880 onward exports of mining products (nitrate and copper) transformed the pattern of economic development in Chile. It is not at all clear that the latifundio system was the source of all of Chile’s economic problems from this period. Many of the social tensions that arose from 1880 onward originated in the urban centers and in the mines. From the turn of the twentieth century, political debate focused on urban areas: the great political skill of the latifundistas lay precisely in isolating the rural area from social and political debate right up to the 1960s. Obviously, this was not an indefinitely sustainable situation; in the twentieth century, with progress in transport and communications, it was impossible for an archaic semi-medieval social structure to coexist with modern urban society in a single country. The passive masses of the peasantry

8 The Unidad Popular and the Pinochet Dictatorship: A Political Analysis

finally realized things could be different; although their lives may have been unchanged for generations, they did have the capacity to press for social reforms.

From social issue to social crisis Harsh criticisms of the effects of economic liberalism were emerging during the latter part of the nineteenth century. ‘Can a social situation be allowed to develop peacefully where tenancy is the ideal? The doctrine of passive indifference, laissez-faire, suggests that this leads to the social optimum; but an optimum for whom? For both landlord and tenant, or for one of them only?’20 Moreover, What is needed for the big to be able to exploit the small, the strong to exploit the weak, entrepreneurs to exploit workers, landowners to exploit their tenants, the rich to exploit the poor? Only one thing: freedom, in other words a guarantee that the State will not intervene in the struggle for existence in order to alter the final result in favor of the underdog. That is what the free market system gives those with most power.21 And how could the underdog be helped to improve its situation? State intervention was needed to establish new economic and social conditions (the promotion of industry and a solution of the agrarian issue), ‘to lift the lower social classes from the suffocating situation in which they find themselves’. 22 State protection was needed to make equality of opportunities possible in a world of unequals: ‘there is no greater inequality than that of applying equal rights to people who are in fact unequal’. In short, ‘politics is not the art of establishing a free market system; it is the art of satisfying social needs’.23 The first strikes broke out after 1880, and widespread social unrest occurred in the initial decade of the twentieth century. Similar events were taking place in Europe, which doubtless affected the Chilean national climate both ideologically and practically. All of this fed into the important institutional reforms that were drawn up in the 1920s (the Constitution of 1925), as well as the development of social legislation – which had been non-existent until then. Later, ‘the social issue became the battle cry in the struggle by the parties on the political left which did not accept reformist legislation as a definitive solution, and began to promote a revolutionary upheaval in Chilean society’.24 From 1950, twin criticisms of the development model emerged: on the one hand, it was felt that the pace of growth was very slow; and on

The Road to Socialism of the Unidad Popular 9

the other, it was seen that the distributive situation had not changed significantly. Until then, it had been thought that industrialization would lift Chile out of underdevelopment; expansion in the industrial sector was expected to be a pole of economic attraction that would generate an increase in incomes and jobs, putting pressure on the rest of the economy, particularly in rural areas where migration would improve the lot of non-migrants. However, it was now seen that industry was creating relatively few jobs compared to growth of the labor force; consequently, industrial workers were earning wages only slightly above subsistence levels. It could be said that the utopian solution – industrialization – was working very slowly and failing to resolve the existing problems; more effective solutions had to be found. But in reality, during the 1950s and 1960s there was a perception of crisis in the air that involved more than a slow growth rate or an imperfectly working democracy. Some people perceived the existence of an integral economic sociopolitical crisis,25 others believed that the country was facing a crisis involving all its values and certainties, 26 and still others posited the breakdown of the capitalist system. From 1920 onwards, a growing imbalance began to emerge between the steady incorporation of social groups into the political process and the slow economic improvement of such groups. In arithmetical terms, this meant that the number of new voters grew significantly and progressively faster than the rise in economic well-being experienced by them; this translated into stronger pressures for socioeconomic improvement among deprived groups. Increasing aspirations and expectations among the newly enfranchised sectors of the population also occurred, induced by demonstration effects channeled through the communications and transport media, and by greater urbanization, particularly in Santiago, together with political competition for votes, by promising solutions for all.27 Consequently, despite the considerable social and economic changes after 1940, compared with the previous period, not all the results desired and expected by a large part of the population had been achieved. This produced ‘a state of great frustration in that there was sufficient evidence to show that the processes of economic transformation and social change carried out during past decades … have not managed to improve the economic and social situation of the majority in any significant way’.28 Furthermore, economic policy had failed to achieve stability and growth. Aníbal Pinto synthesizes the perceptions existing at that time: ‘Neither stability nor development’; ‘Chile, a case of frustrated development’.

10 The Unidad Popular and the Pinochet Dictatorship: A Political Analysis

Brief review of the political issue The different political positions Throughout the nineteenth century, and right up to 1920, the oligarchy had almost totally dominated public affairs. However, from 1938 onwards the middle class consolidated itself as the main political actor. Between 1920 and 1938 there was a sort of transition as power shifted between the two classes, institutionalized through constitutional changes and new political and social legislation. This period was preceded by a lapse of approximately 30 years marked by a significant increase in social unrest, in which numerous strikes and violent street disorders were harshly repressed. In theory, independence had removed all institutional titles of nobility and primogeniture. However, for more than a century the same hierarchical structure persisted whereby social differences were basically marked by surnames, prejudices and customs. From 1830 to 1920 an ‘oligarchic order’ prevailed in Chile: a ‘superior’ dominant landed class, conservative and catholic, and ‘wedded to ancestry and prestige’ had total control.29 Chile was an institutionally well-ordered and stable country, with strong governments based on a concept of abstract authority as a sort of substitute for the former distant Spanish monarchy – ‘one obeys and respects the governor for the simple fact that he is governor, rather than respecting the individual himself who holds power’. This principle made it possible to avoid personality cult as the basis of government; the government’s actions would be backed and bounded by the Constitution.30 Up to 1920, politics had been a pastime or sport for the oligarchy, a mechanism for reinforcing their elevated social position. ‘Parties were alliances between estate owners; a favorable political combination could bring benefits to certain families’. 31 ‘Cabinet crises, verbal duels in Congress, even elections themselves were experienced as things in which nothing definite was at stake’. 32 The important decisions were not taken in the presidential palace La Moneda, or in Congress, but in the social clubs frequented by the rich and famous (Club de La Unión, Club Hípico), and/or at social gatherings in the mansions of prominent public figures. Frequently there were family links between presidents, ministers and members of parliament. However, there were fundamental achievements under these regimes. The geographical unity of the country was consolidated by colonization and land conquest, and Chile’s current geographical borders were established. In addition, the Republic was consolidated in

The Road to Socialism of the Unidad Popular 11

an institutional sense, with orderly and regular transfers of executive power occurring. Finally, it was the state that assumed and fulfilled the function of defining Chilean nationality. Nevertheless, worker protests rocked Chile from top to bottom, ‘and the blood of those who had rebelled was shed in the desert, on the streets and on the lonely southern plains. What turned this former docile tenant into militant worker?’33 These changes, and the pressures from new social groups which until then had been extremely passive, were incomprehensible to the ruling class, which ‘continued to believe they were living among the people of 40 years ago; they had grown used to considering their situation untouchable and thought that the common people would remain as before, tranquil, making no demands and totally subordinated to their patrón’.34 This explains the arguments of the political right during the 1930s: (i) Democracy and universal suffrage meant replacing government by able men with government by demagoguery. To avoid this, it would be necessary to reestablish the ‘plural vote’, whereby people fulfilling certain conditions (being from ‘well brought-up families with education and property’) were granted more than one vote.35 (ii) Unlimited defense of private property; the state could intervene only to protect private property. (iii) Poverty was seen as inevitable, a fact of nature. In 1933 the president of the Conservative Party stated, The social fact that is most painful to see is the great number of poor people compared with the few rich. But this is inevitable, a natural situation that will always exist for as long as the world is the world; it is part of God’s plan that it should be so … If all of us were rich … the human race would die of hunger, and would thus pay for rebelling against divine punishment which condemned it to earn its daily bread by the sweat of its brow. For men to be able to live on the land, there have to be poor and rich. Thus, some people work in response to the goal of wealth, and others goaded on by poverty.36 In Chile, the evolution and expansion of political parties of the center and left were related to the development model and the leading role the state was steadily acquiring. In this regard, Pinto (1970) points to an important difference between Chile and Argentina. At the end of the nineteenth century, growth in Argentine exports was generated by that country’s farmers, a pattern of economic advance which placed the state on the fringe of the economic process. In Chile, on the other hand, the

12 The Unidad Popular and the Pinochet Dictatorship: A Political Analysis

state was the principal national actor – it managed to capture, administer, spend and distribute a significant part of the resources generated by exports (nitrate and copper) under foreign investor control. The public sector, linked to the state, became an important basis of support for parties of the center. In turn, the concentration of large groups of mine workers was the basis of support for parties on the left. It is worth mentioning that worker parties arose in Chile before the Russian Revolution of 1917. All these elements combined to form a relatively advanced sociopolitical structure in a country that was economically underdeveloped at the turn of the century. The Radical Party was the first important center party, and between 1920 and 1950 it became the mouthpiece of the urban middle class. The party’s platform can be summarized as follows: (i) It was critical of capitalism, but not of liberal democracy. It believed that through successive reforms it ought to be possible to improve the social welfare of all workers. (ii) It advocated that ‘individual capitalism’ should be replaced by a regime of social solidarity; this meant enhancing the role of the state as the economy’s engine and guiding force. The state was seen as a crucial instrument for realizing economic and social aspirations; it should be mediator and referee on socioeconomic issues. (iii) Limited private property rights were to be recognized, so as to restrict the political power of capital. In this way a more equitable income distribution would be achieved that would generate greater harmony among the social classes.37 The Radical Party’s economic program included the following elements: (i) A development strategy based on industrialization; this specifically meant reducing the relative importance of agriculture and mining. There was a kind of correspondence between industrialization, urban areas and the location of public administration, which was the basis of support for the political center. (ii) Significant expansion of public education: ‘To govern is to educate’ was the slogan of the first Radical Party president. Education was seen as the principal means of achieving economic and social mobility. (iii) The adoption of policies of a populist hue to enhance the distributive situation of the middle class and workers, thereby (temporarily) alleviating social tensions. This included an expansion of public-sector employment, wage rises above increases in productivity and the establishment of price controls, especially on mass consumption goods: food, transport and public utility services. From the 1960s onwards, the Christian Democrat Party usurped the Radicals as the main party of the center. Fundamental problems that

The Road to Socialism of the Unidad Popular 13

had not been addressed by the Radical Party, such as the agrarian issue and the ‘Chilenization’ of the GMC (Gran Minería del Cobre; Large Copper Mining), remained outstanding, to be dealt with by the Christian Democrats.38 Ahumada (1958, 1966) provides an overall interpretation of the ‘integral crisis’ that Chile was experiencing, and which constituted the conceptual basis underlying the Christian Democrat platform. According to Ahumada, this ‘integral crisis’ in Chile had several dimensions. In the first place, there was economic crisis, associated with slow growth and persistent distributional inequality. Secondly, there was a sociopolitical crisis caused by two distinct factors: on the one hand, an excessive concentration of power, due to the fact that powerful groups had managed to appropriate a ‘share of collective effort that was excessive in relation to their contribution, driving those lacking power into ostracism and marginalization’ (1966, p. 515). Power is a function of organization: unorganized groups have no power. In rural Chile prior to 1960, peasants had no power whatsoever; their isolation and lack of organization reinforced a situation of poverty and ignorance.39 In addition to this, there was also a crisis of social participation. It is important to be able to elect one’s representatives, but it is also essential to ensure that those elected ‘do effectively represent their electorate’; i.e. that they keep campaign promises. Demagoguery and the failure to fulfill commitments generates skepticism among people, and they begin not to care who gains power. A third dimension of the ‘integral crisis’ lay in a lack of solidarity among Chilean society. Solidarity is the feeling that ‘acts as a shock absorber and lubricant in solving the inevitable disputes that exist between different members of society. Solidarity is insufficient if it is impossible to mobilize a collective group effort to undertake tasks that are important for the life of the group’ (p. 516). ‘Revolution in Freedom’ was the solution proposed to this integral crisis. Ahumada (1966, p. 519) argues: ‘Revolution in Freedom’ is not against private property, nor against the market, nor pro-capitalist, nor pro-statist, nor pro-Communist. What is it for? What is it against? … It is for a just society, in which there is effective equality of opportunity so that all human beings, regardless of birth, may give their best according to their abilities; in which there is effective equality before the law and the wishes of the majority. It is for an efficient society that exploits the advantages of modern technology. It is in favor of a free society, with freedom to criticize and dissent, open to change; free to

14 The Unidad Popular and the Pinochet Dictatorship: A Political Analysis

submit to those who, in the name of that same freedom, interfere with freedom. It is in favor of a decent society. There was great similarity between the basic goals of the Radical Party and those of the Christian Democrats; both really wanted social modernization and the incorporation of marginalized sectors into society. However, in the eyes of the right, the social modernization and reforms of the Radical Party were a lot more tolerable than those proposed by the Christian Democrats. This explains why the political right allowed an old politician, who was a radical and a mason, supported by the mass of ordinary people, to take office in 1938, following an electoral victory by just 13 000 votes.40 The essence of the Radical Party’s program consisted of industrialization and the expansion of public education; social modernization would be achieved as a by-product of this. By contrast, the Christian Democrats explicitly advocated agrarian reform, the unionization of the peasantry and the setting up of institutions to organize and channel the demands of the popular sectors. A basic characteristic of the parties of the center has been their repeated defense of liberal democracy, systematically questioned by certain groups on both the right and left of the political spectrum. While some members of the right objected to universal suffrage, arguing, ‘How can the vote of a yokel (‘roto’) be worth the same as that of a gentleman?’, from the left it was the formal aspect of democracy that was objected to: ‘voting every four years only gives the appearance of change, when in reality everything stays the same: the exploiters and the exploited remain’. The political right and left joined in harrying the centrist parties for adopting ambiguous positions. Yet, it was precisely the political center that kept faith most strongly with its democratic convictions, guarding them and fighting for them in a very clear and unequivocal way. It was also the parties of the center, supported by the left, that promoted and led the deepening of democracy through the massive incorporation of new voters (see Table 1.5), as well as the organization of marginalized groups and their inclusion in society. From the 1930s onward, the group of parties on the left ‘put forward socialism as their ideal for society’.41 In their view, the country’s socioeconomic problems were related to its semi-feudal, semi-colonial structure: imperialism and the latifundio system were the root of all evil. Unless these roots of oppression were destroyed, it would be impossible to install a new system to allow an improvement in the effective well-being of the working class. In this, the basic aims of the leftist platform could clearly be inferred: expropriation and nationalization.

The Road to Socialism of the Unidad Popular 15

It is true that the left played an important role in consolidating democracy and creating Chile’s formal institutional framework during the twentieth century. However, from the turn of the century, some of the leading figures on the left had questioned the effectiveness of democracy as a mechanism for resolving the workers’ situation. They argued that formal democracy only served to preserve and protect the privileges of bourgeois capitalists,42 that it worked only for the small privileged class that controlled all the communications media, along with production and exchange, and that it did not serve the workers or the common people.43 The painful lesson of history, that everyone on the left has now learnt, is that although formal democracy is slow in resolving economic problems, when set against dictatorship it has real validity and is essential for avoiding terrible violations of human rights.

The foreign context It has been said that Chile is a perennial imitator of foreign models. The country has ‘played at French literature, English parliamentarianism and Swiss cantonism. And it has always ended in a caricaturesque mockery – a flawed version of the original.’ 44 This perception perhaps explains the impetus for originality seen from 1960 onward and captured in a series of political slogans: ‘Revolution in Freedom’, ‘the Chilean road to socialism’, ‘the monetarist route to lifting Chile out of Latin America’. The Russian Revolution of 1917 stimulated the creation of Communist parties throughout Latin America; the notion of class struggle was introduced in Chile, and workers saw an example of how to take power. The Great Depression suggested that the democraticcapitalist system of developed countries was in deep crisis, and this stimulated the vision of future worker governments everywhere. Popular Fronts took power in Spain and France, and the same happened in Chile in 1938, with a Popular Front comprised of the Radical Party and the left. After the Second World War, the Cold War provided the backdrop for invasions by US marines in Latin American countries (during the 1950s), aimed at preventing control of the government being obtained by members or sympathizers of leftist parties: it was widely believed that ‘democracy would only work in Latin America when those elected were sympathizers of the United States’. This attitude stimulated antiUS feeling, which was accentuated in the 1960s by the triumphant consolidation of the Cuban Revolution. Between 1810 and 1820, Latin

16 The Unidad Popular and the Pinochet Dictatorship: A Political Analysis

America had gained political independence from Spain; now, the Cuban model was pointing the way for Latin America to achieve economic independence from the United States. In synthesis, the Cuban Revolution caused a leftward shift of the whole political spectrum throughout Latin America. The political élite saw that a large part of the electorate were in favor of profound changes in the country’s economic structure, and the platforms of the different political parties began to include issues such as agrarian reform and the ‘Chilenizationnationalization’ of large-scale copper mining known as the GMC (Gran Minería del Cobre).45 In an attempt to neutralize anti-US sentiment in Latin America, at the beginning of the 1960s the United States government decided to promote the program known as the ‘Alliance for Progress’, aimed at accelerating the process of economic growth in the region. The rationale for this program was that faster economic growth would help to eradicate poverty and, in this way, win over supporters of leftist parties and sympathizers of the Cuban Revolution. The Alliance for Progress promoted two basic structural changes: agrarian reform and tax reform, policies which were supported by the political parties of the center and the left.

Increase in political participation In Chile a quasi-monopoly of suffrage was the mechanism that had given the political right control of the government for nearly a century; this quasi-monopoly ended in 1938: as Hamuy (1967) points out, the main effect of moving from a restricted electoral system to one that is broadly representative is the generation of pressure for greater change. This is because a large number of people suddenly acquire ‘something that they have never possessed or experienced: namely, power. The power to choose their political authorities’ (p. 494). When this huge, passive, formerly excluded mass of people was brought into the electoral system, they began to exert pressure through the vote for the state to respond to their social demands, thereby generating needs that surpassed existing resources. ‘The masses that have so suddenly been incorporated into the Chilean electoral process are changing and upsetting everything. Their inclusion has upset both the establishment and the solution to development problems at the same time.’46 Prior to 1920, the number of voters amounted to no more than 9 per cent of the total population of voting age; according to the figures

The Road to Socialism of the Unidad Popular 17

there had been no significant increase in the relative number of voters for 45 years (see Table 1.5). In other words, in the oligarchic order, ‘protected democracy’ kept more than 90 per cent of the voting-age population out of the electoral system; this is what has been described as the ‘quasi-monopoly of suffrage (by the right) that restricted access to the government to the most able’. It would be interesting to see studies investigate the mechanism for selecting the most able and make a critical assessment of the results of this process. As the center steadily acquired greater political power, a significant increase in the absolute and relative number of voters occurred – the process that has been called ‘democratic deepening’. Following 30 years of social upheaval between 1890 and 1920, the percentage of those eligible to vote who actually exercised their right nearly doubled in the subsequent 18 years (rising to nearly nearly 15 per cent). Once the center came to power in 1938, this process accelerated

Table 1.5

Chilean Voters and Population, 1870–1989

Total Voting-age Percentage of voters in populationa populationa,b Voters Total population Voting-age population (000s) (000s) (000s) (%) (%) (1) (2) (3) (4) = (3)/(1) (5) = (3)/(2) 1870 1876 1885 1894 1915 1920 1932 1942 1952 1958 1964 1970

1 943 2 116 2 507 2 676 3 530 3 730 4 425 5 219 5 933 7 851 8 387 9 504

919 1 026 1 180 1 304 1 738 1 839 2 287 2 666 3 278 3 654 4 088 5 202

31 80 79 114 150 167 343 465 954 1 236 2 512 2 923

1.6 3.8 3.1 4.3 4.2 4.5 7.8 8.9 16.1 15.7 30.0 30.8

3.3 7.8 6.7 8.7 8.6 9.1 15.0 17.4 29.1 33.8 61.4 56.2

1989

12 961

8 240

7 142

55.1

86.7

Source: Borón (1971). Notes: a For years not coinciding with a population census, total and voting-age population were estimated on the basis of population growth rates between censuses. b Voting-age population corresponds to inhabitants of at least 21 years old before 1970, and at least 18 years old thereafter, estimated on the basis of data on population over 15 and 20 years of age, allocating years corresponding to 18-, 19- and 20-year-olds on a pro-rata basis.

18 The Unidad Popular and the Pinochet Dictatorship: A Political Analysis

significantly; in little more than a decade the 1920 percentage of voters more than tripled, with the recognition of women’s right to vote (1947) accounting for a large part of this increase. Thereafter, in the space of just 20 years the relative percentage of voters topped 50 per cent of the voting-age population (see Table 1.5): by 1970 the relative number of voters had grown to seven times its 1920 level.47 The breakup of the right’s quasi-monopoly of suffrage caused a gradual decrease in its political power, as can be seen in Table 1.6 and Figure 1.1. Indeed, as democratic deepening proceeded,48 the percentage vote obtained by the right correspondingly declined. A simple econometric model makes it possible to quantify this relation:49 an increase of 10 percentage points in the relative percentage of voters (i.e. a rise in the percentage of registered voters from 20 to 30 per cent) caused a 6.4 per cent reduction in the percentage of the vote won by the right in the period before 1970; an implicit assumption here is that people who vote once for a given political party continue to vote the same way. The econometric results are statistically

Table 1.6 Results of Chilean Parliamentary Elections, 1912–1969 (percentages)

1912 1918 1921 1925 1932 1937 1941 1945 1949 1953 1957 1961 1965 1969

Right

Center

Left

75.6 65.7 54.6 52.2 32.7 42.0 31.2 43.7 42.0 25.3 33.0 30.4 12.5 20.0

16.6 24.7 30.4 21.4 18.2 28.1 32.1 27.9 46.7 43.0 44.3 43.7 49.0 36.3

0.0 0.3 1.4 0.0 5.7 15.3 28.5 23.0 9.4 14.1 10.7 22.1 29.4 36.6

Sources: Borón (1971) and Valenzuela (1978). Note: The right includes the Liberal and Conservative parties, the center comprises the Radical, Agrarian Labor and Christian Democrat parties and the left includes the Socialist and Communist parties. As from 1965, half of the votes for the Radical Party are included in left and the other half are assigned to the center. Percentages do not add up to 100 per cent as they do not include independents or other political parties not mentioned above.

The Road to Socialism of the Unidad Popular 19 70 Right Wing Voters/Total Voters (%)

1918 60 1921 1925

50

1945 1937 40

1949 1957

1932

30

1961

1941 1953

20

1969 1965

10 0 0

10

20

30

40

50

60

70

80

Voters/Voting Age Population (%) Figure 1.1

Right-Wing Voters (Parliamentary Elections)

significant and suggest a very simple hypothesis: greater electoral participation was probably the fundamental factor in explaining the loss of the right’s political power in the twentieth century, involving a drastic cut in its share of the vote in parliamentary elections, which plunged from 70 per cent in the pre-1920 period to below 30 per cent in the 1960s. Obviously a deeper analysis would be needed to fully explain the causes of this phenomenon. In the ruling electoral system it was possible for a candidate to win the presidency with less than 50 per cent of the votes. There was a desire to change this situation for the presidential election of 1970, by establishing a second-round election between the first two relative majorities, when the leading candidate in the first round had less than 50 per cent of the vote; however, this initiative failed to gain parliamentary support either on the right or on the left. Table 1.7 shows the number and share of the votes won by the winning candidates in three presidential elections held between 1938 and 1970. In 1938 the Popular Front candidate, Pedro Aguirre Cerda, won with 48.1 per cent of the votes and a difference of 13 000 votes over the second-placed candidate (Gustavo Ross); this margin represented 2.9 per cent of the total votes cast. In 1958 the winning candidate, Jorge Alessandri, obtained 31.6 per cent of the vote, polling 33 000 more votes

20

Table 1.7

Results of Three Chilean Presidential Elections: 1938, 1958 and 1970

Candidate

1938 No. Votes/ of votes total (000) (%)

Votes/Pop. voting age (%)

Candidate

1958 No. Votes/ of votes total (000) (%)

Votes/Pop. voting age (%)

Candidate

1970 No. Votes/ of votes total (000) (%)

Votes/Pop. voting age (%)

P. Aguirre G. Ross

212 199

48.1 45.1

7.2 6.8

J. Alessandri S. Allende

390 357

31.6 28.9

8.8 8.1

S. Allende J. Alessandri

1070 1031

36.4 35.1

20.5 19.7

Total Votes:

441

–

15.0

Total Votes:

1236

–

28.0

Total Votes:

2923

–

56.2

The Road to Socialism of the Unidad Popular 21

33 000 votes more than the runner-up (Salvador Allende); this difference represented 1.1 per cent of the total votes. In 1970 Salvador Allende won with 36.4 per cent of the votes and by 39 000 votes over the secondplaced candidate (Jorge Alessandri); on this occasion, the margin of his victory was 1.3 per cent of the total vote. If one takes the number of votes obtained by the winners of these presidential elections in relation to the population of voting age as a point of reference, the following picture emerges: the winning candidate in 1938 obtained 7.2 per cent of the votes of the voting-age population; this percentage rose to 8.8 per cent in 1958 and to 20.5 per cent in 1970. On the other hand, the percentage difference between the first- and the second-placed candidates was 0.4 per cent of the voting-age population in 1938, 0.7 per cent in 1958 and 0.8 per cent in 1970. Thus, Salvador Allende’s triumph in the 1970 presidential elections, by a relatively narrow margin, was consistent with the recent Chilean historical trend; one could even argue that Allende’s representativeness in 1970 was greater than that of Alessandri in 1958 or Aguirre Cerda in 1938. However, when what is at stake is a change in the ruling political and economic system, the elected president ought to need very significant electoral support.

The two governments prior to Unidad Popular During the period 1950–70, the Chilean economy was characterized by chronically high inflation, moderate growth and frequent balance of payments crises. In fact, the economy represented a typical case in the old structuralist–monetarist controversy relating to the determinants of inflation. Jorge Alessandri (1958–64), an independent candidate, was elected president in 1958 with the support of the right, and the economic priority of his government was to control inflation. His long-term outlook included two main elements: (i) Success in the counterinflationary program would generate a better economic environment that would automatically stimulate growth. (ii) Distributional problems would mainly be resolved through economic growth – an expansion of the ‘economic pie’ whose corresponding spillover (or ‘trickle-down’) would eradicate poverty and resolve the social issue. The Christian Democratic government of Eduardo Frei (1964–70) came to power with an absolute majority of 56 per cent of the popular vote, drawing electoral support from a spectrum of political parties

22 The Unidad Popular and the Pinochet Dictatorship: A Political Analysis

ranging from the center to the right. It is thought that the votes of the right basically represented a vote against Salvador Allende rather than support for Eduardo Frei. The economic program of the Frei government focused on introducing basic structural changes, such as agrarian reform and Chilean participation in the ownership of the GMC. The long-term Christian Democrat vision was to achieve redistribution with growth, in the framework of changes in the ownership structure in certain economic sectors (copper and agriculture). Table 1.8 shows the evolution of the principal macroeconomic variables during the Alessandri and Frei governments. In general terms, the following was true for both governments: economic growth fluctuated around 4 per cent per year, the annual inflation rate was about 26 per cent and unemployment stayed close to 6 per cent. The major difference between the two related to the issue of distribution: real-wage growth remained below 2 per cent per year during the Alessandri government, but rose to 8 per cent a year during the Frei government, when there was also a fall in the level of unemployment compared to the previous presidential period. There is no doubt that workers began to increase their bargaining power significantly under the Christian Democrat administration. In the two governments leading up to 1970, the macroeconomic situation was relatively under control, with moderate and stable growth rates. During the Frei government there was also a significant increase in workers’ purchasing power; the wage adjustment mechanism incorporating 100 per cent backward indexation (on past inflation) was established during this period. The Christian Democrat government undertook some basic structural reforms, which were implemented gradually so as not to undermine macroeconomic stability. There was a perception that structural reforms could generate short-term disequilibrium, so, when an accumulation of inflationary pressures built up, priority had to be given to restoring macroeconomic stability. The agrarian reform process was undertaken to modify the existing pattern of landholding and to bring the peasant population into the political and economic structure. The ‘Chilenization’ of the GMC consisted of negotiating the acquisition of a 51 per cent share in the ownership of the large mines: a process initiated in 1967, when the Copper Corporation (CODELCO) purchased 51 per cent of the El Teniente mine from Kennecott, for US$80 million, and also acquired 25 per cent of the Andina and Exótica mines. Following these deals, a significant rise in the world price of copper occurred, which increased the companies’ profits, and this put greater pressure on the

Table 1.8

Principal Macroeconomic Variablesa during the Alessandri and Frei Governments, 1958–1970

Alessandri (1958–64) Frei (1964–70)

Economic growth (%)

Annual inflation (%)

National unemploymentb (%)

Real wages – annual growth rate (%)

Exports (% GDP)

International reservesc (months’ imports)

3.7 3.9

25.8 26.2

7.5 5.5

1.8 8.0

14.5 15.4

2.2 4.9

Sources: Central Bank of Chile; INE. Notes: a Annual average for the corresponding presidential period. b Period 1960–64 for the Alessandri government. c Value for the final year of the period.

23

24 The Unidad Popular and the Pinochet Dictatorship: A Political Analysis

Frei government to expand state ownership of the GMC. In 1969, the government acquired 51 per cent of the mines in Chuquicamata and El Salvador from Anaconda for US$180 million, to be paid at an interest rate of 6 per cent per year over the following 12 years.50 The 1960s were characterized by a sharp increase in political and social activity. The number of registered voters rose from 1.5 million in 1958 to over 3.5 million in 1970 – a 130 per cent increase in just 12 years. In addition, the number of people belonging to unions, which had been virtually unchanged since 1950, doubled during the Frei government. In the course of six years, the unionization of manual workers expanded by 38 per cent and that of white-collar workers by 90 per cent. In the same period, union membership among peasant workers grew from only 2000 people in 1964 to more than 114 000 in 1970 (see Table 1.9). By the end of the decade, the evolution of external sector variables was quite positive (see Table 1.8). Total exports amounted to US$1112 million, in which the share of copper was over 75 per cent. During the 1968–70 period the economy benefited from the high price of copper in the world market, which climbed to record levels in real terms. International reserves had always been in the two-digit range prior to 1968, and the relatively high level achieved in 1970 (US$394 million – equivalent to nearly five months’ imports) was seen by the Frei government as an indicator of responsible economic performance. The popular perception of the Frei government in 1970 was a mixture of recognition and disappointment. On the one hand, good initial performance in the first three years was acknowledged, when growth accelerated and inflation was brought down. But, at the same time there was a sense of frustrated expectations in the face of greater political and social participation and the economic results. It is interesting to note that despite the significant and sustained rise in real wages during the Frei administration, the number of strikes went up considerably (see Table 1.10). The macroeconomic austerity implemented from 1967 onwards to contain inflationary pressures was not supported or understood by the majority of workers, even though there was no cumulative deterioration in real wages, nor a significant rise in unemployment. Despite the structural reforms that were introduced, the assessment of the Frei administration made by the Unidad Popular was damning: ‘it failed to break the traditional model of economic and social structures’; in other words, it was a reformist government that made

Table 1.9

Evolution of Unionization in Chile, 1932–1970 Mining and Industry sectors No. of unions No. of members

1932 1952 1960 1965 1970

421 1982 1892 2026 4001

Peasant sectors No. of unions No. of members

54 801 283 383 271 141 290 535 436 974

421 15 23 33 510

54 801 1 035 1 825 2 126 114 112

Total No. of unions

No. of members

– 1997 1915 2059 4511

– 284 418 272 966 292 661 551 086

Source: Third Presidential Message to the National Congress, 1973.

25

26

Table 1.10

Number of Strikes and Evolution of Real Wages, Chile, 1960–1970

Number of strikes Annual increase in real wages (%)

1960–64a

1965

1966

1967

1968

1969

1970

98 0

142 13.9

586 10.8

693 13.5

648 –2.0

1127 4.3

1580 8.5

Sources: Number of strikes: Martner (1988); Real wages: Ffrench-Davis (1973). Note: aFigures refer to the total for the period, i.e. the total number of strikes in 1960–64 was 98; the annual change in real wages in the period 1960–64 was 0.

The Road to Socialism of the Unidad Popular 27

less of a break with the past than it should have done (see references in Pinto, 1970).

The Unidad Popular view of the Chilean economy51 The Unidad Popular diagnosis According to the Unidad Popular (UP), the Chilean economy in 1970 was based on four fundamental characteristics that needed to be corrected: it was monopolistic, externally dependent, oligarchic and capitalist.52 The following indicators from the 1960s are evidence of the degree of concentration existing in the economy: (a) 248 firms controlled all economic sectors, and 17 per cent of all firms owned 78 per cent of all assets. (b) In industry, 3 per cent of firms controlled more than 50 per cent of value-added and nearly 60 per cent of capital. (c) In agriculture, 2 per cent of properties accounted for 55 per cent of the land. (d) In mining, three US companies controlled large mining copper production, which accounted for 60 per cent of Chile’s exports in 1970. (e) In wholesale commerce, 12 firms – 0.5 per cent of the total – accounted for 44 per cent of all sales. (f) In the banking sector the state bank (Banco del Estado) controlled nearly 50 per cent of all deposits and loans, and three private banks (out of a total of 26) controlled more than 50 per cent of the rest.53 Supposedly, these big monopolists had increased their share and their profits thanks to numerous special measures, such as preferential credit lines, subsidies, special tax breaks, differential tariffs and special access to foreign currency. According to a UP analyst, ‘the role of the State has always been to favor big monopoly capital and its basic interests’.54 As regards Chile’s external dependency, the following was pointed out: (a) the mono-exporting nature of the country, with copper accounting for over 75 per cent of total exports, meant that fluctuations in the copper price on world markets had a huge effect on Chile’s balance of payments and on government revenues. (b) Profit repatriation by foreigners represented about 20 per cent of exports. (c) Of the 100 largest industrial companies at the end of the 1960s, 61 had foreign shareholder participation. According to Vuskovic (1970), who later became Minister of Economics in the UP government, the significant presence of foreign firms provoked a high degree of external dependency because imported technology meant that production methods in Chile were copied

28 The Unidad Popular and the Pinochet Dictatorship: A Political Analysis

from abroad, and because Chile also acquired the consumption patterns of the developed countries (the so-called ‘demonstration effect’). In addition the Chilean bourgeoisie began to acquire a pattern of interests and tastes which were identified more with international capital than with national interests. The oligarchic nature of the economy was attested to by the pattern of income distribution in the 1960s. While the poorest 10 per cent of the population received a 1.5 per cent share of total income, the richest 10 per cent took 40.2 per cent. The ratio between the income of these two groups was 1 to 27.55 From the UP point of view, these characteristics showed that the fruits of Chile’s economic development were being concentrated among a small privileged élite. According to Vuskovic, the process was being perpetuated in the following way. (i) The unequal distribution of income was generating a differentiated pattern of consumption and demand in which the market was dominated by goods demanded by high-income groups; consequently, firms basically produced to satisfy this type of demand. (ii) There was a dual productive system, comprising a modern high-technology sector and another backward sector. While the first of these incorporated technological progress into the production of goods for high-income groups, the backward sector stagnated. The growing participation of foreign investment reinforced this dual structure. (iii) Because of the relatively small volume of goods demanded by highincome groups, and given their broad spectrum of consumption, modern firms operated at an inappropriately low scale with low levels of efficiency. Consequently, the structure of production was inefficient, as mainly non-essential goods were being produced. The small scale of production led to greater concentration, thereby reinforcing the initial bias in the pattern of income distribution. This was a vicious circle, in which the initial unequal pattern of income distribution generated a productive structure that was highly monopolistic and which accentuated the existing income distribution bias. Inequalities in income and wealth led to a high degree of concentration of power; thus, the interrelationship between political and economic power reinforced the structure prevailing in the country. In order to change these economic conditions, a substantial change in the structure of ownership was needed. This would generate a different pattern of demand which would stimulate the production of the basic goods consumed by the vast majority. Thus, economic resources would not be wasted in producing non-essential products.56

The Road to Socialism of the Unidad Popular 29

The economic proposals of the Unidad Popular The UP platform made an explicit statement of its anti-imperialist, anti-oligarchic and antimonopoly nature, and this set the tone for the profound structural changes it proposed to carry out, which would be to the benefit of both blue- and white-collar workers, as well as peasants and small-scale entrepreneurs – in short, the overwhelming majority of the Chilean population. The UP government was to be a historic experiment in which the transition to socialism would take place through existing institutional structures. To facilitate this transition, two elements would be needed: nationalization of the means of production and greater popular participation. The political objectives of the UP were set out very clearly.57 Their declared purpose was the establishment of the most democratic regime in Chile’s history, by transferring power from dominant groups to the workers. For this purpose Chilean workers would have to acquire real power, and use it effectively. The aim of the structural changes was ‘to overcome capitalism’, and what was at stake was replacement of the ruling economic structure by the construction of socialism. The UP structural reforms were wide-ranging: (a) Nationalization of the country’s main resources (the GMC, coal, nitrate, iron and steel). (b) Expansion of the Area of Social Ownership by nationalizing the biggest industrial companies. (c) Intensification of agrarian reform. (d) Nationalization of the banking system. (e) State control of the main wholesale and distribution firms. In synthesis, the structural reforms aimed at transferring control of the means of production into state hands. The advantages and the rationale for this goal were that if the state gained control of the means of production, it would be in a better position to take economic decisions giving priority consideration to workers’ welfare. Such control would produce an increase in the economic surplus controlled by the state. With the additional resources obtained, the state could plan and guide economic development in a direction favoring the vast majority. In fact, according to the UP critique the main problem is not efficiency but a question of power: who controls the economy and for whom? … What is at stake is the ownership of the means of production by a small minority; so, the real economic issues are: who has the power to set prices, and hence profits, and who captures the economic surplus and decides how to reinvest it? … Focusing the discussion on efficiency avoids

30 The Unidad Popular and the Pinochet Dictatorship: A Political Analysis

having to discuss who really holds economic power and why the small minority who own the means of production can subjugate the majority. In the words of the Minister of Economics, Pedro Vuskovic, shortly after Allende assumed the presidency, ‘State control is projected to destroy the economic base of imperialism and class domination by putting an end to private ownership of the means of production’.58 One current of opinion within the Unidad Popular maintained that short-run macroeconomic policies were complementary to and supportive of the structural reforms, thereby demonstrating that ‘it is possible to carry out deep structural reforms and at the same time achieve significant positive results in the redistribution of income, growth, inflation and employment’.59 This, as was explained, was because even traditional macroeconomic policies contain an implicit class dimension: ‘short-run policies, by definition, are a tool to maintain the status quo’: not only are they the expression of a given institutional context, but they aim at its consolidation. In this sense, the macroeconomic policies of the UP could not be analyzed separately: ‘this would be a serious analytical error … they should be examined within the prevailing context that will provide the rationale explaining why what was done was done’.60 In a different viewpoint, it has been argued that controlling of inflation was really a key objective for the UP for political and economic reasons. At the political level, the UP had announced during the campaign that it would defeat inflation, and it had criticized previous governments for their inability to bring this problem under control. Furthermore, given the proximity of municipal elections (March 1971), the UP government rapidly needed some indicator of success. From the economic standpoint, given that income redistribution was to be carried out via nominal wage increases, it was important to reduce inflation so as to ensure a rise in real wages. Key elements in UP macroeconomic arguments for the rapid expansion of economic activity were the high levels of spare capacity and unemployment existing in the Chilean economy, as well as a high level of international reserves and industrial inventories. UP economists made no comment on constraints relating to the level of specific sectoral capacity, which can differ widely from the overall figures, nor to the fact that bringing available spare capacity into use is a ‘once-only’ take-up of slack. A mechanistic assumption implicitly suggested that structural changes would rapidly help to solve future bottlenecks.

The Road to Socialism of the Unidad Popular 31

The UP counter-inflation policy was based on the following arguments: (a) Inflation is really a structural phenomenon. Price controls, the abolition of the mini-devaluation crawling peg system and the new economic structure would bring inflation to a halt. (b) State control of the greater part of the production and trading apparatus would lay the foundations for ending inflation. (c) Given a combination of price controls and wage increases, wages would rise more than prices, and this would lead to a cut in per-unit profit rates. However, in view of the existence of spare capacity, an increase in output and sales would compensate for the decline in per-unit profits, thereby maintaining their overall level.61 According to the UP Minister of Finance, the effects of these measures would mean that, in a very short period of time, ‘price increases will disappear and in the future inflation will be remembered as a nightmare of previous governments that were the servants of large-scale capital’.62 The UP program itself contained a less rhetorical point of view, according to which inflation would disappear because of anti-monopoly measures and the support of the majority of the population.

The macroeconomic situation during the Unidad Popular Populist policies It has been argued that the UP government implemented a set of clearly populist macroeconomic policies, aimed at achieving a rapid revival of the economy alongside extensive redistribution.63 According to this populist paradigm, expansionary policies initially generate a high growth rate with a rise in real wages, with price controls holding down inflationary pressures. The initial stage of a populist program produces highly successful results – high growth simultaneously with lower inflation and greater purchasing power for the workers. In the second stage, the strong expansion of demand generates growing disequilibrium: stocks become exhausted; the foreign sector acts as a safety valve, but foreign currency starts to become scarce. All of this stimulates the inflationary process, together with capital flight and a demonetization of the economy. The public sector experiences high deficits as a result of subsidizing mass consumption goods and the exchange rate; at the same time, tax revenue shrinks in real terms, and the public deficit rises substantially. The third stage ends in government attempts to apply a counter-inflationary adjustment policy, cutting subsidies and lowering real wages. Subsequently, a different

32 The Unidad Popular and the Pinochet Dictatorship: A Political Analysis

government, with greater credibility, will apply a tough orthodox stabilization program whose consequences are unemployment and a loss of purchasing power among low-income groups. In brief, this populist paradigm inflicts a terrible cost on the very groups it was intended to favor. Latin America has lived through numerous populist experiences; systematically, all have ended in abject failure. So, why do these experiments continue to occur, and why is their course of action not altered when they do fail? Sachs (1990) suggests that populist economists do not understand the extent of the risks involved in the type of measures they adopt. As the populist experience is successful at the outset, thereby boosting the government’s popularity, any questioning of growing disequilibria is ignored as mere (and irritating) technicality: either something will turn up to resolve such problems (this is what Sachs calls ‘the magic solution’) or else future problems will be resolved by the structural transformations being carried out in the present. However, it needs to be understood that the growing disequilibria, which ultimately lead to collapse, are the outcome of the excessive success of the initial phase. Nevertheless, and despite the fact that the UP macroeconomic policy prescription fully coincided with those of typical populist governments, Bitar (1979) and Larraín and Meller (1990) argue that the expansionary policies were really a mechanism for obtaining a strong base of political support to enable them later to carry out radical changes in the Chilean economy and society. It is beyond doubt that the basic aim of the whole experiment was this radical transformation, and not simply an improvement in the distribution of income and a higher growth rate. What the UP was proposing was nothing less than the replacement of a capitalist system with a socialist one, and its real intention was to bring this about. The evolution of the macroeconomy64 An auspicious beginning: 1971 The Chilean economy lived through an unprecedented boom in 1971, as a result of highly expansionary economic policies. There was widespread improvement in the population’s living standards, and a sensation of total success among the UP leaders. 65 However, a cool analysis of the economic situation would reveal growing disequilibria, as we shall see. In terms of traditional macroeconomic variables, the first year of the UP government achieved results that were relatively spectacular for the

The Road to Socialism of the Unidad Popular 33 Table 1.11 Evolution of the Main Macroeconomic Variables, Chile 1970–1973 (percentages)

GDP growth rate Inflation rate (CPI) Unemployment (national) Real wages (annual increase)

1970

1971

1972

1973

3.6 36.1 5.7 8.5

8.0 22.1 3.8 22.3

–0.1 260.5 3.1 –16.6

–4.3 605.1 4.8 –25.3a

Sources: Central Bank of Chile, CIEPLAN, ODEPLAN. Note: a Corresponds to the first three quarters of 1973.

Chilean economy (Table 1.11): (i) The annual rate of GDP growth climbed to 8.0 per cent, much higher than the 3.6 per cent figure of the previous year, and the highest growth rate since 1950.66 (ii) Inflation came down from 36.1 per cent in 1970 to 22.1 per cent in 1971. It is interesting to note that in the first quarter of 1971 (there were municipal elections in March), the rate of price increases fell to very low levels compared with Chile’s normal inflation rate: during this period, inflation was 3.4 per cent on an annualized basis, compared with 16.2 per cent in the equivalent period in 1970. (iii) Nationwide unemployment fell significantly, dropping from 5.7 per cent in 1970 to 3.8 per cent in 1971; this latter figure was the lowest recorded in Chilean statistics.67 Quarterly figures on unemployment in Greater Santiago show a reduction in the number unemployed from 8.3 per cent in the fourth quarter of 1970 to 3.8 per cent in the fourth quarter of 1971. (iv) Average real wages rose by 22.3 per cent. Another interesting result was an improvement in the income distribution in an overall sense, and specifically among blue-collar workers: low-wage blue-collar workers received larger real wage increases than workers with relatively high wages (Table 1.12). Real minimum wages for blue-collar workers rose by 39 per cent in 1971, whereas those of white-collar workers went up by ‘only’ 10 per cent over the same period. In this way, the differential between minimum wages for whiteand blue-collar workers narrowed from 49 per cent (1970) to 35 per cent in 1971. This narrowing gap between white- and blue-collar workers was considerably less pronounced when measured in terms of average wages: whereas the average real wage for blue-collar workers rose by 20 per cent, the average for white-collar workers went up by 19 per cent. Thus, the share of labor in GDP increased from 52.2 per cent in 1970 to 61.7 per cent in 1971, compared with an average of 48.4 per cent during the

34 The Unidad Popular and the Pinochet Dictatorship: A Political Analysis Table 1.12 Minimum and Average Real Wages for Blue- and White-Collar Workers, Chile 1970–1973 (1970 = 100) Minimum real wages Blue-collar White-collar 1970 1971 1972 1973a

100 139 123 76

100 110 86 48

Average real wages Blue-collar White-collar 100 120 108 80

100 119 99 78

Sources: World Bank and CIEPLAN. Note: a Corresponds to the first three quarters of the year.

period 1960–69. These figures were the outcome of a combination of policies aimed mainly at generating an expansion in aggregate demand. As has been seen, the wages policy meant a 22.3 per cent rise in average real annual wages, obviously far greater than productivity increases. Central government spending grew by 36 per cent in real terms, expanding the share of fiscal spending in GDP from 21 per cent in 1970 to 27 per cent in 1971. As part of this expansion, the public sector launched into a gigantic housing program, initiating the construction of 67 000 houses in 1971, compared with 24 000 in 1970. Finally, monetary policy was accommodating, so as not to affect the expansion of demand and production: M1 expanded by 119 per cent in 1971.68 These economic measures were based on generalized price controls. In a context of nominal wage hikes above 50 per cent, government spending rising by more than 60 per cent in nominal terms and the money supply expanding by more than 100 per cent, the annual inflation rate in 1971 (22.1 per cent) seems surprisingly low. However, this is explained by price controls in the private sector and the freezing of public-sector utility prices.69 Two factors explain the relative success of price controls. 70 Firstly, the government gained both direct and indirect control of the links in the chain of production and consumption, through numerous institutional changes. The supervisory functions of public agencies of commercialization and control, already in existence, were extended, and new ones were created. In addition, the principal private-sector wholesale and distribution firms were nationalized, and bank credit line facilities were linked to price fixing, through government intervention. Finally, neighborhood consumer watchdog commitees known as JAPs (Juntas de Abastecimientos y Precios) were set up, which were supposed to check that local shops were keeping to official prices and

The Road to Socialism of the Unidad Popular 35

maintaining stocks of merchandise. Secondly, the overall climate of structural reform, in which many firms had been taken over or expropriated by the government, led entrepreneurs to adhere to official price directives. It was very risky to do otherwise: entrepreneurs had to think twice before violating official prices because this government was not like previous ones. Consequently, the overexpansion of real wages in 1971 was related in a significant way to the effectiveness of price controls. However, wage increases for workers exceeded the limits set by the UP government with the union confederation CUT (Central Unica de Trabajadores), despite the latter being controlled by the political parties in the UP. The long union tradition of maximizing wage increases explains this behavior, together with competition from Christian Democratic union leaders, who sought to improve on offers achieved by their rivals in the UP, so as to gain popularity among the workers. First signs of disequilibrium Despite the glittering overall picture, several indicators were pointing to a growing disequilibrium during the course of the year. The general government budget deficit grew from 3.5 per cent of GDP in 1970, to 9.8 per cent in 1971. At a broader level, the consolidated nonfinancial public-sector deficit went up, from 6.7 per cent to 15.3 per cent. Credit, to the public sector alone, expanded by 124 per cent, and more than 90 per cent of loans granted by the Central Bank to the public sector took the form of primary money. This was one of the causes of the 119 per cent growth in M1. In short, monetary policy was totally out of control. The level of international reserves, meanwhile, fell by 59 per cent. In fact the loss of reserves could have been greater, but in November the government suspended external debt service and entered into rescheduling negotiations. The trade balance went from a surplus of US$95 million in 1970 to a deficit of US$90 million in 1971, with the sharp fall in the world price of copper the main factor behind this deterioration. Only drastic import controls and exchange rate appreciation prevented a larger external trade deficit that year. As well as exchange controls, the main tool used to control imports was a 10 000 per cent prior deposit requirement, a preexisting regulation that the UP government used intensively, significantly increasing the number of products covered by it. While the overall level of consumption rose by 12.4 per cent in 1971, total gross investment declined by 2.3 per cent: whereas publicsector investment rose by 10.3 per cent, private-sector investment fell by 16.8 per cent.

36 The Unidad Popular and the Pinochet Dictatorship: A Political Analysis

Given the abrupt rise in real wages and strict price controls, profits in the productive sector necessarily contracted. The first signs of scarcity began to be seen in the second half of 1971. This was not considered a serious problem by the UP economists, but more as the natural outcome of income redistribution policies and as a symptom of past disequilibrium. The significant increase in meat consumption (18 per cent), for example, was related to redistribution. In the past, a high-income family consumed 180 kg per year, whereas a lowincome family consumed just 20 kg per year. Therefore, a redistribution of income towards low-income families would necessarily have to raise the overall consumption of meat, especially when one considers that lower-income groups have a higher propensity to consume than highincome families.71 In reply to the criticism that the economy was overheating, some UP economists argued that, if the policy of income redistribution had failed, if counterinflationary policy had failed, there is no doubt that there would had been sufficient spare capacity, international reserves and stocks of merchandise, because it would have been a repetition of the traditional adjustment mechanism of earlier years. The success of the economic policy (of the UP) is related precisely to the disappearance of constraining variables.72 By the end of the year, there were many signals pointing to a significant acceleration in inflation for 1972: the large increase in the money supply, the high fiscal deficit, the new wage increase in January 1972, the practical impossibility of a further contraction in profits in the productive sector, the exhaustion of provisions and stocks, the sharp contraction in international reserves and the appearance of black markets for many products. However, the reaction of the authorities was practically nil. Whereas in 1970 official speeches had identified inflation as a key variable, in the Finance Minister’s November 1971 annual report to the nation not much was said in this respect, beyond mentioning that the counter-inflationary policy of 1971 would be maintained in 1972. Total decline and collapse: 1972–73 As happens with all populist governments, the total decline and collapse of the UP experiment were the clear consequence of earlier ‘successful’ overexpansionary policies. The favorable initial results increased the

The Road to Socialism of the Unidad Popular 37

popularity of the Allende government, causing criticisms of the presence of various disequilibria to be dismissed as mere technicalities. Moreover, the UP government was faced with a difficult dilemma: a cut in real wages was needed to attenuate the existing disequilibria, but such a solution would damage its progressive and revolutionary image. Several economists and sectors within the UP government ‘considered that it was impossible to pursue the expansionary-redistribution policy’, and suggested that 1971 had been ‘the year of redistribution’, but 1972 would have to be ‘the year of accumulation’.73 However, nothing was done: no adjustment or modification was made to economic policies. In discussion on what steps to take, several groups in the governing coalition put forward a series of conditions that were incompatible with solving the problem: maintaining the distributive situation already achieved along with conditions for continued progress with structural changes. This illustrates the UP government’s inability to take decisions in response to the obstacles that arose: multifarious interpretations and solutions put forward by different groups, together with the demands of the different parties within the coalition, paralyzed decision-taking. Paradoxically, this inaction on the part of the UP government led to laissez-faire. One interpretation has suggested that ideology prevailed, suggesting that more importance was given to maintaining the government’s progressive and revolutionary image than in reducing disequilibria. Probably, in situations of misgovernment, more ideological and radical positions do predominate. Until 1972 nominal wage increases were awarded at the beginning of the year. The wage adjustment policy of 1972 followed the pattern of the previous year – nominal wage increases fully indexed to the 1971 CPI (21.1 per cent), but with a higher nominal increase of 32 per cent for the minimum wage. However, once again, in the first quarter of 1972 wages rose more than the amount specified by official policy. Even the government did not apply its own wage policy, and average wages (weighted by employment) in the public sector rose by 48 per cent.74 Clearly, this was hardly an efficient way of reducing the public-sector deficit, which amounted to 15.3 per cent of GDP in 1971. The increase in public-sector wages, together with a big expansion in subsidies to state-owned enterprises (SOEs), amounting to 4.6 per cent and 9.5 per cent of GDP in 1972 and 1973, respectively, and a decline in income from taxes (revenue fell by 3 per cent of GDP in 1972 and by a further 3 per cent in 1973), generated large publicsector deficits: 24.5 per cent in 1972 and 30.5 per cent in 1973. Given the rudimentary nature of the capital market, a significant portion of

38 The Unidad Popular and the Pinochet Dictatorship: A Political Analysis

these deficits (60 per cent in 1972 and 73 per cent in 1973) ended up being financed through monetary emission by the Central Bank. The final outcome were monetary expansions of 173 per cent in 1972 and 413 per cent in 1973; in the space of three years, the money supply grew by 30 times. This huge increase in the quantity of money had clear destabilizing effects on suppressed inflation, scarcity and external imbalances. Black markets sprung up for most goods, and the gap between official prices and those on the black market widened. On the external front, a substantial exchange rate appreciation led to contraband in exports of all kinds of tradable goods. Table 1.11 provides a perspective on the years 1972 and 1973 within the overall period. The following features can be identified: (i) The fall in GDP was not so spectacular in relative terms, compared to the paralyzed economic climate.75 (ii) An inflationary surge registered record levels in the long history of Chilean inflation: 260 per cent in 1972 and 605 per cent in 1973 (as measured by the CPI). However, the producer price index (WPI) pointed to an inflation figure above 1000 per cent for 1973. (iii) The national unemployment rate rose modestly. (iv) Total gross investment fell by 20 per cent in 1972 and dropped a further 6 per cent in 1973; consequently, the level of investment in 1973 was 26.7 per cent below the 1970 figure. (v) Real wages plummeted, but this was not perceived empirically at the time, because there were two distinct types of prices following very different paths: the system of official prices and those on the black market.76 In short, the awarding of excessive nominal wage increases, in order to raise real wages and improve the distribution of income, failed completely: the macroeconomic policy of the UP reduced workers’ purchasing power by 23 per cent. Eight years were to pass before workers’ real wages regained the level they had been at in 1970. Supposedly, when scarcity and bottlenecks become widespread the external sector acts as a safety valve; a restricted supply of imports is seen by most agents as the main economic constraint. However, the fall in domestic production in many cases was the main cause of the domestic goods scarcity: for example, agricultural output of food products. Table 1.13 shows the sharp increase in total imports, measured in current dollars, between 1970 and 1973: while food imports grew 3.8 times between 1970 and 1973, capital goods imports declined over the same period. In physical terms, wheat imports expanded from 200 000 tons in 1970 to 951 000 tons in 1973, while domestic production declined by 43 per cent during the same period.77

The Road to Socialism of the Unidad Popular 39 Table 1.13 Selected Components of the Balance of Payments, Chile 1970–1973 (US$ million) 1970 Total exports (FOB) Copper exports Total imports (CIF) Food imports Capital goods imports Trade balance Current account Balance of payments

1112 839 956 136 276 156 –81 114

1971 999 701 1015 192 248 –16 –189 –300

1972 849 618 1103 318 186 –253 –387 –231

1973 1309 1049 1447 512 243 –138 –295 –112

Source: Central Bank of Chile.

Net short-term international reserves held by the Central Bank contracted by 62 per cent in 1972 compared to their 1971 level: this means that the UP government lost 84 per cent of its initial stock of reserves in just two years. In 1973, net disposable short-term international reserves were equivalent to only two days’ imports. The explosion in public spending For the Allende government, public spending was a mechanism that had to fulfill several objectives: economic revival, urgent redistribution and solution of social problems, and the financing of structural reforms. For the redistribution function, various mechanisms were put into operation: (a) Wage increases and an expansion of public-sector employment, which generated growth in the public-sector payroll by 3.7 per cent of GDP in a single year (1971) and an additional rise of 1 per cent in the following year. Note that in 1973 these relative amounts fell back to the 1970 level (Table 1.14); most of the reduction of the payroll in 1973 corresponded to a cut in real wages in the public sector. Table 1.15 illustrates the significant expansion of employment in the public sector: between 1970 and 1973, central government employment and employment in public-sector firms expanded by 50 per cent and 35 per cent respectively. These two elements alone – high wage increases and an excessive expansion in public employment, equivalent to an increase in the public sector payroll of nearly 5 per cent GDP – were already generating an unmanageable fiscal imbalance. (b) Figures for social expenditure went up considerably, rising by 59.4 per cent in real terms in just two years (see Table 1.16). A significant part

40 The Unidad Popular and the Pinochet Dictatorship: A Political Analysis Table 1.14 (% GDP)

Consolidated Non-Financial Public Sector, Chile (1970–1973)

1970 Current income Taxes Direct taxes Indirect taxes Current expenditure Wages and salaries Social security payments Social area subsidies Savings Net capital income Capital formation Total expenditure Total balancea General government deficit State enterprises deficit Area of social ownership deficit

38.14 25.50 7.73 10.82 30.86 15.83 8.60 0.00 7.28 3.57 10.41 41.27 –6.69 –3.51 3.19 0.00

1971

1972

1973

37.65 26.35 6.19 11.66 39.45 19.54 11.87 0.00 –1.79 –3.00 10.48 49.93 –15.28 –9.76 –5.52 0.00

34.48 23.60 4.28 11.13 46.41 20.50 11.86 4.60 –11.93 –2.96 9.64 56.05 –24.53 –14.12 –5.81 –4.57

21.26 20.37 5.68 10.12 41.05 15.76 6.03 9.49 –19.79 –2.35 8.35 49.39 –30.48 –10.52 –10.46 –9.52

Source: Larraín (1986); reproduced in greater detail in Larraín and Meller (1990). Note: a Financing of the deficit was mostly domestic, via monetary emission.

of this increase did not necessarily correspond to more goods and services in social spending, but instead to real wage increases awarded to staff in the education and health sectors. (c) Another important redistributive element involved handouts of specific goods. During those years half a liter of milk was distributed freely to every child in the country and 1 800 000 breakfasts and 560 000 lunches every day to schoolchildren, as well as 128 000 school overalls and aprons and 4 000 000 exercise books.78 Another element used for distributive purposes was a subsidy on rates charged for public utility services: between 1970 and 1973, the real price of electricity fell by 85 per cent, mail and telephone services went down by 33 per cent and 23 per cent respectively and bottled gas by 21 per cent; real fuel prices (gasoline and petroleum) fell by 31 per cent between 1970 and 1972, to recover in 1973.79 Control of public utility prices generated operating losses for state-owned enterprises (SOEs). Other elements, that were not anticipated, also acted to raise the level of public expenditure. Instead of helping to finance the expansion of fiscal spending, SOEs (excluding CODELCO) began to put increasing pressure on fiscal resources. In a single year (1971), SOE deficits grew by

The Road to Socialism of the Unidad Popular 41 Table 1.15 employed)

Public-sector Employment in Chile, 1970–1980 (number of people

1970 Central governmenta State enterprisesb Area of Social Ownershipc

National Health Service (SNS) CODELCO State Railroad Company Post and Telegraph Company

1971

196 353d 167 587

1972

295 553d 226 321 162 545

1973

204 655d 130 842

159 592d

1970

1973

1980

54 360 23 697 27 185 10 871

68 627 31 484 26 404 11 059

62 924 29 958 11 193 7031

Source: Sjastaad and Cortés (1981). Notes: a Includes public employees in ministries only. Excludes teaching staff (Ministry of Education), ENAP, ENAMI, CODELCO, Banco del Estado, Armed Forces. b For a complete list of state enterprises, see Sjastaad and Cortés (1981). The evolution of employment in the biggest firms (number of people) was as follows: c The Areas of Social Ownership with the highest number of employees were: textiles (28 310), coal (15 650), pharmaceutical-chemicals (13 900). The total figure includes traditional state enterprises such as Endesa-Chilectra (12 950), CAP-INDAC (10 900), ENAP (5350), IANSA (3300), etc.; these are excluded from the other state enterprises figures. d Month of September for 1970 and 1973; month of June for 1980.

2.3 per cent of GDP; a further additional increase of 0.3 per cent was reported in 1972. Disaster struck in 1973 when deficits exploded to 10.5 per cent of GDP (see Table 1.14). Part of these losses related to the subsidy to public-services charges just mentioned, but another part was due to management problems within the firms themselves. Companies in the Area of Social Ownership, meanwhile, instead of producing surpluses

Table 1.16 Social Expenditure during the Unidad Popular Government, Chile 1970–1973 (1976 US$ million) Education 1970 1971 1972 1973

362 473 524 355

Health 154 212 248 237

Total housinga

Social spending

109 229 228 230

Source: Martner (1988); basic data reproduced from the World Bank (1979). Note: a Also includes other social welfare expenditure.

635 924 1012 828

42 The Unidad Popular and the Pinochet Dictatorship: A Political Analysis

to speed up the growth of the Chilean economy, rapidly became sources of demand on fiscal resources (see Table 1.14). Social security was a further component of spending to undergo significant increases, with social security payments rising by 3.3 per cent of GDP in 1971 alone. It is worth pointing out that military pensions, which at the end of the 1960s averaged approximately three times the average of civil pensions, grew almost fivefold during this period. All the above meant increases in the expenditure of the consolidated non-financial public sector from 30.9 per cent of GDP in 1970 to 39.5 per cent in 1971 and to 46.4 per cent in 1972. Given this magnitude of public expenditure, it is pertinent to examine what was happening to public revenues. The UP economists blamed the opposition-controlled Congress for failing to legislate the tax increases needed to finance the expansion of public spending. But, even if it had done so, the income of the public sector could have not expanded at the explosive pace of expenditure. Tax revenue increased slightly in 1971 compared to 1970, but in subsequent years there was a severe contraction, with a decrease of more than 5 per cent of GDP in tax collected in 1973 compared to 1970 (see Table 1.14). Within this reduction in tax revenue, indirect taxes maintained their relative level (between 10 per cent and 11 per cent of GDP), while direct taxes declined gradually; the rise in inflation affected direct taxes via the delay in collecting them (the Olivera–Tanzi effect). A reduction in social security contributions was the main factor underlying this drop in tax revenue, especially in 1973. An additional, partly exogenous element also caused a substantial decline in public-sector income during this period. In 1971 there was a sharp fall in the international price of copper, and this, combined with the policy of maintaining an artificially appreciated exchange rate, drastically reduced GMC revenues and, hence, funds received by the Treasury. The final outcome of the excessive expansion of public expenditure and decline in tax revenue was a widening and disproportionate public-sector deficit; the 6.6 per cent deficit of 1970 grew successively to 15.3 per cent in 1971, 24.5 per cent in 1972 and 30.5 per cent in 1973. The deficit in 1973 was shared almost equally between the government sector (10.5 per cent), public-sector firms (10.5 per cent) and firms in the Area of Social Ownership (9.5 per cent). The main, indeed almost exclusive, source of financing was of domestic origin, with an overwhelming preponderance of monetary emission (the

The Road to Socialism of the Unidad Popular 43

Central Bank was not autonomous at this time, but totally dependent on the Finance Ministry, as it remained until 1989). Vuskovic (1975, pp. 18–19) gives a very particular explanation for the generation of these growing public deficits: behind the fiscal deficit lay both overt and covert resistance, on the part of the bourgeoisie, against contributing the resources needed to sustain basic public services and improve the incomes of workers in the public sector; a refusal by Congress to legislate new taxes together with their imposition of budget cuts, and even an active campaign of resistance to paying existing taxes. Scarcity, black market and rationing The existence of imbalances, combined with a reluctance to apply orthodox adjustment policies (austere fiscal and monetary policies plus the freeing of prices combined with a wage freeze), clearly accentuated the magnitude of the disequilibria. The only existing instruments were controls, but these lost effectiveness as time passed; in such circumstances, black markets sprung up and proliferated, as did speculation in most goods markets, especially for food products. To combat speculator-intermediaries, the state set up distribution channels for basic products at official prices, but as the differential between official prices and those on the black market was very wide, a queuing phenomenon arose, leading to the creation of a new profession of ‘queue stander’. However, this did not solve the underlying problem, since the sales of goods at official prices were limited to small quantities, whereas on the black market there was the option of buying larger amounts. Furthermore, it was enough for a good to be offered in the official market in limited quantities for people to assume a future cut in its supply; this stimulated hoarding and the appearance of a black market in the good in question. In the second half of 1972, already high and accelerating inflation (in three figures on an annual basis) coexisted with widespread scarcity and proliferating black markets, and the price differential between the official and the black market widened to between five and 10 times for a wide variety of products.80 The explanation given by the economic authorities was as follows: scarcity and black markets were the result of counter-revolutionary actions by reactionary groups and ‘enemies of the people’: ‘the black market is a synthesis of anti-patriotic actions on the part of conserva-

44 The Unidad Popular and the Pinochet Dictatorship: A Political Analysis

tives … it is false to blame current consumption problems on bad government policies’.81 In a context of scarcity and black markets, nominal wage increases become ineffective. The official CPI underestimated the true inflation rate, and access to goods supplied at official prices became crucial.82 Therefore, the UP economists argued that direct government control of the distribution of goods, accompanied by rationing, was a necessary and efficient mechanism to combat the black market and guarantee the maintenance of real consumption levels among lowincome groups. The logic of the controls led to an intensification of their use: when existing controls become ineffective, the final solution seems to be total control. In December 1972, the Finance Minister announced the following measures to deal with the situation: (i) The creation of a nationwide state distribution agency (Secretaría Nacional de Distribución) to centralize wholesale trade and prevent goods flowing to the black market. SOEs would send their entire output and would suspend payments in kind to their workers. Private firms were offered special deals on purchase contracts ‘which would be difficult to refuse’. (ii) At the retail level, there would be direct control of the distribution of goods, so that ‘all families would receive a basket of goods according to their real needs’; for this purpose, the agency would ‘set a quota per family for goods such as oil, sugar, rice, coffee and meat, up to a total of 30 products which would be distributed by the JAPs’; the JAPs would ‘define the real needs of each family’.83 This official announcement that ‘rationing was on the way’ had an impact on several fronts. In the first place, there was a sharp increase in demand, especially for non-perishable consumer goods. Everyone tried first to obtain goods specifically mentioned on the Finance Ministry’s list, then afterwards all kinds of consumer goods which it was imagined would be included in the ‘basket of 30 products’. In other words, the official announcement of measures to resolve the problems of scarcity and black market only worsened them: most families tried to stock up with any consumer product they could find in the market. Meanwhile, political opposition hardened. The Chilean economy was perceived to be heading towards a comprehensive and generalized system of rationing controlled by the state and the JAPs, where money would be replaced by party credentials and connections. Moreover, the infrastructure needed to implement the rationing scheme did not exist at that time; there were only a few dispersed ‘popular baskets’

The Road to Socialism of the Unidad Popular 45

distributed by certain state agencies to their political clientele and to JAPs located in low-income communities.84 Despite the dramatic and chaotic nature of the situation, the UP government won 45 per cent of the vote in the March 1973 parliamentary elections. Several factors influenced this, but without doubt rhetoric and ideology played an important role: low-income groups still perceived that ‘the UP government was their government’85 and felt that they had to support it through thick and thin. However, after the elections the situation deteriorated still further, and the economy headed towards total collapse. How the story ended is well known. The evolution of the exchange rate In situations of political and economic instability and uncertainty, the parallel or black market exchange rate is an indicator that synthesizes what is happening, reflecting the existing degree of distortion. From the conceptual point of view, the exchange rate can be viewed as the price of a financial asset of high relative liquidity. Asset markets are closely integrated and they adjust rapidly to eliminate disequilibria; the black market exchange rate adjusts almost instantaneously to the latest news. Domestic assets (pesos) and foreign assets (dollars) are imperfect substitutes, and this turns exchange rate risk and expectations of devaluation into crucial variables for determining the exchange rate path and the differential (or premium) between the official and parallel rates. Expectations regarding future political and economic events are reflected in this premium even before the events take place, and the existence of the premium makes economic policy management difficult, often generating a sort of self-fulfilling prophecy. The premium is highly volatile, and this causes instability in the goods market: a rising premium causes black market prices for tradable goods to rise. In a context where ‘news’ or ‘rumors’ are circulating about confiscations, expropriations and rising taxes on domestic non-financial assets, the black-market exchange rate takes on a life of its own, totally independent of the official exchange rate or even of expectations of devaluation of the official rate. Nearly all these conceptual elements were present in the evolution of the parallel exchange rate in the period 1970–73. The exchange rate premium86 went up from 36 per cent in the first quarter to 50 per cent in the second half of 1969 (a year before the presidential elections), and during the pre-election period in 1970 it rose to 90 per cent. This would corroborate the hypothesis that the premium was anticipating the expected triumph of Salvador Allende; however, it also went up

46 The Unidad Popular and the Pinochet Dictatorship: A Political Analysis Table 1.17 Quarterly Evolution of the Official and Parallel Exchange Rate, Chile 1970–1973 Quarter

1970

1971

1972

1973

I II III IV I II III IV I II III IV I II III IV

Real exchange rate Official Parallel (E°/US$ January 1970) 9.95 10.03 10.01 9.67 9.29 8.51 8.04 7.80 7.96 6.75 7.05 5.27 4.35 3.20 2.69 8.38

15.21 18.54 22.11 23.77 29.13 34.18 43.99 43.16 45.00 64.01 87.83 61.92 79.66 121.41 110.43 22.68

Premium or differential parallel rate/ official rate 1.53 1.85 2.22 2.46 3.14 4.03 5.47 5.54 5.67 9.55 12.51 11.80 18.53 38.57 40.76 2.73

Source: Central Bank and Chilean newspapers.

significantly in the post-election quarter, topping 146 per cent. From this moment on, the premium went on up, with the parallel rate climbing to 40 times the official exchange rate in the quarter preceding the military coup (Table 1.17).87 In the following quarter, the parallel rate was ‘only’ 2.7 times the official exchange rate, and it had dropped back to 1.3 times by the fourth quarter of 1974. In synthesis, it is true that the premium reflected expectations of future political and economic events, but it only captured and anticipated part of them. Once the event actually occurred, the premium suffered considerable variations; this was seen both in the post-election period of 1970 and in the post-military coup period of 1973. For 1970–73 the more appropriate hypothesis is that the parallel exchange rate followed its own course, totally independently of the official exchange rate. The official rate appreciated continuously throughout the period of the UP government, with the official dollar price falling by more than 70 per cent in real terms. The 217 per cent real devaluation that occurred in the wake of the military coup was unable to fully regain

The Road to Socialism of the Unidad Popular 47

the real 1970 value of the official rate. Exchange controls, high tariffs and non-tariff barriers prevented the expansion of imports that would otherwise have been generated by the highly appreciated real value of the official exchange rate. The real parallel rate, meanwhile, displayed a diametrically opposite trend, depreciating almost continuously throughout the period (except for the six months leading up to the parliamentary elections of 1973, when there was a reversal of the trend). The real parallel exchange rate at the end of the UP government was five times higher than at the start. This evolutionary pattern suggests that as the Allende government carried out its program of nationalization, expropriation and confiscatory interventions, totally passive in the face ‘occupations’ of estates and firms, the value of the most internationally liquid asset in the Chilean economy was being pushed up. Given the systematically rising trend of the real parallel exchange rate after March 1973, it could be argued that despite economic paralysis and the wave of rumors, the military coup was not an event that had been anticipated by most economic agents operating in the black market for foreign currency.

The structural reforms of the Unidad Popular Without doubt, structural reforms were the distinctive feature of the UP government. As has been mentioned above, its diagnosis of the functioning of the Chilean economy pointed to four structural characteristics that needed to be corrected: it was capitalist, it was dependent, it was oligarchical and it was monopolistic. These characteristics were generating contradictions that constituted an increasingly powerful brake on economic development, and as a result, there was an ever worsening of the people’s living standards. ‘It is the very structure itself that is in crisis’ (Finance Minister, Exposición del Estado de la Hacienda Pública, November 1970, p. 12). The solution, therefore, was to change the structure: in other words, to bring the economy under state control. The UP program made clear what state control or nationalization of the Chilean economy would consist of: The nationalized sector of activities will cover the following: 1. 2.

The large copper mines, together with nitrate, iodine, iron and coal mines. The country’s financial system, especially private banks and insurance.

48 The Unidad Popular and the Pinochet Dictatorship: A Political Analysis

3. 4. 5. 6.

Foreign trade. Large firms and distribution monopolies. Strategic industrial monopolies. Activities in general which constrain the nation’s social and economic development, such as the production and distribution of electrical power, along with rail, air and sea transport, communications, the production, refinery and distribution of oil and its derivatives (including liquid gas), iron and steel, cement, petrochemicals and heavy chemicals, wood pulp and paper’.88

The whole UP program was anti-capitalist. Other measures addressed the other perceived weaknesses of the Chilean economy: GMC nationalization was anti-imperialist; the intensification and completion of agrarian reform was anti-oligarchic; and the creation of the Area of Social Ownership was anti-monopolistic. Nationalization of GMC GMC nationalization featured in the electoral platforms of both the UP and the Christian Democrat candidates in the 1970 presidential election. As we have seen, this process had already been initiated in the Frei government with the ‘Chilenization’ of the GMC. Moreover, given the progressively conflictive historical relationship between the US firms which were operating the GMC and successive Chilean governments, the vast majority of the population were in favor of such a measure. In December 1970, just one month after taking office, the UP government sent a bill to Congress containing a constitutional reform to nationalize the GMC; it should be remembered that the UP did not have a majority in Congress. The rationale for sending a constitutional reform bill instead of an ordinary bill was that the former would allow the government to call a plebiscite if it was rejected in Congress. Constitutional reform also underscored the seriousness of the proposed decision to nationalize the GMC, and sent a clear signal to the US government that nationalization enjoyed broad national support. Finally, constitutional reform would provide a lot of flexibility in dealing with the legal and technical measures established in the earlier ‘Chilenization’ process. The Joint Congress unanimously approved nationalization of the GMC in July 1971. The constitutional decree of nationalization established the state as the sole owner (with absolute and exclusive

The Road to Socialism of the Unidad Popular 49

control) of all minerals in Chilean territory, 89 automatically anulling all contracts previously established in the GMC. The constitutional reform also established a compensation mechanism for the US firms involved (Anaconda and Kennecott). (a) Expropriated firms had the right to compensation in line with the book value of their assets; but from this book value the following factors had to be deducted: any revaluation of assets after 1964, 90 the value of assets in defective condition and the ‘excess profitability’ which the US firms were supposed to have perceived from 1955 onwards.91 (b) The payment of compensation would be carried out over a maximum period of 30 years at an interest rate around 3 per cent. In the decree, Congress specified criteria for calculating the US firms’ ‘excess profitability’: comparison of profitability in Chile with the international profitability of the parent companies, and contracts made by the Chilean government with foreign firms in which maximum profitability clauses existed. Although the US firms had the right to appeal against the resulting size of the compensation, President Allende’s decision on the estimated amount of ‘excess profitability’ could not be appealed against. Table 1.18 illustrates this issue. The calculation of excessive profitability92 produced negative figures which not only meant that Chile would pay nothing for the GMC, but that in practice foreign firms were deemed to owe significant amounts to the Chilean state.93

Table 1.18 Calculation of Compensation Associated with the Nationalization of Large Copper Mining, 1971, (US$ million) Chuquicamata

El Teniente El Salvador Exótica Andina

Less: Assets (book value) Defective assetsa Asset revaluation Excess profits

242 18.5 0 300

319 21 199 410

68 6 0 64

15 5 0 0c

20 2 0 0c

Net compensation

–76.5b

–311b

–2b

10

18

Source: Fortín (1979); original source: Contraloría General de la República. Notes: a Includes specific duties that the Chilean state charged on the mines. b A negative sign indicates a balance favorable to the Chilean state. c The Exótica and Andina mines began operations in 1971.

50 The Unidad Popular and the Pinochet Dictatorship: A Political Analysis

The view of some UP economists was that GMC nationalization ‘brought imperialist exploitation of our main basic wealth to an end, and partially corrected historical errors by discounting the excessive accounting profits obtained by the company since 1955 from the compensation to be paid’. In other words, the ‘backbone’ of national development became Chilean, without a single penny having been paid. A superficial comparison between the processes of GMC ‘Chilenization’ and nationalization that focuses exclusively on the compensation paid suggests that nationalization was more convenient for Chile. However, when one considers the reprisals taken by the US companies and the US government (which included, among other measures, the freezing of CODELCO bank accounts in USA, the inability of CODELCO to acquire inputs and replacement parts in USA, and obstacles to doing so in other countries, the departure of more than 150 GMC technicians and supervisors who received job offers from Anaconda and Kennecott in other countries, a financial blockade of Chile in public and private-sector banks in the USA and in multilateral agencies, and difficulties and confiscatory rulings related to the marketing of copper), it is not at all obvious that the cost of GMC nationalization was zero, or less than the cost of ‘Chilenization’. This case illustrates a more general problem: the lack of political realism on the part of the UP government to build into its analysis the possible reaction of agents affected by measures taken by the government. Agrarian reform and the end of Latifundism94 In the early 1960s there was a consensus regarding the poor performance of the agricultural sector: it was seen as a stagnating backward sector. Because of underused productive resources, it was unable to generate self-sufficiency in food, which created inflationary pressures and external imbalances. Under the Alessandri government the first Agrarian Reform Act was passed (Law No. 15 020, 1962), permitting the expropriation of badly run estates in exchange for a compensation paid immediately in cash. The Frei government had a dual purpose in agricultural modernization: on the one hand, to increase food production and agricultural productivity; and on the other, to bring the marginalized mass of peasant people into society and into the market economy. Using the previous Agrarian Reform Act, the government Agrarian Reform Corporation (CORA) managed to expropriate more than 500 estates (1.2 million hectares) in three years.

The Road to Socialism of the Unidad Popular 51 Table 1.19 Agrarian Reform during the Governments of Frei and Allende, 1964–1973

No. of properties Government of E. Frei (1964–70) Government of S. Allende (1971–73) 1971 1972 1973

Expropriations Area

1400

3557

4409 1379 2189 836

6409 2027 3013 833

Occupations of properties 214a

1278 1228 n.d.

Sources: Martner (1988), Kay and Silva (1992) for the figures on ‘occupations’: the breakdown of the yearly ‘occupations’ figures is as follows: 1965: 13; 1966: 18; 1967: 9; 1968: 26; 1969: 148; 1970: 456. Note: a Includes figures relating to the period 1965–69.

But the Christian Democrat platform (‘Land for those who work the land’) aimed to create 100 000 new agricultural owners, and for this a new Agrarian Reform Act was needed (Law No. 16 640, 1967) to facilitate the expropriation process. This new legislation set an upper limit to estate size (80 hectares of basic irrigation equivalent), and it was now no longer necessary to prove that an estate was badly run or abandoned. The owner could maintain a ‘reserve’ up to 80 hectares, and the rest was automatically subject to compulsory purchase. Furthermore, estates could not be subdivided. Compulsory purchase compensation would be paid with 30-year bonds; less than 10 per cent would be paid in cash. The new law enabled practically double the number of estates and hectares to be expropriated during the ensuing three years of the Frei administration (see Table 1.19). In addition, a legal provision was passed permitting peasants to join unions and organize (Law No. 16,625; see Table 1.9). Such unions had to concern themselves exclusively with union matters (wage negotiations, improvements in working condition, and so on), and under no circumstances could they take part in the expropriation process. The ‘occupation’ of estates was considered illegal, and the government made it clear that ‘an occupied estate would not be expropriated’. For the UP, agrarian reform was crucial to the task of transforming an underdeveloped capitalist society into a socialist one; this meant not only

52 The Unidad Popular and the Pinochet Dictatorship: A Political Analysis

the compulsory purchase of all latifundios, but also that ‘the bulk of the agrarian sector should be in state hands, or else in the hands of peasant or consumer cooperatives’.95 The UP platform argued for ‘speeding up the Agrarian Reform process … without owners having a preferential right to choose their reserve’.96 Once in government a proposal was made to lower the maximum size of properties to 40 hectares, but, as this did not gain the necessary parliamentary majority, the existing Agrarian Reform Act was used instead. In the first year of the Allende government nearly as many estates were expropriated as during the whole Frei administration, using the same legislation (see Table 1.19). In the second year the process was intensified still further, and the ‘destruction of the latifundio system’ was practically completed. There was also a surprising increase in peasant unionization: by 1971 there were 208 000 unionized peasants – an 82 per cent increase on the previous year.97 In synthesis, during the first year of the Allende government there was a notable acceleration of the agrarian reform process and in peasant unionization; for many UP sympathizers, this showed how efficient the left was compared to the reformist stance of the Christian Democrats.98 Obviously, this rapid process created and fomented a degree of peasant effervescence that was impossible to restrain, seting off an upsurge of illegal property occupations or ‘tomas’ (see Table 1.19), in which there was no lower limit to what was ‘occupiable’. According to the prevailing rationale of the time, occupations were seen as ‘another indicator of the growing class struggle in agriculture, and revealed the strength the peasant movement had acquired, which was seen as a very important element for the future development of the class struggle nationally’.99 Despite illegal expropriations, the bulk of agrarian reform was carried out through the existing legislation. In this sense, the Chilean case contrasts with other Latin American experiences in which agrarian reform has been the consequence of massive social upheavals that have completely altered the structure of agrarian landholding.100 However, despite the existence of a legal framework and the validity in the idea of the need to incorporate the mass of marginalized peasant people, the situation generated a dangerous conflict in terms of political stability: their political and social inclusion necessarily altered the existing relationships between the social classes. Given asset redistributions and land expropriations as well, the degree of conflict evidently increased and gained strength. So should the agrarian reform process never have been started? The truth is that, in the second half of the twentieth century, it was neither possible nor sustainable for

The Road to Socialism of the Unidad Popular 53

nineteenth-century socioeconomic relationships in Chilean agriculture to remain virtually unchanged; in reality, the process should have been initiated much earlier, which would have provided the time needed to carry it out in a gradual and a moderate way. Compensation was another issue. Agrarian reform during the period 1965–73 meant the expropriation of more than 6000 properties covering an area of 10 000 hectares; the capital losses for the former owners have been put at close to US$1billion.101

Creation of the Area of Social Ownership102 The creation of the Area of Social Ownership (APS), which involved bringing the country’s main industrial firms under state control, symbolized the essence of the UP’s ideological nature. Transferring the means of production of a capitalist company to the APS was the mechanism ‘to achieve the effective socialization of those means and manage them so as to seek not only maximum profits, but a better use of productive capacity, an increase in employment and investment, and the use of national raw materials, etc., and for output to be organized in accordance with the needs of the vast national majorities’.103 The process of nationalization and socialization of industry is based on the Marxist concept of ‘the historical need to transform relations of ownership and production to permit a true development of productive forces’. ‘When a certain phase of development is reached, productive forces in society clash with existing production relations or, to express the same thing in legal terms, with the rights of property relationships that have been developed until then.’ (Quoted material from Ramos, 1972.) In synthesis, by bringing ‘the strategic monopolies’ under state control, the creation of the APS was the most innovative and crucial element of the UP program in the construction of socialism. The state would now be able to capture sizeable surpluses or monopoly rents, whose reinvestment would enable high and sustained growth to be generated. The Allende government found some difficulty in operationally defining what it understood as ‘monopoly’ or ‘strategic industry’,104 as well as great legal problems in developing the APS, because the parliamentary opposition obviously displayed its total disagreement with such a project. The impossibility of passing new legislation that would allow setting up the APS, led the Allende government to take advantage of any currently valid law or clause for this purpose: this was referred to as ‘exploiting legal loopholes’.

54 The Unidad Popular and the Pinochet Dictatorship: A Political Analysis

For the compulsory purchase of firms, Decree Law No. 520 (August 1932) was used. This legislation had been passed by a 100-day socialist government of that year – one of several short-lived governments that held power during the chaotic first few years of the 1930s. The legislation had been kept valid although it had never been used. Despite not being a law passed in the usual way, every government and parliament had declared its applicability. The law permitted the expropriation of industrial and commercial firms involved in the production and distribution of prime necessity goods for the following reasons: productive recession, the hoarding of goods, and idle productive capacity in times of scarcity. As can be appreciated, the definition of these concepts was sufficiently vague for most firms eventually to be subject to compulsory purchase. There was one legal restriction, however: expropriation required full compensation in cash, of an amount determined by an independent tribunal. In summary, although the law existed, applying it would be very costly. An alternative procedure to expropriation was ‘intervention’ or ‘requisition’ of firms, which consisted in placing a private firm under state administration. This was a legal action under the Return to Work Order (Decreto de Reanudación de Faenas) introduced at the start of the 1940s, allowing ‘intervention’ when there was a stoppage of work caused by labor disputes and/or a work stoppage in industries vital to the national economy. This procedure could not be used directly to transfer ownership of the company, but in practice this was often the outcome. Labor disputes would be instigated by government sympathizers, or set off spontaneously to provoke intervention. By that time, the financial situation of the firm was already weak, and the subsequent management by a state-appointed administrator, together with a growing scarcity of raw materials, weakened the intervened firm even further. After a while, many owners were ready to sell their firms to the government. The authorities also made use of an administrative device to weaken owners’ resolve. As has been seen, the economy was operating under generalized price controls. A state agency, known as DIRINCO (Dirección Nacional de Industria y Comercio), had attributions to approve price increases in goods and services throughout the economy. By the simple expedient of rejecting price increases at a time of rapidly rising wages, DIRINCO could endanger a firm’s financial situation. This was another procedure used to convince proprietors to sell. Despite resistance by the owners of industrial firms and the high level of political conflict generated in the cities, the pace of intervention and

The Road to Socialism of the Unidad Popular 55 Table 1.20 Productive Enterprises under State Control, by Economic Sector, Chile 1970 and 1973 (number of firms) Majority shareholding in equity capitala 1970 1973

Firms intervened in without Total participation in equity 1970 1973 1970 1973

Industry Mining Forestry Fishing Services Construction Others

26 2 5 4 0 1 6

57 8 9 12 0 8 24

0 0 0 0 0 0 0

168 13 7 8 27 10 26

26 2 5 4 0 1 6

225 21 16 20 27 18 50

Total

44

118

0

259

44

377

Source: See Larraín (1991) for a more detailed breakdown by industrial sectors and by percentage equity share. See also Martner (1988) and de Vylder (1974). Note: a More than 50 per cent shareholding.

requisition was quite fast: every other day a productive firm was intervened during the first two years of the Allende government. In this way, the industrial APS managed to embrace 225 productive firms (see Table 1.20), employing nearly 130 000 people and accounting for about 20 per cent of industrial employment and 40 per cent of industrial output.105 If the other productive sectors are included, in 1973 the Chilean state was in control of 377 productive firms, including an appreciable proportion of the biggest ones (see Table 1.20). State control of the banks106 From the very beginning the UP set about gaining absolute control of the banking sector. In December 1970 President Allende stated, ‘only when the banks are in the hands of the people, through the government which represent their interests, will it be possible to fulfill our program’. In the words of the Minister of Economics, ‘it does not suit anyone, except for a few circles of big economic interests, for the banks to continue to be a tool for the concentration of credit and, especially, income and wealth’; the nationalization of the banks meant democratizing credit by extending it to medium- and small-scale entrepreneurs, and implied drastic cuts in interest rates.107 During the early months of 1971, the government managed to acquire all foreign banks through a process of negotiation in which compensa-

56 The Unidad Popular and the Pinochet Dictatorship: A Political Analysis

tion was set in each case. However, the foreign banks represented a very small fraction of the country’s financial activity, and the big challenge was to gain control of local private-sector banks. Lacking a legal basis for bank expropriation, and perceiving the impossibility of obtaining Congressional approval for legislation to this effect, the government had recourse to a more simple method. It opened a purchasing power for bank shares at very attractive prices; CORFO conferred powers on the state bank, Banco del Estado, to acquire bank shares and the Central Bank set up a special credit line to finance the operation. At the same time, the government also began to intervene in the banks, basing this on two pretexts: the detection of some financial irregularity or the existence of labor problems that were preventing normal operations. Faced with the choice of selling their shares at a good price or ending up with shares of dubious value in banks with severe problems, shareholders decided to sell on a massive scale. Echoing what had happened in the mining, agricultural and industrial sectors, this process took place extraordinarily rapidly. As 1971 came to an end, state control over the banking system was almost total. As the Finance Minister announced in November that year, nationalization of the banking system has practically been completed. The State now controls 16 banks which together provide 90 per cent of all credit … This nationalization process means that the links between financial capital and industrial monopoly capital have been broken.108 Thus, in little over a year, CORFO, acting through the Banco del Estado, acquired a majority shareholding in 14 commercial banks and a minority 30 per cent holding in the three remaining banking institutions. The state’s participation in financial operations was even greater than this suggests: several other public institutions offered medium- and long-term credit, the most important of which were CORFO, CORA, the National Mining Company (ENAMI) and the National Savings and Loans System (SINAP). In global terms, 85 per cent of the financial sector in Chile was in state hands by 1973.

Property rights The UP’s structural reforms attacked and called into question the institution of property rights. For that reason, it is surprising that GMC

The Road to Socialism of the Unidad Popular 57

nationalization enjoyed unanimous national support, agrarian reform had the support of more than 70 per cent of society, the creation of the APS was supported by about 40 per cent of the population, and there were no great objections or resistance to bank nationalization. Was there any rationale justifying the expropriations? Is it fair to expropriate an asset belonging to a private agent because the social welfare gain is greater than the individual loss? Copper was considered too important for national development to be left in foreign hands; this explains the GMC expropriation process. Agrarian reform was based on the need to modernize the economic and social conditions of Chilean agriculture. But, if foreign firms were the owners of the GMC and landowners were the proprietors of the big latifundios, what right did the government have to interfere with and even expropriate their possessions? What things can an individual possess that are not subject to the possibility of expropriation? In other words, how sacrosanct is private property? From the legal point of view, individuals faced a serious restriction as regards private ownership: they could not refuse a purchase offer (or expropriation) by the government, as they would a similar offer from another private agent. The government’s expropriatory action had to fulfill two requirements: serve the goal of public welfare, and offer a ‘fair compensation’. If the private agent was paid a ‘fair compensation’ for the good expropriated, then expropriation would not generate conflict; but, how was a ‘fair compensation’ to be established? If this corresponded to the owner’s reserve price, the expropriation would be a beneficial transaction, or at least not harmful, from the private agent’s point of view. But, obviously that was not viable as the owner would have incentives to raise his reserve price without bound. As a result, conflict arises at the moment of establishing the price of a bilateral transaction for which there is no market. The Allende government effectively used the existing legislation in its vast expropriation program. Opposition criticism stressed the fact that the government had recourse to ‘legal loopholes’ and ‘ancient obscure legislation that no one had used before’: however, this does not invalidate the expropriations, nor does it really explain the hostility towards the process. There are two distinct basic questions. The first has to do with the problem of the price or ‘fair compensation’ to be paid for the expropriated asset. In the case of bank nationalization, there was a fairly uncontroversial process in which bank shares were acquired by the government at attractive prices. In other cases the opposite occurred,

58 The Unidad Popular and the Pinochet Dictatorship: A Political Analysis

and it would seem that the underlying goal was to pay the minimum possible; if GMC nationalization was achieved without a penny being paid, why should anything be paid for the latifundios and industrial firms which clearly were of lesser economic value? The UP government faced a budget constraint which hindered its overall expropriation program. A simple way of reconciling the expropriation goal with the budget constraint lay precisely in bringing down the purchase price. Labor stoppages, strikes, interventions, requisitions, occupations of factories and land, price controls, and control of credit and foreign currency were all elements brought into play in a context of great political and economic tension, but at the same time they became the mechanisms that significantly lowered the sale price of an expropriated asset. Private owners and entrepreneurs were faced with all the power and all the economic and administrative machinery of the government, as well as pressure from workers, which notably weakened their bargaining power. Such direct and indirect pressure mechanisms and the final price of the expropriated good created a vicious circle which produced a general atmosphere of unsustainable tension. The issue of private ownership and property rights has been absent from the traditional economic literature.109 Indeed, it can be seen that the central economic questions – what?, how?, and for whom? – do not even raise this issue. The economic theory of prices and resource allocation assumes an initial distribution of productive factors without ever questioning how the initial distribution came about: how an economic agent became the owner of capital; how property rights were established. However, even for a beginner it is clear that the simple existence of property rights affects the allocation of resources and the distribution of goods; the same happens with the existing wealth distribution. In other words, the optimal allocation of resources depends on a given initial distribution of the endowment of productive factors; if this initial distribution is changed, the social or ‘Pareto’ Optimum is altered. The relation between resource scarcity and property rights is not conceptually obvious. It might be suggested, mistakenly, that if there was no scarcity, property rights would not be necessary; on the other hand, when certain abundant goods become scarce or acquire an economic value, property rights need to be specified, as has happened in the exploitation of marine resources, for example. The argument that private property is a necessary and sufficient condition for a rational economic institutional framework to lead to an efficient allocation of resources is invalid. In the

The Road to Socialism of the Unidad Popular 59

Walrasian theoretical model of perfect competition (in which all neoclassical economists believe), prices are the only mechanism needed to achieve the optimum (the efficient allocation of resources): institutions are totally superfluous.110 To generate a stable situation in relation to the acquisition and possession of goods and assets, social rules are needed to guarantee security of ownership. The existence of an institutional framework of property rights implies that individuals have the right to use, consume, obtain income from, transfer and sell the goods or assets which belong to them; in all these issues the owners have the right to exclude other agents.111 Furthermore, private agents would not invest in a given project if property rights were not well specified, because they would not have any certainty of being able to appropriate any eventual benefits. All of which must lead us to ask: what incentives to invest did latifundistas or entrepreneurs have during the Allende government, when they knew they could be expropriated? A year before the presidential election of 1970, and in the light of prior knowledge of the UP platform, there must have been a contraction in investment by entrepreneurs and latifundistas who attached more than a small probability to a Salvador Allende win. To ensure compliance with the institutional framework and to guarantee property rights, a state presence is required. However, this can become a double-edged sword:112 by avoiding chaos and anarchy, the state reduces (or eliminates) negative-sum games relating to pillage, theft and other crimes, but when it has a monopoly on the use of force, it can use this for its own benefit. To avoid such distorting action by the state, some people argue in favor of setting up externally valid rules on property rights; an extreme version of this analysis suggests that property rights should take on the characteristic of a divine right. Historical evidence shows that property rights which may have been justifiable and valid at a certain historical moment, and which have even been transferred legally, may become unjustifiable at another time.113 Political, technological, economic and social change can provoke a redefinition of property rights and the addition of new meanings to such rights; for example, in the nineteenth century there was no need to define who had the right to control a television channel. In synthesis, the current perception is that ‘there are new rights that are created in response to new economic forces’. 114 The central dilemma of a modern society is in resolving what to do about acquired rights whose existence is no longer justified.115 There are two extreme

60 The Unidad Popular and the Pinochet Dictatorship: A Political Analysis

solutions – ignore the need for change or ignore the acquired rights; history teaches us that both solutions generate conflict and lead to chaos. Let us imagine, theoretically, that the UP government had sufficient resources (because the price of copper had risen considerably, for example) to provide ‘adequate compensation’ in carrying out its vast program of nationalization: in such circumstances, the transfer of private property to the state would have been made with a relatively low degree of contentiousness. Supposedly, this would have lowered the level of tension generated by the process of ‘occupations’, interventions and expropriations. However, the serious macro- and microeconomic disequilibria described above would still have persisted; progressive systemic change (replacement of capitalism by socialism) and a perception of its irreversibility were, in my judgement, the primordial factors underlying social discard. Through its structural reform program and eventual systemic change, the UP government was planning to change the way of life of the whole Chilean population, closing off future alternative possibilities. The second underlying issue is of a clearly ideological nature. The final goal of the UP program was to redirect the Chilean economy on to an irreversible course that would steadily bring about the replacement of capitalism by socialism. There is broad agreement as regards the fact that private property is a central factor in capitalism; but, while for Hume the establishment and stability of the institutionality of property rights is the crucial element for achieving perfect social harmony (in fact, ‘little or nothing else needs to be done’), for Marx the existence of private property generates a class structure which is the source of inequalities and social conflicts. Following this latter argument, the Allende government launched into an extensive program of expropriations to transfer private-sector wealth to the public sector, which in the long run would eliminate inequality and social conflict. The result was precisely the opposite: was it really feasible to imagine that social peace would be achieved after a stage involving such massive expropriation and maximization of conflict? Could such a profound systemic change have been carried out without causing the breakdown of democracy?

2 The Economic Model of the Military Dictatorship

The destruction of Chilean democracy The analysis of social scientists1 The myth of Chilean democracy was deeply rooted: ‘the oldest and most stable democracy in Latin America’ in a region characterized by military coups and political instability. From 1831 to 1970 a long succession of presidents had been elected by vote, and all had completed and respected their terms of office. Of course, during a long lapse of time such as this there were short periods of conflict, but what other Latin America country could boast a similar record of 140 years’ continuous fulfillment of democracy? Chile’s historical tradition reiterated and maximized the democratic myth, ignoring any historic conflicts and events that might diminish it. Even during the first half of 1973, and despite the socially division situation that existed, much of the population did not conceive of the possibility of a coup, because, as was popularly believed, ‘Chile’s military are different – constitutionalist rather than coup-plotting’. But on 11 September 1973, Chilean democracy collapsed like a house of cards, and the democratic myth was replaced by a brutal dictatorship. Where did these coup-plotting soldiers come from? Who were the torturers and the exilers? What happened to the brave, indomitable democratic spirit of the Chilean people? Was our entire democratic history really just a farce?2 It has been argued that what Chile had prior to 1973 was a formal democracy, but not a real one; nevertheless, in the four decades prior to the coup this ‘formal’ Chilean democracy had resolved problems of stability, succession and representation, as well as the establishment of institutional mechanisms for resolving political conflict. This was 61

62 The Unidad Popular and the Pinochet Dictatorship: A Political Analysis

reflected in the ‘high degree of legitimacy enjoyed by the democratic regime’.3 The effective working of formal democracy reinforced the democratic myth; everyone’s economic and social problems could be resolved in a consensual way through the mechanism of periodical elections, without affecting anybody’s welfare. This can be seen as the political equivalent of the economic concept of the Pareto Optimum.4 The aggressive rhetoric of the UP and the widespread nationalization program of President Allende’s government suggested an irreversible march towards a ‘proletarian dictatorship’. The military coup was supported by a clear majority of the Chilean people to put an end to the chaotic political, economic and social situation and to remove any real possibility of an eventual proletarian dictatorship: ‘democracy had to be sacrificed to avoid communist dictatorship’. The democratic myth led to a belief in a ‘short clean coup’, which would rapidly re-establish Chile’s historical tradition. But the military had different ideas. The 1973 coup was not a comedy of errors. Was it perhaps the Latin equivalent of a Greek tragedy, whose finale was pre-ordained by the assumption of Salvador Allende? Could a ‘Chronicle of a Coup Foretold’ have been written in December 1970? There are those who believe that this Greco-Chilean tragedy really began at the turn of the twentieth century; others trace its roots to the second half of the 1960s. Some suggest that the tragedy could have followed ‘other courses and other finales, above all if the actors could have foreseen the future’.5 What caused this lack of foresight? There are several explanations for the breakdown of Chilean democracy; they are not mutually exclusive and in fact probably share complementary elements, for they stress different aspects of a complex phenomenon: an imbalance between political and social development, the prevailing consensuses and their evolution, ideological polarization and the role of the military.6 The ‘great contradiction’ between rapid political development and slow economic development supposedly generated a growing imbalance which ended in the breakdown of democracy.7 From the 1940s onward, new sectors began to gain influence and power in control of the state, and political participation by the people also increased; on the other hand, the Chilean economy displayed a relatively slow rate of growth (around 4 per cent) which was not enough to solve the basic problems of the majority.8 Rapid political development created mechanisms for pressure and stimulated the proliferation of social demands; competition between political parties generated an escalation of proposals and solutions that fed on people’s aspirations and expectations; everything would become possible if party A or B won the election, but no one

The Economic Model of the Military Dictatorship 63

pointed out the costs involved in solving any problem. The acceleration of political demands gave rise to excessive economic pressures, leading to a negative process of interaction in which economic crisis induced political crisis and vice versa, until eventually the system collapsed. This explanation suffers from several shortcomings. Over a long period in this century, Chilean society had been able to reconcile the political– economic disequilbrium by generating a peaceful and stable consensus or modus vivendi; how this disequilibrium was managed and why it subsequently became unmanageable need to be explained. Control of the disequilbrium was achieved by institutionalizing social conflict as a political–electoral contest:9 political parties became the mechanism for articulating and channeling the interests of different social groups; ‘it could be said that the Chilean people recognized each other publicly through the parties’.10 The triad of ‘social organization–political party–state’ was for most of the population the only legitimate and viable processor of their respective demands.11 The political system was able to generate legitimacy for itself over several decades while governments of different ideological hues alternated. A simple indicator of Chile’s rapid political development is the greater relative participation of the population in elections. As we saw in Chapter 1, between 1920 and 1970 voters increased their participation as a fraction of the population of voting age (Table 1.5); in absolute terms the number of voters went up from 167 000 (1920) to nearly three million (1970) in the space of 50 years. The bringing of new groups into the electoral process, insofar as this was channeled through other political parties than those already prevailing, introduced changes in the power relationships between the different social groups. Valenzuela and Valenzuela (1986) try to show that the relative increase in the number of voters did not affect the relative composition of the three big political blocs (right, center, left). However, we have already seen that econometric estimations show that the relative vote of the right fell by 6.4 percentage points for every 10-point increase in the relative percentage of voters (period 1918–69). Similarly, econometric estimates show that the center and left increased by 4.0 and 7.7 percentage points respectively (Figures 2.1 and 2.2).12 And if one considers the percentage of new voters captured by the three big political blocs, one can see a significantly smaller share going to the right compared with the center and left in the post-1937 period; the right attracted only 15.2 per cent of new voters, whereas the center and left captured 38.1 and 38.8 per cent respectively (Table 2.1). Given that between 1937 and 1969 the number of voters increased by

64 The Unidad Popular and the Pinochet Dictatorship: A Political Analysis

55 1965

Center Voters/Total Voters (%)

50

1949

1957

45

1961

1953

40 35 1921

30

1937

1918

25

1969

1941

1973

1945

1925

20

1932

15 10 5 0 0

10

20

30

40

50

60

70

80

Voters/Voting Age Population (%) Figure 2.1

Center Voters (Parliamentary Elections)

Left Wing Voters/Total Voters (%)

40

1973

35

1969

30

1965

1941

25

1961

1945 20 1937

15 10

1953 1949

1957

1932

5 1918 0 0

10

20

30

40

50

60

Voters/Voting Age Population (%) Figure 2.2

Left-Wing Voters (Parliamentary Elections)

70

80

The Economic Model of the Military Dictatorship 65 Table 2.1

1918–37 1937–69 1969–73

Distribution of New Voters, Chile 1918–1973

New voters (000s)

Right

231.6 1895.3 1379.6

23.5 15.2 23.5

% New voters captured by Center Left 30.7 38.1 22.0

27.0 38.8 40.3

Sources: Borón (1971) and Valenzuela (1978). Note: The right includes the Liberal and Conservative parties; the center, the Christian Democrats, the Radical Party and the Agrarian Labor Party; and the left includes the Socialist and Communist parties. From 1965 on, half the votes for the Radical Party are included in the left and the other half in the center. Voters by sector do not add up to the total number of voters, as they do not include independents or political parties not mentioned above.

5.6 times, this result obviously meant a profound change in Chile’s political composition. It is worth remembering that a simplifying assumption implicit in these estimates is that people voting once for a given political party continue to vote in the same way. The significant rise in the number of voters and the effects of the 1925 Constitution are linked to a high degree of political discontinuity among the governments elected between 1932 and 1970. Indeed, in that lapse of time there were six governments, each with a different political ideology: Right (1932–38), Radical (1938–52), Caudillo-populist (1952–58), Right (1958–64), Christian Democrat (1964–70), Left (1970–73). This discontinuity was matched by political antagonism on the part of each government towards its predecessor: seldom does a new government invite the previous one to collaborate, even partially. The triumphant new government would want to have full control of the whole political apparatus: a government initiating a new period tends to start everything anew, or with a new direction that differentiates it from the previous government. Its wish is to displace those who were previously in power, replacing the largest number of officials so as to make the new policy their own.13 But, why did this political discontinuity occur? For Vial (1986), the great mass of the population living in a situation of extreme misery and who had been incorporated into electoral activity constituted the central factor underlying political destabilization. The poor, who have represented about 30 per cent of the Chilean population during the twentieth century, are easily attracted by demagoguery, and this turns them into a highly fickle electorate. Their growing political participation generated pendular swings which eventually led to a breakdown

66 The Unidad Popular and the Pinochet Dictatorship: A Political Analysis

in democracy. Vial argues that the vote of the poor is a factor for instability, because those who live in extreme misery gain little from stability: ‘stability is a non-existent value for them, whereas they may have something to gain through social upheaval’.14 A different and more global explanation than the previous one relates to the prevailing consensus in Chile in the twentieth century and to factors that produced its breakdown. There are still people who yearn for the pre-1920 consensus: an oligarchical order in which no significant change was ever put forward at election time. Obviously a situation in which every government was chosen by a sort of select club, to which less than 10 per cent of the population of voting age belonged, could not be permanent and stable. The turbulent 1920s and the early 1930s, together with the reforms introduced under the 1925 Constitution, laid the foundations for a new consensus. The so-called ‘Mesocratic Republic’, which lasted over 40 years (from 1932 to 1973), established a new framework in which the middle class began to gain predominance; the majority of presidents, ministers and parliamentarians came from the middle class. During a significant part of this period, there was a sort of implicit and explicit consensus among political and social actors to resolve the various conflicts through the institutional channels established in the Constitution. But it has been pointed out that, until the 1960s, this consensus excluded a significant part of the population. Indeed, and contrary to what is argued by Vial, Gazmuri (pp. 207–11; in Tagle, 1992) argues that the political agreement established in the 1930s marginalized the poorest people of the country, particularly those from rural areas. Opening up towards these forgotten groups was to occur only very slowly, and even then basically restricted to the electoral sphere. If the poor were excluded, then they could hardly be the cause of the political alternations observed. In synthesis, during the ‘Mesocratic Republic’ there was a consensus on the validity of the political-electoral system. In relation to this, Arriagada (1986) stresses the fact that in Chile, unlike what happened in other Latin American countries, the right played a significant role in creating a democratic system: ‘it was the Right that played inside the party system, interested in obtaining the Presidency of the Republic by election rather than through coup d’état’.15 A similar case could be made regarding the role of the left. The consensus on the acceptance and relevance of the electoral mechanism was probably necessary but not sufficient for democratic stability; slowly, different viewpoints and proposals regarding the way

The Economic Model of the Military Dictatorship 67

to structure Chilean society began to be made explicit and compete with one another. These acquired a clear but exaggerated profile in the 1960s: the right argued for traditional capitalism with appropriate and responsible economic policies to generate higher growth; the center proposed the modernization of capitalism together with the political and social incorporation of marginalized groups; the left criticized the capitalist system, arguing that it was marching towards its own disintegration, and advocated paving the way for progress towards socialism. Thus, the ‘phenomenon of the three thirds’ arose – the coexistence of three global and supposedly exclusive projects to provide solutions to the basic questions. From the 1958 presidential election onwards, they have had equal electoral bases of around 30 per cent each. These opposing projects were essentially expressions of social restructuring which affected the basic consensus on society’s way of life. In such conditions, capacity for compromise is weakened, and the agreements that are reached are more formal than real. Yet, when a given party wins a presidential election, to what extent is it feasible or permissible for it to change the existing way of life? On the other hand, maintenance of the status quo means a precarious way of life for many people. This is the old dilemma between continuity and change: ‘How much can be changed while leaving everything the same?’, or ‘How much can be changed without the system becoming destabilized?’ In reality, the problem of the basic consensus is considerably more complex than this. What components of the basic consensus are needed to maintain democratic stability, and among what people is the consensus to be produced? Possible items include avoidance of civil war, respecting the rules of the game and having a shared vision about what is a ‘just order’; but the limits on the rewards the winner of a political contest can appropriate for himself remains a valid issue.16 The situation described above leads to progressive political polarization, and there are two arguments regarding this: the change in the function of the political center and an upsurge in ideology. Each of these will briefly be considered below. Ever since the beginning of the twentieth century, there has been a marked political polarization in Chile. There was a traditional and clearly defined right, while a left slowly began to take shape, and by the 1930s had acquired a clear profile. When these two political blocs captured a significant percentage of the electorate, a centrifugal tendency was generated that dangerously raised the level of social conflict. The center avoided this extreme polarization by acting as a ‘hinge’.17 The Radical Party, a pragmatic party with a great capacity for

68 The Unidad Popular and the Pinochet Dictatorship: A Political Analysis

negotiation, fulfilled this function in the period leading up to the 1960s, but it became worn out and suffered a high political cost, coming to be identified as ‘the party of fixers and dealers’. In the 1960s the Christian Democrats took the place of the Radical Party, and the center ceased to be a hinge and a shock absorber, as this party wanted to plow its own furrow. Furthermore, with an ideological platform (modernization of capitalism with social integration), the Christian Democrats generated a ‘double centrifuge’ phenomenon which radicalized the political spectrum, pushing the left further to the left and the right further to the right.18 This hypothesis, which argues that the center, by definition moderate, was responsible for the extreme polarization of the left and the right, is somewhat paradoxical. Although the political center argued for and coincided with some of the proposals of the left or the right, why did they not support where they coincided but instead opted to abandon their principles and aims for other more extreme ones? Is it more important to be different and have an image of one’s own than to contribute to greater social welfare? Are ideas, values and principles so changeable that they get redefined according to what other people are arguing? In the 1960s there was an upsurge of interest in ideologies and utopian visions; everything seemed possible. It was only a question of political will: the elimination of social injustice, overcoming poverty and the transformation of Chile into a modern and developed country could all be achieved. There was much enthusiasm, as well as heated and highbrow conceptual debates, and an excess of voluntarism; the existence of such noble goals and objectives got in the way of pedestrian discussion about means and mechanisms. Forgotten dimensions of existence were reclaimed: feelings, the unconscious, the imagination, the erotic. To the question as to whether it is possible to build a non-repressive civilization, the answer was yes. It was enough for people to realize the possibilities for freedom that technical process has engendered in society, and act accordingly to change oppressive structures. The revolution was a rallying cry shared by nearly everyone. Imagination had to achieve power.19 Excessive imagination generated utopias and alternative ideologies that competed for attention. This exacerbated ideological competition led to a radicalization of argument; the search for a minimum consensus was seen as logically incorrect as well as ethically corrupt.

The Economic Model of the Military Dictatorship 69

Fundamentalist purism emerged: ‘every actor stressed the exclusiveness of his proposal, any partial advance was decreed as insufficient; all measures in the economic, social or political field were belittled in comparison to a theoretical model – utopia – that constituted a moral imperative for those adhering to it’.20 Ideas and rhetoric took on a life of their own and began to impact upon political reality. Eduardo Frei Montalva stated in his presidential campaign that he would ‘not change a single iota of his program even for a million votes’: for him, the program was more important than any political agreement. After Eduardo Frei’s electoral triumph, the General Secretary of the Socialist Party declared that he would deny ‘bread and water to the new government’. In the 1970 presidential campaign the right proposed and insisted (thinking that Jorge Alessandri would be the winner) that ‘whichever candidate obtained one more vote than his rivals should be the President’; in this way, it was intended to rule out any chance of compromise in Parliament if the leading candidate won less than 50.1 per cent of the vote. Thus a kind of ‘political autism’ was generated.21 In addition, negative campaigning – ‘the trading of insults’ – created a climate of confrontation between the different ideological positions. According to Moulián (1982, 1986), this led to a ‘self destructive, fatalistic logic’ in which ‘anything is better than giving ground’; this was seen in the adventure of the the right’s own way in the 1970 presidential elections, as well as in the suicidal guerrilla infantilism of various groups in the UP. Ideological rhetoric increased during the UP government; ‘it was not enough to hold the reins of government, one had to achieve total power’, and to ‘move forward without giving anything away’ suggested fairly unequivocally that there were important groups in the UP willing to make the current process irreversible and to impose their will on the rest of society. All of this was accompanied by hyperactive political mobilization; marches and demonstrations did not end with the presidential campaign but became part of the scenery (like the cordillera of the Andes) during the government of President Allende: everyone took to mass mobilization to show that they had majority popular support. The communications media acted as a powerful catalyst, stoking the confrontational fire. It was difficult to distinguish between real events and the symbolic conflict presented by the newspapers, radio and television. Events were presented in an exaggerated and distorted way. Falsehoods and

70 The Unidad Popular and the Pinochet Dictatorship: A Political Analysis

character assassination were the order of the day. Everything took on political significance, and even the most insignificant event was transformed into something relevant and ominous.22 Political mobilization became political confrontation, and political logic began to be replaced by the logic of confrontation. It is true that ideological polarization and symbolic rhetoric generated constraints that made negotiation difficult and hindered political agreement, but it was not the diatribes or the inflammatory speeches that led to the breakdown of democracy. During the UP government, there were concrete events that materially harmed many economic agents, and which suggested that in the near future others would be affected; 5.5 agricultural estates were expropriated, or occupied per day; every other day a productive firm was nationalized or taken over. There was no lower size limit on what could be expropriated or occupied. As time went by, it began to get more difficult to acquire basic consumer goods, and black markets, queues, rationing and scarcity all came to affect daily life. Serious macroeconomic disequilibria caused uncertainty and global instability, and the rapid nationalization of the economy produced well-founded fears over the future reversibility of the process. Moulián raises an interesting point by asking why was there no coup in Chile before 1973, and, more specifically, why was there not one in 1938 when Aguirre Cerda won by such a small margin? He suggests that the reform program put forward by the radical governments was tolerable, and so it did not affect democratic stability. Moulián also argues that the government of Frei Montalva was the true continuation of popular fronts in Chile, since it carried out the anti-oligarchic reforms that were still pending (‘Chilenization’ of the GMC, agrarian reform and rural unionization).23 This assertion makes it worth reiterating the previous question: why was there no coup during the government of President Frei?24 In our judgement, the differences that existed between the Frei and Allende governments are the key to the central factors leading to the breakdown of democracy in 1973. The crucial difference does not relate to the existence of exclusive global projects, to ideological polarization or to an intensification of political militancy. During the government of President Frei, nobody ever doubted that there would be new presidential elections in 1970, and that the minority of today might become the majority of tomorrow. In contrast, during the government of President Allende doubts steadily grew about the possibility of reversing the profound

The Economic Model of the Military Dictatorship 71

reforms; events and official rhetoric reinforced the idea of a country moving inexorably towards an irreversible social framework. It was not a matter of being afraid of change, because there were changes and profound ones during the Frei government, but rather it was fear of irreversible change which explains the massive support for the military coup. In 1973 there was an increase in the level of social conflict, and a slow but steady paralysis of economic activity. The multiplicity of incidents, the irate and interminable arguments, innumerable and useless meetings among government authorities, as well as those of opposition groups and joint meetings between government and opposition, accompanied by waves of rumor and counter-rumor, finally made it impossible to find a political solution. On 22 August 1973 the opposition in the Chamber of Deputies approved a bill which explicitly declared ‘the President’s actions to be illegitimate’. This was an invitation to intervention by the Armed Forces. Why did the latter accept the invitation? Maybe to avoid a possible civil war? Historical evidence shows that ‘civil war does not occur among civilians’:25 division within the Armed Forces is needed for a civil war to begin. The propaganda put out by extremist groups in the UP, in which soldiers and lower ranking officers were invited to disobey their superiors, the participation of the high command of the Armed Forces in the Ministerial Cabinet of President Allende and the prolonged and deep political crisis constituted the factors that were able to generate such a division.26 In short, the Armed Forces carried out the coup to prevent their own internal division and thereby avoid a possible civil war.27 But if the military coup avoided division in the Armed Forces and, in consequence, civil war, then, why was it so bloody? What was the justification for the subsequent human rights violations? After 1973 political scientists and analysts discovered the extent of their ignorance of the Armed Forces; they constituted a ‘state within a state’ with their own rules and a culture and operational logic very different from those of civil society. In the period 1931–73 there was a poor civil–military relationship; there were ‘two worlds that were totally non-communicating’, there was mutual ignorance and disdain.28 Civil power systematically reduced the military budget, and this generated resentment in the Armed Forces. This was particularly serious when one considers that the Armed Forces saw themselves as the moral bulwark of the nation: the ultimate depository of the nation’s destiny, the supreme guarantors of threatened national unity, a bulwark against divisions between

72 The Unidad Popular and the Pinochet Dictatorship: A Political Analysis

groups in civil society, with a messianic active and practical role as saviors of the nation in the face of the crisis that threatens its destruction.29 So, the Armed Forces carried out the military coup to save the country from destruction. 30 But, why did they stay around for 17 years? Garretón provides the answer by explaining the ambivalent conceptual interaction between Nation and State peculiar to the Armed Forces. The military coup was justified in the name of the Nation, against a state that had broken away from the higher destiny of the Nation, thereby compromising its survival. On the other hand, once the military regime had established itself, the State became identified with the Nation and the military were charged with fulfilling its destiny – call it the common good or any other name; then, any discrepancy is seen as a questioning of the essence of the Nation. ‘This produces the triple identity between Nation, State and Armed Forces (or military government). The Armed Forces are the bulwark of the Nation and the guarantors of its historical continuity.’ 31 Thus Chile began to function as one huge barracks. The analysis of orthodox economists32 According to orthodox economists, Chile’s slow development was caused fundamentally by the state’s growing role in the economy; this phenomenon culminated with the UP government, where the goal of the state gaining complete control caused economic and social chaos and led to the breakdown of democracy. De Castro argues that the explanation of the 1973 sociopolitical crisis is not to be found in the three years of bad economic management by the UP government: the chaos sown by Allende’s Marxist government only accelerated the gradual socialization that had been going on uninterruptedly in Chile since the mid-1930s.33 From this standpoint, part of this gradual socialization corresponded to the numerous misguided measures of a redistributive nature adopted by the state from the 1930s onwards; from that moment on, the state created the notion of a ‘handout culture’ promising ‘a substantial improvement in living standards to the vast majority of Chilean people by sacrificing only the most rich’; in other words, poverty was to be resolved by taking from some to give to others, and this led to an undermining of the prevailing harmony in Chilean society. Supposedly in order to carry out its redistributive function, the state began to increase its involvement in the economy. This statist

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intervention was seen in different ways: direct state intervention to manipulate economic variables (price controls, setting the interest rate, fixing the exchange rate, and so on); the development of a bloated bureaucracy; a propensity to set up state activities in parallel to private activity in productive sectors and services; nationalization and progressive statism in the economy; the development of planning systems which really sought the direct control of a range diverse activities; an increase in state investment in areas of low social profitability and the politicization of public institutions. Thus a highly shambolic institutional framework was drawn up which restricted the development possibilities of those not protected by the state. Different factors were behind the expansion of statism: (i) sociopolitical pressures leading to an increase in public spending aimed at generating employment and expanding investment levels; the public sector became employer and investor of last resort; (ii) jobs created in the public sector had the characteristic of irreversibility, thereby keeping political clientele subsidized with employment in fiscal institutions, as well as in semi-fiscal and state ones; (iii) the state became the promoter of the common good and, a contrario sensu, the notion was generated that private action did not lead to this. Hence, a paternalistic relationship between state and society developed in which the state gave out benefits and society expected them; in a modern society on the other hand, benefits are achieved as a result of a development process. The increase in state interventionism in the economy generated a variety of interrelated problems: (a) As the state took on more functions, it created numerous agencies, firms and services which generated a bloated bureaucracy cut off from internal and external control mechanisms. Public-sector expansion meant an increase in spending, and, in addition to this, fiscal bureaucracy became a powerful pressure group which generally obtained special privileges. All this translated into an imbalance between fiscal spending and revenues, generating a public deficit with consequent inflationary pressures. (b) The control of prices, interest rate and exchange rate are the indirect results of inflation; they are an easy but misguided solution for attacking inflation – they suppress its manifestations instead of attacking the root of the problem. These controls in turn became important mechanisms for the distribution of benefits and rents.

74 The Unidad Popular and the Pinochet Dictatorship: A Political Analysis

(c) In this way, the state acquired enormous discretionary and abusive power which led to different social groups organizing themselves in an attempt to capture and use state resources to their own benefit. The political process became a game of influences and pressures that generated massive transfers between different social groups and economic sectors. Private-sector participation in publicsector decision-taking was even institutionalized: during the period 1958–64 the four most powerful private organizations had representatives with voting rights in all (public) financial institutions including the Central Bank, the Banco del Estado and CORFO … every business group had voting power in the government agencies that were relevant to its specific sector.34 (d) Chilean society became oriented towards rent-seeking.35 Excessive state control of the economy made the success of productive activities depend much more on political patronage – conceding tax or tariff exemptions, granting or denying profitable prices, allowing or prohibiting the import of substitutes, approving or rejecting domestic or foreign loans, etc. – than the true social profitability of such activities and the technical and entrepreneurial capacity of those working in them. In this way entrepreneurs sought closer affinity with politicians and government personalities – ministers, under-secretaries, heads of Dirinco, president of the Central Bank and the Banco del Estado, president of CORFO, and so on – than with the technicians, professionals and other employees working in their firms and who could increase the real productivity of their productive processes. It is easier to obtain a financial return by charging a high price permitted by a high tariff, than a real return based on a low price, within the reach of the masses, made possible by cost reductions achieved through real increases in productivity. When the real rate of interest is negative, it allows any investor to undertake investment projects of zero or low profitability because they can finance the projects with loans whose costs are subsidized (or negative). Hence the demand for credit exceeds its supply, and friendships and political contacts become more important in obtaining a loan than the social profitability of the investment project. The state has come to exercise such a degree of interference in the economic life of the country that it can, on its own say-so, ordain the success or failure of any activity. Entrepreneurs in general have colluded with the dominant political groups to ensure a return on their activities.

The Economic Model of the Military Dictatorship 75

The result of this is that the non-competitive structure of economic organization has facilitated the formation of power groups whose actions are against the general interest. As a result, the Chilean state’s redistributive policies have ended up favoring those groups with the greatest organized lobbying power; the poor – who are independent individuals, or otherwise in the informal sector and do not have any lobby mechanisms at their command – remain completely excluded from economic development with no chance of altering their situation. An economy with an expanding state and pressure groups fighting for total control leads to stagnation; this prevents the solution of economic and social problems, generating social and political crisis. Disputes for control of the state, the sustained increase in the latter’s involvement in the economy and the persistent interaction between economic and political interests and an inability to resolve real economic problems, ended up undermining and destroying democracy.

The structural reforms of the 1970s36 The application of structural reforms The deep political, institutional, economic and social crisis of 1973 was used as a benchmark for a complete reversal of state involvement in the Chilean economy and of the development policies that had been in force over the four previous decades. Prior to 1973, Chile’s economy had been characterized by a long history of government intervention and control, and by a development strategy based on import substitution enforced through high tariffs and non-tariff protection, complemented by an overvalued currency. In 1973, an economy under heavy state control, virtually closed and with almost total price control, was turned into a market economy with free prices, completely liberalized and integrated into the world economy, and in which the private sector had an increasingly predominant presence. Most of the liberalizing and deregulatory measures were applied against the backdrop of a drastic counter-inflationary stabilization program. Traditional economic analysis of the post-1973 structural reforms has stressed aspects related to the type of monetarism (closed-economy and open-economy monetarism) and the sequence of the reforms (opening up trade prior to liberalization of the capital account; fiscal reform before external opening). As our purpose is to identify and

76 The Unidad Popular and the Pinochet Dictatorship: A Political Analysis

analyze the profound and long-term ideological changes, it would seem to be more appropriate to use the changes in the role of the state as a framework for analysis. The state and everything linked to the public sector was turned into the central cause of all the problems; the less it interfered in the economy, the greater and faster would be the growth of social welfare. This formed the background to the numerous economic reforms introduced during the military regime: privatizations and reprivatizations, reform of the state and fiscal reform, liberalization, deregulation, opening up the economy and Central Bank autonomy. In other words, the final goal aspired to was a state with no tool available to it that could alter the optimum evolution generated by the free play of market forces: this type of environment would supposedly stimulate the private sector to become the dynamic engine of growth. In a system of free markets, where laissez-faire rules, the prime function of the state should be to maintain law and order; this means, among other things, protection of private property and ensuring the fulfillment of contracts. When the state becomes involved in other tasks, it is not using resources efficiently in undertaking activities that constitute its natural purpose and for which it has comparative advantages. Additional objectives complementing this argument are, firstly, state modernization, meaning a reduction in public-sector bureaucracy, excessive controls and interventionism, thereby increasing its functionality. In this way, the waste of time and resources experienced by the private sector in complying with the various bureaucratic requirements would be reduced. Simplification of necessary rules and procedures has a significant positive externality: it would appreciably reduce situations stimulating rent-seeking and corruption. On the other hand, for the private sector to be able to correctly evaluate investment projects at the microeconomic level, the state’s responsibility would consist of maintaining a balanced macroeconomic environment, with stable and permanent rules. Finally, the state would not be able to participate at all in the production of goods, not even in social goods: it would only be concerned with regulation and ensuring that certain minimum levels of education and health are maintained. The Chilean version of this laissez-faire model with a leading role for the private sector involved the following elements: • Reform of the state, a process involving different objectives in different periods during the military dictatorship: (a) Elimination of

The Economic Model of the Military Dictatorship 77

the Area of Social Ownership, and the return of firms and lands expropriated through irregular procedures by the Unidad Popular government to their previous owners – i.e. what could be referred to as a process of reprivatization. (b) A reduction in public spending and the elimination of the fiscal deficit. (c) An increase in the efficiency of public-sector firms. These three processes were carried out in the 1970s. (d) After the financial and productive collapse of 1982, it became necessary to undertake a second reprivatization process. (e) Privatization of traditional public-sector enterprises created by CORFO. (f) Tax reform. (g) Pressures to increase publicsector saving. • Greater labor-market flexibility, to enhance the international competitiveness of the economy; in practice this meant a weakening of union power and the atomization of workers. • Promotion of the private sector and the individual agent. Privatization came to be synonymous with rationalization, efficiency and quality: ‘whatever the private sector does is optimal and beautiful’. In addition, it was posited that each individual is mature and responsible enough to understand and assume the consequences of his or her actions. Thus the proposition help yourself would be more ethical and efficient than one suggesting a paternalistic and condescending attitude of the part of the state. The above justified and implied a significant transfer of real and financial assets from the public to the private sector. A significant part of these transfers were linked to processes of privatization and reprivatization, but another part – probably much larger – corresponded to the socialization (or nationalization) of private-sector losses during the economic collapse of 1982–83. Table 2.2 synthesizes the economic reforms instituted during the military regime in the 1970s.37 Table 2.3 provides the time sequence in which these reforms were implemented, along with three variables (growth, inflation and unemployment) to illustrate the macroeconomic environment in which they were carried out. Let us examine some aspects of these reforms in terms of these three dimensions. Among the reforms relating to the productive arena, we will look separately at the reprivatization process and the increase in efficiency of public-sector firms. The first reprivatization process 38 occurred in 1974; 257 firms and more than 3700 plots of land and estates that had been taken over and/or transferred illegally to the state (or to workers) were quickly returned to their former owners. This reprivatization

78 The Unidad Popular and the Pinochet Dictatorship: A Political Analysis Table 2.2

Basic Structural Reforms in the Chilean Economy in the 1970s

Situation in 1972–73

Post–1973 1. Privatization In 1980, 45 firms (including one bank) owned by public sector

State control of more than 400 companies and banks

2. Prices Free prices (excluding wages and exchange rate)

Generalized price controls

3. Trade regime Single exchange rate Uniform 10 per cent tariff (except automobiles) High tariffs (average tariff 94 per cent; maximum 220 per cent) Prior import deposits (10 000%) No other trade barriers Multiple exchange rate Existence of prohibitions and quotas

‘Cascade’ sales tax High public employment High public-sector deficits Control of interest rate Statization of banks Control of credit

4. Fiscal regime Value-added tax (20%) Reduction in public employment Public-sector surpluses (1979–81) 5. Domestic capital market Free interest rate Reprivatization of banks Liberalization of capital markets

6. Capital account Total control of capital movements Gradual liberalization of capital flows Government the main foreign borrower Private sector the main foreign borrower 7. Labor market regime Powerful unions with strong bargaining Atomization of unions with zero power bargaining power Immobility law Ease of dismissal Obligatory wage increases Drastic cut in real wages High non-wage labor costs (40 per cent Low non-wage labor costs (3 per cent of wages) of wages)

process did not involve any monetary transaction; owners were asked to desist from any type of legal action (nor initiate one); in addition, they had to assume outstanding debts. In the agricultural sector, as was seen in Chapter 1, the Frei and Allende governments had carried out a far-reaching agrarian reform process. After 1973, 30 per cent of expropriated land was returned to its previous owners and 20 per cent was auctioned among non-rural inhabitants. Approximately 30 per cent of the remaining expropriated land was allocated to small-scale peasant farmers, but state programs providing support to the peasantry through special credit lines and technical assistance were reduced; the result was that about one-third of peasants were forced to sell their land and work on land belonging to the new owners.

The Economic Model of the Military Dictatorship 79 Table 2.3

Time Sequence of the Structural Reforms of the 1970s 1974 1975 1976 1977 1978 1979 1980 1981

Liberalization of prices Privatization Fiscal reform Trade liberalization Domestic capital market liberalization Capital account opening Labor market reform 1974 1975 1976 1977 1978 1979 1980 1981 Growth (%) Inflation (%) Unemployment (%)

5.5 –12.9 3.5 9.9 8.2 8.3 7.8 5.5 369 343 198 84 37 38 31 9 9 16 19 18 17 17 17 16

Another reprivatization process between 1974 and 1978 which did involve monetary transactions was the dismantling of the APS created by the UP government. At the end of 1973, more than 400 firms and banks were legally under the control of the state as a result of intervention or ownership. By the end of 1980, there were only some 45 firms (including one bank) in the public sector; the rest had been reprivatized. This sale of state-controlled firms was carried out in the midst of a severe domestic recession (GDP in 1975 fell by 12.9 per cent and unemployment rose to nearly 18 per cent, having been in single figures in previous years), and in the context of a very narrow credit market. Only a few economic agents in the private sector were in a position to make bids, and this led to the formation of big conglomerates which dominated the structure of the economy through their ownership and control of the main firms and banks. The state received US$543 million for the sale of those banks and companies,39 and the size of the subsidy provided by the state in this process has been calculated to be in the order of 30 per cent.40 Most of the firms were acquired with a down-payment equivalent to between 10 and 20 per cent of the total amount; CORFO provided the credit needed for the balance. This stimulated concentration of ownership among a few groups through the sale of big packets of shares or even 100 per cent of the shares of a firm, under the assumption that the process would generate higher sale prices for the reprivatized firms. Many of them, as well as many reprivatized banks, were virtually bankrupted in 1982–83 and had to be taken over and bailed out by the state, forming a so-called ‘área rara’ or anomalous sector of the economy.41 Subsequently, they went through a second reprivatization process. As regards enhanced efficiency among state-owned firms, three new principles came to govern their behavior: (a) The principle of self-financing, which means that

80 The Unidad Popular and the Pinochet Dictatorship: A Political Analysis

state firms cannot receive central government transfers or credit, nor can they contract foreign debt. (b) Principles of action defined by profit maximization, which means two different things: an end to the use of public charges as a subsidy mechanism, and state firms could now begin to subcontract part of their activities. (c) A certain degree of freedom in price-setting among state firms. The result of these measures were seen within a relatively short time. In 1973, public-sector firms had a negative savings rate and a deficit of 8 and 10.4 per cent of GDP, respectively; in 1976 they recorded positive savings of 1.6 per cent an a deficit of 0.1 per cent. Fiscal reform in 1974–75 aimed to reduce the size of government and eliminating the persistent fiscal and public-sector deficits. Public spending underwent a severe contraction through drastic cuts in the public-sector payroll, which was brought down from 20 per cent of GDP (1971–72) to 15 per cent in 1975, reaching 12 per cent in 1981; public-sector employment declined by 30 per cent over this period. In addition, there were cuts in social spending and public investment. On the fiscal revenue side, far-reaching tax reforms were carried out in 1975: taxes were fully indexed to inflation, using monthly indexation based on the CPI, and a special taxation unit indexed to the CPI was also created; these measures practically eliminated the Olivera–Tanzi effect.42 A ‘cascade’ sales tax was replaced by a system of value-added tax (VAT) at a rate of 20 per cent, and this became the government’s main revenue source. VAT at 20 per cent suppressed all existing exemptions and was charged on all goods and services (domestic and imported), including basic consumption goods. Its enforcement was easier, which thereby reduced evasion.43 The tax reform also included the abolition of taxes on wealth and capital gains, as well as a significant reduction in rates charged on profits. In synthesis, the previous complex tax structure was significantly simplified. The results of the tax reform were seen in a rapid reduction of fiscal deficits and their transformation into surplus. Tax revenue grew from 22 per cent of GDP in 1973–74 to 27 per cent in 1975–77, while the chronic fiscal deficit disappeared and surpluses were recorded from 1979 to 1981. Following the privatizations and the fiscal and tax reforms, a third set of measures was visualized to minimize state intervention in the economy: measures aimed at liberalizing and deregulating the economy, as well as its international integration. (a) Price liberalization. The government system that controlled nearly all prices was dismantled very swiftly: one month after the military

The Economic Model of the Military Dictatorship 81

coup, Decree Law No. 522 abolished the vast majority of price controls. However, at the same time, it established a short list of fixed prices mostly in food products and public service charges; later most of the prices on this list were set free.44 (b) Liberalization of the national financial market. Interest rates (which had always been controlled) were set free as from 1975. In addition, selective and quantitative restrictions on bank credit were eliminated, preferential financing for small-scale entrepreneurs and peasant farmers was reduced, obligatory reserve requirements for commercial banks were cut back, non-bank financial institutions (known as financieras) were authorized to do business, and the operation of foreign banks was similarly facilitated. This liberalization of the domestic financial market was carried out at a considerable pace and by 1977 was almost complete. The Banco del Estado, for example, the most important bank belonging to the public sector, saw its share of the domestic credit market cut from nearly 50 per cent at the start of the 1970s to 14 per cent by 1981.45 (c) Labor market flexibility. Prior to 1973, labor legislation involved a tenure law, mandatory wage increases, minimum wages, relatively high severance pay for workers, constant adding of new elements in non-wage labor costs, and so on. This labor legislation, moreover, was implemented in a context where unions had relatively high and growing bargaining power. The main elements of the labor legislation reform were the following: unions and workers lost their bargaining power,46 regulations on job tenure were made more flexible, the social security contribution paid by employers was lowered considerably (from 40 per cent in the 1960s to less than 3 per cent in the 1980s), and there was a general reduction in non-wage labor costs. During a significant part of this period (1973–82), there were government rules on wage indexation, but the government itself lowered the real wage level by more than 30 per cent between 1973 and 1975. The integration of the local economy into the world economy, meanwhile, meant replacing the inward-looking development strategy with an outward-looking one; domestic relative prices were brought into line with international relative prices, and the country specialized in the production of goods in which it had comparative advantage. In this way, the state cannot interfere in resource allocation, because relative prices are exogenous to the country. The liberalization of the trade account achieved this objective.47

82 The Unidad Popular and the Pinochet Dictatorship: A Political Analysis

The opening up of the capital account sought Chile’s financial integration into international markets. For a small, open economy, an appropriate exchange rate policy would be to fix the nominal exchange rate, which would act as a nominal anchor for the economy. According to the monetary approach to balance of payments, if this small economy faced a very elastic supply of external credit, the quantity of national money would become endogenous in the absence of sterilization policies, and the rate of interest (rather than the exchange rate) would constitute the automatic mechanism for equilibrating the balance of payments. According to this approach, the capital account plays a central role in resolving the problem of external imbalance: to generate an inflow of financial capital into the country, the rate of interest must be allowed to rise freely. The big advantage of a small, open economy functioning according to the monetary approach to the balance of payments is that it has a simple and highly visible rule: the level of the nominal exchange rate. Any alteration to this rule is immediately perceived by all economic agents. Given the high rate of inflation inherited by the military regime, one would have expected the control of inflation to be the first priority as an economic goal; ex-post, it is interesting to see that the implementation of the structural reforms described above was really the main economic achievement of the 1970s. As regards inflation, what is surprising is how fiercely it resisted despite everything that was done to bring it under control. Let us briefly review the counter-inflationary stabilization program: from the outset (end of 1973–beginning of 1974), near total price liberalization was decreed; this abrupt liberalization was supposed to constitute a stabilization mechanism, it was thought that once free prices had achieved their equilibrium level, inflation would be brought to a halt. By 1974, there were only 33 controlled prices, and in 1976 less than ten; yet annual inflation remained at a three-digit level. In 1975 a stabilization program based on the closed-economy monetary approach was applied. This approach contends that inflation is caused by monetary expansion which, in turn, is caused by fiscal deficit (in 1973 and 1974, there were two-digit fiscal deficits as a percentage of GDP); as a consequence, fiscal discipline and monetary control are seen as basic elements in the fight against inflation. The adopted program involved severe fiscal and monetary shocks: GDP fell by 12.7 per cent and unemployment rose to more than 15 per cent. However, despite the steep cut in the fiscal deficit (1.8 per cent of GDP in 1977), the

The Economic Model of the Military Dictatorship 83

annual inflation rate was still above 80 per cent in 1977. In 1978 a new stabilization program was put in force, this time based on the openeconomy monetary approach, in which the central mechanism for reducing inflation is the exchange rate. This was used as a nominal anchor for guiding inflationary expectations: a fixed nominal exchange rate supposedly generates equalization between domestic and foreign inflation. In 1979 a fixed nominal exchange rate was set, which was to last three years; inflation finally came down to a single-digit level in 1981. In short, inflation took eight years to drop to a single digit. The main explanation for this slow process points to an inconsistency (from 1978 onwards) between the criteria for indexing the exchange rate and wages; while the exchange rate was indexed according to future inflation (an active crawling peg), wages were indexed on past inflation.48 However, inflation came down precisely when this inconsistency in economy policy (1978–81) was in force, for which reason one still has to explain why inflation really fell. The slow decline in inflation during the 1970s thus remains to be explained. In my judgement, there are two factors that have to be included in any explanation. One is the supply shock caused by liberalization of the domestic capital market, which generated high nominal and real interest rates; these rates remained at persistently high levels for years. The other factor is linked to the liberalization of the capital account: the massive flow of foreign loans expanded the availability of monetary resources domestically and led to a substantial and sustained increased in domestic spending. The Armed Forces and the Chicago economists Many of the most far-reaching and profound changes commented on here were implemented in a brief period (two to four years) by a group of Chilean economists popularly known as the ‘Chicago Boys’. 49 The program of economic liberalization and privatization was imposed against a backdrop of severe political restriction and an environment of repressed human rights. These circumstances suggest a series of related questions: What elements produced the close affinity between the centralized power of the military dictatorship, and the decentralized economic framework of the free market? How were the Chicago-trained economists able to completely restructure the economy without any resistance from the business community? Could the same have been done under a democratic regime?50 It seems strange that a dictatorship of the Armed Forces, in which all power is hierarchically centralized, should support an economic model

84 The Unidad Popular and the Pinochet Dictatorship: A Political Analysis

based on decentralization and the atomization of economic decisionmaking, and holding that anything related to the state is inefficient. However, the military and the Chicago economists shared the same mission: namely, to ‘save Chile’. The military saw themselves as the country’s protectors, and the economists from Chicago considered themselves the repository of the formula for maximizing the welfare of Chilean society.51 Both the military and the Chicago economists considered themselves technocrats. In their respective specialties, the concept of social class was irrelevant; their economic policies were characterized by the use of clear rules, which were homogeneous and uniform, without favoring the interests of any class in particular. 52 The military felt they had saved Chile from becoming a communist country, and the ‘Chicago Boys’ believed they had the recipe for transforming Chile into a highly developed country from which the communist menace would be banished for ever. Moreover, the military did not trust politicians; for this reason Congress was shut down, and the Constitution suspended; political parties were prohibited and opposition leaders were imprisoned or exiled. The political context was a paradise for technocrats; the Chicago economists believed themselves to be in possession of the correct approach to Chile’s economic problems, as their ‘scientific’ analysis was undistorted by political considerations. The authoritarian-bureaucratic model of O’Donnell (1972) provides an explanation for the emergence of dictatorships in Latin America in the 1970s and 1980s. Following the crisis at the end of the 1960s, with the economic failure of democratic government and a lack of understanding among politicians, the region saw the emergence of authoritarian governments advised by technocrats. These regimes were characterized by political repression and the exclusion of democratic participation; their goal was orderly economic progress and modernization of the country. The military–technocrat combination insulated both economy and government from political agitation and pressure from lobbyists and interest groups. The Armed Forces created the ‘conditions’ for economic process to be undisturbed by the political process; the technocrats applied the appropriate policies to stimulate growth. It has been argued that the Latin American dictatorships were in no way equivalent to European fascism of the 1930s. The former had as a central aim the achievement of civil apathy, for fear of mass mobilization even among their own sympathizers; moreover, they did not encourage the establishment of political parties, which might act as a

The Economic Model of the Military Dictatorship 85

nexus between the state and civil society. The Armed Forces did not need political parties or civil representatives; they are hierarchical and the guarantors of order. 53 This arrangement was governed by the principle of comparative advantage: the Armed Forces concerned themselves with political and ethical aspects, while the technocrats concentrated on economic issues. The Chicago economists had full support from General Pinochet to develop their new economic model. Given General Pinochet’s long stay in power, the economic model was maintained in spite of the heavy social costs it implied. Businessmen and entrepreneurs did not criticize policies, despite the fact that many of them suffered economic losses: in a repressive regime anyone who openly disagrees pays a high price. Furthermore, the previous government had been considered by entrepreneurs as a workers’ regime, which constituted a serious threat to private property and the foundations of the capitalist system; now they perceived the military government as ‘their government’ and, although the reforms and policy changes might mean short-term losses, the situation in general augured well for reaping benefits in the medium and long term. Those responsible for the economic reforms themselves acknowledged that under a democratic regime they would not have done even one-fifth of what they did.54 The elimination of certain public spending, subsidies, tax exemptions, the discriminatory tariff structure, and so on, would have encountered opposition from politicians and power groups. On the other hand, these economists did not have to worry about the economic and social costs of the reforms,55 nor did they offer any judgement whatsoever on the political context. Successes of the Economic Model By the start of the 1980s, the liberalizing reforms had produced the new ‘Chilean economic miracle’. 56 Table 2.4 summarizes indicators selected as evidence of this ‘miracle’. (a) The inflation rate, which had soared to over 600 per cent per year in 1973 (more than 1000 per cent when measured by the wholesale price index – WPI), dropped to below 10 per cent in 1981 (or to –3.9 per cent according to the WPI). (b) The average annual rate of economic growth rose to nearly 8 per cent in the period 1976–81. (c) Total exports expanded by three to four times (in current dollars) between 1973 and 1980/81, attaining a record US$4705 million in

86 The Unidad Popular and the Pinochet Dictatorship: A Political Analysis Table 2.4

Indicators of the ‘Chilean Economic Miracle’

Annual inflation (%) CPI (revised) WPI (wholesale prices) Economic growth (GDP %) Exports (US$ million) Total exports Non-traditional exports International reserves (US$ million) Budget deficit (% GDP) Increase in real wages (%)

1973

1980

1981

606.1 1147.1 –4.3

31.2 28.1 7.8

9.5 –3.9 5.5

4705 1821 4074 –5.5b 8.6

3836 1411 3775 –2.9b 9.0

1309 104 167 21.0a –25.3c

Sources: Ministerio de Hacienda; Banco Central (1986); Cortázar and Meller (1987). Notes: a Excluding APS deficit. b A negative figure indicates a surplus. c Corresponds to the first three quarters of 1973.

1980. The expansion of non-traditional exports was more impressive still: in 1973, these amounted to just US$100 million, yet by 1980 they had risen to over US$1800 million. (d) International reserves held at the Central Bank increased from US$167 million in 1973 to US$4074 million in 1980. (e) The public sector (excluding the APS), which had recorded a deficit equivalent to 21 per cent of GDP in 1973, recorded surpluses of 5.5 per cent and 2.9 per cent in 1980 and 1981, respectively. (f) Real wages rose by 9 per cent per year during most of the ‘miracle years’. This ‘economic miracle’ was associated with an import boom and a boom in speculation. As regards the former, Table 2.5 provides some illustrative indicators: annual growth of imports for the period 1976–81 (according to the national accounts) was 21.8 per cent; consumer goods imports recorded an average annual expansion of nearly 40 per cent over this period. This is much higher than the rates for capital goods imports (15.8 per cent) and intermediate goods imports (11.3 per cent). The financial sector played a fundamental role in the speculative boom, as this is fed and grows only if there is a supply of credit to sustain it. As a consequence, the relatively abundant availability of easy-access credit explains how a boom of this nature was sustained

Table 2.5

Indicators of the Import Boom, Chile 1976–1981 1976 Current (US$ million)

Constant (US$ million at 1981 prices)a

1776 229 127 54 375 1172

1885 367 204 87 601 1879

Total imports Imports of consumer goods Imports of non-food consumer goods Automobile imports Capital goods imports Intermediate goods imports

1981 Current (US$ million) 6364 1907 1167 428 1250 3207

Annual Growthb 27.5 39.0 41.8 37.7 15.8 11.3

Source: Central Bank of Chile. Import values are CIF. Notes: a The US Producer Price Index was used as deflator. b These annual growth rates have been calculated in constant (1981) dollars.

87

88 The Unidad Popular and the Pinochet Dictatorship: A Political Analysis

and how it was propagated. But the existence of easy credit does not fully explain what it was that led economic agents to borrow and spend at the rate and in the amounts they did. Other factors also affected the speculative boom of 1976–81. Firstly the propaganda element, which continually stressed two aspects: consumerism and the ‘economic miracle’. On the other hand, the visual element, by which the avalanche of imported products that filled shop windows and the streets, accompanied by a boom in the construction of spectacular shopping centers and luxury apartments (‘everything imported’, except for the site), provided empirical evidence for the propaganda element. In addition, sudden access to easy credit became a reality for numerous economic agents, who were blinded by the possibility of ‘buying today and paying tomorrow’; people who had always had serious difficulties in obtaining small loans must now have been dazzled by this new experience where ‘every bank is a friendly bank’, and where if one asks for a loan of 100, it is suggested that 200 would be better. While the 1971 consumer boom was financed with domestic monetary emission, the consumer boom of the ‘economic miracle’ was basically financed through foreign borrowing. The sudden drying-up of foreign credit in 1982 and subsequent years brought the economic boom of the 1970s to an abrupt halt.

The economic and financial collapse of 1982–1983 The crisis of 1982–1983 In 1982 the ‘economic miracle’ succumbed to the worst economic crisis Chile has lived through in the last 50 years. In that year GDP fell by 14.4 per cent, and the rate of economic growth was again negative in 1983 (Table 2.6); industry and construction recorded negative growth rates of 21.1 per cent and 23.4 per cent respectively. The annual average number of bankruptcies in the period 1975–81 was 277, with this figure rising to 810 in 1982. Moreover, during that year the true situation of financial distress was disguised through continuous bank loans to insolvent clients (principally firms related to the banks’ owners). The situation blew up at the beginning of 1983 when the government liquidated three banks and intervened in five of the other main commercial banks, and the Central Bank had to offer extensive loans to the rest in order to provide short-term liquidity. The bad-debt portfolio of the banking system exceeded bank assets by three to four times. In short, the majority of economic agents had amply

Table 2.6

Some Indicators of the ‘Chilean Collapse’a

Economic growth (% GDP) Industry (annual growth) Construction (annual growth) Open unemployment (%) Effective unemployment (%) (including public employment programs) No. of company bankruptcies (annual average 1975–81: 277) Change in Central Bank International Reserves (US$ million) Budget deficit (% GDP) Annual variation in real wages (%) Annual inflation (%) CPI WPI (Wholesale prices)

1982

1983

–14.1 –21.1 –23.4 19.6 26.1 810 –1197.8 2.3 0.3

–0.7 3.2 –5.5 26.4 31.3 381 –554.8 3.0 –10.9

20.7 39.6

23.1 25.2

Sources: Banco Central (1986); Ministry of Finance; INE; National Bankruptcy Inspectorate. Note: a Not including indicators of the financial collapse.

89

90 The Unidad Popular and the Pinochet Dictatorship: A Political Analysis

exceeded the limits of reasonable borrowing, and the difficulties (indeed impossibility) of repaying such loans affected the economy as a whole. On the other hand, the effective rate of unemployment (including people in special public employment programs, in which beneficiaries received between US$20 and US$40 per month as unemployment compensation) exceeded 30 per cent in 1983. The Central Bank saw a drain on its international reserves, which by the end of 1983 were equivalent to 53.6 per cent of their 1981 level. As regards foreign debt, at the end of 1977 this amounted to US$5.2 billion, by the end of 1982 it had reached the sum of US$17.1 billion. By 1983 the total was about 13 per cent bigger than GDP. The fiscal budget, which had managed a surplus in 1980 and 1981 (see Table 2.4), recorded deficits of 2.3 per cent and 3 per cent of GDP in 1982 and 1983, respectively. Finally, the annual inflation rate climbed to over 20 per cent during those two years. Faced with the magnitude of this economic collapse, analysts tended to look for a single factor responsible for the crisis: the fixing of the nominal exchange rate which led to an overvaluation of the peso, lack of control over the domestic financial market, capital account liberalization, policy errors relating to the time and speed at which liberalizing reforms were carried out, the dogmatism of the economic authorities and various adverse external shocks (for example, the deterioration in the terms of trade, the rise in international interest rates and the sudden reduction in lending from abroad). However, the truth is that the deep economic crisis of 1982–83 was caused by a mixture of all these factors – it was a consequence of both domestic policy errors and adverse external shocks. Domestic policy errors had to do with the way in which the reforms were carried out, the existence of inconsistent policies and macroeconomic policy management in certain crucial periods. Let us analyze some of these explanations individually.57 Table 2.7 shows balance of payments figures for the period 1977–81. The trade balance showed a widening deficit which grew to 11 per cent of GDP in 1981, mainly due to growth in imports, which tripled between 1977 and 1981, whereas exports less than doubled over the same period (in 1977 the FOB values of exports and imports were almost equal). The current account recorded even bigger deficits, with figures of 7.7 and 16 per cent of GDP in 1980 and 1981, respectively. However, despite these deficits, the overall balance of payments was in

The Economic Model of the Military Dictatorship 91 Table 2.7 Balance of Trade, Current Account Balance and Overall Balance of Payments, Chile 1977–1981 (US$ million)

1977 1978 1979 1980 1981

Trade balance (CIF)

Current account

–186 –599 –514 –1041 –3270

–551 –1088 –1189 –1971 –4733

Balance of payments 113 712 1047 1244 67

Source: Central Bank of Chile.

surplus during the entire period 1977–81, thanks to the massive entry of foreign loans, which not only helped to finance the current account deficits but also significantly raised the level of international reserves at the Central Bank. The exchange rate policy implemented in 1979 has been held to be the main culprit for the huge trade and current account deficits of 1980 and 1981. Using the monetary approach to the balance of payments as a theoretical framework, the economic authorities decided to fix the nominal exchange rate at 39 pesos per US dollar in June 1979, in the belief that this would be the appropriate exchange rate policy for a small, open economy that was integrated with the world economy. That year, domestic inflation bordered on 40 per cent, but, according to the economic authorities, the fixing of the nominal exchange rate would make domestic inflation equal to the world rate; the fixed nominal exchange rate would lower expected inflation and directly bring down the level of price increases among tradable goods. Along with this policy of fixing the nominal exchange rate, capital account controls were eased, for, according to the monetary approach to the balance of payments, money supply would thus become endogenous58 (the Central Bank adopted a non-sterilization59 policy) and, by the Law of One Price, it is the exchange rate that determines the level of domestic prices. As an extension of the Law of One Price, with a fixed nominal exchange rate domestic inflation equals foreign inflation, and the exchange rate thus becomes the main stabilization mechanism.60 When the fixed nominal exchange rate policy began to be applied, it was assumed that convergence between domestic and international inflation would occur very quickly: indeed, this was necessary to avoid an appreciation of the exchange rate which would cause a loss of competitiveness and an increase in foreign debt. However, the process

92 The Unidad Popular and the Pinochet Dictatorship: A Political Analysis

turned out to be very slow, firstly because the lifting of capital account controls sucked in large foreign credit flows which increased domestic spending and put upward pressure on the prices of non-tradable goods. On the other hand, the existence of an institutionalized inflationary inertia caused many prices such as wages, domestic interest rates, rents, debts, etc., to be indexed to the inflation of the preceding period. It took two years for the domestic six-month inflation rate to reach single-figure levels (Table 2.8). The rise in Chile’s CPI during the first half of 1981 was 5.5 per cent, similar to the rise in the wholesale price index (WPI) in the United States; but by June 1981 accumulated CPI inflation in Chile since June 1979 already amounted to 67 per cent – the equivalent figure for the WPI in the United States during this period was just 26.2 per cent. As a stabilization mechanism, the exchange rate worked slowly and created serious distortions during the adjustment process. The sluggish convergence of inflation caused a sharp deterioration in the real exchange rate, discouraging exports and provoking a big expansion of imports to the detriment of national production. The appreciation in the real exchange rate and the corresponding loss of competitiveness in the tradable sector between June 1979 and June 1982 exceeded 30 per cent.61 However, the widening current account deficit was not seen as a problem by the economic authorities, because every year there had been a fiscal surplus as well as an overall balance of payments surplus, and this was taken as an indication that the national currency was not overvalued. Moreover, the fact that there was a fiscal surplus meant that the current account deficit was being generated by the private sector; consequently, there was no cause for concern because the latter knew what they were doing. In other words, there are ‘good and bad’ current account deficits: a bad current account deficit is one generated by a public-sector deficit, which is a twin cause for concern as both deficits have to be eliminated; on the other hand, a good current account deficit generated by the private sector should not even be a subject for discussion.62 The appreciation in the real exchange rate was not reversed by achieving convergence between domestic and foreign inflation. Furthermore, it had been assumed that the real exchange rate set in June 1979, when the nominal rate was fixed, was at an equilibrium level, so a real exchange that had appreciated three years later by more than 30 per cent could not also be an equilibrium, especially when the current account deficit (expressed in dollars) had more than tripled.

Table 2.8 Six-Monthly Inflation Rates in Chile after Implementation of the Fixed Nominal Exchange Rate Policy: June 1979–June 1982 (%) Consumer price index Six-monthly Accumulated inflation inflation since June 1979 Dec. 79 Jun. 80 Dec. 80 Jun. 81 Dec. 81 Jun. 82

20.6 14.5 14.7 5.5 3.8 0.4

20.6 38.1 58.3 67.0 73.4 74.1

Wholesale price index (WPI) Accumulated Six-monthly inflation inflation since June 1979 26.7 14.8 11.6 – 1.2 – 2.8 – 0.7

26.7 45.5 62.3 60.4 56.0 54.9

United States WPI Six-monthly Accumulated inflation inflation since June 1979 7.0 6.4 5.6 5.0 0.4 1.3

7.0 13.8 20.1 26.2 26.7 28.3

Sources: INE (National Institute of Statistics) and Banco Central (1986).

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94 The Unidad Popular and the Pinochet Dictatorship: A Political Analysis

The real exchange rate appreciation coincided with a big rise in domestic spending which stimulated production and employment (see Table 2.9). During the period 1979–81, the Chilean economy lived through a boom in which a strange combination of factors came together: overvaluation of the national currency, high growth rates, extremely high levels of consumption (particularly of imported goods), massive inflows of foreign lending and huge rises in share prices and property values. The appreciation of the real exchange rate was one of the factors leading to the rise in spending, especially on durable goods. As Table 2.9 shows, domestic spending rose by 10.5 per cent, 9.2 per cent and 11.6 per cent per year during the period 1979–81, while domestic output was growing strongly, but at slower rates (8.3 per cent, 7.5 per cent and 5.3 per cent). 63 In 1981, domestic expenditure was 10.3 per cent higher than GDP. Imports grew at even higher annual rates, especially imports of non-food consumer products, which went up by 38 per cent per year in 1980 and 1981. An overvalued currency affects domestic spending through two different mechanisms: firstly, the appreciation of the real exchange rate means a reduction in the relative price of tradable goods with respect to non-tradables, and this stimulates a shift in domestic consumption in favor of tradable goods. In addition, trade policy reforms had reduced protection for consumer durable goods, thereby favoring their import. This twin effect discouraged domestic tradable-goods production (Table 2.9). Furthermore, a fixed nominal exchange rate with backward-looking wage indexation equivalent to 100 per cent of the CPI, together with a falling inflation rate, generated higher real wages, leading in turn to higher levels of consumption. Other factors contributing to expenditure growth among the Chilean people included relatively easy access to consumer credit (commercial banks and financial institutions were now competing in a market that previously had been controlled by the wholesale and retail trade), as well as a rise in share prices and real-estate values (Table 2.10). In the euphoric atmosphere being experienced, these developments made people feel wealthier: despite holding the same stock of fixed assets, people believed the value of their wealth had grown, so they raised their permanent level of consumption. In sum, changes in relative prices, the stimulation of a behavior pattern involving higher spending in a context of import liberalization and an overvalued national currency, generated widening deficits on the trade account of the balance of payments, and capital account opening provided the resources needed to finance this deficit.

Table 2.9

Annual Growth Rates of Chilean Macroeconomic Variables, 1979–1981 (percentages)

Domestic Total expenditure expenditure (1) (2) 1979 1980 1981

10.5 9.2 11.6

8.3 7.5 5.3

Tradables

Domestic production Non-tradables

Total

(3)

(4)

(5)

7.0 5.5 4.8

10.0 10.0 5.4

22.7 18.7 15.7

Imports Non-food Real wages consumer goods (6) (7) 19.0 38.3 37.3

8.2 8.6 9.0

Employment (8) 2.3 3.5 5.1

Sources: Columns (1), (2), (3), (4) and (5): National Accounts: Banco Central (1986). Column (6) Balance of Payments: Banco Central (1986). Dollar amounts have been deflated by the WPI of the United States. Column (7): Cortázar and Meller (1987). Column (8): Jadresic (1986).

95

96 The Unidad Popular and the Pinochet Dictatorship: A Political Analysis Table 2.10

Selected Financial Sector Indicators, Chile 1976–1981

Real interest on Index of real private- Index of real share Index of real urban loans (%) sector credit prices property values (1) (2) (3) (4) 1976 1977 1978 1979 1980 1981

51.4 39.4 35.1 16.6 12.2 38.8

100.0 197.4 324.8 427.6 597.4 719.1

100.0 165.1 296.8 336.6 620.7 493.3

100.0 n/a n/a n/a 166.3 363.3

Sources: Columns (1), (3), (4): Arellano (1983). Column (2): Ramos (1984).

This explanation relates the origin of the 1982 crisis to the real side of the economy – to a current account deficit generated the surplus on the capital account.64 An alternative hypothesis reverses the direction of causality by arguing that the main cause of the collapse was the opening up of the capital account: it suggested that the large inflow of foreign lending caused the exchange rate appreciation and the expansion of domestic spending – in other words, the surplus on the capital account generated the deficit on the current account.65 In other words, the policy of fixing the nominal exchange rate was not mistaken: the same substantial capital inflow under a floating exchange rate would have caused an even greater exchange rate appreciation.66 Between 1977 and 1981, Chile’s economy recorded ever bigger net capital inflows (Table 2.11). To absorb this massive entry of foreign funds, an exchange rate appreciation was needed in order to generate a deficit on the trade balance and achieve equilibrium in the markets for tradable and non-tradable goods. Table 2.11

1977 1978 1979 1980 1981

Total Net Capital Flows, Chile 1977–1981

Total net capital flows excluding reserves (US$ million)

Total net capital flows excluding reserves (% GDP)

Gross external debt (US$ million)

577 1946 2247 3165 4698

4.7 12.7 10.7 12.3 15.9

5613 7011 8663 11 207 15 591

Sources: Banco Central (1986) and (1988); Finance Ministry (1982).

The Economic Model of the Military Dictatorship 97

Two distinct (but not mutually exclusive) explanations ascribe a key role to capital account liberalization in generating the crisis. The first of these implicitly argues that capital flows are autonomous, or exogenous: as barriers are lowered and controls lifted, a flow of external lending is generated. It is worth remembering that in the 1970s there was a worldwide oversupply of petrodollars, due to the oil price shock, and the inflow of foreign lending increased throughout Latin America. Given the peripheral nature of the region, events linked to international capital markets and economic conditions in industrialized countries generate autonomous flows towards Latin America. 67 The second explanation, which may even be complementary to the above, assumes an endogenous cause for capital flows; in this case the differential between domestic and foreign interest rates leads local agents to borrow abroad. In fact these two explanations are the same: abundant external credit is the main factor responsible for the exchange rate appreciation, and this is what led to the expansion of domestic spending and the trade deficit. In other words, the high level of capital inflow was a consequence both of demand and supply elements. On the demand side, the main factors were the lifting of capital account restrictions, together with the persistent differential between domestic and international interest rates. The increase in international liquidity in the 1970s, together with the favorable attitude of international banks towards the evolution of the Chilean economy and the removal of obstacles to capital entry, produced ever higher amounts of foreign lending. Chile’s foreign debt almost tripled in four years, rising from US$5.6 billion in 1977 to US$15.6 billion in 1981 (Table 2.11). A slower rate of capital inflow would have led to less exchange rate appreciation and a smaller increase in domestic spending, and this would also have meant a smaller adjustment burden for the Chilean economy when the international banks decided to drastically curtail the flow of credit. As can be seen, there has been a big debate regarding the direction of causality between the current account and the capital account. A ‘mixed’ solution is suggested by McNelis (1991), whereby the current account is what initially causes the rise in foreign borrowing, but subsequently, as the capital account begins to be opened up and restrictions are lifted, capital flows take on a life of their own and become exogenous, or independent of events on the current account. The final hypothesis for explaining the 1982 crisis relates to the liberalization of the domestic capital market. When this market, which traditionally had operated in a context of financial control and

98 The Unidad Popular and the Pinochet Dictatorship: A Political Analysis

repression, was set free, neither the financial institutions nor the Superintendency of Banks possessed the human capital or technology to ensure a prudent administration of banking and financial businesses, nor for adequately assessing the risks of the different operations. A lack of control of the new domestic financial market caused a high degree of fragility in the financial system as a whole.68 The operations of commercial banks and finance houses were carried on virtually without supervision or regulation. The number of financial institutions grew from 19 banks (of which only one was foreign) in 1974, to 45 banks (of which 19 were foreign) and 15 finance houses in 1981. Table 2.11 shows that the real volume of credit extended to the private sector expanded by more than 600 per cent in the period 1976–81. A part of this increase in credit volumes financed fixed investment, which grew at more than 15 per cent per year between 1976 and 1981. Numerous factors contributed to the fragility of the financial system: (a) Real interest rates on loans were very high during the whole period (see Table 2.12). Such high rates affected the solvency of productive enterprises, which defaulted on the payment of loans granted by banks, thereby affecting the latter’s solvency. Debtors sought further credit to avoid bankruptcy, and the banks acceded by providing loans and rolling over bad debts so as to postpone losses. Due to the persistence of high interest rates, the risk of insolvency among productive firms and banks increased, and the whole financial system found itself in difficulties. (b) There were close ownership relations between productive firms and financial institutions, especially those belonging to the big conglomerate groups. A high percentage of loans was granted to firms linked to the bank or finance house providing the loan, and many such loans were questionable from the financial standpoint; moreover, a recurring cycle of loan renewal (rollover) occurred. Due to asymmetric information and the non-existence of consolidated accounts for conglomerates as a whole, it was practically impossible for the Superintendency of Banks to assess the risk of this type of credit. Eventually the rollover of unpaid loans by insolvent firms affects the capital and the viability of banks, regardless of whether these belong to conglomerate groups or not. Furthermore, it affects the rate of interest and the amounts available for new loans; firms that were formerly solvent might begin to become insolvent in the new context, thereby helping to increasing the rollover of unpaid loans.

Table 2.12

Evolution of External Variables Relevant to the Chilean Economy, 1978–1983 Terms of trade (1980 = 100)

1978 1979 1980 1981 1982 1983

84.4 99.4 100.0 83.6 78.1 91.8

Copper price (US¢ per lb) Nominal Real (1976)a 61.9 89.8 99.2 78.9 67.1 72.2

54.1 69.8 67.5 49.3 41.0 43.6

LIBOR (%) Nominal Reala 8.3 12.0 14.2 16.5 13.3 9.8

1.1 2.6 2.0 6.0 5.3 4.6

Foreign borrowingb (US$ million) 1769 2014 2995 4336 831 376

Sources: Banco Central (1986); CEPAL Notes: a Deflated by the WPI of the United States. b The difference from the figures in Table 2.11 is due to the exclusion of foreign direct investment.

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100 The Unidad Popular and the Pinochet Dictatorship: A Political Analysis

This type of interaction between productive firms and the financial sector generated a speculative Ponzi-type game in which everyone had positive incentives to stay in the game, raising the level of risk and expanding the size of the funds involved (through rising rates of interest). (c) The overvaluation of the domestic currency, together with a climate of euphoria fed by massive capital entry, generated a speculative boom; the real index of share prices went up by 84.4 per cent in 1980, and that of urban real-estate values rose by nearly 120 per cent in 1981 (Table 2.10). Higher prices among financial and fixed assets stimulated agents to borrow, but when the speculative bubble burst, these prices fell at the same time as dollar-denominated debts were rising with the devaluation. The final outcome was a negative-sum game in which most agents had debts far in excess of the value of their assets, leading to a generalized situation of bankruptcy. Each of these explanations of the 1982–83 crises is related to questions of domestic policy. We will now refer briefly to another kind of explanation: external shocks. The Chilean economy suffered large adverse external shocks from 1980 onwards (Table 2.12). Taking the years 1979–80 as a reference point, Chile’s terms of trade deteriorated by 20 per cent in 1981–82; the copper price fell 20 cents in 1981 compared to 1980 and a further 12 cents in 1982 (each one cent fall in the price of copper represented a US$25 million reduction in Chile’s exports); in other words, the deterioration of the terms of trade had a negative impact on the Chilean economy equivalent to nearly 3 per cent of GDP each year. The second external shock came from the rise in international interest rates. Here there were two distinct effects – a nominal shock and a real shock: a relatively high nominal interest rate causes liquidity problems, whereas a relatively high real interest rate represents a burden for borrowers. During the 1979–82 period, and especially in 1981, a nominal shock was caused by the international interest rate which rose on average to 14 per cent per year; the real shock occurred in 1981–83 when the real interest rate climbed to an average of 5.3 per cent per year. As result of these shocks, the interest payments Chile had to make, amounting to approximately 20 per cent of exports in 1978, rose to nearly 40 per cent in 1981 and over 50 per cent in 1982 (export values were the same in those years). The third external shock was caused by the sudden cut in international lending; whereas in 1981 Chile received US$4.3 billion in

The Economic Model of the Military Dictatorship 101

foreign loans, this figure dropped to US$831 million in 1982 and US$376 million in 1983 (Table 2.12). In other words, by 1983 the annual foreign lending flow had been cut to the monthly level of two years earlier. To summarize, external shocks aggravated the disequilibrium generated by domestic policies. Furthermore, the simultaneity and persistence of this phenomenon helped to induce a more drastic adjustment process. Somewhat less than half of this deterioration is explained by external factors, while the rest was due to domestic economic policies that failed to consider either the widening foreign trade gap or the fact that a significant fraction of loans from abroad were generally not being used to expand domestic productive capacity. The automatic adjustment mechanism At the start of the 1980s the Chilean economy enjoyed a free market system with free prices, a liberalized external sector (with a tariff system involving a uniform 10 per cent tariff rate, and a fixed nominal exchange rate), total deregulation of the financial market, with free interest rates, few controls on capital movements and no pressure of any sort from social or political groups. As well as this, government economic authorities stated clearly that the private sector was the main agent in the economic sphere. Two basic economic policy principles predominated at that time – total neutrality of economic policy and, given the structural characteristics described above, management of the economy through permanent rules that would not be modified, whatever happened. These rules were as follows: a fixed nominal exchange rate, a balanced fiscal budget and endogeneity of the money supply. In summary, the government would not play any role in macroeconomic management; it would only ensure compliance with the rules of the game. This economic environment explains the type of measures or non-measures adopted when the crisis began to develop. Chile’s adjustment process in the 1980s is interesting; few developing countries have implemented an economic framework of freemarket openness and deregulation, so this represents an opportunity to analyze the behavior of an economy of this type, in a situation of substantial external imbalance. Chile’s adjustment was an extremely uneven process which suffered a variety of changes in orientation associated with the multiple changes of finance minister during this period.69 The outcome was a costly, prolonged and deep recession. Only in 1987 did GDP regain its 1981 level. We will now analyze how the crisis and adjustment process unfolded, following their historical sequence; here, quarterly analysis

102 The Unidad Popular and the Pinochet Dictatorship: A Political Analysis

(and even monthly or daily analysis) sometimes allows for a better understanding of what happened than the traditional annual framework.70 Starting with the second quarter of 1981, and up to the first half of 1982, the interest rate was the main instrument of the automatic adjustment mechanism. During the second half of 1982, the exchange rate assumed the central role in a chaotic macroeconomic adjustment. Since the second half of 1981 various signals had been suggesting the existence of profound economic problems (Table 2.13). (a) The current account deficit was showing an upward quarterly trend: from US$400 million in the second quarter of 1980, the deficit had widened to nearly US$1.4 billion by the second quarter of 1981. (b) The Central Bank, having seen its reserves grow during the previous 16 quarters, now lost nearly US$200 million, with a further drain of nearly US$300 million in the following quarter. From this moment on, the Central Bank lost reserves during the next six quarters. (c) The share price index began to fall continuously as from the third quarter of 1980, and by the end of the third quarter of 1981, the fall in real terms was close to 33 per cent. (d) From the second quarter of 1980 on, the number of firms declaring bankruptcy was more than 100 per quarter. In the second quarter of 1981 the main private-sector sugar refinery in Chile (CRAV) declared bankruptcy, with a loss of US$100 million. (e) In the second half of 1981 two large banks, together with two smaller banks and two finance houses, had to be taken over by the Central Bank.71 Until well into the first half of 1982 the economic authorities demonstrated a surprisingly passive attitude towards adopting any macroeconomic measures to stem the growing current account deficit. Dogma played an important role here. According to the theoretical framework of the monetary approach to the balance of payments, the Chilean economy had an automatic adjustment mechanism, so it was not necessary to introduce policy measures. Supposedly, the domestic interest rate would be the instrument that would put the automatic adjustment mechanism into operation. Devaluation was totally rejected as a way of dealing with the problem of external imbalance, as this was considered useless for a small open economy that was fully indexed; moreover, the fixed nominal exchange rate (which had lasted two years without alteration) was the nominal anchor of the whole system: a symbol of success, trustworthiness and continuity of the economic model.72 Given the conceptual importance of the automatic adjustment mechanism, it is helpful to restate its rationale. The mechanism

Table 2.13

First Signs of Severe Economic Problems, Chile 1980-I to 1982-II External sector (US$ million) Current Change in account International balance reserves (1) (2)

1980

1981

1982

I II III IV I II III IV I II

9.4 – 390.1 – 617.9 – 972.4 833.8 –1377.2 –1464.2 –1057.4 – 687.8 – 656.9

584.0 576.6 264.2 335.1 53.6 –192.6 129.3 –288.7 –197.7 –258.6

Index of share prices (Dec. 1978 = 100) Nominal Real

No. of company bankruptcies

No. of interventions in banks and finance houses

(3)

(4)

(5)

(6)

233.0 347.1 378.3 367.9 346.3 336.3 299.8 278.3 270.5 259.4

160.4 222.5 228.2 206.2 186.1 175.8 153.2 140.0 135.1 129.8

68 113 125 109 84 112 101 134 125 238

– – – – – – 8 – – 2

Sources: Column (1): Le Fort (1986). Column (2): Banco Central (1986). Column (3) and (4): Stockmarket bulletin Bolsa de Comercio (various issues). Column (5): National Bankruptcy Inspectorate. Column (6): Newspaper Estrategia (various issues).

103

104 The Unidad Popular and the Pinochet Dictatorship: A Political Analysis

operated in the following way: in a small, open economy such as Chile’s, with a fixed nominal exchange rate and a policy of nonsterilization on the part of the Central Bank, the money supply becomes endogenous and only fluctuates as a result of inflows and outflows of foreign currency. If inflows are insufficient to finance the current account deficit a loss of international reserve is caused, which in turn generates a monetary contraction that will raise the rate of interest. This causes a cut in spending and lowers the demand for imports to a level compatible with the level of foreign borrowing the country can sustain. In addition, the contraction of domestic spending will cause non-tradable goods prices to fall, and this will help to enhance the international competitiveness of the domestic economy.73 Furthermore, the differential between domestic and international interest rates will attract foreign capital, so by allowing the domestic interest rate to play out its role, letting it find its own level, the external imbalance will be eliminated. The economic authorities in Chile used the domestic interest rate as the sole means of adjustment for an entire year (second half of 1981 and first half of 1982). Table 2.14 shows how this mechanism operated.74 The Central Bank began to lose international reserves from the fourth quarter of 1981 onward, at a rate fluctuating between US$200 and US$300 million per quarter (nearly 1 per cent of GDP); real M1 had been declining in 1981 and by the second quarter of 1982 it had fallen to a level 9.4 per cent below that of the previous year. The real domestic interest rate rose substantially in the third quarter of 1981, and continued doing so from then on, climbing to 45.8 per cent (on an annual basis) by the second quarter of 1982. The sharp rise in the domestic interest rate rapidly affected domestic spending and the level of imports. Table 2.14 shows the following compared with the equivalent quarter of the previous year: (i) After a year of quite strong expansion in domestic spending, there was a fall of 1.2 per cent in the fourth quarter of 1981; and it went on falling, by 13.6 per cent in the first quarter of 1982 and 19.9 per cent in the second quarter. (ii) The impact on the level of imports was quite considerable. In current dollars, these declined by 33.4 per cent in the fourth quarter of 1981 and by 53.9 per cent in the second quarter of 1982. Such results would suggest that the automatic adjustment mechanism was operating correctly. Despite the sharp increase in the domestic interest rate – which gave rise to large and growing differentials in relation to international interest rates75 – the inflow of foreign capital began to decline significantly;

Table 2.14

1980

1981

1982

I II III IV I II III IV I II

The Working of the Automatic Mechanism, Chile 1980-I to 1982-II Changes in international reserves (US$ million)

Real money supply (M1/P) (billion pesos – Dec. 1978 prices)

Real interest ratea (annual basis) (%)

(1)

(2)

(3)

(4)

36.2 37.9 37.3 40.1 41.4 40.7 38.2 39.7 39.4 37.4

15.7 13.5 16.6 12.2 15.0 21.2 27.7 38.8 42.9 45.8

92 785 93 995 94 767 106 283 103 367 104 415 116 585 105 039 89 277 83 674

584.0 576.6 264.2 335.1 53.6 –192.6 129.3 –288.7 –197.7 –258.6

Domestic spending

(million pesos – 1977 prices)

Imports

Annual rate of change (%) (5)

(US$ million

11.7 0.2 8.9 17.1 11.4 11.1 23.0 –1.2 –13.6 –19.9

1191.8 1328.2 1539.3 1761.2 1590.5 1970.1 1644.5 1173.4 1095.2 907.5

(6)

Annual rate of change (%) (7)

33.5 48.3 6.8 –33.4 –31.1 –53.9

International capital flows (US$ million)

Rate of change of non-tradable goods prices (annual basis) (%)

(8)

(9)

572.4 539.6 932.7 1120.3 1060.0 1764.0 1218.2 655.8 654.4 340.4

30.1 39.6 38.1 24.8 20.2 19.7 25.3 20.2 0.8 2.4

Sources: Columns (1) to (7): Banco Central (1986). Column (8): Le Fort (1986). Column (9): Le Fort and Guillet (1986). Note: a Interest rate on 30- to 90-day paper corresponding to loans granted by commercial banks.

105

106 The Unidad Popular and the Pinochet Dictatorship: A Political Analysis

the supply of foreign lending was again becoming strongly inelastic. On the other hand, domestic non-tradable goods prices were reacting very slowly: in order to improve Chile’s international competitiveness, these prices had to change by much less than the corresponding rate of international inflation, but despite the marked reduction in domestic spending, their level was still way off target. Finally, the automatic mechanism was having a highly damaging effect on the productive sector and on employment. Table 2.15 shows the impact on the real sector of the economy: up to the second quarter of 1982, GDP had shrunk by 12.8 per cent compared with the previous year’s level, industrial output fell by 24.8 per cent and the effective rate of unemployment rose to 24.9 per cent. This table also contains information on the construction sector which shows a nearly 30 per cent decline in activity over the same period. However, this would indeed be consistent with the goals of the automatic adjustment mechanism: the production of non-tradable goods had to decline for resources to shift towards the production of tradables. But in reality, the way in which the automatic mechanism was operating discouraged production as a whole, of both tradable and non-tradable goods. The above illustrates how mistaken the argument of the automatic mechanism was (relying on fluctuations alone without setting a limit on the rise in the rate of interest). On the one hand, to recover international competitiveness deflation should have been generated, whereby the price of non-tradable goods should have fallen by nearly 30 per cent; on the other hand, it is well known that despite an appreciable difference in interest rates, capital flows dry up when a country’s level of indebtedness becomes risky. This simple twin lesson was never assimilated by several of the economists in official positions during this period, and today they still argue that the automatic mechanism was not allowed to operate for long enough to achieve the adjustment. This is a clear example of the cure being worse than the disease, and shows the extent to which dogma can obstruct perception of reality. Chaotic macroeconomic policies From July 1981 to May 1982, the economic authorities repeatedly declared that the automatic mechanism would resolve the problems of Chile’s external disequilibrium. But, after nearly a year’s wait the impression had grown that the process was operating very, very slowly and at very high social cost. The sharp cut in output, the steep rise in unemployment, the large number of bankruptcies and problems in the financial sector all gave rise to widespread skepticism, not only towards

Table 2.15

Impact of the Automatic Mechanism on the Real Economy, Chile 1980-I to 1982-II Gross domestic product (Million pesos – Annual rate of 1977 prices) change (%)

1980

1981

1982

I II III IV I II III IV I II

(1)

(2)

Index of industrial output (1981-II = 100 (3)

86 936 89 750 89 122 97 638 94 303 98 136 97 829 93 148 86 735 85 530

11.0 3.2 5.4 11.8 8.5 9.3 9.8 –4.6 –8.0 –12.8

84.3 89.3 90.0 97.3 88.5 100.0 96.1 88.4 70.9 75.2

Construction sector index (1981-II = 100) (4)

Effective unemployment rate (%) (5)

72.6 78.3 75.7 85.4 91.6 100.0 92.2 93.9 75.7 70.3

16.8 18.4 17.1 15.5 13.7 15.1 15.5 16.1 21.0 24.9

Sources: Columns (1) to (4): Central Bank Monthly Bulletin. Boletin Mensual, various issues. Column (5): Jadresic (1986); includes PEM and POJH programs.

107

108 The Unidad Popular and the Pinochet Dictatorship: A Political Analysis

the automatic adjustment mechanism but towards the whole economic model. It was increasingly believed that the private sector alone would not be able to lift the Chilean economy out of recession, and that government intervention would be needed. This skepticism was further fueled by an unexpected event: devaluation. The devaluation of 14 June 1982 was considered the economic event of the year – it was probably the event of the decade (ten years later the 39-peso dollar and the terrible consequences of the delayed devaluation still remain in the memory of that time). To better understand the impact produced by this measure, it should be remembered that for almost three years the nominal exchange rate had been fixed at 39 Chilean pesos per US dollar, and this was seen as a crucial economic factor underlying the system and its distinctive label. This exchange rate was not considered a tool, but the goal of economic policy. Moreover, from July 1981 the authorities had repeated ad infinitum that there would be no devaluation, firstly every month, then weekly and in the end almost daily, through all the communications media. The Chicago economists provided all kinds of argument against devaluation. In the first place they stressed all the advantages of having a fixed exchange rate that was known and stable. Secondly, they argued that devaluation would be useless because the Chilean economy had perfect first-degree homogeneity with respect to the exchange rate,76 so any devaluation would automatically and instantly be transferred to prices: as a consequence, there would be no change in relative prices and the existing disequilibrium would persist, but now in an inflationary context. Finally, devaluation was considered not only useless but also dangerous, because it could have a negative impact on both inflation and expectations. In brief, official propaganda and the widely disseminated opinions of government economists had convinced most people that there would be no devaluation. 77 When it actually happened, the people, particularly those who had debts in foreign currency, felt let down by the government. The devaluation suddenly generated a huge lack of credibility, and the exchange rate issue remained at the center of discussion for an entire year. Of course, devaluation has both positive and negative effects. It has a positive effect on the level of economic activity by providing incentives for the production of tradable goods (export goods and goods competing with imports). This is complemented by the fact that imports become more expensive so demand for them declines; these factors help to reduce disequilibrium in the external sector. However, the effects are not symmetric: while the level of imports falls rapidly, the level of exports

The Economic Model of the Military Dictatorship 109

rises very slowly. Devaluation also improves the country’s foreign image, in terms of its capacity to generate foreign currency, since it causes an increase in its international competitiveness. The negative effects of devaluation include the generation of inflationary pressures via a rise in the price of imported inputs; devaluation also generates inflationary expectations, particularly if everyone has already learnt that devaluation causes inflation. Devaluation also raises the level of indebtedness of people with debts in foreign currency (in May 1982, nearly 50 per cent of loans granted by commercial banks were denominated in dollars). Theoretically, the commercial banks should not have been affected by devaluation, because their external financial operations in foreign currency exactly matched their domestic foreign currency operations; that is, loans in foreign money that national banks obtained on the international market were transferred to economic agents in the domestic market. In other words, the exchange rate risk was assumed by private-sector debtors rather than bankers. However, the commercial banks were indirectly affected by the devaluation due mainly to their clients’ difficulties in paying off their higher debts. Before the devaluation, the economic authorities adhered to the policy of non-intervention as a dogma: All structural reforms have now been put into practice, so the Chilean economy has the mechanisms for self-correction to resolve any economic problem and the less the government interferes in the economic sphere the better. After devaluation, the team of Chicago economists78 had great difficulty switching from a non-interventionist stance to one of active policies to deal with the wide variety of problems that were arising. Exchange rate and monetary policy were the main tools used to confront external disequilibrium and the deep domestic recession. Exchange rate policies implemented during 1982 During the period from June to December 1982, the Chilean economy had four exchange rate regimes: a fixed nominal rate of 39 Chilean pesos per dollar, in force until 14 June when there was an abrupt 18 per cent devaluation (that same day) followed by gradual adjustment – monthly devaluations of 0.8 per cent in the exchange rate based on a basket of currencies;79 then a totally free exchange rate announced on 5 August which lasted less than a week, to be followed by ‘dirty’ floating; then another abrupt devaluation of 40 per cent on 29 September, followed by gradual adjustment based on the differential between domestic and foreign inflation (see Table 2.16 for

110 The Unidad Popular and the Pinochet Dictatorship: A Political Analysis Table 2.16 Monthly Evolution of the Nominal and Real Exchange Rate in Chile, 1982

January–May June: 1–14 June: 15–30 July August September October November December

Nominal exchange rate (pesos/dollar)a (1)

Real exchange rate indexb (June = 100) (2)

39.0 39.0 46.4 46.6 60.6 65.0 67.7 70.1 74.4

– 100.0 – 116.7 147.7 151.8 150.9 151.2 158.6

Source: Newspaper Estrategia (various issues). Notes: a The figures used correspond to the average of weekly data (the Friday figures are used as the weekly figure). From August to December the dollar selling rate was used. b The nominal exchange rate has been deflated by the CPI.

the monthly evolution of the nominal and real exchange rates in Chile during 1982). The exchange rate policy modification introduced on 14 June 1982 had two components: an abrupt 18 per cent devaluation – the exchange rate rose from 39 to 46 Chilean pesos per dollar, along with replacement of the previous exchange rate policy by a gradual exchange rate adjustment rule involving monthly 0.8 per cent devaluations, also taking into account variations in a basket of five different currencies (dollar, mark, yen, pound and franc). 80 The idea of linking the Chilean peso to a currency basket is positive from the theoretical point of view, since it attempts to keep the real value of the exchange rate constant by taking into account the relative weight of Chile’s international trading partners; the previous rule – which linked the Chilean peso exclusively to the dollar – meant that the dollar appreciation was an additional factor that had contributed to overvaluation of the Chilean currency. However, the devaluation was too small. It was thought that the Chilean economy had lost at least 30 per cent of its international competitiveness since the application of the fixed nominal exchange rate policy, so the 18 per cent devaluation was an insufficient and tardy measure – too little, too late. Furthermore the 0.8 per cent monthly devaluation, along with variations related to the gradual adjustment of

The Economic Model of the Military Dictatorship 111

an exchange rate based on a basket of five currencies, was a truly complex rule for most economic agents (even for economists too), particularly compared to the fixed nominal exchange rate that had been in force for the three previous years.81 Immediately following this initial correction the economic authorities lost control of the situation, despite the fact that the new nominal exchange rate held steady for nearly 50 days. Exchange rate policy began to be determined by economic agents through their desire to acquire foreign currency: net daily sales of currency by the Central Bank largely determined the multiple changes that the economic authorities began to adopt towards exchange rate (and monetary) policy. Table 2.17 provides figures on net monthly foreign currency sales by the Central Bank to the financial sector during 1982. Before June, with the exception of April, these sales were below US$100 million. From June onwards, they began to rise month by month, climbing to around US$600 million in September. In the two weeks prior to the devaluation of 14 June 1982, net sales amounted to half to what they had been in the two weeks following devaluation, which suggested that devaluation had not been anticipated by the majority of the economic agents. Monthly information on currency sales provided by the Central Bank also agrees with the weekly evidence. On the other hand, the fact that foreign currency sales by the Central Bank increased over time is a clear sign that the new exchange rate policy was seen as inadequate.

Table 2.17 Net Monthly Foreign Currency Sales by the Central Bank, 1982 (US$ million) January February March April May June: 1–14 June: 15–30 July August September October November December

25.2 60.0 71.9 224.5 97.3 55.8 110.0 203.7 247.7 579.8 515.2 386.2 149.9

Source: Central Bank of Chile, Informe Económico y Financiero, various issues.

112 The Unidad Popular and the Pinochet Dictatorship: A Political Analysis

In order to bring this situation to an end it was decided to completely alter the exchange rate system. In the first week of August an entirely free exchange rate was established, on the assumption that there would be clean floating. The economic authorities explicitly declared there would be no intervention by the Central Bank. Chile had not had a free exchange rate for at least 50 years, so its new policy of clean floating was a real surprise for all economic agents. Introducing the measure in this way was consistent with the rational expectations hypothesis, since this hypothesis holds that only through surprise measures can the economic authorities can achieve an impact on the economy. Once again, the Chicago economists provided conclusive arguments in favor of a free exchange rate: they stated that in this way Central Bank reserves would be protected, bringing to an end the rising trend of net foreign currency sales; it would allow the Central Bank to run an autonomous monetary policy by cutting the link between the exchange rate and the money supply; the former controlled and regulated exchange rate was the last price in the Chilean economy that was not free; now the Chilean economy would be able to achieve a Pareto Optimum. Technically, the measure was adopted at a highly inappropriate moment. Less than two months had passed since a highly significant alteration to exchange rate policy had been introduced; economic agents had still not recovered from the impact of the previous devaluation when suddenly they were faced with another large-scale change in the rules of the game. There was great uncertainty in the economy, and the free floating policy aggravated this sensation. On the other hand, the domestic currency market was relatively small and the exchange rate came to be determined by speculative pressures rather than the behavior of exports, imports or net capital flows. Furthermore, in this type of free market the role of the public sector should be specified a priori, particularly when one considers that the state copper companies were generating about 45 per cent of foreign currency export earnings, and oil imports were carried out by a single state-owned firm. One should never announce a change in exchange rate policy on a Thursday afternoon,82 these matters are best left to the weekend – in order for the news to be absorbed as calmly as possible: on 6 August 1992 the situation was truly chaotic. Everyone wanted to buy dollars but the commercial banks did not want to sell them; nobody knew what the price of the dollar was. The Finance Minister ‘clarified’ the issue by arguing that the dollar price would be determined by the interaction of supply and demand; the Central Bank president provided more clues by stating that the Central Bank would behave as any other economic agent, without being subject to pressures from the currency markets.

The Economic Model of the Military Dictatorship 113

The policy of free floating lasted just three days. On the first day the peso fell by 18.5 per cent; by the third day it had lost 43.4 per cent of its pre-float value against other currencies (see Table 2.18). In order to avoid additional devaluations and a bigger run on the peso, the Central Bank had to intervene in the exchange market, selling a much larger quantity of dollars than it had been selling before the announcement of the free floating policy. In August and September 1982, it became clear that the Central Bank was intervening in the exchange market. However, the economic authorities insisted that the float was clean and that Central Bank foreign currency operations corresponded to currency associated with state-owned copper firms. Nevertheless, daily dollar sales by the Central Bank were much greater than amounts consistent with this explanation, and the result was an even greater loss in credibility for the economic authorities. The Central Bank had to increase its daily sales of foreign currency in August and September 1982 to avoid a further devaluation of the peso (see Tables 2.17 and 2.18). During this period of ‘dirty’ floating, non-orthodox exchange rate policies were put into practice: (a) On 17 August 1982, a preferential exchange rate was created, known as the ‘preferential dollar’, 83 at a

Table 2.18 Daily Rates for the Dollar under the Free Floating and ‘Dirty’ Floating Systems, August–September 1982 (pesos/dollar)a August

August

August

September

2 3 4 5

46.7 46.8 47.1 47.0

gradual exchange rate adjustment

6 9 10

55.7 62.8 67.4

free floating

11 12 13 30 10 17 24

62.7 60.2 57.3 61.7 62.0 69.3 67.0

‘dirty’ floating

Source: Newspaper El Mercurio, various issues. Note: a These values correspond to the dollar selling rate. CPI inflation in Chile during August and September 1982 was 3.2 per cent and 4.3 per cent respectively.

114 The Unidad Popular and the Pinochet Dictatorship: A Political Analysis

value of 50 Chilean pesos per dollar (Table 2.18 gives the dollar price through the month of August). This meant a violation of the Law of One Price in the exchange market. The preferential dollar could only be acquired by agents who had loans in foreign currency prior to 5 August 1982; it was thus intended to compensate those who had kept faith with the fixed nominal exchange rate policy. This subsidy to foreign currency debtors represented a very substantial amount of public resources. (b) In view of the fact that the Central Bank continued to lose foreign currency, on 20 September 1982 controls and restrictions on the acquisition of foreign currency were imposed. As a consequence, there were now three different foreign exchange markets: the preferential, the formal market for exports and imports as well as formal financial capital movements managed by commercial banks, and the informal market for operations among private agents. Several days were needed to clarify who had access to the formal currency market: the status of invisible transactions and similar issues was not clearly defined. Under this new triple currency-market setup, what remained unclear were the rules for the future evolution of the price of foreign currencies on the formal market (which was governed by the ‘dirty’ floating regime). Restricted access measures eliminated the speculative component in the foreign exchange market – Central Bank officials filtered out speculators – to enable the ‘true’ equilibrium value of the foreign currency to be attained. However, the Central Bank did not wait to find out what this ‘true’ value was, and ended up with an exchange rate policy of ‘dirty’ floating. On 29 September 1982, a new exchange rate policy was implemented, fixing the exchange rate at 66 pesos per dollar, a level representing a nominal devaluation of nearly 70 per cent in relation to the 39-peso dollar, and a real devaluation of slightly more than 50 per cent (see Table 2.16). The second component of the new exchange rate policy involved a mini-devaluation rule with gradual daily adjustment. This time a very simple rule was established. The exchange rate would be devalued daily by an amount equal to the difference between domestic and international inflation. 84 This new measure was to last 120 days; 15 days later, the period was extended to 200 days. But no information was given regarding what exchange rate policy would be once this period had elapsed: in October 1982, 200 days seemed a very long-term horizon. Let us now look at some of the technical comments that this third (or rather fourth) change of exchange rate policy gave rise to. This time the size of the devaluation did coincide with economic agents’

The Economic Model of the Military Dictatorship 115

expectations; that is, it largely corresponded to the predominant value in the foreign exchange market at that moment (see Table 2.18); the arguments put forward by economists lobbying for a smaller devaluation – since a 50 per cent devaluation was much greater than the loss of international competitiveness (estimated at 30 per cent) – were not heeded. However, although most agents in October 1982 agreed that the exchange rate had a correct value and that the gradual adjustment rule was easy to understand, most people proved reluctant to take out loans in foreign currency, despite the large differential that existed between interest rates on peso loans and those in foreign currency. Empirical evidence of this behavior is provided by the fact that national commercial banks had certain foreign credit lines that were not being used, for the simple reason that Chilean economic agents did not want to accept loans in foreign currency: There was almost total uncertainty about the future value of the exchange rate, and great mistrust of the statements made by the economic authorities and in their ability to meet future foreign currency needs. In order to resolve this type of problem, on 21 October 1982 the Central Bank adopted the following measure: in order to enable national commercial banks to obtain foreign loans in foreign currency and convert them into peso loans in the domestic credit market, the Central Bank would assume the exchange rate risk and the commercial banks would have assured access to repurchase currency within a six-month period. These were swap operations involving a significant subsidy on the part of the Central Bank, and they prevailed for many years. Monetary policies applied in 1982 The monetary policies deployed to confront the crisis were related to the exchange rate policies of the same period. As long as the fixed nominal exchange rate policy was in force, money was considered endogenous – that is, increases or decreases in the money supply would be induced exclusively by foreign currency operations carried out by the Central Bank. During the first half of 1982 (and in fact throughout the year) the Central Bank saw its reserves dwindle; before the devaluation of 14 June, M1 money supply both in nominal and real terms had shrunk 10 per cent since the previous December (see Table 2.19). This restrictive endogenous monetary policy, known as ‘monetary policy of extreme neutrality’, was part of the automatic adjustment mechanism. The week following the 14 June devaluation, fearing the inflationary expectations this devaluation would generate, the monetary authorities

116 The Unidad Popular and the Pinochet Dictatorship: A Political Analysis Table 2.19 Evolution of Monetary and Real Sector During 1982. Chile, Selected Months Nominal money Real money GDP growth Index of Effective supply (M1) supply (M1/P) (annual rate)a Industrial output unemployment (US$ billion) (billion pesos) (%) (annual variation %) rate (%) (1) (2) (3) (4) (5) 1981 1982

Dec May June August Sept. Oct. Dec.

82.5 74.0 74.1 70.8 71.6 66.6 75.0

41.3 37.1 37.0 33.6 32.5 28.9 31.1

–4.6 –12.8 –19.1 –16.2

–12.4 –16.6 –20.6 –18.2 –17.8 –17.7 –15.1

16.1 24.9 29.1 29.3

Sources: Columns (1), (2) and (3): Central Bank; Column (4): SOFOFA; Column (5): Jadresic (1986); includes PEM and POJH programs. Note: a Quarterly figures.

gave an assurance that the endogenous monetary policy of extreme neutrality would be maintained. This was justified by arguing that devaluation alone would cause an increase in reserves accumulated by the Central Bank through its positive effect on the trade balance, and this would expand the money supply. However, the main effect of the devaluation was to create expectations of further devaluations, leading to a widespread acquisition of foreign currency (Table 2.17), which in turn redounded in a tightening of liquidity in the economy. The following week, public opinion began to react to the 25 per cent unemployment rate and the sharp economic recession (Table 2.19), and there was a prevailing sensation that some measure urgently needed to be taken to revive the economy, because neither the previous automatic adjustment mechanism nor the recent devaluation seemed capable of achieving an effect in the short term. The Central Bank authorities declared they would apply a more active monetary policy, increasing M1 by 11 per cent in nominal terms over the remaining six months of the year (according to their estimations, inflation for the rest of the year would be 11 per cent). This type of monetary policy was known as ‘active neutralism’, as its aim was to keep the level of M1 constant in real terms, compared with its predevaluation level. However, using June 1982 as the base for the real level of M1 meant a 10 per cent cut in money supply compared with the end of 1981.

The Economic Model of the Military Dictatorship 117

The mere announcement that M1 would be increased through a mechanism other than through foreign exchange operations introduced an element of uncertainty about monetary policy management. In the light of this, the Central Bank was moved to give an assurance that even though ‘we have a monetary program, we are willing to change it rapidly if it turns out to be incorrect’. From this moment onwards, since Chileans had been brought up to believe that any increase in the money supply that did not come from foreign exchange operations would generate inflation, economic agents began to be concerned about changes in M1 and any news released by the Central Bank with regard to its money supply goals. When the floating exchange rate system was established in August 1982, the monetary authorities declared they were now better placed to implement an autonomous monetary policy; the previous program established in June 1982 had failed because the exchange rate was not free. Now nominal M1 would rise by 12 per cent over the course of the next five months.85 The private sector considered this program of monetary expansion to be insufficient, given that nominal M1 was already 14 per cent below its end-1981 level (real M1 in August was 18 per cent lower; see Table 2.19). What really happened was that despite having installed a floating exchange rate system, the Central Bank was totally incapable of controlling the money supply. September 1982 saw a new Finance Minister and a new Central Bank president appointed. Both stated clearly that monetary policy would be the main instrument for reviving the economy. Through this policy – active monetary policy – it was intended that real M1 would regain the level it was before the Central Bank made its sale of large quantities of foreign currency. No further specific information (in terms of months) was given in this regard; the new economic authorities waited more than 40 days before being more explicit; meanwhile, the recession steadily intensified: in the third quarter of 1982 unemployment topped 29.1 per cent, while GDP and industrial output suffered reductions of 19 per cent and 18 per cent respectively compared with the year before (see Table 2.19). In the second week of October, the Finance Minister announced that real M1 would rise to reach its June 1981 level, which meant an increase of more than 20 per cent. But the period during which this increase would be carried out was not stated: this was to be left to the discretion of the Central Bank. The monetary authorities implemented this measure in the following way: on 20 October they announced that M1 would rise by 16 per cent

118 The Unidad Popular and the Pinochet Dictatorship: A Political Analysis

over the next 15 months. Two days later, they stated that there had been a typing error in the previous announcement and that the 16 per cent increase was programmed for the following three months. However, it was unclear whether the increase was in nominal or real terms. Considering that inflation in the month of September had exceeded 4 per cent and that it was predicted to remain at 4 per cent per month over the coming three months, the difference between a real or nominal increase in M1 was quite large. The Central Bank waited 24 hours more before clarifying that the 16 per cent increase referred to nominal M1. This active monetary policy was unable to raise real M1 to a level close to that of 1981 (see Table 2.19). Thus, Chile’s economic authorities came to realize that despite having applied different exchange rate systems, they did not have control of money supply, for which reason monetary policy did not constitute a useful or powerful instrument for reviving the economy when it was in the depths of a deep recession and there was freedom of capital movement. Summary of 1982 We have reviewed the various hypotheses that attempt to explain the 1982–83 crisis. The measures used to confront the crisis also had the effect of increasing its magnitude and thus its costs. It is worth pointing out that the implementation of countermeasures to correct previous errors – applied at the worst moment of the crisis – had large redistributive effects (for example, the introduction of the subsidized exchange rate or preferential dollar). While unemployment was climbing to above 20 per cent and GDP growth was falling to negative annual rates of about 10 per cent, the automatic adjustment mechanism was applied in a dogmatic fashion. Later the economic authorities were more interested in achieving credibility than in reviving the economy, as credibility was believed to be a prerequisite for revival. However, a series of errors were committed in the attempt to regain confidence. In order to neutralize the impact generated by the first devaluation and avoid admitting the existence of a serious problem of external imbalance (and therefore exchange rate problems), free access to the foreign exchange market was maintained. Then, with the aim of increasing credibility, and in the midst of a run on the peso, all restrictions on short-term capital movements were lifted.86 However, the opposite happened: the devaluation of 14 June 1982 (which was too little, too late) generated expectations of bigger devaluations. The maintenance of free access to the foreign exchange

The Economic Model of the Military Dictatorship 119

market and the lifting of restrictions on short-term capital movements encouraged capital flight. The numerous unclear and frequently changing exchange rate and monetary policies added to distrust of the economic authorities. By the end of 1982, the Central Bank had seen its international reserves dwindle by 30 per cent, so it became necessary to introduce exchange controls and impose restrictions on capital movements. The high real rates of interest, the large real devaluation, the sharp contraction in GDP and the sudden drying up of lending from abroad, all caused serious problems to productive and financial sectors. Many borrowers could not fulfill their debt service in foreign currency under the new exchange rate, others were unable to pay the high rates of interest on their debts in national currency, and the banks began to accumulate an increasingly large volume of bad loans. From the end of 1982 onwards, domestic debt became a very critical problem. The total collapse of the financial system was avoided thanks to constant liquidity provided to private banks by the Central Bank. In addition, the government had to undertake special bail-out operations for different types of borrowers: as we have seen, a preferential exchange rate was established for debts in foreign currency, but in addition special rescheduling programs were introduced for the big conglomerate groups, the bad-debt portfolio of the banking system was taken over by the Central Bank, home loans were subsidized, and interest arrears and penalties were written off. The Central Bank provided most of the financing needed for such programs, which amounted to considerable sums, but at the same time the unemployed and workers suffered a significant contraction in their incomes.

The adjustment process of the 1980s Before the foreign debt crisis of 1982, Chile experienced economic problems and adjustment difficulties similar to those of other Latin American countries; the fact of already having made the basic structural reforms suggested by the International Monetary Fund and the World Bank did not mean greater protection in facing external shocks or reducing adjustment costs. However, by the end of the 1980s the Chilean economy had managed to carry out external and domestic adjustment and was better placed than most Latin American economies to meet the 1990s. The Chilean economy in 1982–83 was affected by domestic imbalance and external disequilibrium. The former expressed itself in a high

120 The Unidad Popular and the Pinochet Dictatorship: A Political Analysis

rate of unemployment and falling workers’ wages. The external imbalance was linked to a scarcity of foreign currency caused by the huge effort needed to service the external debt. The government chose to reduce external disequilibrium, even though this meant aggravating the domestic imbalance in the short and medium term. There is a political rationale to explain this governmental choice. Domestic disequilibrium hurt Chilean workers, whereas the foreign imbalance affected the international banking system and multilateral agencies. Which of the two disequilibria was politically controllable? The answer was obviously domestic disequilibrium: it was a matter of bringing the soldiers out into the streets. But conflict with external economic agents could not be resolved in the same way. Like other Latin American countries the foreign debt then became the priority variable. The economic team of that time opted for investment in reputation,87 believing that a country that avoided conflict with foreign creditors and paid its external debt service on time, regardless of the domestic cost it had to incur, would be seen as a trustworthy nation which in the long run will regain access to international capital markets. The adjustment process in the Chilean economy was not gradual; moreover, there were significant alterations to economic policy as well as setbacks in the evolution of the external disequilibrium. However, the final outcome was quite successful (see Table 2.20). Indeed, by comparing 1981 (which recorded the greatest external imbalance) and the years 1982 and 1983 (those of greatest domestic disequilibrium) with the final period of the military dictatorship (1987–89) the following can be seen. (i) A trade deficit equivalent to 70 per cent of exports (FOB) in 1981

Table 2.20 Selected Chilean Economic Variables Illustrating Existing Imbalances and Successful Adjustment in the 1980s Balance of Current GDP CPI National Foreign Foreign trade (FOB) account Growth Inflation unemployment debt/GDP debt/exports (US$ million) (US$ million) (%) (%) (%) (%) (No.) (1) (2) (3) (4) (5) (6) (7) 1981 1982 1983 1987 1988 1989

–2677 63 986 1229 2219 1578

–4733 –2034 –1073 –808 –167 –740

5.5 –14.1 –0.7 5.7 7.4 10.0

9.5 20.7 23.1 21.5 12.7 21.4

15.1 26.1 31.3 13.1 11.0 9.9

86.2 108.3 113.2 104.8 86.2 69.0

4.1 4.6 4.7 4.0 2.7 2.2

Sources: Central Bank; Jadresic (1986), updated with data from the University of Chile’s unemployment surveys.

The Economic Model of the Military Dictatorship 121

was transformed into a sustained trade surplus averaging more than 20 per cent of exports. (ii) The huge current account deficit of 1982 (US$4.7 billion) was brought down to an average of below US$500 million. (iii) The annual rate of economic growth throughout the period 1987–89 was above the 1981 rate of 5.5 per cent, and dramatically better than in the crisis years 1982–83. (iv) Annual inflation rates of around 20 per cent at the end of the 1980s, although higher than in 1981, are low relative to Latin American standards of that time. (v) Unemployment rates were well below those of the crisis years. (vi) Finally, the external debt was a problem that had more or less been overcome by the end of the 1980s; the external debt/GDP and external debt/exports ratios were way below those seen in the period 1982–83, and are at levels that suggested (in 1989) that the Chilean economy has achieved a sustainable service of its external debt. Many economists argue that the successful adjustment of the 1980s laid the foundations for Chile’s healthy economy of the 1990s. How was such a successful adjustment process achieved? Three stages can be distinguished in the process: 88 at the outset (1982–83), deflationary policies were applied to close the income–expenditure gap. Subsequently, in 1984 an expansionary policy was implemented to close the domestic output gap manifested in an unemployment rate above 30 per cent. From 1985 onwards, a third stage brought with it policies of relative price adjustment, in view of the perception that the external disequilbrium was a long-term problem. The years 1982–83 saw the worst economic recession in Chile since the 1930s. GDP plummeted by 15 per cent, industry and construction suffered contractions in excess of 20 per cent, effective unemployment89 rose to 30 per cent, company bankruptcies tripled, the Central Bank lost more than 45 per cent of its international reserves and the bad debt portfolio of the private financial system grew to an average of nearly three times its capital (the two main banks, Banco de Chile and Banco Santiago, had losses totalling four to five times their capital). The adjustment process entered a new phase in 1984. The deep and prolonged recession of 1982–83 called for recovery measures to reduce the high costs of adjustment, and a new economic team took charge of this. Although domestic borrowers had already received some help from the government in alleviating their financial situation, public opinion perceived that an expanding economy was the best route to solving the domestic debt problem more definitively and for reducing the social cost of high unemployment. Furthermore, given that the income– expenditure gap had been closed and the necessary devaluation had already occurred – that is, the main stabilization and structural

122 The Unidad Popular and the Pinochet Dictatorship: A Political Analysis

adjustment policies had already been applied – it was assumed that Chile’s economy was in condition to initiate a growth process. The expansionary policies applied in this second phase generated GDP growth of 6.3 per cent in 1984 and industrial expansion close to 10 per cent;90 effective unemployment was brought down to below 25 per cent. As a counterpart to this, there was a rapid deterioration in external accounts: the trade balance (FOB) surplus was cut from US$986 million (1983) to US$283 million, and the current account deficit widened from US$1073 million (1983) to US$2060 million. Such extreme external vulnerability suggested a new economic perception: external adjustment is a long-term process requiring the maintenance of austerity in domestic spending. A new economic team took office in 1985 whose priority was a reduction of foreign borrowing requirements. For this, a further real devaluation was thought necessary, since the previous one – which had compensated for the loss of international competitiveness experienced in the three years of the fixed nominal exchange rate – was now thought to have been insufficient to generate the real transfer needed for external debt service. Exports were to be the engine of economic growth. A considerable amount of external resources were needed to finance this program. It is surprising that following the deterioration of the current account in 1984, in 1985 Chile managed to obtain a volume of new money from the international private banking sector similar to that obtained the previous year. In addition, the country signed a three-year Extended Fund Facility (EFF) with the IMF, and a three-year program Structural Adjustment Loan (SAL) with the World Bank. The policies that contributed to macroeconomic adjustment in the 1980s involved the following: a cooperative position on the problem of external debt, which made possible the entry of significant resources from multilateral organizations; a significant real devaluation made possible thanks to the de-indexation of wages in 1982, and the high level of unemployment resulting from the deep economic contraction; a significant fiscal adjustment, needed to transfer the large volume of public resources used to avoid collapse in the productive and financial sectors; a set of heterodox foreign trade policies (higher tariffs, imposition of surcharges and price bands); monetary policy (rate of interest ‘suggested’ by the Central Bank, banking regulation); and measures relating to capital movements (for example, exchange controls). Finally, one would have to add the highly favorable external shock provided by the terms of trade which began at the end of 1987 and lasted until 1992.

The Economic Model of the Military Dictatorship 123

Two basic principles guided the behavior of the Chilean government during the 1980s in the face of external debt problems. The principle of non-confrontation meant that the government underwrote the unguaranteed foreign debt of the national private financial sector (the value of non-recoverable loans of the private banking sector corresponding to foreign borrowing has been estimated by the World Bank at more than US$3.5 billion); moreover, it kept up full and punctual payment of interest on the external debt, and in exchange obtained an orderly and advantageous rescheduling of most of the principal. The second guiding principle held that the application of consistent macroeconomic policies and a serious adjustment effort would attract external lending. These two principles underpinned the notion that it was profitable for Chile to invest in its reputation, as this would permit access to the international voluntary credit market. Table 2.21 illustrates the main foreign lending flows during the adjustment period. New money (medium- and long-term loans) from private banks dropped steadily to zero. Multilateral agencies (IMF, World Bank and IDB) provided an annual average amount of US$760 million over the period 1983–87, which covered 40 per cent of external debt service. Investment in reputation, therefore, only had an effect on the multilateral organizations. The international private banking sector dedicated numerous eulogies to Chile’s adjustment process, but it did not facilitate access to the voluntary (medium- and long-term) credit market until 1989. At the end of 1987, the Chilean economy experienced a significant positive terms-of-trade shock, which reduced (and even eliminated) the Table 2.21 Main Sources of External Financing, Chile 1983–1987 (US$ million) 1983

1984 1985 1986 1987

Commercial banks (new money) 1300 780 714 370 0 Multilateral agencies (World Bank, IDB, etc.) 335 448 549 507 519 IMF (annual increments)a 600 176 303 243 124 Supplier credit 145 391 207 341 509 Short-term commercial credit –1339 280 36 129 147 Total (capital account financial flowsb plus annual IMF loan) 1041 2075 1809 1590 1299 Sources: Fontaine (1987); Central Bank; IMF. Notes: a At the end of 1987 total loans provided by the IMF amounted to US$1450 million. b Excluding amortization payments.

124 The Unidad Popular and the Pinochet Dictatorship: A Political Analysis

need for new foreign loans. Indeed, if one uses the period 1980–86 as a base for the international prices of three important export products, the following can be seen: (i) The price of a pound of copper rose from US¢72.4/lb (1980–86 average) to US¢80.8 in 1987, US¢117.9 in 1988 and US¢129.2 in 1989.91 (ii) The price of fishmeal varied from US$391.7/ton (1980–86 average) to US$383.4/ton in 1987, US$544.4/ton in 1988 and US$409.1/ton in 1989. (iii) The price of wood pulp rose from US$462.8/ton (1980–86 average) to US$612.9 in 1987, US$739.7 in 1988 and US$829.5/ton in 1989. National Accounts provide the following figures for the positive effect of the terms of trade (base year 1986): 2.6 per cent of GDP in 1987, 6.3 per cent in 1988 and 6.9 per cent of GDP in 1989. In short, a positive external shock of more than 5 per cent of GDP (on average) during 1987 to 1989 meant the Chilean economy received an annual amount close to US$1.5 billion – virtually double the annual lending provided by the multilateral agencies up to then. The real devaluation As most of the basic reforms had already been implemented in the 1970s, devaluation came to be the central tool of adjustment in the 1980s. Devaluation raises the domestic local currency price of tradable goods, thereby increasing the relative price of tradables compared to non-tradables; this change in relative prices encourages a preference for tradable goods in production, while encouraging a switch towards nontradables in consumption. These two processes helped to reduce the current account deficit. However, in order for a nominal devaluation not to be eroded by inflation and to effectively produce a change in relative prices, it needs to be supported by complementary fiscal and monetary policies. This is a necessary but insufficient condition; in the short and medium term, a real devaluation also requires real wages to fall (if there is 100 per cent wage indexation, then it becomes necessary to de-index). And the use of an exchange rate regime with minidevaluations (crawling peg) following an abrupt devaluation has proved to be the most appropriate way of maintaining the new real value of the exchange rate.92 In Chile’s adjustment process, nominal devaluations have generated real devaluations. Table 2.22 shows that yearly nominal devaluations were greater than the corresponding inflation rates between 1982 and 1985; later, a degree of correspondence resulted from the application of a mini-devaluation rule which considered the differential between domestic and foreign inflation. However, this crawling peg rule was

The Economic Model of the Military Dictatorship 125 Table 2.22 Nominal Devaluation and Inflation, Chile, 1981–1988 (percentages) 1981 1982 1983 1984 1985 1986 1987 1988 1989 Nominal devaluation 0.0 30.5 54.8 25.0 63.4 19.9 13.7 11.7 9.0 Average annual inflationa 19.7 9.9 27.3 19.9 30.7 19.5 19.9 14.7 17.0 Source: Central Bank monthly bulletin Boletín Mensual (various issues). Note: a This inflation rate corresponds to the average annual variation in the CPI.

not applied very strictly; the Central Bank established a band: a reference exchange rate with an additional margin of 2 per cent, later widened to 5 per cent. Thus, after 1986 the Central Bank had the possibility, within a relatively small margin, of changing from a passive crawling peg to an active one. The real devaluation caused a significant shift of resources towards the tradable sector. By using the evolution of the share of the tradable and exporting sectors in GDP (real and nominal), the export sector raised its share of real GDP by 5 percentage points, and the tradable sector as a whole did so by nearly 2 percentage points. This increase in real GDP share is associated with a greater relative use of productive factors and with a relatively bigger productivity increase. The export sector, along with the tradable sector in general, raised their share of nominal GDP by 12 percentage points, reflecting the greater relative increase in their revenues. Part of this increase is due to a greater relative use of factors of production; another part corresponds to a reversal of the deterioration suffered by the tradable sector during the fixed nominal exchange rate period (1979–82). However, a significant part also corresponds to an inter-sectoral redistribution of income. Given that nearly 36 per cent of exports were generated by the copper conglomerate CODELCO, the public sector captured a considerable fraction of this domestic income redistribution. If we take the level of the real exchange rate for the two-year period 1980–81 as a benchmark, the real devaluation of the 1980s (up to 1986) would amount to 80 per cent (see Table 2.23). How was a real devaluation of this magnitude possible? What prevented large nominal devaluations generating greater inflationary pressures, as happened in other Latin American countries? This is one of the points still to be resolved both empirically and analytically, but several factors can already be identified: (a) The decline in real wages made the local economy more competitive; but how could a fall in real wages of 10 per cent (according to official

126 The Unidad Popular and the Pinochet Dictatorship: A Political Analysis Table 2.23 Real Exchange Rate and Real Wage, Chile 1980–1987 (1980–81 = 100)

IMF (1) 1980 1981 1982 1983 1984 1985 1986 1987

106.2 93.8 132.3 124.3 141.2 180.6 195.4 182.0

Real exchange rate World Bank Central Bank (2) (3) 107.4 92.6 105.7 126.0 127.8 142.7 186.8

106.8 93.2 103.9 124.1 129.8 159.8 175.9 90.6

Real wage Official Calculated (4) (5) 95.7 104.3 104.0 93.0 93.1 89.0 90.9 81.2

95.0 105.0 110.3 91.1 86.5 80.0 81.5

Sources: Col. (1): EFF-IMF Program (July, 1987). The nominal exchange rate is adjusted by a weighted price index (CPI) and a weighted exchange rate of Chile’s 16 most important trading partners. Values correspond to the month of December each year. Col. (2): World Bank (1988). Real exchange rate index weighted according to trade flows. Average yearly values. Col. (3): Central Bank (cited in Fontaine, 1987). Average real effective exchange rate for each year, calculated as the average WPI of Chile’s main trading partners (weighted by imports), converted into pesos at the official exchange rate and deflated by the Chilean CPI. Average yearly values. Col. (4): INE. Col. (5): Basic nominal wage data obtained from the ACHS (Chilean Insurance Association) which has a large sample of firms (4000) covering a broad range of firm sizes, sectors of the economy and regions. The same 4000 firm sample has been used for the period 1980–1987. Wages have been weighted using national sectoral employment figures.

statistics) generate a real devaluation of 80 per cent? A review of the path of real wages in the 1980s suggests that the wage contraction was probably close to 20 per cent (Table 2.23). (b) Public spending cuts, relatively more intensive in non-tradable goods, would have helped to raise the relative price of tradable goods with respect to non-tradables and, as a consequence, would have induced a real devaluation; econometric results suggest, however, that this effect is not empirically relevant.93 (c) Structural changes, such as greater or lesser mobility or availability of external capital and terms-of-trade shocks, also affected the evolution of the exchange rate. The decision to bring about a significant real devaluation was a key element in reducing external and domestic disequilibria. On the one hand, it raised Chile’s international competitiveness, stimulating an expansion of exports and production of import-competing goods; in this way, the external deficit was narrowed. On the other hand, the real devaluation generated a transfer of income to the export sector in particular, and in this case to the GMC (public sector); then, with this

The Economic Model of the Military Dictatorship 127

greater availability of resources, the public sector was able to reduce both the fiscal deficit and the quasi-fiscal deficit, easing inflationary pressures and helping to solve the domestic imbalance.

Heterodox policies used in the adjustment The free-market economic model, involving free trade with low tariffs, deregulation and neutral policies, was modified during the adjustment process in the 1980s. Let us look first at the different economic measures relating to foreign trade after 1982. In the first place, tariffs were raised from 10 per cent (1982) to 35 per cent (1984) (Table 2.24), from which it can be deduced that Chile undertook two trade reforms, although the greater part of the attention has been concentrated on the reforms carried out in the 1970s. Chile’s 1980s trade reform, in which import tariffs were brought down to 11 per cent (1991), has passed largely unnoticed – a circumstance that is particularly strange, for whereas the earlier reform ended in failure, the 1980s reform has enjoyed notable success. Another interesting aspect is the difference in the speed with which the two trade reforms were undertaken: in the 1970s liberalization process, tariffs were lowered from 22 per cent to 10 per cent in two years, whereas in the 1980s they fell from 20 per cent to 11 per cent in the space of five-and-a-half years. On top of the tariff increase, tariff surcharges were also applied. Each year from 1983 to 1989, an average of nearly 50 products had to pay surcharges; these initially had a value which fluctuated around 20 per cent, later dropping to 5 per cent. Surcharges were maintained for more than three years on some products such as tyres, milk products, matches, clothes and cotton cloth.

Table 2.24 Nominal Tariffs Following the External Debt Shock, Chile 1982–1990 (percentages) 1982

1983

1984

1985

1986

1987

1988

1989

1990

10

20a

20–35b

30–20c

20

20

15d

15

15

Source: Central Bank. Notes: a Tariffs raised to 20 per cent in March 1983. b Tariffs raised to 35 per cent in September 1984. c Tariffs lowered to 30 per cent in March and to 20 per cent in June 1985. d Tariffs lowered to 15 per cent in January 1988.

128 The Unidad Popular and the Pinochet Dictatorship: A Political Analysis

From 1983 on, price bands for sugar, wheat and vegetable oil were similarly re-established; this mechanism, which had been abolished in 1980, had the aim of isolating the national producer from fluctuations in international prices. By transforming the price bands (applied) into the equivalent tariff for each product, the following values are obtained: 64 per cent (1984–89 average) for sugar, 27 per cent (1984–87 average) for wheat, 70 per cent (1988–89) average for oil. Monetary policy, for its part, changed radically as from 1983. It was no longer a totally passive monetary policy with free determination of the interest rate; from 1983, and up to 1989, an active monetary policy was applied, which focused on suggesting the deposit interest rate (1983–85) and then, in the period 1985–89, on guiding real rates of interest. The Central Bank’s interest-rate signal became a decisive factor in the spending decisions of economic agents.94 Indeed, this action on the part of the Central Bank was notable: real annual interest rates in excess of 30 per cent (on 30- to 90-day loans) in 1981 and 1982 dropped to 15 per cent in 1983, and kept on falling until they reached single-figure levels from 1986 onwards. From the institutional perspective, there was a far-reaching change in the regulation and supervision of the banking and financial system culminating in the General Banking Law (1986); in this way, rigorous control mechanisms were established to preserve the solvency of banking and financial institutions. The new measures included full provision against losses and the withdrawal of the 100 per cent state guarantee of deposits. Exchange controls were established in September 1982 to put a brake on massive capital flight; this included suspending the monthly sale of US$10 000 per person, introducing maximum currency quotas for travelers abroad, lowering the amount of foreign exchange an exporter could keep abroad and establishing a 120-day minimum for the payment of imports. Exchange controls generated a parallel currency market with an average differential of nearly 20 per cent in the two years 1983–84. Moreover, the Central Bank set up a swap mechanism in which an agent could make interest-paying deposits in dollars at the Central Bank, with a guarantee of repurchase, with the Central Bank bearing the devaluation risk.95 Finally, the preferential dollar mechanism was created, which was really a subsidy for agents holding dollar debts; the amount of this subsidy was considerable. Specific tariff surcharges, price bands and the preferential dollar openly violated the principle of neutrality in the economic rules of the game. On the other hand, given their exceptional and transitory nature (six months

The Economic Model of the Military Dictatorship 129

for surcharges, one year for the price bands), their visibility and need for renewal put pressure led to their abolition; nevertheless, they may have generated significant private rents while in force. Adjustment costs The adjustment process needed a trade surplus (CIF) in order to service the foreign debt; a trade surplus meant transfering real resources abroad. To measure the total amount of the resource transfer made by Chile to accommodate external debt service, one has to consider the size of the surplus (CIF), together with variations in international reserves. Although such an indicator mixes real and financial resources, it provides a better quantification of the effort actually made by the country.96 Between 1982 and 1988 (except 1984), the Chilean economy effected a real transfer amounting to nearly US$800 million per year (Table 2.25); this figure represented between 3 and 4 per cent of GDP,97 and on average 18 per cent of exports, declining over time to 10 per cent by 1989. Distributive impact Domestic debt and Central Bank subsidies High real rates of interest, the large real devaluation, deep economic recession and the sudden drying up of foreign lending caused serious problems of liquidity and solvency in the productive and financial sectors. Borrowers in foreign and national currency were not in a position to service their debts, and the commercial banking sector began to accumulate a growing portfolio of loans in arrears and bad debts, which became an increasingly urgent problem from 1982 onwards. In these circumstances the Central Bank played the crucial role of lender of last resort, providing a continuous flow of liquidity to prevent the collapse of the financial and productive system.98 But the Central Bank also fulfilled another function, that of bailing out (important) debtors. The main mechanism used for this was the preferential dollar. The other benefit received by these borrowers was the process of de-dollarization, i.e. the conversion of dollar debts into debts in pesos just before a new sudden devaluation (September 1984). The subsidy provided by the Central Bank in this process amounted to US$232 million. In 1983, the private-sector financial system was technically bankrupt; non-recoverable and risky loans were equivalent to a significant multiple of commercial bank capital. To avoid financial collapse, the main private

130

Table 2.25

Measure of Real Transfer Abroad, Chile 1982–1988 Trade balance (CIF)

1982 1983 1984 1985 1986 1987 1988 1989

Exports (%) (3)

Net interest payments

Debt

(US$ million) (1)

Trade balance (CIF) plus change in international reserves (US$ million) (2)

(4)

(5)

–492 534 –141 511 652 766 1576 943

673 1075 –158 610 880 721 844 506

18.2 28.1 –4.3 16.0 21.0 13.8 12.0 6.3

35.0 61.5 –7.8 32.1 46.6 42.4 44.0 26.3

3.9 6.0 –0.8 3.0 4.2 3.5 4.4 2.9

Sources: Banco Central, Boletín Mensual, and Deuda Externa de Chile.

Trade balance (CIF) plus change in international reserves as % of

The Economic Model of the Military Dictatorship 131

banks received total support from the Central Bank, and the remainder obtained significant emergency loans. The Central Bank channeled big flows of financial resources and implemented a series of measures to reestablish a solvent financial system;99 for this purpose, it used public resources for recapitalizing the commercial banks while at the same time imposing restrictions on the use of future banking profits.100 The economic authorities used various solutions to solve the problem of peso debtors. During 1982 there was an attempt to apply a market solution – it was intended that through bankruptcies and auctions of the real guarantees associated with unpaid loans, the losses would be shared between debtors and creditors on a case-by-case basis. But neither the debtors nor the banks were interested in applying this solution; furthermore, the number of insolvent debtors was so high that the slow judicial system was incapable of dealing with the problem. Debtors in pesos complained, moreover, that they were being discriminated against, for while debtors in foreign currency and commercial banks were receiving subsidies from the Central Bank, peso debtors were being required to go bankrupt. If one of the basic principles of a market system is economic policy neutrality, what justified such discrimination? As the market solution was not working and the economic situation was getting worse, the number of peso debtors rose significantly and they began to lobby for a political solution: the government had to intervene to help debtors and thus redistribute the losses among the rest of society. In short, the Central Bank gave relatively high subsidies to the private banking sector as well as to debtors in pesos and foreign currency (see Table 2.26). From a technical point of view, the significance of such subsidies is analogous to those provided by the government through fiscal spending: they are transfers of society’s resources towards certain economic sectors and agents. In general, they are not included or calculated as public-sector expenditure. The amount of resources the Central Bank assigned to bailing out debtors amounted to US$6 billion in the period 1983–85, or approximately 30 per cent of GDP in those years. The quasi-fiscal subsidies provided by the Central Bank, which exceeded 4 per cent of GDP every year during the period 1982–85, were more than the traditional nonfinancial public-sector deficit for the same period. The Treasury had to provide resources (Treasury Bonds) to recapitalize the Central Bank – this grant generated the debt the Treasury still has with the Central Bank.

132 The Unidad Popular and the Pinochet Dictatorship: A Political Analysis Table 2.26

Quasi-fiscal Subsidies Supplied by Central Bank, Chile 1982–1988 1982 1983 1984 1985 1986 1987 1988

Subsidy via ‘preferential dollar’ (US$ million)

906

638

395

932

111

37

a

Quasi-fiscal subsidies supplied by Central Bank (% GDP)

4.9

3.9

4.5

6.9

2.8

1.2

0.6

Sources: ‘Preferential dollar’ subsidy: Gémines and IMF. Total quasi-fiscal subsidy: Larrañaga and Marshall (1990). Note: a The subsidy was no longer in operation in 1988.

Notwithstanding the magnitude of the resources involved, it should be noted that the Central Bank averted the bankruptcy of the most important part of the country’s private productive and financial system; however, a substantial proportion of this assistance did not have a neutral distributive impact. The most important consequences of this financial crisis were threefold. In the first place, an experience of ‘learning by suffering’: instead of anticipating possible negative results, ideological short-sightedness or blindness made it impossible to act until the problem had already been generated. The economic authorities designed and set up a new institutional system for the supervision and regulation of the banking and financial system. Banks and economic agents adopted very cautious attitudes in their supply and demand strategies for loans in the year following the financial crisis: the banks restricted their loans only to trustworthy and safe clients who provided the real guarantees needed, and were undertaking low-risk investment projects of attractive return; economic agents, for their part, took care not to repeat the previous overborrowing experience, and apart from this, they had difficulties in providing the necessary guarantees. On the other hand, government intervention in the banks and firms belonging to the two biggest conglomerate groups in the country created the economy’s anomalous sector or ‘área rara’ – an undefined system of ownership in which it was unclear to whom the assets of the complex and elaborate interconnected framework of productive and financial firms created by these two groups actually belonged. It took quite a long time to untangle and reprivatize this ‘área rara’. The Central Bank ended up in a quite complicated asset situation which has continued to affect the degrees of freedom it enjoys in its monetary policy management throughout the 1990s.

The Economic Model of the Military Dictatorship 133

Unemployment and real wages The main effects of the policies of domestic expenditure contraction were a steep rise in unemployment and a severe cut in the real wage; moreover, both circumstances were maintained for a considerable time. Effective unemployment was above 24 per cent for four years in a row (1982–85), topping out at 31.3 per cent in 1983. The average real wage was cut by nearly 20 per cent and remained depressed for a long period; the net minimum wage fell by 40 per cent (see Table 2.27). It is interesting to examine the historical evolution of unemployment and real wages before and during the adjustment process. In the first phase of the adjustment, unemployment rose rapidly to over 20 per cent; at the same time, and because of wage indexation, real wages rose during the first half of 1982. Along with the devaluation, wage indexation was abolished and in 1982 a special provision was issued aimed at lowering nominal wages, specifying that the floor level for real wages was that which existed in 1979, before the establishment of the fixed nominal exchange rate. This provision meant a fall in real wages of nearly 20 per cent. Invoking the neoclassical approach, it was argued that a contraction in real wages would reduce unemployment. This is what happened in the end, but not immediately: for a couple of years real wages fell but the unemployment rate remained stuck above 24 per cent.

Table 2.27

Unemployment and Real Wages, Chile 1980–1989

Effective Real wage index Index of net unemploymenta (revised) minimum wage (%) (1980–81 = 100) (1980–81 = 100) (1) (2) (3) 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989

17.0 15.1 26.1 31.3 24.7 21.7 17.3 14.1 11.3 9.2

89.0 111.0 115.4 98.6 94.9 88.6 89.4 89.2 96.0 n/a

97.1 102.9 102.0 79.6 67.6 64.3 61.3 57.6 61.6 87.5

National Income per capita (1980–81 = 100) (4)

Employment growth (%) (5)

99.1 100.9 81.0 80.1 81.6 81.9 85.7 92.2 100.7 109.1

3.5 5.1 –12.1 – 3.0 11.4 6.3 8.9 8.4 6.3 3.7

Sources: Columns (1) and (5): Jadresic (1986) and University of Chile. Column (2): Meller (1992). See Table 2.23. Column (3): INE. Column (4): Central Bank and INE. Note: a Includes emergency employment programs PEM and POJH.

134 The Unidad Popular and the Pinochet Dictatorship: A Political Analysis Table 2.28 Structure of Unemployment and Employment by Households of Different Income Levels, Greater Santiago 1981–1983 (percentages) 1981

1982

1983

Percentage of households where head of household is unemployed Families of 20% lowest-income group 10.0 Families of 30% low-middle-income group 2.9 Families of 30% high-middle-income group 1.6 Families of 20% highest-income group 0.3

26.8 7.3 4.3 2.3

24.7 10.2 6.1 2.5

Percentage of households where head of household is employed Families of 20% lowest-income group 56.0 Families of 30% low-middle-income group 78.7 Families of 30% high-middle-income group 77.4 Families of 20% highest-income group 86.9

35.1 65.2 72.0 78.7

42.4 64.2 66.2 79.4

1.1 1.4 1.7 1.9

1.1 1.4 1.7 2.0

Average number of income-earners per household Families of 20% lowest-income group Families of 30% low-middle-income group Families of 30% high-middle-income group Families of 20% highest-income group

1.2 1.5 1.8 2.1

Source: Riveros (1984). Basic data come from the University of Chile’s employment and unemployment surveys.

From Table 2.28, which synthesizes the structure of unemployment and employment by households of different income levels during the years of deep recession (1982–83), it can be seen that unemployment affected the poorest groups of the population proportionately more: over 50 per cent of the unemployed belonged to the 20 per cent lowest-income group. Furthermore, the impact of unemployment is relatively more severe among these groups because they possess relatively fewer income-earners. The duration of unemployment during the adjustment was longer than three months for more than 60 per cent of the unemployed, which caused serious problems of survival for their families. A preexisting program of unemployment compensation covered just 15 per cent of the unemployed, for which reason two public employment programs were set up (known as PEM and POJH) for the purpose of channeling unemployment subsidies, into which nearly 500 000 people were drafted during 1982–83. During the years of deepest recession, therefore, more than 50 per cent of the unemployed received no subsidy, 30 per cent received a subsidy equivalent to 60 per cent of the net minimum wage (under the POJH program), and the remaining 20 per cent received a subsidy equivalent to 30 per cent of the net minimum wage (under PEM).

The Economic Model of the Military Dictatorship 135

The total cost of these unemployment subsidies during 1982 and 1983 varied between 1 and 1.5 per cent of GDP. After 1983 there was a deterioration of nearly 50 per cent in the purchasing power of unemployment subsidies, and as the level of unemployment also fell, this meant a decrease in their annual cost. From the economic policy viewpoint, the relationship between unemployment and wages, and/or employment growth and real wages, is fundamental. There is no unidirectional causal relationship that runs from real wages to unemployment or vice versa. The harsh stabilizing adjustment of 1982–83 led to a deep economic contraction which generated Keynesian unemployment; the classical recipe of cutting real wages raised the level of this Keynesian unemployment. In a context where unemployment subsidies were small or non-existent, massive and persistent unemployment caused a sustained fall in the real wage. However, over the course of time low real wages helped to create jobs (see Table 2.27). Consequently, although the cut in real wages was ineffective in preventing a rise in unemployment during the stabilization stage of the adjustment process, exactly the opposite occurred in the prolonged structural phase of this process. In other words, because of the high level of unemployment and the long period of austerity in domestic spending, as time passed Keynesian unemployment turned into classical unemployment. The recession generated spare capacity, and because of the economy’s slow recovery, the existence of this spare capacity discouraged investment: this process generated classical unemployment. Given the low level of investment that characterized the recessionary period, existing productive capacity could not absorb all available labor at the real wages initially in force; the profitability of the capital stock needed to achieve full employment was too low, and to expand would require real wages to be held down for a considerable period of time. This shows that the relationship between real wages and unemployment is not unidirectional. At the aggregate level it could be said that Chile’s 1980s structural adjustment was carried out at the expense of the labor market. Due to its distributive implications, it is important to make a disaggregated analysis of the labor market by economic sector, region and firm size, for which purpose a relatively large sample of firms (3747) employing more than 200 000 people was used. The results show that during the recovery period of the structural adjustment, workers in small firms (less than ten people) were those who suffered the greatest relative fall in real wages, that the real devaluation (and the corresponding change in relative prices) basically benefited workers in large firms (more than

136 The Unidad Popular and the Pinochet Dictatorship: A Political Analysis

50 people) producing tradable goods, and that small firms experienced a greater employment growth than large firms. The prolonged contraction in real wages thus generated a big expansion in employment.101 The most important mechanisms (from the empirical point of view) associated with this job creation were, firstly, the expansion of production in sectors and firms that were relatively labor intensive – in this case the principal mechanism was high output–employment elasticity which occurred in small firms – and secondly, that although labor demand functions at the sectoral level showed a high wage–employment inelasticity, the big cut in real wages encouraged relatively greater use of labor. In this case, once again the effect was more significant among small firms, because here there was a relatively bigger fall in the real wage, and small firms have low (inelastic) wage–employment elasticities in several sectors. The fiscal adjustment The fiscal sector, as has been pointed out, showed a surplus in the years prior to the external debt shock. It was precisely this shock that was one of the causes of the fiscal deficits that appeared in later years. The fiscal deficit (as a percentage of GDP) varied between 2.3 per cent and 3.7 per cent between 1982 and 1985 (see Table 2.29), figures which suggest the presence of a moderate fiscal adjustment. However, looking

Table 2.29 Fiscal Deficit, Employment and Wages in the Public Sector, and Social Spending, Chile 1980–1986 Fiscal deficit

(1) 1980 1981 1982 1983 1984 1985 1986

–5.5 –2.9 2.3 3.0 3.5 3.7 1.1

Public employment Index of public-sector Social spending (000s) wages ($ million 1986 Central govt. Total public (1980–81 = 100) prices) sector (2) (3) (4) (5) 257.7 240.8 235.8 233.3 232.6 236.5

335.9 312.2 305.2 300.5 300.7 306.0

92.5 107.5 108.1 86.9 85.6 82.3 82.6

252.7 255.2 250.1 211.2 218.5 231.7 223.6

Sources: Col. (1): Larrañaga and Marshall (1990). A negative sign indicates a fiscal surplus. Col. (2) and (3): Larraín (1986). Col. (4): Gatica, Romaguera and Romero (1986). The mean of the maximum and minimum wages among Category-B (lower wage) workers has been used. Col. (5): Cabezas (1988).

The Economic Model of the Military Dictatorship 137

carefully at the evolution of specific government variables one can see that public-sector employment declined by 2 per cent, real publicsector wages were cut by between 13 and 17 per cent – later there was a real cut in public-sector payrolls of more than 17 per cent – and the level of social spending (education, health and housing) diminished in real terms by 10 per cent from 1983 onwards. To make inter-temporal comparisons, this type of spending needs to be measured in per capita terms. Per capita social expenditure was cut between 6 and 12 per cent between 1980–81 and 1987 (see Table 2.30). The reasons for this severe fiscal adjustment included the unemployment subsidy programs that the government had to set up during the stabilization phase of the adjustment process, as well as a far-reaching social security reform prior to the external crisis (1981), in which the state-run ‘pay-as-you-go’ system was transformed into a system of individual capitalization administered by the private sector. Putting this reform into practice meant that the state was left with the passive sector and at the same time lost the contributions of a large part of the active sector, thereby generating an ongoing annual operational deficit varying between 3 and 4 per cent of GDP. The quasi-fiscal subsidy with which the Central Bank avoided financial and productive collapse, together with foreign debt service, which were beginning to represent nearly 3 per cent of public spending (1985), was also a cause of the fiscal adjustment that was urgently needed.102 How was this adjustment carried out? The payroll of the fiscal sector was cut from 7.8 per cent (1981–82) to 5.8 per cent of GDP (1985). 103 Pensions, which were fully indexed to the CPI, in 1985 suffered a Table 2.30 Composition of Social Spending Per Capita, Chile 1980–1987 (1980–81 = 100) Social spending per capita

1980 1981 1982 1983 1984 1985 1986 1987 Source: IMF.

Health

Education

Housing

104.8 95.2 101.9 81.2 85.5 82.3 80.7 87.5

95.7 104.3 123.8 107.0 101.9 99.2 96.4 93.6

100.5 99.5 69.7 57.7 67.5 92.6 86.7 92.9

138 The Unidad Popular and the Pinochet Dictatorship: A Political Analysis

permanent cut equivalent to 1 per cent of GDP. Per capita public-sector social spending (health, education, housing) fell by as much as 10 per cent. On the other hand, fiscal revenues increased with the real devaluation and because of the processes of privatization and reprivatization. Taxes and transfers from state firms to the Treasury grew by more than 2 per cent of GDP between 1981 and 1985. The distributive aspect of the public spending cuts has been regressive for two reasons: (i) In the Chilean case, employees in the public sector receive lower salaries than urban workers with similar skills, although they benefit from greater stability in the medium term than jobs in the private sector. Given the level of wages, a significant percentage of public employment corresponds to the 40 per cent lowestincome group. (ii) The general reduction in social spending affected lower-income groups relatively more: nearly 50 per cent of social spending on health and education is received by the 40 per cent lowest-income groups, along with 77 per cent of public housing programs.104 An interesting social policy applied by the military regime during the adjustment period was the targeting of certain components of social spending towards the most vulnerable groups. Some of these programs provided food distribution to expectant mothers and children under six years old, as well as breakfasts and school lunches for children in primary education at public schools (see Table 2.31). The distribution of food was undertaken at health clinics, so there was an additional medical check-up for expectant mothers and children. These targeted programs helped to improve the indices of infant undernourishment, and in the 1980s Chile achieved one of the lowest rates of infant mortality in the whole of Latin America (0.84 per cent).

Table 2.31 Milk and Near Substitutes Distributed National Nutrition Program. Chile, 1980–1985 (tons of milk) Basic program 1980 1981 1982 1983 1984 1985

25 195 24 636 24 762 17 053 11 718 12 641

Targeted program 4020 5146 5525 4993 16 132 17 630

Total 29 215 29 782 30 287 22 046 27 850 30 271

Source: Ffrench-Davis and Raczynski (1988). Data based on INE-Ministry of Health.

The Economic Model of the Military Dictatorship 139

Overall observations on the adjustment The Chilean experience would suggest that it is undesirable to distinguish between good and bad trade deficits; a relatively high, unsustainable and unfinanceable current account deficit is inevitably going to need an adjustment, independently of whether it has been generated by the public sector or by the private sector. The external adjustment process in the Chilean economy was relatively successful; at the start of the 1990s the external constraint was no longer an obstacle to growth, the annual inflation rate (about 20 per cent) was relatively low by Latin American standards of the time, and exports had undergone a significant quantitative increase. The adoption of a co-operative stance towards external creditors bore fruit. Continued financial support from multilateral agencies involved the granting of loans amounting to between 2.5 and 3 per cent of GDP five years running; in addition, the IMF and the World Bank played a very active role in negotiations and renegotiations with private-sector banks. The wage contraction and high unemployment over a long period were crucial mechanisms for the severe domestic adjustment, with the cut in real wages being the central factor in the real devaluation. A question remains as to whether so rigorous an adjustment could have been imposed in other political circumstances. Could a democratic government have adopted a domestic adjustment program in which unemployment was kept above 24 per cent for four years, where real wages were cut by 20 per cent and remained depressed for five years, and per capita social spending was cut by 10 per cent over six years? There are other important considerations in relation to this process, such as the appreciable positive external shocks (nearly 5 per cent of GDP) which clearly facilitated both external and domestic adjustment, as did the application of heterodox policies (rise in tariffs and surcharges, price bands, control of the interest rate and control of capital movements) as regards domestic adjustment. Nevertheless, adjustment costs were very high. Excessively severe adjustment policies in an economy that is not perfectly flexible or instantaneously adaptable provoke secondary costs of a similar magnitude to the primary ones. In my judgement, the most negative element of the Chilean adjustment process was the discriminatory treatment handed out to different agents; here the economic authorities showed a clearly regressive bias by providing numerous special subsidies to foreign currency debtors

140 The Unidad Popular and the Pinochet Dictatorship: A Political Analysis

alongside paltry or zero subsidies to a significant percentage of the unemployed. While 600 000 unemployed people received an unemployment subsidy equivalent to 1.5 per cent of GDP, less than 10 000 dollar debtors benefited from assistance worth 3 per cent of GDP. Around 400 000 unemployed people received nothing at all. It is clear that the owners of real and financial assets received protection during the adjustment process, depositors enjoyed public insurance on their deposits, which were inflation-indexed, while workers suffered big losses through wage de-indexation and unemployment. It is true that the Central Bank had to play the role of lender of last resort to avert the collapse of the productive and financial system. However, a complex distributive question remains: when a firm or a bank has lost more than 100 per cent of the present value of its capital, to whom does it belong? Most of the measures applied tended to subsidize the redistribution of assets to existing conglomerates and to high- and middle-income sectors. Other measures could have been introduced for workers and unemployed people to have acquired a share in those firms to compensate for the losses they had suffered. The result of the adjustment, in an economy with a flexible labor market, and where unemployment subsidies are practically nonexistent, is economic insecurity and a severe deterioration in workers’ living standards. Workers do not have the means to protect themselves during an adjustment period; when neither the formal labor market nor the government provide jobs or subsidies for the unemployed, subsistence needs lead to the adoption of a survival strategy in which the sharing of food, housing and jobs becomes a key element of the informal economy. The main function of the informal economy is not therefore associated with its contribution to GDP, but rather in attenuating and resolving the subsistence problem of the unemployed and their families. These informal arrangements arose to augment a practically nonexistent social safety net. But the social costs of this type of solution are high and unequally distributed; the unemployed and their families live below the subsistence level. From the country’s point of view, undertaking adjustment to correct external disequilibrium is a public good which supposedly benefits all economic agents in the country. So why should not all economic agents cooperate and sacrifice equally? Employed workers and the rest of society ought to share part of their incomes with the unemployed, perhaps through the tax mechanism, which could finance unemployment insurance as happens in developed countries. Austere adjustment programs would

The Economic Model of the Military Dictatorship 141

be less unpopular if everyone perceived that each economic agent was contributing in the same way.

The structural reforms of the 1980s External debt formed the backdrop to the profound structural reforms of the 1980s – a period that illustrates how particularly grave and unfavorable circumstances can be turned into a surprisingly successful economic outcome. Between 1982 and 1987 the outstanding balance of external debt amounted to over 100 per cent of GDP, and four times annual exports. This represented a heavy burden for the country, as in the period 1982–86 servicing this debt, considering interest payments alone, involved an average annual sum close to 8 per cent of GDP and around 50 per cent of exports. The payment of interest alone was already having negative effects on economic growth in the short and long term: in the short run, a scarcity of foreign currency causes a bottleneck for economic expansion by restricting the level of imported inputs needed in the productive process; the long-term effect was related to the external transfer that was being made, which had its effect by reducing the domestic resources available for investment and growth. Thus the dilemma posed in the 1980s seemed to be pay up or grow. The virtual collapse of the productive and financial systems in the 1982–83 crisis had revealed the national private sector’s tendency to borrow, grow and go bust. If the state was not suitable as the engine of growth, then how could the Chilean economy grow? Who would be willing to invest after the collapse, merely to attempt to pay the interest on the external debt? Yet by the time of restoration of democracy at the end of the 1980s, the situation could be synthesized in the following way: the foreign debt had ceased to be a problem, there was a large and vigorous entrepreneurial sector, and exports had become the engine of growth in the economy. We will now examine the structural reforms associated with the positive results seen at the end of the 1980s; given the technical specificity of the issue, the discussion of the solution of the external debt problem will be omitted.105 A further reduction in the presence of the state Taking the state’s involvement and the changes made to it as the basis of analysis, and using the same three-dimensional categorization as

142 The Unidad Popular and the Pinochet Dictatorship: A Political Analysis

before, the following reforms to the Chilean state took place in the 1980s: in the productive arena, there was a second process of reprivatization, as well as large-scale privatization of firms traditionally in state hands and a reform of social security, in which the previous ‘pay-asyou-go’ system (administered by the public sector) was replaced by a system of capitalization run by the private sector; in addition, there were tax reforms aimed at reducing fiscal revenue. The second reprivatization of the anomalous ‘área rara’ (firms and banks belonging to the most important groups which had gone bankrupt in 1982) was undertaken between 1984 and 1986. The total net worth of the firms and banks in this anomalous sector was estimated at US$1.1 billion.106 Certain lessons had been learnt from the reprivatization process of the 1970s, which was really a debt-based privatization, in which the high debt/equity ratio the newly reprivatized firms started out with contributed to the fragility of the financial system. Furthermore, a high concentration of ownership was generated, as well as complex interrelationships between productive firms and banks, and this made the functioning of a large part of the productive and financial system conditional on adequate management by the two main conglomerate groups. In this second reprivatization process different sale procedures were used: ‘popular capitalism’, 107 transactions on the stock exchange and an auction among pre-selected buyers. These operations (with the exception of those linked to popular capitalism) required cash payment of 100 per cent of the value of the transaction; in this way, reprivatized firms began without debts. On this occasion, diversification of ownership was clearly pursued; an implicit political goal was to ensure the irreversibility of the whole process (Table 2.32 illustrates the number of shareholders involved). Without any doubt, the privatization of the firms created by the state, and which had always belonged to the public sector, was the most far-reaching structural reform of the 1980s. The privatization of the most important state firms (excluding the GMC) began in 1986. The list included most of the firms providing utility services (electricity, telephones, telecoms, fuel distribution), as well as an airline (Lan Chile) and a steel refinery (CAP). The total asset value of the programmed privatization of state-owned firms came to about US$3.6 billion (Table 2.33). The traditional arguments in favor of the privatization of stateowned firms were not valid in the Chilean case, for these firms were operating relatively efficiently as a result of the measures introduced in

Table 2.32

The Second Reprivatization Process, Chile 1984–1987

Financial firms and institutions

COPEC Banco de Chile Banco de Santiago INFORSA Pesquera Coloso INDUS Banco de Concepción AFP Provida AFP Santa María

Reprivatization mechanism Private auction

Popular capitalism

X

X X X

X X X X X

X X

Book value of assets (Sept. 1987) (US$ million)

No. of shareholders (Sept. 1987)

310 285 156 85 47 45 44 18 13

15 922 39 179 15 919 3 447 6 340 5 158 6 110 7 909 6 062

Source: Hachette and Lüders (1987). Note: See Hachette and Lüders (1987) for the full list of reprivatized firms and banks; this table includes those with the highest book value of assets.

143

Privatization of State-owned Firms, Chile 1986–1990

State-owned firms

CAP COFOMAP Chile Films Chilmetro Chilgener Chilquinta CTC ECOM Edelmag Edelnor Elecda Eliqsa Emelari Emec Emel Enacar Enaex ENDESA ENTEL IANSA ISE Gen. ISE Vida Lab. Chile

144

Table 2.33

Activity

steel forestry cinema elec. gen. elec. gen. elec. distrib. telephony computing elec. distrib. elec. distrib. elec. distrib. elec. distrib. elec. distrib. elec. distrib. elec. distrib. coal explosives elec. gen. telecoms sugar refining insurance insurance pharmaceuticals

Percentage privatization 1986

1987

1990

52 n/a 0 63 35 63 11 100 12 0 n/a n/a n/a 100 100 0 0 0 30 46 0 0 23

100 n/a 0 100 100 100 63 100 12 0 n/a n/a n/a 100 100 0 100 30 33 49 0 0 49

100 100 100 100 100 100 99 100 100 16 98 98 96 100 100 16 100 96 99 100 97 99 100

Privatization mechanisms AFP

Stock market

Employees

X

X

Private auction

Book value of assets (Sept. 1987) (US$ million) 679

X X X X X X

X X X X X X X X X

X

X

X X X X X X X X X

X

206 264 52 306

X X X

X X

71 X

X X

X

X X X X X X

X X X X X X

1314 93 90

Table 2.33

continued

State-owned firms

LAN Chile Pehuenche Pilmaiquén Pullinque Sacret Soquimich Schwager Telex

Activity

airline elec. gen. elec. gen. elec. gen. finance nitrate coal telex

Percentage privatization 1986

1987

1990

0 0 100 0 0 55 0 100

0 0 100 100 0 100 42 100

68 100 100 100 100 100 100 100

Privatization mechanisms AFP

X X

Book value of assets (Sept. 1987) (US$ million)

Stock market

Employees

Private auction

X

X X

X

49

X X

44

X X

X X

102 X

8

Sources: Marcel (1989); Sáez (1992); Hachette and Lüders (1987).

145

146 The Unidad Popular and the Pinochet Dictatorship: A Political Analysis

the 1970s; most of them were earning surpluses and transferring resources to the central government. These state-owned firms had adjusted to self-financing, so they could not have a negative impact on the fiscal budget. On the other hand, state-owned firms which did in fact have a negative impact on the fiscal budget – for example, the state-owned railway company – could not be privatized. The case for privatization here was simply the explicit aim of reducing the size of the public sector. Later, at the beginning of the 1990s, the idea that the state ought to withdraw from productive activity began to take hold, and even state ownership of the GMC began to be called into question. An alternative hypothesis suggests an exogenous cause for this process: international banks, finding it difficult to collect the loans (and interest) they had extended, promoted privatization to repay themselves with assets existing in the country (at subsidized prices).108 Different procedures were also used in this privatization process: institutional capitalism, through which the AFPs (private pension fund managers) could acquire limited quantities of shares; ‘worker capitalism’ in which the workers in state firms received special incentives (price subsidies) for purchasing shares in the firms where they worked, being able also to use their social security savings for this purpose; traditional capitalism, consisting of an offer of shares to pre-selected agents through auctions and on the stock market.109 Sales amounted to US$1.1 billion, and the public-sector subsidy was probably over 50 per cent. All these transactions required 100 per cent cash payment of the value of the operation. Here again one saw the aim of achieving a diffusion of ownership, with foreign investors even being attracted. Table 2.33 gives specific percentages that illustrate the rapid pace of the privatization process. In 1990, nearly 30 state firms had transferred 100 per cent of their ownership to the private sector, including CAP (7000 workers), Endesa (2900), Enersis (2500), CTC (7000), Soquimich (4700), IANSA (2000), Schwager (2300), Lan Chile (900), Chilquinta (950) and Chilgener (800). Some critics of privatization suggested that there had been a lack of transparency in several of the sales. We shall look specifically at two cases. Corfo (a public-sector entity) owned 83 per cent of the shares in the steelmaker CAP. In March 1986, it decided to sell 61 per cent of its shares to CAP, and the preferential price paid for them between March and June 1986 was US$0.25. The average price of these shares quoted on the stock market was US$0.31 in May and US$0.39 in June. In this way, Corfo reduced its share of ownership of CAP to 51 per cent, and

The Economic Model of the Military Dictatorship 147

the previous private owners raised their share from 17 to 49 per cent, paying US$72 million for a package of shares which were valued at US$217 million only 15 months later (see Table 2.33). In the case of Endesa, its high debt/equity ratio discouraged share acquisition, so in order to solve this problem the company issued shares to a value of US$500 million, which were all bought by Corfo. The price per share paid by Corfo was 28.93 Chilean pesos, whereas the average monthly quoted price of Endesa shares in 1986 was 13.81 pesos, with a range between 6.4 and 20 pesos. Through this procedure, Endesa’s debt/equity ratio was reduced from 2.61 to 0.77: in essence, the privatization of ENDESA was carried out by transferring a significant part of its debt to the public sector (Corfo). A further criticism of privatization was that as the process was so rapid, there was little discussion of the regulatory framework which would govern the behavior of natural monopolies (in public service utilities) that were now being transfered to the private sector. Despite the validity of the misgivings, the privatization of stateowned firms seems to have led to increased efficiency, as well as a rise in their level of investment: indirect evidence of this can be seen in the foreign investments several of the privatized firms have made. Furthermore, on the whole the effect of privatization on the level of employment was not negative, as had been anticipated a priori (according to the traditional arguments, the privatization of state firms would cause unemployment because these firms tend to be overstaffed due to political pressures). Table 2.34 shows the trend of employment in a group of privatized state firms; the figures show that the number of privatized firms where employment expanded exceed those where it shrank.110 However, among the 11 firms in Table 2.34, the total level of employment in the privatized firms is less than in the previous period. The third reform in the productive arena affected the social security system. Until the reforms, this was a ‘pay-as-you-go’ system administered by the public sector (with no correspondence between individual contributions and the benefits obtained). This system was suffering from serious problems: pensions were declining in real terms, along with growing financial deficits and pressures on the public budget. To help in its financing, systematic increases in contribution rates were required, as well as additional fiscal contributions. The 1981 pension reform replaced this system by one of individual capitalization, where for each agent there is a direct relation between contributions and benefits.

148

Table 2.34 Firm Enersis-Chilmetro Chilquinta SOQUIMICH Chilgener CTC ENDESA Entel IANSA Laboratorio Chile LAN Schwager

Evolution of Employment in Selected Privatized Firms, Chile 1970–1990 (No. of people employed) 1970

1979

1983

1986 a

10 814

7109

4096

5 887 6 512 1 161 2 827 567 3 608

7206 4270 1236 1597

6338 2705 1338 1079 527 1372

2059

2495 983a 4704a 760 6938 2905 1402 2027 592 883 2264

Source: Sáez (1992). Notes: a Year of privatization considered when private-sector ownership passed 50 per cent. b In January 1991, this firm was restructured with 434 employees being made redundant.

1987

1988

1989

1990

2587 956 5024 852a 7374 2828 1456 2103 618 983 2277

2828 770 5527 837 7518a 2925a 1460a 2023a 681a 1093 2296a

2962 746 5453 845 7366 2980 1546 2144 749 1430a 2304

3052 731 4111 876 7530 2833b 1547 2163 728 1551 2171

The Economic Model of the Military Dictatorship 149

This new system, managed by the private sector through the AFPs, has grown very significantly: in 1991 it covered 85 per cent of the labor force with accumulated resources amounting to 26 per cent of GDP in 1990. In other words, AFPs have generated a large fraction of national private-sector saving and, given the size of the resources involved, their impact on the capital market has been substantial. Indeed, social security reform is fundamental for the future evolution of the growth of the Chilean economy; the enormous long-term importance of this reform was not perceived during the 1980s. Putting social security reform into practice meant that the state was left with the passive sector, while most of the active sector transferred to the new private system, thereby generating a fiscal deficit close to 4 per cent of GDP, which has steadily diminished as members of the passive sector have died. According to the World Bank, this reduction should begin to be more significant from the year 2000 onwards. Social security reform was planned to be applied precisely at a time of fiscal surplus; but nobody anticipated the external debt shock of the 1980s and its effect on fiscal accounts. Tax reform in the 1980s (1984 and 1988) pursued twin goals: to reduce the amount of tax collected, and for indirect taxes to become the main component of tax revenue. The 1984 tax reform meant a reduction of about 40 per cent in income tax revenue, while the 1988 reform reduced tax collected by nearly 2 per cent of GDP. The 1988 tax reform could have had several motives: on the one hand, the long-term ideological motive of reducing the economic size of the state; on the other, a specific short-term situation – the 1988 plebiscite – where tax cuts were one of the mechanisms used to stimulate economic activity. In addition to this, the international copper price rose substantially, which raised fiscal revenues by nearly 4 per cent of GDP. A side-effect of this form of dutch disease was to produce a shift away from local taxation, although the Copper Stabilization Fund would have partially neutralized this effect. The new role of Chilean exports Several indicators illustrate the significant expansion of Chilean exports in the period 1970–90: (i) These grew from a value of US$1.1 billion in 1970 to US$8.3 billion in 1990. (ii) The relative share of exports in GDP rose from 16 per cent in 1970 to 34 per cent in 1990. (iii) The annual rate of export growth was 7.9 per cent over this 20-year period, whereas GDP only expanded at an average annual rate of 1.7 per cent in the same period. (iv) The relative share of copper in total exports diminished from

150 The Unidad Popular and the Pinochet Dictatorship: A Political Analysis

80 per cent in 1970 to less than 45 per cent in 1990, pointing to a diversification of the Chilean export basket. In my judgement a highly significant indicator of the leading role Chile’s exports have taken on in the national economy is the number of Chilean exporting firms that have emerged in the second half of the 1980s. The number of exporting firms (including Chilean-owned firms, firms with majority foreign capital and joint ventures) which have export earnings of more than US$1 million per year has gone up from 235 (1986) to over 500 (1990); over the same period, the number of firms export earnings of more than US$100 000 rose from nearly 900 in 1986 to more than 1500 in 1990 (Table 2.35). Whereas a lack of private-sector entrepreneurial capacity was seen as one of the decisive factors underlying Chile’s low rate of economic growth before 1970, now one can clearly discern the presence of a new generation of Chilean entrepreneurs with an export-oriented mentality. It is difficult to prove the causality existing between the profound economic reforms of the 1970s (including trade reform) and the appearance of this new generation of export-oriented entrepreneurs. But, as has been mentioned earlier, the structural reforms led to a series of changes in relative prices which created incentives for the expansion of exports: the cuts in tariff protection reduced the anti-export bias, and the rise in the real exchange rate stimulated the production of tradable goods, thereby providing a dual incentive for the export sector. Several factors explain this change: the trade reforms of the 1970s eliminated the anti-export bias caused by the import substitution strategy. Sjaastad (1981) has estimated that the 1970 tariff structure was equivalent to an implicit export tax of 33 per cent. The abolition of this tax stimulated expansion in the sector. Secondly, a persistently depreciated exchange rate in the period 1984–90 provided clear and

Table 2.35 Number of Exporting Firms by Amount Exported, Chile 1986–1990 Amount exported

1986

1987

1988

1989

1990

More than US$100 million US$10–US$100 million US$1 million–US$10 million US$ 100 000–US$1 million

4 38 193 661

6 50 248 772

8 66 303 854

8 76 341 892

8 87 431 1034

Total

896

1076

1231

1317

1560

Source: Central Bank, unpublished figures.

The Economic Model of the Military Dictatorship 151

stable incentives for exporters. In other words, the significant real devaluation established after the crisis of 1982–83, along with the maintenance of an exchange rate at an extremely high level, proved to be key elements underlying export expansion. Finally, the economic environment of external openness and deregulation has enhanced the global efficiency of the economy. These three factors may lead to the assumption that establishing a neutral system of incentives (tariff reduction and the elimination of non-tariff barriers), together with an appropriate exchange rate, are sufficient conditions for stimulating export expansion. However, the state also adopted specific measures which have contributed to the success of Chile’s exports. (a) During the period in which the Great Copper Mines were under foreign control, the annual rate of output growth was below 2 per cent; when the GMC came to be controlled by Chilean stateowned firms, there was a significant expansion in its level of production, exceeding 4 per cent per year. Thus, Chilean participation in world copper exports (excluding the countries of Eastern Europe) grew from 14 per cent in the 1960s to more than 20 per cent in the 1980s. (b) In the case of fruit exports, the state invested in human capital formation during the 1960s: it improved training and research in local universities and set up an important program (‘ChileCalifornia’) through which many Chileans undertook postgraduate studies in agrarian economics. The boom in fruit exports is linked to the introduction of modern technology, and this needs appropriate human capital to operate it. The agrarian reform of 1965–73, for its part, helped to create a land market that allowed the entry of a new type of entrepreneur into the agricultural sector: these saw agricultural activity as a clearly profitable alternative, and were willing to introduce modern technology in order to compete on international markets. (c) As regards forestry products, generous tax incentives have favored the expansion of this sector. For a long time, the activity was tax free; moreover, in the 1970s a direct subsidy to the value of 75 per cent of the cost of forestry plantation and management was in operation. This subsidy, paid at the start of productive activity, proved clearly more attractive for the private sector than making use of a tax incentive for which they would have to wait more than 15 years (according to pre-1974 tax legislation).

152 The Unidad Popular and the Pinochet Dictatorship: A Political Analysis

(d) In the fishing sector, free access to marine resources during the 1980s stimulated fishing activity, but generated overexploitation which could lead to the extinction of various species during the coming years. In synthesis, although Chile has comparative advantages in the exploitation of natural resources, specific actions taken by the state (including inaction in the case of fishing) have been significant complementary factors in the expansion of Chile’s exports. The composition of total exports during the 1980s was as follows: mining, 56 per cent; agriculture, 12 per cent; forestry products and wood, 11 per cent; fishing and marine products, 10 per cent. Industrial exports also grew: the current make-up of exports in this sector is as follows: paper, wood and wood products, 31 per cent; fishmeal and food products, 30 per cent; basic metal products, 9 per cent. In other words, 70 per cent of industrial exports are related to raw materials coming from existing natural resources. Chile’s comparative advantages continue to be structurally the same as in the past – nearly 90 per cent of the export basket depends on the country’s natural resource endowment. But there have been two significant developments. Firstly, a clear diversification between the different natural resource goods that are exported means that the Chilean economy will be exposed to relatively smaller external shocks than in the past, with the collapse of the market in one raw material having less harmful effects than occurred, for example, when synthetic nitrate came on the scene in the 1920s. Secondly, most of Chile’s exports are now produced by Chilean-owned firms. At the beginning of the 1990s, there were more than 1500 exporting firms (Chilean-owned, mixed and foreign); consequently, most of the Ricardian rents and the surplus generated by natural resource exports could now be reinvested in the country.

Economic freedom and political liberty The military coup of 1973 was not one of those barrack-room uprisings that have been so frequent in Latin American history. The Chilean Armed Forces took power to restructure Nation, State and Society – to ‘found a new Chile’. Seen from this viewpoint, they have saved the country from Marxist chaos and hell; the suspension of democracy and political repression were a worthwhile price for modernizing the country and achieving orderly progress. This sacrifice of political

The Economic Model of the Military Dictatorship 153

freedom imposed by the military dictatorship can be considered as a relatively low price to pay, when measured against the chaos of the past and our resplendent modern future. Such is the propaganda view that is tirelessly reiterated through all the communications media. It will strike many as paradoxical to argue that a dictatorship 111 is an appropriate regime for modernizing a country, in circumstances where all modern countries are democratic. For this reason, a full ideological offensive had been devised to show that what really matters is economic rather than political freedom. Furthermore, political freedom is a relative concept as there is no great difference between a dictatorship of the majority and that of a single dictator.112 Personal freedom is one of the fundamental values of western civilization; but, freedom for what? By the simple fact of living in society, personal freedom is necessarily restricted by the actions of others; moreover, it is bounded by traditions and other cultural and religious norms: the freedom women enjoy in European countries is different from Islamic countries, for example. Hayek defines the concept of freedom in negative terms, seeing liberty as the absence of coercion or duress. In this sense, personal freedom is defined as an antithesis of slavery: 113 a free man is the owner of himself and can do what he wishes. This means that the compulsion exerted by society (government or state) should be reduced to the minimum. This basic idea of freedom is, according to Hayek, very different from the concept of political freedom, which corresponds to the right of people to participate in public issues through elections. This type of political freedom can be compatible with the absence of personal freedom: ‘a free people is not necessary a people of free individuals; nor is it necessary to participate in such collective freedom to be free as individuals’, because with political freedom it might be decided ‘to annul or limit individual freedom’.114 But, how could this occur? Reviewing the historical evolution of today’s democracies, Hayek argues as follows: the replacement of absolute monarchy by democracy required the establishment of constitutions and laws defining and limiting government powers, so as to avoid the arbitrary exercise of power and to restrict the conditions under which compulsion exercised over people was admissible; only compulsion in accordance with uniform rules, applied equally to everyone, could be justified in terms of the general interest. A rule limiting government action protects individual freedom, because its purpose is to prevent unjust conduct; i.e. the government is subject to the law. 115 On the other hand, to

154 The Unidad Popular and the Pinochet Dictatorship: A Political Analysis

obtain approval of certain laws through parliament, a democratic government must do what it can to buy the support of the different interest groups by providing them with special benefits. Thus the passing of general-interest legislation is supplanted by laws promoting specific interests. As a result, the law loses the sense of being a general rule, and comes to be the name for anything which emanates from legislative power. For Hayek, in a democracy the need to form organized majorities to lobby for a program of particular actions introduces a source of arbitrariness and partiality: the belief exists that anything a majority can agree on is, by definition, just. However, in democracy the will of the majority, expressed through the political game (arbitrary and partial), ends up with the distribution of seized funds to a minority as its main purpose. Democracy ends up as another form of the inevitable struggle to decide who obtains what, when and how, in which the result is a distribution of income that is mainly determined by political power. By breaking the general principle of equal treatment under the law, the democratic machine opens the door to arbitrariness; the creation of the myth of social justice is one of the results, and it can be seen that people consider what is regularly carried out by democracies as socially just. The knowledge that a growing number of incomes are determined by government action will lead to new and permanent demands by groups, whose position has to be determined by market forces, to achieve something similar to what they think they deserve. This leads to democracy losing much of its capacity to serve as a bulwark against arbitrary power; on the contrary, it becomes a main cause of a progressive and rapid growth in the state’s power and weight. Today’s democracies are frequently governed by bureaucratic states, whose power of regulation, control and planning is unlimited, so that it curtails the freedom of individuals as profoundly and constantly as any totalitarian system would be able to do. ‘Democratic despotism, of benevolent appearance but subject to the rigor of majorities, is harassed more by equality than by liberty’, which reduces ‘each nation to a mere herd of timid industrious sheep whose shepherd is the government. … Thus, we have passed from one absolutism to another’.116 This argument illustrates the futility of political liberty and democracy; but we should not become embittered, for what really matters is economic freedom: for Hayek, Friedman and company, provided there is economic freedom the political context becomes irrelevant. Economic freedom is the right to engage in voluntary transactions; the market is the space in which such transactions take place. The

The Economic Model of the Military Dictatorship 155

people who participate in them do so guided by their own self-interest; if a transaction is consummated it is because each of the parties obtains a benefit, otherwise they would choose not to participate in the transaction. As a result, the market works thanks to people’s preferences expressed freely and voluntarily. In other words, the market lacks mechanisms of compulsion: it is an impersonal system governed by general rules which protect all participating in it. Moreover, economic theory has shown that the pursuit of maximum self-interest by every individual leads, through the system of competitive markets, to the efficient allocation of resources and, consequently, to the social optimum. The free working of the market guarantees the rule of economic freedom. Since individual preferences are expressed therein, free from any kind of compulsion and in a sphere apart from the action of political authorities, it could be said that ‘the market is more democratic than any political regime … it really is the symbol of freedom’.117 Shortly after the military coup, most prices in the Chilean economy were set free, and the market assumed its roles as resource allocator and the context in which voluntary transactions are undertaken between economic agents. Clearly, several questions arise which call the validity of the above argument into question. How did the market protect the tortured, and those who were detained, and those who disappeared? Was the degree of compulsion under the military dictatorship really similar to that of democratic governments? How does the free price mechanism prevent the installation of a system of terror and mass espionage? Are we in the twentieth century really indifferent as to whether or not there is freedom of thought, freedom of expression, freedom of press, freedom of association and gathering? Another social-theorist, John Rawls, identifies the concept of freedom in a democratic regime with the principle of participation. This principle of participation requires every citizen to have the same right to take part in and determine the outcome of the constitutional process that establishes the laws people have to obey. Every responsible adult has the right to participate in public matters, all too should have equal access to political power: Everyone should be able to choose the political group in which they wish to participate, to stand for election or not, and to hold posts of authority. … The main virtue of the principle of participation is to ensure that the government respects the rights and the welfare of the governed.118

156 The Unidad Popular and the Pinochet Dictatorship: A Political Analysis

During the military dictatorship, application of the principle of participation was suspended; the military authorities were responsible for their acts only to themselves (and to their hierarchical superiors); as Hayek would say, ‘they decree their own laws’ and, in effect, they were above the law: there was no mechanism at all to protect the rights and welfare of the governed. The free market, free prices and free competition were powerless and impassive spectators of all kinds of violations of basic liberties, including the most elemental of all – the right to life. The interaction between political and economic freedom is complex: there are both complementary and oppositional aspects. In a democratic regime, where there is political freedom by definition, the free working of the market reinforces and complements people’s freedom of action. Indeed, a society in which resource allocation is decided by the political sector would generate a doubly inefficient and inappropriate situation, compared with one where allocation is undertaken by the market. Firstly, the lack of economic freedom affects and conditions political freedom, because economic goods can be traded for political favors; secondly, the market complements political freedom as it allows society to make a more efficient use of political resources by relieving the political sector of functions the market can undertake more efficiently. This application of the principle of comparative advantage enables the political sector to concentrate on its job of ensuring political freedom; furthermore, there is greater autonomy to exercise it when economic freedom prevails. In a democracy, the political system is based on the principle of ‘one man, one vote’, whereas in the market the ruling principle is ‘one dollar, one vote’. This illustrates the potential antagonism between political and economic freedom. If there was a market in which votes were traded, democracy would be transformed into plutocracy; those with more economic power would acquire more political power. In a country where there is an unequal distribution of wealth, inequality in the economic and social system can undermine any political equality that may have existed historically … Universal suffrage is an insufficient equilibrium, for when parties and elections are not financed by public funds but by private contributions, the political forum falls under the influence of the wishes of the dominant interests. In other words, when there is a concentration of economic power, political freedom is threatened.

The Economic Model of the Military Dictatorship 157

In modern democracies there is an awareness of the need to prevent political freedoms linked to the principle of participation from being undermined by those with greater economic resources. Various mechanisms exist for this purpose, including keeping political parties independent from private economic interests, or via the public allocation of sufficient income to carry out their role in the constitutional framework.119 Democracy, for all its faults, remains the most appropriate regime for resolving modern society’s complex problems in a civilized manner. It is the system that best resolves the peaceful transfer of political power, and which provides the strongest guarantees for the protection of people’s dignity and human rights. There is no natural order from which a perfect social order emerges. Nor is it possible to draw up a constitution which establishes rules that are valid from now to eternity. The fact that a democratic regime is unable to resolve all social problems in a definitive way is not a failure of democracy. The moral is that one has to keep trying over and over again, deepening and perfecting democracy, seeking new solutions to complex social problems – those that already exist as well as those that will arise in the future.

3 A Tentative Synthesis

The legacy of the Unidad Popular Following the tragic end of the UP government and the ‘grim legend’ engendered by the chaotic situation of that period, it is worth asking if there is anything left from this experience to take advantage of economically. Nationalization of the GMC As was mentioned in Chapter 1, copper, and particularly the GMC, was the backbone of economic development for the UP; this premise achieved consensus through the entire political spectrum, for there was unanimity in Congress in favor of GMC nationalization. Nevertheless, there was some concern and uncertainty about the local management’s professional and technical capacity to manage firms of such size. As regards Chilean exports after 1973, we have already highlighted their notable expansion as well as their diversification, an indicator of the latter being the fall in the share of copper in total exports (see Table 3.1). However, an examination of the increase in volumes exported between 1970 and 1990 shows that 42 per cent corresponded to an increase in copper exports, with the GMC – 100 per cent stateowned as from 1971 – the generator of more than 75 per cent of these exports on average. Following the processes of GMC ‘Chilenization’ and nationalization, there was a significant rise in output. Prior to 1965, the level of production from the GMC was stagnating or declining, with the annual rate of growth averaging –2.1 per cent over the five-year period 1960–65. By contrast, growth was above 4.2 per cent during the period 1965–85 (see Table 3.2). 158

A Tentative Synthesis 159 Table 3.1

Importance of Copper in Chilean exports, 1960–1990

Year

Share of copper in total exportsa (%)

1960 1965 1970 1975 1980 1985 1990

67.1 61.9 77.2 65.1 47.2 45.5 47.8

Copper exports (tons)a GMC Total

469 438 514 682 865 1023 1150

532 539 663 823 1028 1288 1556

Copper exports (US$ million)

Total exports (US$ million)

314 396 883 1246 2007 1697 3908

470 684 1112 1590 4705 3804 8310

Source: Central Bank of Chile and COCHILCO. Note: a The figures correspond to two-year averages (to reduce the effect of annual fluctuations): the year indicated and the preceding one. However, the first value corresponds to the average of 1960 and 1961.

To summarize, after the GMC passed into Chilean state ownership, copper production increased significantly, growing at more than 4 per cent per year for 20 years (1965–85); in contrast, growth during the previous 20 years (1945–65), when 100 per cent of the ownership was foreign, was less than 2 per cent per year. During the process of GMC ‘Chilenization’ there was also a big increase in the level of investment. In fact, a simple econometric model points to a decisive structural change in the production of copper by the GMC before and after

Table 3.2 Year 1960–70 1970–75 1975–80 1980–85 1985–90

Export Growth Rates, Chile 1960–1990 GMC 1.2 4.5 6.3 4.2 0.7

a

Copper exports

Non-copper exports

Total exports

GDP

2.7 3.3 5.8 5.3 2.8

5.9 9.9 24.3 –1.2 15.4

3.6 5.6 15.1 1.8 9.6

4.2 –2.2 7.5 –0.4 6.1

Source: Central Bank of Chile and COCHILCO. Note: a The breakdown for 1960–65 and 1965–70 gives the following annual growth rates: –2.1 per cent (1960–65) and 4.6 per cent (1965–70). The rate of growth of total exports has been calculated from the National Accounts (constant 1977 relative prices). The rate of growth of copper exports has been calculated using figures for physical tonnage. The rate of growth of non-copper exports has been caculated as a residual, using the average (first and last year of each period) of the shares of copper and non-copper in total exports.

160 The Unidad Popular and the Pinochet Dictatorship: A Political Analysis

the nationalization process. Copper production during the nationalization stage is clearly on a much higher growth path than during the previous 100 per cent privately owned stage.1 It is strange to discover that while the military dictatorship was carrying out profound economic reforms aimed at reducing the state’s presence in the economy, simultaneously there was a significant expansion in the production of a state-owned firm. As well as the above explanation, another simple and pragmatic factor points to the importance of the GMC’s contribution to tax revenue and the generation of foreign currency: the GMC contribution to the Treasury fluctuated around 2 per cent of GDP per year up to 1965, and grew to an average of 3.1 per cent of GDP per year in the period 1975–90; in some years (1988–90) the contribution even fluctuated around 6 per cent. There is another apparently more relevant explanation for this paradox. In 1976 a special law was decreed, the Reserved Copper Law, which allocated 10 per cent of the dollar value of GMC exports directly to the Armed Forces, as special funds for purchasing weapons. To avoid the effect of fluctuations in the international price of copper, a lower limit was set to the level of funds that would correspond to the armed forces: in cases where 10 per cent of the value of GMC exports fell below this base level, the Treasury would cover the difference: however, no ceiling was set on the amount to be allocated in this manner. In 1987, moreover, the level of the floor price (expressed in US$) was indexed to the producer price index (WPI) of the United States. As a result of this arrangement, the Armed Forces had a particular interest in expanding GMC output. From the point of view of microeconomic or macroeconomic rationality, it is not entirely obvious that Chile should spend more on armaments when the price of copper rises; might our enemies have a greater incentive to attack us when this happens? What would a private-sector entrepreneur think if taxation on his firm was linked to the level of sales, independently of the profit or loss outcome? Why did no government ‘Chicago Boy’ economist question the rationale of the Reserved Copper Law? Clearly, the benefits arising from GMC nationalization undertaken by the UP government were perceived during the military government. Conflict and consensus The high level of conflict, the large macroeconomic imbalances and the rapid rate of systemic reform that characterized the UP administration have become enshrined as circumstances to be avoided at any

A Tentative Synthesis 161

price. Instead, consensus, macroeconomic equilibrium and gradualism have become the prized trilogy of Chilean society at the end of the twentieth century. The resolution of social discord by aggravating the conflict proved to be a method leading to a negative-sum game: nobody wins, everyone loses; hence the necessity and advisability of replacing confrontation by dialogue, in search of consensus. In fact, it could be suggested that a consensus has developed on the importance of reaching consensus. As regards macroeconomic equilibrium, there is an awareness that spending in excess of revenue is not permanently sustainable, for the resulting deficit has to be financed with present debt that has to be repaid in the future; recurrent or high fiscal deficits, as well as wage hikes above productivity increases, generate inflationary pressures; the reduction of inflation requires adjustment programs with severe social costs. As a consequence, the control and eventual elimination of inflation comes to assume a very high priority. Rapid reform can be counterproductive, since it may create worse evils than those it is intended to eradicate; large-scale structural reforms need a large amount of economic support. Gradualism, therefore, is the most appropriate strategy for successfully achieving the required changes. The acceptance of this trilogy of values by Chilean society should form the social basis for the free market to transform Chile into a developed country. Who could disagree with consensus, the absence of inflation and the avoidance of violent and abrupt change? Beyond the generality of this argument, little discussion has arisen over certain central definitions and issues: consensus with regard to what? 2 What type of society does the current consensus propose? Where is the dividing line between slow gradualism and the maintenance of the status quo? Does the whole current economic problem really boil down to a discussion about the first decimal point of the weekly CPI? Consensus, equilibrium and an acceptance of gradualism are easy to achieve when one is dealing with nonconfrontational problems. However, the UP exposed a highly contentious and pressing topic: how to solve the problem of poverty. In very simplified terms, in the analytical framework of the UP the rich were responsible for the existence of poor people, so solving the problem required expropriating from the rich to transfer resources to the poor. Both the analysis and the chosen solution were mistaken and failed totally. Nevertheless, the question posed remains relevant. The Welfare State has been the institutional response in the advanced countries during the twentieth century.

162 The Unidad Popular and the Pinochet Dictatorship: A Political Analysis

The Welfare State There is a central dilemma in a democratic regime operating a laissezfaire market system. On the one hand, there is explicit recognition of the equality of all citizens before the law; moreover, every individual has a vote of equal weight, regardless of social condition. On the other hand, when there are large economic inequalities at the outset, the free market system tends to accentuate them. The market is efficient at allocating resources, but not in dealing with distributive and social issues. The policy of ‘grow first and redistribute later’, or waiting for ‘trickledown’ to resolve the problem of poverty, seems to be a very slowworking solution. For the poor, who vote in the present, a political platform that offers them a solution in 40 or 50 years’ time is not very attractive. A short journey between the boroughs of La Pintana and La Dehesa in Santiago seems like interplanetary travel in terms of economic differentials. The existence of modern means of transport and communications enables these differences to be rapidly visualized, rendering irrelevant the old arguments that the existence of inequality is a natural and necessary byproduct of the efficient working of the market, or that inequality is an indisputable natural phenomenon because it has always existed. When the poor are the majority, they exert pressure through the political process for the state to intervene in the market and resolve the social issue. As Okun (1975) points out, the union of democracy and market is complicated, but each needs the other; to resolve this conflict one would need to add a touch of rationality to the issue of equity and a degree of humanity in the search for efficiency. The creation of the Welfare State, through the tax system, has been the developed countries’ response to this aspiration for a more humane and more civilized society. In the nineteenth century the principle of equality before the law became established; Anatole France said ironically that rich and poor have the same right to sleep out in the open. In the twentieth century the principle of equality of opportunities emerged, forcing the state to explicitly treat people unequally so as to incorporate those excluded from society. This is the basis of the Welfare State: nobody should be excluded from economic progress due to factors that are outside their own control. The Welfare State is concerned for the unprotected sectors of society and looks after equity and social justice, a function which in the end turns it into a mediator in conflicts between entrepreneurs and workers. In other words, the Welfare State is a set of institutions oriented

A Tentative Synthesis 163

towards the harmonious solution of social conflicts,3 for which reason it is said to have been an essential element underpinning the expansion of capitalism in developed countries. The building of the Welfare State in developed countries has led to the creation of a wide variety of instruments and institutions.4 On the public spending side, transfers are made to people for social security, payments to the unemployed, sickness and child benefits, benefits provided through goods and services wholly financed by the state, such as health and education, and subsidies for certain basic goods, such as housing, food and transport. All these components put significant pressure on public spending. On the fiscal revenue side, the principles of ability to pay and progressiveness were established, with taxes being raised on property, inheritance, gifts, company profits and capital gains, as well as a progressive tax on personal income. In synthesis, fiscal policy is linked to social needs. Latin American countries only imitated one part of the developed countries’ institutional framework of the Welfare State – the expenditure part, excluding the unemployment subsidy. 5 In contrast, there has been no similar expansion in the capacity to raise tax revenues; when this has been achieved, as in Chile, indirect taxes have been the basic component of total revenue, whereas direct taxes have accounted for a relatively small share (and a declining one, see Table 3.3). As is well known, a tax burden in which indirect taxes are the main component has a regressive bias. The following example illustrates the theoretical assumptions on which the existence and actions of the Welfare State rest. A millionaire throws a $10 000 bill into the trash by mistake; a poor man picks it up. In this involuntary transfer, is there an increase in social welfare, or not?6 Common sense would say yes, because the satisfaction generated in the poor person is greater than the loss of welfare for the wealthy Table 3.3 GDP)

Composition of Tax Revenues, Chile 1970–1990 (Percentages of

a

Direct taxes Indirect taxes Social security payments

1970

1974

1980

1985

1990

4.6 10.8 7.0

5.7 13.0 3.1

5.4 13.4 5.6

3.2 17.1 2.4

2.8 13.0 5.6

Source: Larraín (1991); Budget Directorate, Public Finance Statistics, 1989–92. Note: a Excluding taxation of state-owned copper companies.

164 The Unidad Popular and the Pinochet Dictatorship: A Political Analysis

one. Given that voluntary action and philanthropy are not abundant, the institutional framework of a Welfare State is needed to produce a similar increase in welfare through the tax and transfer system; obviously, this fiscal policy is constrained by the need to avoid a negative impact on the efficient working of the economy. The theoretical assumption implicit in this argument suggests that redistributive policies based on interpersonal utility comparisons are possible. The personal satisfaction an individual obtains from consuming a good diminishes the more units he consumes of that good (the principle of diminishing marginal utility); so, in the end, in aggregate the marginal utility of an individual’s income level will decline as that income rises. If interpersonal utility comparisons are applied, the marginal satisfaction provided by one additional dollar is greater for a poor person than for a rich one. As a consequence, social welfare increases when an income transfer is made from rich to poor. However, such transfers should not be taken to the extreme of total equality; certain levels of inequality are needed to maintain incentives for saving and investment, without which the overall economic situation would inevitably deteriorate, thereby inducing welfare losses. This was the point of view of classical economists such as Edgeworth and Pigou. This approach was replaced by Paretian welfare economics, where the basic assumption is that interpersonal comparisons are impossible to carry out, thus avoiding addressing the distributive issue. This model makes it possible to derive propositions regarding an efficient allocation of resources in relation to a given distribution of income, but it does not allow dealing with the problem of choosing between different social optima. According to Pareto, there will only be increases in welfare when no one loses and at least one person gains. The current use of interdependent utility functions questions the basic principle of Paretian welfare economics and places the distributive question back at the center of economic analysis.7 Since the eighteenth century, and including Adam Smith (supposedly the apostle of the individualist and egotistical homo economicus), it has been argued that the personal welfare function of each individual includes elements of solidarity and concern for others, as well as envy. This automatically calls into question the basic Paretian proposition that one situation is a Paretian Optimum, compared to another, when the welfare of at least one person increases without causing a reduction in welfare of anyone else. If an individual’s welfare also depends on what happens to others, then people who neither gain nor lose anything in material terms by moving from a situation A to a situation B,

A Tentative Synthesis 165

whereby someone else obtains a material gain, will themselves experience a change in their welfare level which may be either positive or negative. This interdependence in the individual welfare function is currently linked to the existence of a social conscience, according to which all society is concerned for the distressed situation of the poor. Transfers, by taxing the rich in order benefit the poor, thus increase the welfare of both groups and, consequently, the level of social welfare.8 In synthesis, when interdependent utility functions involving a high level of social conscience exist, the use of transfers for dealing with the problem of poverty is an efficient use of resources. This is really the conceptual basis of the modern Welfare State. The political environment and the government can have a significant effect on the prevailing degree of social conscience; in this sense it is interesting to compare the governments of the UP, the military regime and Patricio Aylwin in terms of their levels of social expenditure and tax reforms related to that expenditure. For example, in just three months, the government of Patricio Aylwin managed to approve a tax increase equivalent to 2.5 per cent of GDP to finance an increase in social spending; the tax reform had the support of the entire political spectrum. This situation was totally reversed during the military regime, when both social spending and tax revenue were cut. During the UP government, there was firstly a drastic expansion in social spending; only later did a concern for the consequent fiscal disequilibrium emerge. In developed countries there is talk of a crisis in the institutional framework of the Welfare State, with particular criticism of the magnitude of social spending, which in those countries fluctuates around 28 per cent of GDP. In Latin America the Welfare State has smaller dimensions; however, it is also criticized for excessive bureaucracy, as well as its inoperability and the poor quality of its services. The latter is brought into stark relief by the different quality of social goods provided by the public as compared to the private sector (in health and education, for example). Conservative ideologues have linked the Welfare State to an overall questioning of the function of the public sector, calling for its reduction and eventual dismantling, on the grounds that its presence reduces economic efficiency, discourages work, saving and investment, and diverts resources from the private sector to be squandered in the public sector. Their solution consists of privatizing the functions of the Welfare State; the market would resolve the welfare of all individuals more efficiently. Hospitals and schools would compete among each

166 The Unidad Popular and the Pinochet Dictatorship: A Political Analysis

other, charging market prices and allowing consumers to choose what suits them best. From the consumer’s point of view, there would be more alternatives to choose from; the opportunity to choose benefits for consumers who have different budget constraints and different preferences regarding health and education consumption levels. Implicit in this argument is the idea of rolling the public sector and the Welfare State back to the levels of intervention and expenditure seen in the nineteenth century. However, the privatization of the Welfare State once again raises the problems of social equity and political feasibility. People who are marginalized and excluded by the market have to resolve their welfare situation in the informal sector; in the best of cases this leads to the creation of a dual welfare system: health, education and pensions that are differentiated between rich and poor. The transfer of higher-income contributors from the public to the private sector (as in the case of health), and/or active workers (as in the case of social security), causes a significant reduction in public resources, which eventually has repercussions on the benefits provided by the Welfare State and helps to widen the gap between the private and public welfare system. Is the market for health really analogous to the market for televisions or shoes? Is the possibility of having a wide range of alternatives so fundamental in the case of health? Does a person who gets injured in an automobile accident, or someone who suffers a heart attack, go round different hospitals before deciding which one to stay in? In Chile, if this happened in an area outside Santiago, would it not be preferable for the only local hospital be well equipped? If a consumer buys a television set whose screen fails after a week, they can complain and replace it with another one; but in the case of health, if a low quality hospital operates on a patient and the patient dies because some medical element is not available, or due to staff negligence, the situation cannot be rectified.9 Although the Welfare State arose to provide a minimum social safety net, in the modern world it has begun to take on functions where the market might be inefficient and dangerous or fail to produce the desired good. This might be due to indivisibilities, technical reasons or situations of imperfect and asymmetric information. In other words, although there are multiple inefficiencies in the workings of the Welfare State, the costs involved may be less than those generated by the free actions of the market in solving welfare problems, particularly for low-income populations.

A Tentative Synthesis 167

There is an intermediate option, however, in which the Welfare State gives up its role as a producer of certain public goods needed for social welfare, and instead assumes the role of regulator; this is partly what has been happening in education with private schools and universities. In this way, the Welfare State economizes on resources and assures the required minimum quality in the goods received by consumers. However, this resource saving on the part of the Welfare State is not exactly equal to the cost of the goods generated by the private sector: regulation clearly implies specific bureaucracy and other related costs. Another intermediate alternative is the introduction of a mandatory general insurance to cover those goods provided by the Welfare State. An example of this type is the system of forced saving by workers affiliated to pension schemes (AFPs) and health plans. In the case of pensions, if the principle is established that there should be no fall in living standards at the moment of retirement, this determines the percentage of wages that need to be set aside for this purpose. The advantage of a mandatory national insurance system to cover all the risks a person might face, is that it avoids the ‘free-rider’ problem; everyone pays and nobody benefits for free, and it obliges people who do not take precautions to insure. If such mandatory national insurance were adopted it could eliminate the Welfare State. Specific private insurance companies could administer the different components of social welfare, operating like third-party vehicle insurance. The main problem with this scheme is that the most vulnerable and high-risk people are those who are economically least able to finance such insurance. The mandatory national insurance scheme is most appropriate for a society in which there is an equitable distribution of income; in societies with big inequalities, a Welfare State is necessary. From the point of view of national social welfare, the alternatives for achieving the desirable optimum are very complex. As Klein argues, when people suggest a reduction in the size of the public sector, or the Welfare State, what is it that they are optimizing? Are they maximizing the possible welfare alternatives or are they minimizing decision-taking by a centralized bureaucracy? Are they maximizing efficiency of resource use in generating welfare, or minimizing the amount of resources used up in the sector producing material goods for the economy? Are they maximizing the family contribution to welfare, thereby minimizing the public contribution? Are they maximizing equity or maximizing the global amount of welfare? 10 When they argue in favor of privatizing the functions of the Welfare State, what

168 The Unidad Popular and the Pinochet Dictatorship: A Political Analysis

problem is being solved? The excessive size of the Welfare State? The excessive level of taxation? The operational inefficiency of the Welfare State? The high cost incurred by beneficiaries? In Latin American countries such as Chile, the objection concerning the inefficient operation of the public social security system is probably valid. Although the empirical proof on the future pensions to be provided by the AFPs is still pending, the regulatory function of the State makes it possible to anticipate more efficient results than in the past. The Welfare State is the institution of modern society responsible for ensuring that low-income individuals do not fall below the subsistence level; the definition of this minimum level is its responsibility. The market mechanism cannot be used for this task: just as there is a consensus that it is not right to buy and sell political votes, a human being’s minimum subsistence level cannot be exposed to the free interaction of supply and demand. Okun (1975) argues explicitly that the level of the minimum wage should not be subject to market forces. Changes in the supply or demand for labor ought not to reduce the standard of living of the marginal worker; if the result of this principle is to generate unemployment, then society should cover such a situation through unemployment subsidies. In any society with a minimum social conscience, the basic needs of the population should be excluded from any process of negotiation. However, one has to keep in mind the resource constraints existing in the economy. When operating in a democratic regime in a Latin American country, the Welfare State would face a dilemma: the dissociation between beneficiaries and those who contribute to their financing; the low-income majority would exert pressure through their votes for a greater Welfare State financed by the high-income minorities. In a democratic society with a high concentration of wealth and income, the size of the Welfare State can be a problematic focus of political tension.

The legacy of the military dictatorship The reforms and the structural and institutional economic changes carried out during the military dictatorship have completely altered the national development strategy. In this regard, Chile has been a pioneer country in Latin America, for in the course of the 1970s it carried out reforms which began to be applied in most other countries in the region only at the end of the 1980s and beginning of the 1990s. The

A Tentative Synthesis 169 Table 3.4

Comparison of the Final Years of the UP and Military Governments

Economic growth (GDP) Inflation Export growth Rate of investment (per cent GDP) Real wage growth Per capita consumption growth

1973

1989

–4.3 605.9 2.8 14.7 –25.3 –7.1

10.2 21.4 15.9 23.9 1.9 8.7

Source: Meller (1990).

Chilean economic model has become a model to emulate. The basic question asked in Latin American countries during the ‘lost’ decade of the 1980s was: ‘Is it possible to undertake the economic reforms which Chile has implemented … but without Pinochet? If so, how?’ Comparing a set of indicators for the years 1973 and 1989 (Table 3.4), General Pinochet could say that ‘we received a country in ruins … and we handed over a modern one (a Latin American jaguar)’. In this context, one can speak of two ‘economic miracles’ during the military regime – 1976–81 and 1985–89 – over each period, average GDP growth was persistently above 6 per cent (Table 3.5). For this reason it has been argued that the successful evolution of the Chilean economy in the 1990s is the outcome of the healthy economic legacy of the military regime.

Table 3.5 Economic and Social Indicators of Four Chilean Governments, 1958–1989 (Annual average for each presidential period; %) Alessandri Frei Allende Pinochet (1958–64) (1964–70) (1970–73) (1973–89) Economic growth (GDP) Export growth Rate of investment (per cent GDP) Inflation (Dec.–Dec.) Unemployment Real wage growth Per capita consumption growth New families unable to obtain a home (% with respect to new families)

3.7 6.2 20.7 25.8 7.5 1.8 0.9 20.1

Source: Meller (1990). Note: a This figure falls to 27.2 per cent if one takes the period 1976–89.

3.9 2.3 19.3 26.2 5.5 9.0 2.0 8.9

1.1 –4.2 15.9 218.1 3.9 –8.5 2.9 1.8

3.5 10.6 18.7 57.3a 17.3 2.3 –0.2 43.8

170 The Unidad Popular and the Pinochet Dictatorship: A Political Analysis

However, this same government presided over the two deepest recessions to affect the Chilean economy since the 1930s. In 1975 and 1982 GDP shrank by 12.9 per cent and 14.1 per cent respectively; four to five years were needed for GDP to regain its pre-recession level. Finally, if one compares the average values of different economic and social indicators for four Chilean governments during the period 1958 to 1989, the performance of the military regime turns out to be relatively mediocre. Indeed, the only economic indicator according to which the Pinochet government outperformed the other three is export growth. Basic economic reforms of the 1970s As we have seen, the main economic reforms of the 1970s were price liberalization and the establishment of free market forces, external openness, reprivatization and deregulation. This set of measures was revolutionary in Chilean history, because it meant the abolition of all controls; it was also new in the Latin American context. The chaotic economic situation of 1973 made possible this profound structural transformation, in which rationalization and simplification, increased transparency and the establishment of clear, general rules created a more efficient economic climate. The implementation of these basic structural reforms had considerable macroeconomic consequences. In 1973, when the yearly inflation rate topped 600 per cent, it was easy to see control of inflation as the primary objective. However, eight years were to pass before this objective was achieved; at the same time, the rate of unemployment climbed above 15 per cent and stayed there. In other words, the application of the structural reforms made inflation control difficult and also caused a rise in unemployment. In reality, the Chilean experience of the 1970s did not correspond to the consensus prevailing in the economic literature in the end of 1980s. This suggested the following sequence in the processes of macroeconomic stabilization and structural reforms. Firstly, macroeconomic stabilization needs to be achieved, by bringing the general level of prices under control; secondly, structural reforms need to be implemented to establish correct relative prices (i.e. in line with international prices). Once these two stages have been concluded, the existing environment will stimulate saving, investment and growth. In the Chilean case, the microeconomic structural reforms were introduced while macroeconomic imbalance persisted, thereby generating costs in controlling the disequilibrium.

A Tentative Synthesis 171

Moreover, can it really be said that the ‘economic miracle’ of 1976–81 was the immediate result of the reforms? National rates of saving and investment in that period attained levels of between 18 and 18.6 per cent of GDP respectively (annual averages). Such saving and investment levels could hardly have generated growth rates above 6 per cent as were seen during that period. On the other hand, the average growth in per capita consumption during the same period was 6.2 per cent per year, financed largely by foreign borrowing. In other words, it was a consumer boom and not stimulus to saving and investment induced by structural reforms that generated the ‘economic miracle’ of 1976–81; for this reason, it can be stated that the growth of that period was based on foreign borrowing. Finally, and whatever the causes may be, the economic reforms of the 1970s ended in the collapse of 1982. Lessons from the 1982 collapse As regards the 1982 collapse, discussion has revolved around the causes: the fixed nominal exchange rate, the causation running between the current account and the capital account and liberalization of the domestic capital market. From the methodological point of view, this is equivalent to analyzing what happened before 1982. The methodological approach of this book is somewhat different: it examines what happened at the time of the collapse (1982) and afterwards (1983–84). It also analyzes the factors contributing to the subsequent economic recovery. We can distinguish three lessons here. Firstly, the economic reforms of the 1970s needed a new type of economic agent. Secondly, the monetary approach to the balance of payments failed; and, thirdly, laissez-faire failed too. The post-1973 economic model required a change of mentality and new economic agents with special skills, both in the private and in the public sector. How were private-sector agents to set the relative level of their respective prices, after a long tradition of controlled prices fixed by the public sector? How could a private entrepreneur know how to compete with imported goods in a rapid opening-up process? How does one operate in the context of a free capital market? How is this free financial market regulated? There was a huge scarcity of human capital prepared for an environment in which risk, uncertainty and instability were all rising fast. The emergence of new and efficient economic agents operating in an open competitive framework takes time.

172 The Unidad Popular and the Pinochet Dictatorship: A Political Analysis

The widespread bankruptcy of firms in the productive and financial sectors in 1982–83 meant a highly costly learning process involving the concepts of competition and survival in the Chilean economy: the strongest survived, and they provided the example for the rest. This can be seen as empirical evidence against rapid structural reform. The lesson points to the advantages of gradualism and regulation. This is what was seen in the second process of trade liberalization during the 1980s, and the careful management of the financial market from then until the start of the 1990s. The failure of the monetary approach to the balance of payments has been described in Chapter 2. The management of macroeconomic disequilibrium through an automatic mechanism (the free rate of interest) works slowly and at high cost; the cure proves worse than the disease. The solution adopted was Keynesian macroeconomic fine-tuning, involving a rate of interest suggested and controlled by the Central Bank that was maintained for more than a decade. Moreover, the attempt to gain credibility in the midst of an exchange rate crisis via an increase in free access to currency and the liberalization of the short-term capital account also failed, to be replaced by exchange controls and control of the capital account. The failure of monetarism is different from the failure of laissez-faire. The latter was a revolutionary doctrine in the eighteenth century, which fomented individualism in order to protect people from absolute monarchy: the popular belief was that ‘monarchs and governments should leave the private sector unfettered (on economic issues)’. The monetary approach to the balance of payments, with a fixed nominal exchange rate, provides a framework with clear rules for the government not to intervene in the economy at the macroeconomic level: an automatic mechanism resolves everything. We have already seen why and when government macroeconomic intervention was necessary. Let us now see what happened at the microeconomic level. In laissez-faire, the solution for any disequilibrium, macroeconomic or microeconomic, is a change in relative prices; in the case of an external deficit, deflation is needed. In an open economy, deflation requires an economic contraction to reduce the price of non–tradable goods. The profound economic recession of 1982 caused the near bankruptcy of all productive and financial firms: Central Bank intervention was required to avoid the total collapse of the Chilean economy. What would have happened if laissez-faire had been strictly adhered to – unsuccessful firms simply go bankrupt, including banks (the principle

A Tentative Synthesis 173

of free banking), large firms and conglomerates – with no intervention whatsoever by the Central Bank? It would have retarded the development of the Chilean economy by around back 50 years. A second basic principle of laissez-faire, and the counterpart to nonintervention by government, namely that private-sector profits and losses are private, was also violated: losses were socialized. Central Bank intervention slowed down the economic demolition process of laissez-faire, but generated an anomalous sector of the economy known as the Area de Propiedad Rara (a close substitute to the APS of the UP government). In addition, this type of intervention by the Central Bank not only socialized private-sector losses, but also violated the principle of market neutrality by providing discretionary subsidies to different categories of private debtor. A curious explanation of the near total collapse of the private sector in 1982, blames the government because in 1977, by rescuing the Banco Osorno, it provided a clear signal to the effect that banks would not be allowed to go bankrupt, and this led to a moral-hazard type of behavior. However, during 1976 and 1977 several finance houses did go bankrupt and the owners of the Banco Osorno paid the consequences (they went to jail). The moral that economic agents should have drawn from this period is that maybe banks do not go bankrupt, but bankers can have a very bad time. A more pertinent lesson of this experience is that gradualism should have been applied at that time, and the system of supervision and regulation that was to be imposed later should have been introduced. As has been pointed out, in the post-1982 adjustment and economic recovery process, a wide variety of heterodox policies were put into practice, including a drastic increase in protectionism: import duties went up from 10 per cent to 35 per cent, and remained at 20 per cent or above for six years.11 In addition to this, non-neutral microeconomic rules were imposed, including price bands and tariff surcharges. It is true there was some virtue in these measures: their visibility and their time limit (six-monthly or annual renewal was required). In short, a controlled rate of interest replaced the free interest rate; exchange controls and control of the capital account replaced the preexisting liberalization; supervision and regulation of the banking and finance system replaced the free actions of a relaxed capital market; Central Bank intervention was needed to rescue the private sector, there was a drastic increase in the level of protection, price bands and surcharges were established, there was socialization of private-sector

174 The Unidad Popular and the Pinochet Dictatorship: A Political Analysis

losses and the principle of market neutrality was violated. Finally, it was the government that had to renegotiate and underwrite the private-sector’s foreign debt. Is this not evidence enough that there was some failure in laissez-faire? Confusion exists in seeing laissez-faire as identical to a free-market system with free prices. So, as there was no control of prices in 1982, there is a tendency to believe that it was laissez-faire that made possible the subsequent economic recovery. But as can be appreciated, Keynesian interventionist macroeconomic policies (devaluation and control of the interest rate) were required to save the Chilean economy and the economic model, as well as Central Bank microeconomic intervention, along with heterodox policies and regulation. Recovery and structural reform in the 1980s What would have happened to the economic model if a change in government had occurred in 1982–83? At that time the unemployment rate stood at 30 per cent, and the economic reforms were quite unpopular. The economic measures of 1984 provide one possible answer to this question. In that year, reducing the domestic disequilibrium was defined as a priority; measures were directed toward reactivating the economy and bringing down unemployment. This was the period when Latin America was faced with the dilemma of to grow or to pay caused by the external debt shock. The option of growing in order to pay caused conflict in the short run with foreign creditors; the option of paying to be able to grow caused domestic conflict. A democracy is relatively stronger in facing external pressures, so domestic recovery tends to get priority. A dictatorship, on the other hand, is weaker in facing foreign pressures; the international financial institutions (IMF and World Bank) did not support the Chilean economic team in 1984 and exerted pressure for it to be replaced. From 1985 onwards, Chile adopted a non-confrontational stance towards its foreign creditors. Furthermore, the conditional support of international multilateral institutions changed national priorities. Servicing the foreign debt became the first local priority, for it was considered that in a interdependent world economy the cost of nonpayment would be greater than the cost of debt service. From a pragmatic point of view, this stance seems highly advantageous: the loans provided by such organizations, and their assistance in rescheduling the external debt, made it possible to relax the external constraint; in addition, the basic economic reforms they suggested had already been carried out in Chile during the 1970s.

A Tentative Synthesis 175

One may wonder why there was such massive support for Chile from the international multilateral organizations following the external debt shock; no other Latin American country received loans from them worth 3 per cent of GDP during five consecutive years. There is a simple answer: what credibility and acceptance would the economic reforms suggested by these organizations to other Latin American countries have had if the Chilean economy did not recover? They urgently needed a success story and decided to invest in Chile. Nevertheless, after 1982 a complex situation arose in the Chilean economy: namely, how to climb out of stagnation and depression, and how to stimulate investment and growth. At that time there was a totally sterile debate among economists, focused on examining whether or not the economy had touched bottom, as it was believed that once the economy had bottomed out there was only one possible future: start to grow again. However, in fact another possibility did exist: the economy could remain stuck on the bottom. Macroeconomic stability, structural reforms and existence of a system of right prices, were necessary but not sufficient conditions for growth. Private-sector investment and growth did not arise spontaneously. So, how could the instincts of private-sector entrepreneurs be stimulated? The latter, as a group, behaved like a flock of sheep, so what mattered was encouraging the leaders. For that purpose a series of stimulation measures were implemented: reprivatization of the ‘área rara’ provided subsidies to existing economic conglomerates, while the privatization of large state firms favored new technocrat groups; the mechanism of debt–equity swaps to reduce the foreign debt-subsidized foreign investors; the solution to the domestic debt included rollovers and subsidies for the banks. This entire range of solutions involved a huge transfer of wealth and resources from the public to the private sector, which came to assume a central role in the productive process. This was matched by the emergence of new breed of efficient entrepreneurs, highly competitive and audacious in outlook, who saw the world as their market; and a virtuous circle was generated between national and foreign investors which led to export expansion and growth. Brief assessment of the economic reforms Rationalization and simplification of the rules of the game should not be the monopoly of any specific ideology; whenever possible and whenever they can be identified, the establishment of simple and

176 The Unidad Popular and the Pinochet Dictatorship: A Political Analysis

general rules should always be encouraged. In the Chilean experience, this was seen in the replacement of a complex foreign trade regime involving multiple specific provisions, by a simple and uniform tariff system. In addition, a wide variety of official exchange rates was replaced by a single exchange rate. It has been shown that the priority assigned to maintaining macroeconomic equilibrium is important – particularly the control of inflation; this is greatly assisted by a balanced fiscal budget and a tax structure that is revenue-efficient (VAT is a valuable tool here). Once again, rationalization and simplification of the tax structure, as well as a simple global rule for the expansion of public spending in normal times (for example, that total public expenditure should be bounded by GDP growth), helps to preserve macroeconomic equilibrium. The replacement of a generalized system of price controls by a price system subject to market forces significantly reduced the distortions prevailing in the Chilean economy; in addition, the public sector was relieved of a job that permanently generated tensions with the private sector. However, total liberalization and economic deregulation can create serious problems in certain important markets. For example, in the financial market the abrupt freeing of the interest rate led to exaggeratedly high levels for the real interest rate (30 per cent for several years), which, together with total deregulation of the banking and financial system, was a decisive factor in the 1982 collapse. One effect of labor market flexibility and atomization was a severe deterioration in the real wage; the free market system in health and education left middle- and low-income groups in a highly unfavorable situation. The opening up of the economy, together with incentives for exports provided through changes in relative prices, have invigorated the Chilean economy, leading to the emergence of dynamic, daring and highly efficient and competitive Chilean exporters. In synthesis, a system of free markets with an economy that is open to the outside world generates a highly competitive environment. Competition necessarily raises the level of efficiency: the inefficient eventually disappear from the market. Moreover, a highly competitive environment significantly raises the level of consumer welfare. The transfer of the role of productive agent from the public to the private sector has been successful. However, there has been a lack of transparency in the privatization process. Additionally, the regulatory framework governing the operation of private natural monopolies and the workings of the AFPs needs further development. It is also worth recalling that the private sector has shown once before that it was

A Tentative Synthesis 177

capable of growing rapidly, only later to go bankrupt. This points to the need for bankruptcy legislation in which the socialization of losses is avoided. Established rules work well provided the economy develops normally – the problem arises at times of crisis. The Chilean experience of 1982–83 shows how dogmatism can make a crisis deeper – by turning economic rules or instruments into priority goals and leading to the absurdity that preservation of the rule is more important than saving the economy. In 1982, efforts by the economic authorities to maintain a stable nominal exchange rate did nothing other than provoke a 14 per cent fall in GDP and a rise in unemployment to 30 per cent. Finally, there has been a notably asymmetrical distribution in the cost of adjustment, with significant wealth transfers in favor of higher income groups. General Pinochet and the Economic Model There is a perception that General Pinochet was a fundamental factor in the implementation of the Neoliberal Economic Model. In this regard, to this day the two most renowned former finance ministers of the period 1973–89, Sergio de Castro and Hernán Büchi, stress and eulogize the crucial role General Pinochet is supposed to have played in this context. However, the reality is probably the reverse: General Pinochet needed the Economic Model more than the Economic Model needed him. The failure of the previous development model (inward-looking development) and the crisis of 1973 had generated serious macroeconomic disequilibrium and severe distortions at the microeconomic level. Excessive state intervention in productive activity and in the economic arena, as well as the wide range of controls in force, were factors that were clearly identifiable as responsible for the existing situation. From the economic point of view, more of the same was not a viable alternative: new economic policies had to be applied. In this sense, the international financial organizations probably could have helped to impose the structural reforms in the 1970s as they did later in the 1980s by providing loans to Chile to do what it had done before. The supervision of organizations such as the World Bank and the IMF at that time could have induced external loans to be used for implementing reforms instead of being used mostly to fuel consumption. A further indication that the Pinochet dictatorship was largely irrelevant in establishing the Economic Model is what happened in other Latin American countries in the 1980s. In countries such as Bolivia,

178 The Unidad Popular and the Pinochet Dictatorship: A Political Analysis

Mexico and Argentina, structural reforms similar to those of the Chilean Economic Model were imposed by democratic governments following the crisis caused by the 1982 external debt shock. It is interesting to note that the reforms were put into practice in these three countries in a relatively shorter period of time than what was needed in Chile, and under democracy. In other words, a deep and lengthy economic crisis really constitutes the ante-room for carrying out radical changes in the ruling development strategy. So, in the implementation of the Economic Model in Chile, the political cost of dictatorship could have been avoided as well as the social cost of human rights violations. During the military dictatorship, the argument was repeatedly heard that to make an omelet you need to break eggs. In other words, General Pinochet needed the Economic Model to justify the two costs mentioned above. But in reality, no serious economist, from Adam Smith (the patriarch of laissez-faire) to Milton Friedman (the patriarch of monetarism), has ever argued that the violation of human and political rights is a necessary condition for installing a system of free markets. Are we all neoliberals now? The current consensus among economists across the political spectrum as regards the economic model in force between 1973 and 1989, leads to the question: are we all neoliberals now? Chilean and Latin American economic neoliberalism blends elements of conservatism and liberalism from the developed countries.12 Central propositions in this model are the preservation of macroeconomic equilibria and the rule of free and competitive markets. Let us look at this in greater detail (Ward 1979a, b). (a) The function of the market: the market is the most efficient mechanism. Although it is not perfect, its inefficiencies generate lesser problems than those caused by state intervention. (b) The functions of the state: The state should not pursue economic activities; it intervenes constantly in the people’s lives, thinking it knows what is best, but the reality is the opposite. The state and government are too big; to increase social welfare, a substantial downsizing would be helpful. The essential role of government should be to maintain order. This is vital for the proper functioning of society; when disorder or chaos exists, an individual loses the capacity to influence his own destiny. The worst disorders are those aimed against property and against the person. A good

A Tentative Synthesis 179

government is one that provides an ordered framework for the proper functioning of the market. In addition, this good government should provide only those goods which the market does not supply in sufficient quantity; in synthesis, the government ought to be a collection of services rather than an organism with its own logic. (c) Individualism: the optimizing behavior of rational individuals is a basic principle of the neoclassical economic approach: thanks to the invisible hand of market competition, self-interested individual behavior leads to a perfectly efficient global situation. Thus, encouraging individualism is not really a sin; furthermore, an individualistic stance ensures the greatest respect for each individual. But it also means each person is responsible for himself and should resolve his own problems on his own. There is nothing like a social structure that combines individual preferences and generates something different from the individual; society is considered to be simply a collection of individual agents. (d) Income distribution: the extent of the state’s responsibility in this area is to assure a minimum standard of living for the most poor. For an individual to obtain more than the minimum, he or she needs to make a personal effort; the market works for those who improve themselves, for those who are willing to increase their productivity and work longer hours, and it pays out according to what one puts in. As exchange between the parties is voluntary, every agent gains something in every transaction in which they are involved: redistribution through the market only produces winners. Individuals who do not manage to earn more than the minimum should be the object of social charity. In solving the problem of poverty, it is essential to maximize growth, because it is easier to redistribute when the economy is growing than when it is stagnating. An unequal income distribution is necessary because it stimulates those who have less to make greater efforts to improve their situation, and it is not unfair because no distributive pattern exists that can be considered fair. What really matters is the historical evolution of the income distribution. If wealth possessed by individuals has been acquired legally, then it cannot be questioned; nor can the resulting income distribution be morally or socially sanctioned. Finally, the marginalist analysis provides a pragmatic criterion for neoliberalism as regards how to improve on the present situation. There is no utopian vision of society, and the existing situation is the

180 The Unidad Popular and the Pinochet Dictatorship: A Political Analysis

best starting-point: things have to be improved at the margin, focusing efforts where the marginal productivity of effort is greatest. Gradualism and/or marginalism is the best procedure for changing the existing situation, as it makes it possible to minimize mistakes. A series of gradual benefits will eventually lead society to a better situation. As regards social conflicts on the national scale which create complex and paralyzing situations, the marginalist approach suggests separating a big problem into its constituent parts; it turns out to be more feasible to resolve each one of them separately, because it is relatively easier to make small changes. There are several elements of neoliberalism which generate consensus, particularly those relating to the efficiency of the market as a mechanism for allocating resources. Moreover, it has eliminated all naivety about the generosity and efficiency of the state and publicsector firms. Obviously a social policy in which less than one third of the total resources allocated benefits the target group, due to operating costs and leakages, is highly inefficient. But without any doubt, there is another much bigger distortion than this: although great efficiency is shown in the use of resources allocated to the Armed Forces, it is a severe distortion for an underdeveloped country like Chile to spend more on defense than on education, or health, or the two put together. As regards public-sector firms, these supposedly belong to all Chileans, but in practice they seem to be owned by the people who work in them and by the government party of the day. On the other hand, various criticisms have been made of certain aspects of economic neoliberalism. It has been suggested that it sets the market up on a supreme pedestal, transforming it into the independent variable; values, culture and society as a whole are turned into dependent variables. This is really, the modern anti-utopia, in which society becomes the source of market failures. As has been expressed by Pusey (1991), when the market acquires autonomy and becomes untouchable, a system is reached in which the economy is above society, and the main social responsibilities consist of raising productivity and facilitating adjustment (stabilization and structural) to increase efficiency. The market has all relevant information, which means that when things are calm and there is confidence, the long run extends to three months, but when the market is nervous and uncertain, the long run may shrink to a week (or even less). The basic assumption that individualistic optimizing behavior generates a social optimum has also been persistently questioned. On the one hand, it seems surprising that modern economic analysis characterizes

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human motivation in such a limited way; in fact, the real behavior of individuals continues to be strongly influenced by ethical considerations. Economic analysis attempts to explain the behavior of flesh-and-blood humans, not efficient robots. Given that people live in societies that possess certain values, these values should be included in the analysis to empower the explanatory and policy-proposing capacity of the economy.13 Moreover, Keynes (1926) has indicated that ‘[it] is not true that private and social interests always coincide, nor that individual optimization always operates to the benefit of the public interest … experience shows that when individuals act in a coordinated way they make fewer errors than when they act alone’ (p. 288). Currently there is consensus in modern economic analysis that various deficiencies in the market require state intervention. These include, for example, the absence of competition in a market due to factors such as: entry barriers into the industry; decreasing returns to scale or the existence of a natural monopoly; the need for public goods which cannot be produced by the market specifically for each individual; the presence of externalities; the existence of incomplete markets; the lack of perfect information and the existence of information asymmetries; and the failure of laissez-faire in the face of macroeconomic disequilibrium. Finally, there is problem of equity and the question of income distribution. In countries where there are wide income inequalities, the market’s distributive ethic is the greatest source of discrepancy with regard to economic neoliberalism. According to this ethic, the income of an individual should be based on his or her (marginal) contribution to total output. Is this what really happens in a free market system in the real world? Okun (1975) raises the following objections: if an inventor really received an amount corresponding to his marginal productivity, he should take virtually everything: there would be almost no trickledown. As well as this, family relations and contacts are generally decisive in the type of job an individual acquires in the real world: much of what an agent obtains from the market depends ‘on who one knows instead of what one knows’. In other words, unequal distribution of income generates inequality of access to the door to the market. Thirdly, consider a poor person whose productivity is relatively low: should he die of hunger? In a market system, the poor do not have many choice opportunities; the need to eat today constrains the possibilities of choosing rationally between different options. A poor person acts as if he has no future, because his main problem is survival in the present. The children of poor families are forced to work at an

182 The Unidad Popular and the Pinochet Dictatorship: A Political Analysis

early age to contribute to the family income, thereby cutting short their investment in human capital and so perpetuating the vicious circle of poverty. In developed countries, the prohibition of child labor has existed for a long time. But is this really an efficient measure? ‘When the law prohibits transactions of last resort, it closes escape valves for people who are in a desperate situation. Closing this valve means society has to find a better alternative to prevent or alleviate such despair.’14 To make equality of opportunities effective, and for the poor to be able to look forward to a different future, state intervention in the market is required, and this will generate costs in terms of efficiency. Okun suggests promoting equity up to the point at which the additional benefit from an increase in equity is equal to the cost in terms of greater inefficiency.15 Simply because humans are humans, social institutions need to emphasize and strengthen what unites them; namely, mutual respect. For this purpose, reducing inequality takes on a high priority; the social value of each individual is recognized, including those on the lowest incomes. Social spending, transfers and progressive taxes are mechanisms which, when applied efficiently, fulfill the goal of increasing equity. Finally, it should be pointed out that when countries establish the civil and political rights of individuals in their constitution, they do not include economic efficiency considerations in enshrining those rights. Okun argues that every individual acquires and exercises those rights without paying anything, so there are no incentives to economize on any of them. As there is a universal distribution of these rights, the principle of comparative advantage does not operate; i.e. it makes no sense to specialize in a specific right. Finally, there is no market for transactions in civil and political rights, such as the right to vote, or rather they are prohibited. If this type of market existed, it could be shown that there would be an increase in welfare for buyers and sellers.16 In synthesis, constitutionally enshrined civil and political rights violate the optimizing calculus of economic efficiency. ‘Why then does society establish these inefficient rights?’ Because ‘they are the glue that holds society together’.17

Human rights and historical memory Human life is sacred; the murder of an individual is an offense against all humanity. Chile’s National Commission for Truth and Reconciliation

A Tentative Synthesis 183

verified the deaths of 2279 people that had been victims of human right violations during the military dictatorship; 318 of them were under 20 years old.18 During the government of the Unidad Popular, there were also fatal victims of violent events. So, why have the violent deaths that occurred during the military dictatorship been highlighted? Former US President Jimmy Carter provides the answer. Of all human rights, the most basic consists of not being exposed to arbitrary violence, violence generated by governments, by terrorists, by criminals, by selfproclaimed messiahs, waving political or religious banners. ‘But governments, in possessing power far superior to that of individuals, have a special responsibility. A government’s first duty is to protect its citizens. When it is the government that becomes the perpetrator of violence it loses its legitimacy … Political assassinations, torture, arbitrary and prolonged detention without charge or trial, are the most cruel and horrible of human rights violations.’ 19 ‘All crimes should be condemned, but one must stress the special nature of crimes committed by the state, which makes use of its monopoly of legitimate force to violate the law, instead of respecting it and ensuring its fulfillment.’20 The human rights violations that occurred during the military dictatorship are not only a problem of that period, but constitute a fundamental question for the present and for several future generations. A variety of goals were proposed at the end of the military regime: truth, justice, reparation of damage, national reconciliation, the avoidance of a recurrence of violations in the future.21 This simple statement begs several problems. To try and seek justice done risks the stability of democracy; assigning the same priority to truth as to justice may lead to neither being achieved. Can there be national reconciliation and forgiveness if there is no justice? And if there is no justice, what will ensure new human rights violations do not occur in the future? The importance of public knowledge of the truth is related to the goal of national unity, which needs a sense of common identity and, therefore, of history and shared memories. Truth affects society as whole. Hiding the truth allows those responsible to institutionalize their own self-exonerating versions of what happened and evade their historical responsibility … The most important thing is for the truth to be established in an official way, so that it becomes part of the nation’s historical records: a version of

184 The Unidad Popular and the Pinochet Dictatorship: A Political Analysis

events that enjoys authority and which goes beyond party considerations.22 This is the purpose of the Rettig Report. But … how many Chilean people have read the Rettig Report? In practice, amnesty laws are legal instruments created by repressive regimes to ‘whitewash’ the past, legislating society to forget what happened, erasing it and starting anew. But ‘amnesty laws should not in any way prevent the truth concerning human rights violations that occurred in the past from being discovered and made known’.23 In the Argentine case, the application of justice despite the existence of amnesty laws reinforced knowledge of the truth and helped to put things in historical perspective. Judicial logic, expressed publicly, was able to put the past in order … and became an effective mechanism for the historical and political judgment of the dictatorship regime. The outcome of the trial not only passed sentence on the commanders of the three first juntas; the result was that the systematic nature of repression unleashed by the military government was proven.24 This shows how the application of justice is functional for discovering the truth as well as for history. ‘Should a government try to do justice, even at the risk of being overthrown by those whose responsibility is being investigated, with serious consequences for the very goals that are being pursued?’ 25 In Chile, political expediency has prevailed over the search for justice; it has been considered that a policy of unrestricted trial and punishment would not favor national pacification, nor could it be implemented without military discontent turning in to open rebellion. But, ‘by giving impunity to torturers, don’t we trivialize torture?’ 26 Moreover, for democracy and freedom to prevail, should not politics be subordinated to morals and values? What should be done for the victims and their families? After the First World War, several countries erected a tomb to the unknown soldier, to strengthen national cohesion with a simple appeal to common memory. Something similar could be done with a monument to the victims of repression in Chile. It would also be appropriate to create a Human Rights course in primary, secondary, and technical education as well as at university and military schools. Associated with this, a Museum of the Recent Past should be created; using all modern

A Tentative Synthesis 185

technology, this museum should become a Santiago landmark, visited by everyone, Chilean and foreigner alike, in order to learn, reflect and think about the experience of the period 1970–90. In a relatively short period, Chile has managed to become the world’s second biggest exporter of salmon: perhaps something equivalent should be achieved at the cultural level, with this Museum of the Recent Past serving as a model for the region. In the professional training of economists, a bias has been created against the past, against memory and against history. A basic concept in microeconomic analysis is that fixed costs are fixed; i.e. the fixed costs of a previous period are unrecoverable, they are sunk costs. What matters for current decisions are present and future variable costs, so we look ahead because looking back is irrelevant from the point of view of decision-taking. The ideas of technical progress and modernization reinforce this stance. Exactly the opposite occurs in the training of historians and psychoanalysts; for the latter, in particular, the past determines behavior in the present: current memory, related to the present, is the mechanism for reconstituting the past. As a result, we are also what we remember. Historical memory plays a fundamental social role: it explains to us who we are as a nation, relating the present to the past and thereby forming our way of being. The past gives meaning and significance to the present; incomprehension of the present is related to ignorance of the past.27 It has been suggested that ‘historical memory seems to be subject to the law of supply and demand. Historical memory has to be generated; it is produced in specific periods. But, for it to last beyond the immediate present, there has to be a demand’.28 The 20 years that have elapsed between 1970 and 1990 have been traumatic for all Chileans. Trying to forget or ignore this historical period is an invitation for the events to be repeated, whereas exhaustive review and discussion of this period will help us to overcome the traumas and advance national maturity.

Notes Preface 1. Le Goff, 1992. 2. Ibid. 3. Fentress and Wickham, 1992.

1

The Road to Socialism of the Unidad Popular

1. ‘The tenant loves the land that saw him born because it is his only world; generations of generations have gone before him and he remains there, like the tree, deeply rooted in land’ (Feliú, 1942, p. 218). 2. In H. Godoy (ed.) (1971), there is an excellent collection of articles written over a 120-year period between 1850 and 1970, on the social issue in Chile. The quotations which follow in the text are taken from this work. 3. Arcos, 1852, pp. 201–5. 4. Orrego, 1884, p. 223. 5. Vial, 1981, pp. 502–4. 6. Ibid., p. 504. 7. Aylwin et al., 1986. 8. Morris, 1967; Vial, 1981. 9. Entrepreneurs opposed collective written contracts in the belief that they would be the only ones obliged to fulfill them. Furthermore, they argued that unions were only interested in striking, and labor leaders were seen as agitators and disturbers of the peace (Morris, 1967). 10. This would be equivalent to more than 300 000 children working in 1990. 11. Vial, 1981, p. 535 (italics added). 12. Ibid., p. 535. 13. The nickname ‘siútico’ was used in a derogatory way by aristocrats to refer to middle-class people who become wealthy and try to imitate the patterns of life and customs of other classes, and who aspire to become members of that class. 14. The term ‘roto’ literally means ‘broken, ragged’. 15. McBride, 1938, pp. 272–3. 16. Chonchol, 1970; Villalobos, 1984. 17. Aranda and Martínez, 1970. 18. McBride, 1938, pp. 272–3. 19. Jobet, 1951. 20. Orrego, 1884, p. 228. 21. Letelier, 1896, p. 276. 22. Orrego, 1884, p. 228. 23. Letelier, 1896, pp. 280–1. 24. Morris, 1967, p. 253. 186

Notes 187 25. 26. 27. 28. 29.

30. 31. 32.

33. 34. 35. 36. 37.

38. 39.

40. 41. 42. 43. 44. 45. 46. 47.

48.

Ahumada, 1958. Frei, 1970. Pinto, 1962, 1970; Godoy, 1971. Sunkel, 1965, p. 523. Villalobos, 1984. For excellent analyses of the political evolution of the nineteenth and twentieth centuries, see Atria and Tagle (1991), Moulián (1986), Scully (1992). Villalobos, 1984. Feliú Cruz, 1942, p. 222. Aylwin et al., 1986, p. 34. However in this period (1891) there was a civil war in which 10 000 people lost their lives; this figure represented 0.262 per cent of the population of that time (1891), which would be equivalent to 34 000 deaths among the current population (1990). See Atria and Tagle (1991) and Moulián (1986) for a review and discussion of the level of social conflict in Chilean political development. Morris, 1967, pp. 261–2. Concha, 1918, p. 310. Implicitly, this suggests using weights in the political market like those of the economic market: more pesos, more votes. Cited in Jobet, 1951, pp. 174–5. The precedings is compiled from Johnson, 1961; and Aylwin et al., 1986. For a profound analysis and discussion on the parties of the center, see Moulián (1982, 1986) and Scully (1992). Moulián, 1986. From this it can be inferred that agrarian reform was founded more on social justice than on a capitalist modernization of the countryside (Moulián, 1986). For a more global interpretation of the aims of agrarian reform, see Chonchol (1970). Moulián, 1986. Moulián, 1986. This contains a profound analysis and review of political thought on the Chilean left. Recabarren, 1910. Jobet, 1951. Eyzaguirre, 1965, p. 392. Pinto, 1970. Hamuy, 1967, p. 498. Various reforms have steadily brought more and more people into the electoral process: for example, votes for illiterate people and the lowering of the voting age from 21 to 18 years (carried out in 1970). However, apart from female suffrage, it was not really these factors that induced a larger number of people to register on the electoral roll. The need for an electoral registration card for a series of procedures and formalities, together with the obligation to vote – both measures adopted in 1960s – produced a big rise in the number of voters. Campaigns by center and leftist political parties also contributed to this. Together with a higher relative percentage of voters, democratic deepening included improvements made to the electoral process via mechanisms aimed at eliminating fraud, bribery, etc., introduced through the Electoral

188 Notes Register, the Election Tribunal ‘Tribunal Calificador de Elecciones’, the single identity card, and so on. 49. Let d = D/V and v = V/P, where d is the percentage of votes obtained by the right (D) out of the total number of voters (V), and v is the percentage of voters (V) out of the population of voting age (P). Then a simple econometric model would be: ln d = a0 + a1ln v In this model a1 is the elasticity relating variations experienced in d in response to changes in v. The econometric results for the period 1918 to 1969 are as follows (values in brackets correspond to the t-statistic): ln d =

5.47 (18.6)

–

0.64 ln v (6.84)

R2 = 0.779

50. Some UP economists criticized the terms of these agreements, describing them as excessively generous to the foreign companies. For a review of this topic, see De Vylder (1974) and Fortín (1979). 51. This section is based on Larraín and Meller (1990). 52. For a more indepth discussion of these aspects, see Caputo and Pizarro (1970), Ramos (1972) and Bitar (1979). 53. Bitar, 1979. 54. Ramos, 1972, p. 18. 55. At the end of the 1960s the Gini coefficient for Chile was 0.51, lower than that for Brazil (0.58) and Mexico (0.58), but higher than that for Argentina (0.44) (Bitar, 1979). 56. Vuskovic, 1970; Bitar, 1979. 57. Martner, 1988. 58. Romeo, 1971, p. 43. 59. Vuskovic, quoted in Moss (1973, p. 59). 60. García, 1971. 61. Ibid. 62. Orlando Millas, 1972, quoted in Bianchi, 1975, p. 38. 63. Dornbusch and Edwards, 1991. 64. The three subsections which follow are based on Larraín and Meller, 1990. 65. Even prestigious (non-UP) economists applauded the success of the government’s economic policy on employment during 1971; see Bianchi and Ramos (1972). 66. At the sectoral level, the rate of growth of industrial output increased from 2.0 per cent (1970) to 13.6 per cent (1971), while the growth rate in commerce shot up from –1.5 per cent (1979) to 15.8 per cent (1971). 67. Annual unemployment rates at the national level in Chile are only available since 1961. If the unemployment figures are corrected according to a normal historical expansion of public employment, the unemployment figures for 1971–73 would be: 4.5 per cent in 1971, 4.6 per cent in 1972 and 7.2 per cent in 1973. 68. M1 is the quantity of money; real M1 is the quantity of money deflated by the CPI in order to compare monetary units of the same purchasing power.

Notes 189 69. According to Ramos (1977), another crucial factor was probably that during 1971 there was a real expansion in the demand for money of between 40 and 50 per cent, generated by the fear of expropriation and the generalized widespread uncertainty that the election of Salvador Allende had engendered. 70. World Bank, 1979; Bianchi, 1975. 71. García, 1971. 72. Garretón, 1975, p. 218. 73. Bitar, 1979, p. 131. In this work (Chapter V), there is a detailed discussion of the different options put forward within the UP government. 74. See Bianchi (1975) for disaggregated figures. 75. At the sectoral level the following growth reductions were recorded in 1973: industry (–7.7 per cent), commerce (–6.4 per cent), agriculture (–10.3 per cent). Agriculture already had negative growth rates in 1971 (–1.8 per cent) and 1972 (–7.4 per cent). Given the chaotic state of the economy, the effective economic deterioration in 1972 and 1973 seems to have been underestimated. It would be important to undertake serious methodological studies examining this period. 76. In October 1973 wages were going to be adjusted, so it could be argued that the –25.5 per cent figure given for the decline in the purchasing power of wages overestimated the situation. However, this figure was obtained using the average of the first eight months of 1973, rather than the level in September 1973. After the military coup there was a wage increase but through manipulations of the CPI (see Cortázar and Marshall, 1980) workers’ real wages managed to be decline still further, and the deterioration amounted to –38.6 per cent by the end of 1973. 77. Domestic wheat production was reduced from 1.3 million tons (1970) to 747 thousand tons (1973). The situation was similar for many other food products (see INE and ODEPA). 78. Martner, 1988. 79. Larraín, 1988. 80. See Bianchi, 1975. 81. Banco Central de Chile, Boletín Mensual, January 1973, p. 8. 82. Workers and unions also participated in the black market: a fraction of wages was demanded in kind, which was channeled towards the black market; there was even barter between unions in different sectors (Bitar, 1979). 83. Banco Central de Chile, Boletín Mensual, January 1973. 84. It is estimated that in 1973 there were between 2000 and 2500 JAPs in the whole country, with 50 per cent of them located in Santiago (Bianchi, 1975). 85. The exact phrase used by UP sympathizers was, ‘It might be a hellish government but it’s my government’. 86. During the UP government there were between four and eight official exchange rates, i.e. a multiple exchange rate regime. In 1973 there was a differential of more than 1000 per cent between the highest official exchange rate and the lowest. In order to use a single official exchange rate, the different official rates have been weighted according to the imports corresponding to each group of products. 87. This differential grows as high as 48 times if monthly information is used.

190 Notes 88. Martner, 1988, p. 76. 89. However, as the main objective was nationalization of the GMC, a provisional clause allowed the private sector to continue operating small and medium-sized mines. 90. This especially affected Kennecott (El Teniente), which had raised the book value of its assets from US$120 million to US$319 million. 91. This is the first year for which reliable information on the GMC is available. 92. A rate of return of 12 per cent of book value was used, which was supposed to correspond to normal annual profits; the difference between effective profit and normal profit (12 per cent) during the period stretching back over 16 years (1955–70) gave the amount of excess profitability. 93. For the reaction of the firms and the United States government, as well as reprisal actions, see De Vylder (1974), Bitar (1979), Fortín (1979) and Sigmund (1980). 94. For a more indepth discussion on this point see Alaluf et al. (1972), and De Vylder (1974). 95. Alaluf et al., 1972, p. 499. 96. It also indicated that ‘expropriation could include all or part of the assets of the expropriated properties (machinery, tools, animals, etc.)’. See Martner, 1988, p. 79. 97. Remember that in the Frei government the number of unionized peasants went up from 2126 in 1965 to 114 112 in 1970 (Table 1.9); in six years (1965–71), the number of unionized peasants grew by more than 100 000. 98. Another criticism of the Frei administration’s agrarian reform was that it only managed to benefit 30 000 peasant settlers, or ‘asentados’, instead of the 100 000 that had been promised. 99. Alaluf et al., 1972, p. 519. 100. For example, Mexico and Bolivia; see De Janvry, 1981, and De Vylder, 1974. Another difference lies in the distribution of land made (after expropriation) to the benefit of the Mexican and Bolivian peasantry as a group; in the Chilean case, the ‘reformed’ sector consisted of productive units approximately corresponding to an area equivalent to the expropriated property and peasants corresponding to the former workforce on the property. 101. This figure includes land restitution carried out during the military government and the present value of compensations received in the expropriation process. See Larraín (1988). 102. This subsection is based fundamentally on De Vylder (1974); for a lengthier discussion of this issue, see Marter (1988). 103. Alaluf, 1972, p. 12. 104. In January 1972, the government specified a set of 91 firms that would comprise the APS. But, additionally it implicitly defined as ‘strategic’ any firm with a book value above E°14 000 000 (between US$200 000 and US$1 million, depending on whether the official or parallel exchange rate is used). According to this definition, there were at least 253 firms that would have qualified for inclusion in the APS. 105. The argument by De Vylder and others that ‘only less than 1 per cent of all industrial establishments were nationalized’ (out of a total of 35 000) is clearly irrelevant.

Notes 191 106. This subsection is based on Larraín and Meller (1990, pp. 164–5). For more indepth analysis, see Martner (1988). 107. Martner, 1988, p. 137. 108. Quoted in De Vylder (1974), p. 161; Minister Zorrilla, Segunda Exposición. 109. There will probably be a change in the near future: problems such as intellectual property rights, the assignment of rights of use and exploitation of public areas, etc., will need a review and discussion of property rights concepts. 110. The assumption that adjustment is instantaneous and transaction costs are nil makes the institutional framework irrelevant. Modern economic approaches, in which non-zero transaction costs exist, permit the study of economic institutions in a capitalist system; some approaches argue that the optimum institutional framework is that one which minimizes transaction costs. See Williamson, 1985; Barzel, 1989. 111. For a more extensive and profound discussion of this topic, see Alchian and Demsetz (1973), Becker (1977), Barzel (1989). 112. Becker, 1977. 113. Ibid. 114. Barzel, 1989. 115. Becker, 1977.

2

The Economic Model of the Military Dictatorship 1. This section makes liberal use of the valuable contributions and arguments put forward by sociologists and political scientists at FLACSO. Among others, see Moulián (1982, 1986), Garretón (1983), Lechner (1984, 1985), Flisfich (1985) and Varas (1982); see also Atria and Tagle (1991). It is very difficult (but not impossible) for an economist to contribute to this topic: see Foxley (1985). 2. On this topic, see the selection of articles in Tagle (1982) and CIEPLAN (1986); also see Garretón (1983), Valenzuela (1978), Aldunate, Flisfich and Moulián (1985) as well as the numerous references contained in these books. 3. Garretón, 1983. 4. The economy is at the Pareto Optimum when it is impossible to increase the welfare of one agent without this implying a welfare loss for some other agent. An economy is away from the Pareto Optimum when it is possible to increase the welfare of some agents without anybody else suffering a welfare loss; as a consequence, there is a net and an unequivocal welfare gain if the economy shifts towards the Pareto Optimum. 5. Moulián, 1982, 1986. 6. In my judgement, even though foreign agents such as the CIA intervened, their role was not fundamental: the 1973 coup would have occurred even without CIA intervention. According to Sigmund (1977), the CIA spent US$8 million to destabilize the government of President Allende; even for an underdeveloped country like Chile, US$8 million is not really a significant figure. For a version stressing the role of external factors in the 1973 coup, see Chakvin (1982).

192 Notes 7. Pinto (1962) provides a forecast of Chilean democracy breakdown along these lines. 8. Population grew by about 2.5 per cent, which meant an annual increase in per capita income of 1.5 per cent. 9. Moulián (1986) argues that ‘here it was not just any democracy that was being consolidated, but a democracy with the Communist Party and the Socialist Party participating in government’ (p. 130). 10. Lechner, 1985, p. 25. 11. Garretón, 1983. 12. Let c = C/V, i = I/V and v = V/P, where c and i are the respective percentage of votes obtained by the Center (C) and the Left (I) of total votes (V), and v is the percentage of votes (V) over the population of voting age (P). The results obtained in the estimation of a simple econometric model (using the Cochrane–Orcutt method) for the period 1918–69, using observations corresponding to parliamentary elections alone, are: ln c = 2.26 + 0.40 ln v (3. 87) (2.17) ln i = 0.40 + 0.77 ln v (0.38) (2.55)

13.

14. 15.

16. 17. 18. 19. 20. 21. 22. 23. 24.

25. 26. 27. 28. 29.

R2 = 0.269 R2 = 0.355

Values in brackets correspond to the t-statistic. In the regression for the Center the years 1949 and 1973 have been omitted; in the regression for the Left 1941 has been left out. This type of behavior does not respond fundamentally to ideological fanaticism; radical governments were succeeded by Carlos Ibáñez, who had no ideology at all but whose slogan was ‘la escoba al poder’, ‘to sweep out the radicals’. Vial, 1986, p. 100. Arriagada, 1986, p. 149. For a diferent shade of opinion, see Garretón (1983), who argues that ‘there was no “democratic faith” among the right’ (pp. 29–30). For a profound and extensive discussion on these issues, see Lechner, 1984; Flisfich, 1985; Foxley, 1985. G. Sartori, quoted in Valenzuela, 1978. Valenzuela, 1978; Moulián, 1982, 1986. Viera-Gallo, 1982, p. 53. Valdés, 1986, p. 184. Ibid. Valenzuela, 1978, p. 79. Moulián (1982, 1986). The military event known as the ‘El Tacnazo’ (1969) was a relatively minor incident, focusing exclusively on economic claims on the part of the military. Vial, p. 270 in Tagle, 1992. See Varas (1982), who suggests that ‘hegemonic consolidation inside the Armed Forces occurred after the military coup itself’ (p. 398). Vial, p. 270 in Tagle, 1992. Arriagada, 1986, p. 12. Garretón, 1983, p. 96.

Notes 193 30. Varas (1982) argues that ‘the 1973 military coup provided the Chilean Armed Forces a historic opportunity to materialize its traditional institutional claims that had been silenced for more than 40 years’, thereby ‘managing to escape from its involuntary political ostracism’ (p. 397). 31. Garretón, 1983, pp. 90–1. 32. This section presents the diagnosis made by orthodox economists on the problematic development of the Chilean economy. The bibliographical material used in this section and in the following one is: De Castro (1973), Méndez (1979). The textual quotes correspond to these authors unless indicated otherwise. 33. See also Sergio de Castro’s 1977 and 1978 Exposición de la Hacienda Pública reproduced in Méndez (1979). 34. ‘The doors to foreign trade were closed, thereby suppressing the chance of effective competition. The situation became extreme to the extent of allowing the absurd practice of having representatives of the national productive sector on the board of the Central Bank’ (Méndez, 1979, p. 17). Valenzuela (1978, p. 16) stresses the same point. 35. It is interesting to point out that the essence of this concept was being used as early as 1972 and 1973, in the book El Ladrillo (De Castro, 1973) which served as a ‘navigation chart’ for orthodox economists. The first technical article in economic literature to introduce the concept of rent-seeking appeared in 1974: see Krueger (1974). 36. On this issue, there is a copious literature, so only an outline is provided here. 37. For a more detailed analysis, see Foxley (1982), Ffrench-Davis (1982), Zahler (1983), Ramos (1984), Corbo (1985a, b), Edwards and Cox (1987). 38. The term ‘reprivatization’ refers to the process by which firms that were originally private but had passed into public-sector ownership because the state had nationalized them – considering them strategic, or else to avoid bankruptcy – were returned to the private sector. In Chile, there were two reprivatization processes: the first of them immediately following the Unidad Popular government, and a second one after the economic and financial collapse in 1982–83. The term ‘privatization’ is used for the process in which public-sector firms created by the state were sold to the private sector. 39. For further details, see Larraín (1991). 40. Foxley, 1982. Hachette and Lüders (1987) consider that the relatively low sale prices of reprivatized banks and firms, compared to their book values, corresponded to the relatively high interest rates in the domestic capital market. 41. The reconstitution of the APS during the military dictatorship (which was known as the ‘área rara’) has been described as the ‘monetarist route to socialism’. 42. In an inflationary context in which taxes are not indexed, the delay in collecting tax revenue causes an erosion in its real value; this is known as the Olivera–Tanzi effect. 43. For a review of the role of VAT in tax revenue, see Marcel (1986). 44. See Wisecarver (1985) for a more detailed analysis of price deregulation. 45. For a detailed discussion of the opening up of the domestic capital market, see Arellano (1983), and De la Cuadra and Valdés (1992).

194 Notes 46. In September 1973, unions were suspended. They were not authorized to operate again until June 1979, and then with many restrictions: they could only exist at the firm level; within a firm, workers were encouraged to form several unions or not affiliate to any; unions could not form sectoral or national federations; and the rights of their leaders were abolished almost completely. 47. For a more complete analysis of Chile’s commercial liberalization, see De la Cuadra and Hachette (1988) and Meller (1992). 48. Corbo and Fischer, 1993. 49. See Fontaine (1988) and Valdés (1989). 50. For a deeper analysis of these issues, see Moulián and Vergara (1980), Foxley (1982), Meller (1984a), Montecinos (1988) and Cortázar (1989). 51. The Chicago economists tend to forget that, even in their own terms, all neoclassical optimality results depend on the initial distribution of assets. According to the Negishi theorem, the Pareto Optimum is equivalent to the optimum obtained by maximizing a weighted utility function in which the weights are proportional to initial assets. 52. Montecinos, 1988. 53. O’Donnell, 1972; Cardoso, 1979. 54. Montecinos (1988) contains many quotes relating to this issue made by various Chicago economists occupying high positions during the 1973–81period. 55. In reply to criticism of the high social cost of his policies, one finance minister argued that this was a matter of ‘small political groups mentioning the poor because they are only interested in defending their own particular interests’ (J. Cauas in Méndez, 1979, p. 175). 56. ‘The Chilean reforms are the most significant of those applied in developing countries during recent times’, A. Harberger (Wall Street Journal, 5 October 1979). ‘In order to reestablish friendly relations, Chile should lend its economic team to the government of the United States’, (Editorial, Wall Street Journal, 18 January, 1980). ‘Chile represents a case study of efficient economic administration’, (US State Department; Time, 14 January, 1980. Quotes taken from Foxley, 1980). 57. For more detailed analysis, see Ffrench-Davis (1982), Arellano and Cortázar (1982), Zahler (1983), Sjaastad (1983), Ramos (1984), Harberger (1985), Corbo (1985a, b), Balassa (1985), Corbo, de Melo and Tybout (1986), Edwards and Cox (1987), Morandé and Schmidt-Hebbel (1988). 58. That is, the Central Bank does not have control over money supply. 59. Non-sterilization means the Central Bank does not neutralize the monetary impact of variations in international reserves. 60. If P is the level of domestic prices, P* is the level of international prices and e is the exchange rate, then the Law of One Price sustains that: P = eP*. Taking derivatives, we have that: P = ê + P*, where the notation ^ indicates the rate of change of the variable. Thus, the rate of domestic inflation P is equal to the sum of the rate of devaluation ê plus the rate of international inflation P*. If there is a fixed exchange rate policy, ê = 0, so P = P*. 61. See Arellano and Cortázar (1982) and Corbo (1985) for similar figures. The WPI is not a reliable indicator due to its questionable representativity.

Notes 195 62. In the monetary approach of the balance of payments, what matters is what happens to the balance of payments as a whole (the overall result of the balance of payments), and not any one of its parts. 63. These growth rates are overestimated; in an economy engaged in a process of opening up to the exterior, the traditional methodology of national accounts calculation leads to an overestimation of growth rates. For revised national accounts calculations, see Meller, Livacic and Arrau (1984), Meller and Arrau (1985). 64. It remains to be explained why foreign agents financed this excessive spending, and why it generated an overall surplus on the balance of payments. See, in Schmidt-Hebbel (1988), the analysis and estimation of an inter-temporal optimization model to examine the validity of the ‘real’ model of the current account in the boom and crash of 1976–82. 65. Harberger, 1985; Edwards, 1986; Edwards and Cox, 1987; Morandé and Schmidt-Hebbel, 1988. 66. Edwards (1986) estimates that the nominal exchange rate in mid-1981 was about 30 Chilean pesos per US dollar, instead of the fixed nominal rate of 39 pesos to the dollar. 67. Valdés (1989) argues that there was an irresponsible supervision policy in countries whose banks provided excessive loans to Chile. 68. For a deeper analysis of this hypothesis, see Arellano (1983), Barandiarán (1983), Ramos (1984), Meller and Solimano (1984), De la Cuadra and Valdés (1992). 69. Between February 1982 and February 1985 a new finance minister took office every six months. This was in notable contrast to the previous period in which a single finance minister lasted nearly six years. 70. When a crisis begins to develop in a Latin American country, economic events occur rapidly; news, rumors, or policy errors can have destabilizing consequences in a short time. The long-term horizon shrinks to a quarter or even a single month; the short run becomes the only thing that matters. 71. Bail-out operations undertaken by the Central Bank meant amounts in excess of US$300 million for the Banco Español and more than US$100 million for the Banco de Talca, which were among the six biggest private-sector commercial banks in Chile. 72. In July 1981 the Finance Minister emphatically declared that the fixed nominal exchange rate would be maintained for many years to come. 73. Since the Law of One Price was assumed to operate as well, then tradable goods prices could not vary because they were determined by international prices. 74. In reality, this scheme had began to operate fully as from the first quarter of 1980. The increase in international reserves at the Central Bank in 1980 caused an expansion of the money supply in real terms, putting downward pressure on the real domestic interest rate. However, despite a massive entry of external funds, the real domestic interest rate fell only a few points, remaining way above international levels. 75. In 1981, the LIBOR rate climbed to an annual rate of 18.5 per cent during the third quarter. However, changes in this rate in 1981 and 1982 were relatively small compared with the changes in the domestic interest rate in Chile.

196 Notes 76. Using a small open economy model in which the Law of One Price prevails, and with 100 per cent indexation on the CPI, Corbo (1982) provides an empirical verification that the Chilean economy displayed perfect homogeneity of degree 1 with regard to the exchange rate. In a later paper, however, he shows that the Chilean economy does not have homogeneity of degree 1 (Corbo, 1985a). 77. Even General Pinochet was moved to state that ‘devaluation would be equivalent to suicide’. 78. Despite the fact that the Finance Minister changed three times in 1982, all three were ‘Chicago Boys’, and they kept the same economic team in the other positions. 79. Deindexation of wages was adopted as an additional measure. 80. The weighting of the variations in these five currencies was related to the share of the respective countries in Chile’s foreign trade. 81. There were other problems with the marketing of this initial modification of exchange rate policy: (a) the measure was announced on a Monday – something that should never be done: a devaluation should best be annouced on a Saturday. (b) The day following the devaluation announcement, the Finance Minister expressed the opinion: ‘I do not like devaluation and I do not believe it will work, but it was the only thing we could do to achieve an increase in international competitiveness.’ 82. Something had been learnt, however: the previous change in exchange rate policy was announced on a Monday. 83. This preferential dollar was to be governed by a gradual exchange rate adjustment rule related to the evolution of the CPI during the previous month. 84. International inflation was assumed to be 1 per cent per month during the first three months; later it was lowered to 0.5 per cent per month. 85. It should be recalled that, only one month earlier, it had been announced that M1 would rise by 11 per cent over the following six months. Thus, the monetary authorities seem to have been following a rule indicating that if you lower the number of months by one, the percentage increase in M1 should go up by one. 86. Prior to July 1982 there were special deposit requirements and expiry terms for foreign financial loans aimed at requiring such capital to remain in the country longer. From the Chilean standpoint, the permanency of external financial loans in the country for extended periods made it possible to count on resources that could be used for productive investment. However, when reserve and expiry term requirements were abolished, the Central Bank argued that this was being done to establish equality between the cost of short-term and long-term borrowing: ‘one more distortion in the system has been eliminated’. However, the Central Bank authorities did not talk of distortions when they introduced the ‘preferential dollar’. 87. Rosende, 1987; Fontaine, 1987. 88. There is a methodological difference in the classification of the stages of adjustment compared to Barandiarán (1988), who distinguishes macroeconomic stability (contraction of GDP), recovery (GDP regains its preadjustment level) and sustained growth. In this approach, the empirical

Notes 197

89.

90.

91.

92. 93. 94.

95.

96.

97.

98.

99.

GDP values provide the breaks in the adjustment stages. In the approach suggested in the text, on the other hand, the stages of adjustment are defined by the economic policy environment. Effective unemployment includes special public employment programs known as PEM (Minimum Employment Program) and POJH (Employment Program for Heads of Households), in which participants received between 30 per cent (PEM) and 60 per cent (POJH) of the minimum wage. Alternative sources argue that the rate of GDP growth was 8.3 per cent in 1984 and 1.1 per cent in 1985. Growth rates in industry were 11.9 per cent (1984) and 1.6 per cent (1985), and in construction 19.3 per cent (1984) and –0.5 per cent (1985). See Arrau (1986). A rise in the price of copper of one US cent per pound is worth about US$30 million. Consequently, the rise in the copper price alone generated additional increases for Chile averaging US$1500 million per year in the two-year period 1988–89. Edwards, 1989. See Arrau et al. (1992), Repetto (1992) and Corbo and Fischer (1993). Fontaine (1987, p. 113). In the IMF stand-by agreements one sees implicit pressure from this body for the Central Bank to end its policy of guiding the real interest rate, which supposedly would be done when the financial system became more robust. This mechanism encouraged loans in pesos and the purchase of dollars in the parallel market, to later place ‘swaps’ at the Central Bank; see further details in Valdés (1992). There is a big difference between transfers abroad made by two countries with the same trade surplus but where one of them suffers a US$1000 million fall in its reserves. This measure is almost equivalent to the total amount paid in foreign debt service, discounting foreign loans. Fontaine (1987) provides lower figures and percentages. This is due to two factors: (i) He uses only the trade surplus (CIF) to measure the transfer, and (ii) he does not exclude 1984. This year was clearly an outlier, so its inclusion in the calculation of an annual average generates a distortion. The ‘free banking’ school has questioned this Central Bank bail-out of the financial system. This school argues that the highly risky behavior of the Chilean banking sector in the period 1977–82 originated in a government decision to prevent the bankruptcy of the Banco Osorno in 1977, which stimulated bank boards to adopt a ‘moral hazard’ type of behavior (Barandiarán, 1983; Harberger, 1984). However, free banking in a country like Chile is a highly risky proposition, with an appreciable likelihood of disastrous consequences. What would have happened in 1982 if the Central Bank had allowed the Banco de Chile and the Banco Santiago, as well as all other insolvent banks to go bankrupt? For interesting discussion and an excellent review of these issues see De la Cuadra and Valdés (1992). The main measures were: (i) Commercial banks could sell their bad and risky debt portfolio to the Central Bank up to an amount equivalent to twice the bank’s capital, but with a buyback commitment. In this operation, the commercial banks received Central Bank bonds of zero risk and a real interest rate of 7 per cent per year, whereas the bad-debt portfolio sold

198 Notes

100.

101.

102. 103. 104. 105.

106. 107.

would have an annual charge of 5 per cent real. (ii) The interest rate subsidy paid by the Central Bank on swap operations. A commercial bank could make a deposit in foreign currency at the Central Bank, earning the LIBOR rate plus 4 per cent (this spread narrowed over time) and, at the same time, take out a loan in pesos whose interest rate corresponded to the deposit interest rate. In this swap operation, the Central Bank guaranteed the sale of foreign currency and also absorbed the risks and losses associated with any eventual devaluation. Thus was generated the future ‘subordinate debt’ problem of the privatesector banks who sold their bad-debt portfolio to the Central Bank. It took thirteen years to achieve a final solution to this ‘subordinate debt’. In reality, the steep five-year fall in the unemployment rate is surprising (from 25 per cent in 1984 to 10 per cent in 1989). In 1984, the present author predicted that unemployment would reach 10 per cent only by the year 2000, and only then provided the economy grew at 6 per cent per year. For this calculation an output–employment elasticity of 0.5 was used, together with annual expansion in the workforce of 2 per cent; so, if the economy was growing at 6 per cent, employment would grow at 3 per cent and the rate of unemployment would fall by 1 percentage point per year. In 1984, cutting unemployment from 25 per cent to 10 per cent would have taken 15 years. What was not considered in this calculation was that despite the inelasticity of labor demand (wage–employment elasticity in the short run was close to –0.3), the big wage contraction (–20 per cent) and its maintenance over a long period of time encouraged job creation in the short and medium term. Previously this foreign debt service represented 0.5 per cent of public spending (1981) (Larraín 1991). These figures refer to the fiscal sector; the figures in Table 2.30 refer to the public sector. Rodríguez, 1985; Sanfuentes, 1989. The solution of Chile’s external debt problem involved a series of issues: negotiation and renegotiation with creditor banks; the granting of a state guarantee on private-sector foreign debt; the evolution of foreign debt by type of borrower and type of lender; the mechanisms for the reduction and conversion of foreign debt (Chapters XVIII and XIX); and the pros and cons of these mechanisms. It is worth pointing out that the foreign debt bail-out, through the various means, involved sums of above US$2800 million via Chapter XVIII and US$3400 million via Chapter XIX; this generated high levels of rent distribution to different agents. On these topics see Ffrench-Davis (1989), Larraín and Velasco (1989); see also Valdés (1989) and Meller (1986). Equivalent to 6 per cent of GDP at that time; Hachette and Lüders, 1987. Under this system, the government sold shares in the firms of the anomalous sector or ‘área rara’ at below market prices, providing a loan for 95 per cent of the purchase price at a zero real interest rate. In addition, under ‘popular capitalism’ buyers could set up to 20 per cent of the total value of the transaction against their personal taxes in the following year. Buyers whose marginal tax rate was more than or equal to 30 per cent received a tax break worth more than the cash payment they had made in

Notes 199

118. 119.

acquiring the shares. Given these benefits, there was a limit on the number of shares each person could acquire. Pinto, 1987. For further details on this entire process, see Marcel (1989) and Hachette and Lüders (1992). Comparing employment levels in the year of privatization and the year following might not be valid, for some state firms may have laid off workers to make their privatization attractive. Even today (1999), very few people talk of dictatorship; most prefer to use the term ‘previous government’ or ‘military regime’; analogously, instead of military coup one talks of military ‘pronouncement’ or ‘intervention’. The journal Estudios Públicos dedicated its first edition to these issues, setting out Hayek’s arguments. The same happened with edition No. 50, dedicated to Hayek himself. See Hayek (1980), Godoy (1993) and Fontaine (1980). Hayek quoted in Godoy (1993, p. 30). Hayek, 1980. All statements from this author in this chapter come from the same work. Fontaine (1980, pp. 124–9). Friedman and Friedman (1980, p. 35). Fontaine goes slightly further by suggesting that ensuring the free working of the market requires the exercise of a ‘strong and vigorous authority’, that creates objective order and leaves this as a legacy that transcends isolated wishes and passing circumstances, as happened in Chile ‘during the initial decades of the Republic’ (Fontaine, 1980, pp. 144–5). There is a logical inconsistency in this argument: the great virtue of the market is that it is an impersonal system, but Fontaine suggests that a strong and vigorous personal authority is needed for it to work. Rawls (1978, pp. 256–64). See Ibid., pp. 260–1.

3

A Tentative Synthesis

108. 109. 110.

111.

112.

113. 114. 115. 116. 117.

1. A semilogarithmic regression of (physical) production of copper (tons) from the GMC, with dummy variables for a structural break in the periods 1940–70 and 1971–90, estimated by the Cochrane–Orcutt method, produces the following results: lnQ =

5.95 (73.8)

–

0.47d + 0.008t + 0.0232dt (1.27) (2.02) (2.40)

R2 = 0.78 F = 57.5

where Q is output of copper (tons) per year, d is a dummy variable for the period 1971–90 and t is a trend variable. The coefficient of the trend variable in the period 1940–70 is 0.008, i.e. GMC output grew at 0.8 per cent per year. There is a structural change in the trend of the two periods in which the dummy variable for the period 1971–90 has the value 0.232. So, physical output from the GMC grew by 3.1 per cent (2.3 per cent + 0.8 per cent) per year in the period 1971–90. The values in brackets correspond to the t-statistic.

200 Notes 2. For an excellent and profound conceptual discussion on this consensus, see Lechner (1984). 3. Barr, 1987; G. Rodríguez, 1991; Wilson and Wilson, 1982. 4. Wilson and Wilson, 1982; Shonfield, 1984; Barr, 1987. 5. For a detailed review of Chilean social policies, see Arellano (1986) and Raczynski (1992). 6. Blinder, 1987. 7. See Wilson and Wilson, 1982. 8. This argument is totally valid when transfers are voluntary, and it is weakened when they are mandatory. 9. Klein, 1988. 10. The maximization of welfare equity means applying the principle of equal access for equal needs. The presence of the private sector in the production of certain social goods, even though it violates the above principle, frees resources from the Welfare State and consequently makes it possible to maximize the total level of social welfare (Klein, 1988). 11. What would have been the reaction of orthodox economists if, during a post-1989 government, tariffs had been raised from 10 per cent to 20 per cent? It would had been said that this was a profound change in the rules of the game, which destroyed the essence of the economic model and caused irreversible damage to future growth of the Chilean economy. 12. For the differences between the overall economic visions of conservatism and liberalism, see Ward (1979a, b). The following paragraphs use elements of these papers. 13. Sen, 1986. 14. Okun, 1975, p. 20. 15. Ibid, p. 90. 16. James Tobin, quoted in ibid. 17. Ibid., pp. 10, 14. 18. Rettig Report, 1991. There were 641 additional cases in which the Commission could not make up its mind. 19. Carter, 1978, p. 326. 20. Zalaquett, 1991, p. 156. 21. On these issues, see the excellent article by Zalaquett on which this section is mainly based. 22. Zalaquett, 1991, p. 153. 23. Ibid., p. 163. 24. Acuña and Smulovitz, 1991, p. 16. 25. Zalaquett, 1991, pp. 150 and 175. 26. Jacques, 1992, p. 32. 27. Le Goff, 1992. 28. Fentress and Wickham, 1992, pp. 201–2.

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Index adjustment process of 1980s 119–41 costs of 129 distributive impact 129–32 fiscal adjustment 136–8 heterodox policies used in 127–9 real devaluation 124–7 unemployment and real wages 134–6 AFPs see pension schemes Agrarian Reform Act (1962) 50, 51, 52 Agrarian Reform Corporation (CORA) 50, 56 agrarian reforms 6, 50–3, 70, 78 agrarian sector 4–8 growth and employment in 6 poor performance of 6 productivity and prices 7 reforms see agrarian reforms Aguirre Cerda, Pedro 19, 20, 70 Alessandri, Jorge 19, 20 government of: Agrarian Reform Act 50, 51; economic/social indicators 169; macroeconomic variables 23 Allende, Salvador 20, 21, 22 government of: Area of Social Ownership 53; economic/social indicators 169; nationalization policies 55–6, 62; property rights 57 Alliance for Progress 16 dismantling of 79 amnesty laws 184 APS see Area of Social Ownership Area de Propiedad Rara 172 área rara 79, 132, 142 reprivatization of 175 Area of Social Ownership 29, 42, 48, 77 creation of 53–5 Armed Forces and Chicago economists 83–6

culture of 71 intervention by 71–2 as moral guardians 71–2 see also military dictatorship automatic adjustment mechanism 101–6, 115 failure of 106 impact on economy 107 working of 105 Aylwin, Patricio 165 balance of payments 39, 90, 91 balance of trade 91, 120 Banco del Estado 27, 56 loss of share of domestic credit market 81 voting power 74 bankruptcies 103 banks state control of 55–6 black market 43–5 Buchi, Hernan 177 capital flows 96, 97 autonomous 97 endogenous 97 exogenous 97 Carter, President Jimmy 183 Caudillo-populist government 65 Central Bank assumption of exchange rate risk 115 falling reserves 102 foreign currency sales 111, 113, 114 international reserves 90, 91, 104 intervention by 113 as lender of last resort 140 monetary emission by 38 subsidies 129–33 quasi-fiscal 132 swap mechanism 128 voting power 74

216

Index 217 Central Unica de Trabajadores (CUT) 35 centre voters 64, 65 ‘Chicago Boys’ 83–6, 108, 112, 160 child labor 2 prohibition of 182 Chile-California program 151 ‘Chilean collapse’, indicators of 89 ‘Chilenization’ 13, 16, 22, 158 of GMC 48–50 see also nationalization Christian Democrat Party agrarian reform 51 goals of 14 government 65 ‘hinge’ function 68 rise of 12–13 structural reforms of 22 classical unemployment 135 closed-economy monetarism 75 CODELCO see Copper Corporation consensus 161 COPEC, reprivatization of 143 copper importance of 159 price of 99, 100, 124 Copper Corporation (CODELCO) 22, 40 freezing of assets 50 generation of exports by 125 Copper Stabilization Fund 149 CORA see Agrarian Reform Corporation CORFO 56 voting power 74 costs of adjustment 129 counter-inflationary program, outcome of 82–3 coup d’état 66 current account deficit 91, 102, 103, 120, 121 CUT see Central Unica de Trabajadores de Castro, Sergio 177 Decreto de Reanudación de Faenas 54 deflation 106 democracy

destruction of 61–75; analysis of orthodox economists 72–5; analysis of social scientists 61–72 myth of 61 democratic deepening 17 devaluation 102, 108–9, 113 expectation of 116 negative effects 108–9 nominal 125 positive effects 108 real 119, 122, 124–7 Dirección Nacional de Industria y Comercio (DIRINCO) 54 DIRINCO see Dirección Nacional de Industria y Comercio ‘dirty’ floating system 113, 114 dollar exchange rates 113 domestic debt 129–33 domestic disequilibrium 120, 126 domestic interest rate 104, 106 domestic production 95 domestic spending 105 double centrifuge phenomenon 68 economic freedom 152–7 economic miracle 85–8, 169, 171 indicators of 86 economic/financial collapse 88–119 automatic adjustment mechanism 101–6 chaotic macroeconomic policies 106–9 crisis of 1982–1983 88–101 exchange rate policies 109–15 indicators of 89, 96 monetary policies 115–18 economy, Unidad Popular view of 27–31 elections results 20 1912–1969 18 right-wing voters in 19 see also voters employment 134 agrarian sector 6 conditions of 2–3 evolution in privatized firms 148 public-sector 41, 136

218 Index ENAMI see National Mining Company equal treatment under law 154, 162 excess profitability 49 exchange rate 91 appreciation of 92 concept of 45 control of 73 evolution of 45–7, 110 fixing of 91–2, 109 free 112–13 nominal 110 policies (1982) 109–15 preferential 113 real 110, 126 exports 124, 130, 158 agriculture 152 composition of 152 copper 99, 100, 124, 159 fishing 152 fishmeal 124, 152 forestry 152 fruit 151 growth rates 159 metal products 152 new role of 149–52 number of exporting firms 150 wood pulp 124, 152 expropriation 53–4, 59, 60 Extended Fund Facility 122 external debt shock 127, 136 external disequilibrium 120, 126 external financing, sources of 123 external shocks 99, 100–3, 127, 136 fair compensation 57 financial sector indicators 96 financieras 81 fiscal deficit 136 fiscal reforms 77, 78, 80, 81 fixed exchange rate 91–2, 109 Fixed Nominal Exchange Rate Policy 91–2, 93 food distribution programs 138 foreign borrowing 99 foreign currency acquisition of 116 sales of 111 foreign debt 120, 121

increase in 97 foreign exchange market 114 free exchange rate 112–13 free floating system 112–13, 117 free market system 101 freedom concept of 153 economic 152–7 personal 153 political 152–7 Frei, Eduardo 21–2 government of: agrarian reform 50, 52; assessment of Unidad Popular 24–5; economic/social indicators of 169; macroeconomic variables 23; popularity of 24 political rhetoric of 69 Friedman, Milton 178 GDP see gross domestic product General Banking Law 128 GMC see Gran Minería del Cobre gradualism 161, 180 Gran Mineria del Cobre (GMC) Chilenization of 13, 16, 22, 70 nationalization of 48–50, 158–60; compensation 49; loss of skilled workforce 50 ‘great contradiction’ 62 Great Copper Mines 151 Great Depression 15 gross domestic product (GDP) 90, 94, 101, 106, 107, 116, 125 fall in 38 growth in 120 hacienda system 4 handout culture 72 heterodox policies, application of 127–9, 139 human rights 182–5 IMF see International Monetary Fund imports 95, 105 Import Boom 87 income distribution 179 income redistribution 33–4, 36 individual capitalism 12

Index 219 individualism 179 INDUS, reprivatization 143 industrialization 9 infant mortality, low rate of 138 inflation 82–3, 90, 93, 120, 121 nominal 125 as structural phenomenon 31 integral crisis 13 interest rates 119 control of 73 high 98, 104 real 119 international loans, cuts in 100–1 International Monetary Fund (IMF) 119, 123, 139, 174 international reserves 90, 91, 104, 105 intervention 54, 60, 103 by Central Bank 113 JAP see Juntas de Abastecimientos y Precios Juntas de Abastecimientos y Precios (JAP) 34, 44 Keynesian policies macroeconomic fine-tuning unemployment 135

172

labor market reforms 77, 78, 81 laissez-faire model 8, 76 failure of 172, 173, 181 land ownership 5–6 latifundio system 1, 4, 5, 6, 14 compulsory purchase of latifundios 51–2 economic problems of 7 end of 50–3 fair compensation and 57–8 property ownership by 57 latifundistas 1, 5, 7 incentives to invest 59 see also latifundio system Law of One Price 91 violation of 114 Left government 65 left-wing voters 64, 65 legal loopholes 53, 57 lender of last resort 140

loans international, cuts in renewal 73, 98 rollover of 60, 98

100–1

macroeconomic equilibrium 161 macroeconomic policies 22 Alessandri and Frei Governments 23 chaotic 106–9 evolution of macroeconomy 32–9 of Unidad Popular 31–47; evolution of exchange rate 45–7; evolution of macroeconomy 32–9; increase in public spending 39–43; populist policies 31–2; scarcity, black market and rationing 43–5 macroeconomy, evolution of 32–9 signs of disequilibrium 35–6 total decline and collapse 36–9 magic solution 32 marginalism 180 Mesocratic Republic 66 military dictatorship destruction of democracy 61–75 economic/financial collapse 88–119 final years of 169 justification for 72 legacy of 168–85; basic economic reforms of 1970s 170–1; lessons from 1982 collapse 171–4; neoliberalism 178–85; recovery and structural reform 174–5 structural reforms of 1970s 75–88 minifundistas 5 see also latifundio system monetarism 75 closed-economy 75 failure of 172 open-economy 75 monetary expansion 38 monetary policy active 118, 128 autonomous 117 of extreme neutrality 115 passive 128

220 Index monopoly 53 Museum of Recent Past

185

National Commission for Truth and Reconciliation 182–3 National Mining Company (ENAMI) 56 National Savings and Loans System (SINAP) 56 nationalization 47–8, 55, 158 of banks 55–6 of GMC 48–50 Neoliberal Economic Model 177, 178–82 new voters 65 nominal exchange rate 110, 111 nominal money supply 116 non-confrontation principle 123 non-tariff barriers, elimination of 151 oligarchic order 10–11, 17, 28 Olivera–Tanzi effect 42 elimination of 80 open-economy monetarism 75 Paretian welfare economics 164 Pareto Optimum 58, 62, 112, 164 passive monetary policy 128 patron 1, 4, 5, 11 ‘pay-as-you-go’ system 137, 142, 147 PEM program 134 pension schemes (AFPs) 167 reprivatization 143 personal freedom 153 peso debtors 131 phenomenon of three thirds 67 Pinochet, Augusto and economic model 177–8 government of, economic/social indicators 169 plebiscite of 1988 149 plural vote 11 POJH program 134 political autism 69 political issues foreign context 15–16

increased political participation 16–21 political positions 10–15 political liberty 152–7 political participation election results 18 growth in voter numbers 9, 16–17 increase in 16–21 see also voters popular capitalism 142 populist policies of Unidad Popular 31–2 preferential dollar 113 preferential foreign exchange market 114 price controls 34, 73, 77, 78 price liberalization 80–1 prices in agrarian sector 7 consumer price index 92, 93, 94, 120 controls 34, 73, 77, 78 copper 99, 100, 124 fishmeal 124 producer price index 160 wood pulp 124 principle of participation 155 privatization of state-owned firms 144–5, 146, 147; criticisms of 147; evolution of employment 148 of welfare state 166 proletarian dictatorship 62 property rights 56–60 protected democracy 17 public sector deficit 42 employment 41 expansion 73 public spending see social expenditure public-sector employment 41 pulperia 2, 4 purchasing power, reduction in 38 quasi-fiscal subsidies 132, 137 quasi-monopoly of suffrage 17, 18 queue standers 43

Index 221 Radical Party economic program 12–13 goals of 14 government 65 ‘hinge’ function 67–8 rise of 12 rationing 43–5 Rawls, John 155 real exchange rate 110 real money supply 116 real wages, evolution of 26 rent-seeking 74, 76 reprivatization 77, 78, 142, 143 área rara 175 banks 143 Second Reprivatization Process 143 Reserved Copper Law 160 Rettig Report 184 Revolution in Freedom 13–14, 15 rhetoric, significance of 69 Right government 65 role in democratization 66 right-wing voters 19, 65 Ross, Gustavo 19, 20 rotos 1, 4, 14 Russian Revolution, and rise of Communist Party 15 sales tax, elimination of 80 Second Reprivatization Process 143 Secretaria Nacional de Distribucion 44 SINAP see National Savings and Loans System siútico 3–4 slum dwellings 2 Smith, Adam 164, 178 social crisis 8–9 social expenditure 136, 137 composition of 137 cuts 126, 138 explosion in 39–43 increase in 39–40, 41 targeting of 138 social issues agrarian society 4–8 rich and poor 1–4

social justice 154 social unrest 8 SOE see State-owned enterprises state control see nationalization state involvement, reduction in 141–9 state-owned enterprises privatization of 144–5, 146, 147 subsidies to 37 strategic industry 53 strikes 8 number of 26 Structural Adjustment Loan 122 structural reforms of 1970s 75–88 of 1980s 141–52 application of 75–83 Armed Forces and Chicago economists 83–5 Christian Democrat Party 22 successes of economic model 85–8 time sequence of 79 Unidad Popular 47–56 Superintendency of Banks 98 tariffs elimination of non-tariff barriers 151 nominal 127 reduction in 151 surcharges 127 tax reforms 80 tax revenues, composition of 163 tomas 52 total net capital flows 96 trade balance 130 deficit in 35 trade surplus 121, 129 Treasury Bonds 131 ‘trickle-down’ 21 triple currency market 114 truth, public knowledge of 183–4 unemployment 107, 134 classical 135 duration of 134 falling 121 Keynesian 135

222 Index unemployment (contd) and real wages 133–6 rising 116, 120 Unidad Popular and balance of payments 39 Consolidated Non-Financial Public Sector 40 economic proposals 29–31 final years of 169 governments prior to 21–7 legacy of 158–68 macroeconomic policies of 31–47; decline and collapse of macroeconomy 36–9; disequlilbrium of macroeconomy 35–6; evolution of exchange rate 45–7; evolution of macroeconomy 32–9; increased public spending 39–43; populist policies 31–2; scarcity, black market and rationing 43–5 populist policies of 31–2 property rights 56–60 public-sector employment 41 social expenditure 41 structural reforms of 47–56 agrarian reform 50–3 creation of Area of Social Ownership 53–5 nationalization of GMC 48–50 state control of banks 55–6 view of Chilean economy 27–31 violence during regime of 183 and wages 34

unionization 52, 70 evolution of 25 urban workers 2 value-added tax 176 introduction of 80 voters centre 64, 65 left-wing 64, 65 new, distribution of 65 numbers: growth in 9, 16–17; and population 17 participation of 63–5 right-wing 19, 65 women as 18 Vuskovic, Pedro 30 wage adjustment policy (1972) 37 wages blue- and white-collar workers 34 de-indexation of 122 early twentieth century 3 falling 120, 136 public sector 136 real 126; evolution of 26; and unemployment 133–6 rising 39 Welfare State 161, 162–8 privatization of 166 white-collar workers 34 women, right to vote 18 worker capitalism 146 workers blue-collar 33–4 urban 2 white-collar 34 World Bank 119, 123, 139, 149, 174