Can Chile Recapture the Growth of Its 'Golden Decade'?

Chile’s economy appears to have held up well against significant recent headwinds, and some private-sector observers go so far as to suggest that growth rates similar to those of the "Golden Decade" may be realized again.

Despite the earthquake and subsequent tsunami in February, job losses and the closing of numerous small businesses last year because of the global financial crisis, Chile was the top destination for foreign direct investment in Latin America during the first quarter of 2010. During the recent World Conference for Trade and Development, the United Nations reported that Chile, with US$5.7 billion in foreign direct investment, had outpaced Brazil (US$5.6 billion) and Mexico (US$4.3 billion) among favorite locations for investors in the first quarter.

What’s more, the Santiago Chamber of Commerce forecasts that Chile’s foreign capital flow this year could reach US$15 billion to US$20 billion. This is reflected in the dizzying pace in the service sector, communications, mining and retail sales resulting from higher spending on public and private reconstruction initiatives, and meaningful expansion in internal demand, according to a press note from the country’s Central Bank.

Analysts widely forecast that the Chilean economy could grow at a rate of 6% in 2010, which would be in line with the goal outlined by the government of President Sebastian Piñera. Chile’s economy contracted last year by 1.5%. But market optimism has run so deep that the private sector has voiced the possibility that Chile will return to annual growth of 7%, which it achieved from 1987 to 1997, a period known as the “Golden Decade.”

Things are different now, however, says Juan Eduardo Coeymans, a professor of macroeconomics at the Catholic University of Chile. During those golden years, Coeymans notes, a combination of unique factors accelerated growth. “Chile was emerging from a military dictatorship, and the arrival of democracy was strengthening economic deregulation and free trade,” he says. Those factors increased investor confidence and facilitated the arrival of significant volumes of foreign capital. They also encouraged a political climate of reform, leading to free-trade agreements with the world’s principal economies. None of these variables could recur with as much intensity, he says.

Chile has already taken maximum advantage of global trade liberalization. It has more than 20 free-trade agreements with countries including the United States, China, Japan and Australia, as well as with the trade blocs Mercosur (Argentina, Brazil, Paraguay, Uruguay; Chile is an associate member) and the European Free Trade Association (Iceland, Lichtenstein, Norway and Switzerland).

Unresolved Issues in Education

Clearly, it is hard to replicate the economic globalization that played such an important role during the Golden Decade. Yet some argue that it is possible to re-create the climate of political consensus of those years to promote significant reform. Foremost should be reforms related to the quality of education, says Rodrigo Fuentes, professor of economic growth at the Institute of Economics at the Catholic University of Chile.

“You can’t aspire to an annual growth rate of 7% without accelerating productivity. In order to do that, you need to improve human capital, which also means incorporating initiatives for optimizing the level of education,” Fuentes says. Such reforms should involve training workers in the appropriate ways to adopt new technologies, to acquire more knowledge, and to become more professional in their respective areas, while strengthening their dependence on a base of formal education.

That is precisely the Achilles’ heel of the Chilean labor force, argues Andrea Repetto, professor of economics at the School of Government of Adolfo Ibáñez University. “The level of scholarship of our workers is low, as research projects have revealed.” According to CASEN 2006 -- the latest version of the main tool used by the government to evaluate educational policy -- almost 20% of the Chilean labor force have not completed eight years of primary education, while 40% have not finished secondary school. International achievement tests have ranked Chilean children below international standards over the last decade, Repetto notes.

This shows that Chile faces a tremendous challenge, Fuentes argues. Improving the quality of education takes time; results may be visible only over generations. Nevertheless, Fuentes says, productivity can be increased in a short period with changes in the labor market. Fuentes proposes making the workday more flexible; changing the system of unemployment insurance compensation; and devising more effective policies for adjusting minimum salaries so “any increases in salaries are reflected in an increase in real productivity.”

Repetto adds that it is important to deal with the labor market’s high turnover rate; some 35% of the country’s formal workers have work contracts that typically last only six months. Half of workers with indefinite contracts don’t last 12 months on the job, according to the Chilean government’s unemployment bureau. “As a result, it’s hard to train workers, and you spend a lot of money without changing the turnover rate,” Repetto says.

It will also be necessary, she notes, to promote telecommuting and labor incentives so companies can hire more women and young people.

The High Cost of Energy

Another important issue is the country’s dependence on high-cost energy, says Guillermo Le Fort, professor of economics at the University of Chile, in a report published by the Chilean economics magazine Capital. “If we don’t manage to significantly lower the high cost of energy by using all of our potential, it will be hard to recover our productivity.”

From 1995 to 2003, Chile maintained a competitive structure of energy costs, largely through imports of Argentine natural gas at a low price. In 2004, however, Argentina restricted its shipments of hydrocarbons, forcing Chile’s electric utilities to operate with imported diesel fuel, which made their costs shoot up.

Currently, two-thirds of Chile’s electric energy is generated with its own hydropower resources. But domestic production of petroleum, natural gas and coal are low, so Chile must import petroleum and liquid natural gas at high prices. Chile is counting on results from small renewable energy projects in the north and south, based largely on wind, the sun and biomass. However, “the cost of developing attractive energy alternatives continues to be very high,” says Hugh Rudnick, professor at the Institute of Electrical Engineering at the Catholic University of Chile.

What are Chile’s best options for lowering energy costs? Taking maximum advantage of hydroelectric resources and coal, Rudnick says. But Chile will have to wait until 2012 to exploit new hydropower complexes and coal-fired plants because construction of these projects has only recently begun.

Meanwhile, Chile can make progress in other areas. One is to improve government efficiency, Coeymans says. “There seems to be an enormous waste of resources in the government, when you discover that there are 70 journalists working inside the same ministry.” A recent Ministry of Health audit revealed that 160 lawyers and 70 journalists worked in the agency, provoking a public outcry. Fuentes says the government should correct these inefficiencies, which distort resource allocation and increase production costs.

Copper and the Low Fiscal Deficit

Despite these challenges, the consensus among experts is that various favorable factors will permit Chile to achieve high growth. One is the high price of copper on world markets.

Currently, the price of copper is above US$3.30 a pound on the London Metal Exchange. That, notes Coeymans, “is providing incentives for the big mining companies that operate in Chile to invest more capital in order to increase their production levels.” According to the Santiago Chamber of Commerce, mining was the leading sector for foreign direct investment in the first quarter, with US$1.6 billion invested.

The world’s largest copper producer’s dependence on the extraction of the mineral “is a double-edged sword,” warns Javier Bronfman, professor of public policy at the School of Government at the Adolfo Ibáñez University. “It puts us in a delicate situation with regard to international fluctuations in that commodity.” When the global financial crisis broke out in September 2008, it struck a hard blow against copper prices, which dropped to US$1.14 a pound. That had a strong impact on production costs, which led to the closing of numerous small and midsize companies tied to the sector.

That is why Coeymans suggests that the government apply efficient mechanisms for covering price risks to protect not only small mining companies, but all smaller companies, “since they are responsible for generating more than 60% of jobs in Chile and contributing 30% of the GDP.”

But copper isn’t the whole story. Chile possesses strong macroeconomic accounts, which drive growth. “The best example is its extremely low fiscal deficit, which represents only 5% of its GDP, according to the latest report of the International Monetary Fund,” explains Dalibor Eterovic, professor of political economics at the School of Government of the Adolfo Ibáñez University. He is also manager of economic research and fixed income at LarrainVial, a Chilean provider of financial services.

In the context of the indebtedness affecting numerous developed countries, he says, “Chile offers the characteristics of a safe haven, which will make it easier for it to attract foreign capital.”

In any case, Chile’s future is in its own hands. Either it deals with the great unresolved issues and turns its economic advantages into high, sustained growth, or it lets these good times, which are more than satisfying to the country’s businessmen, become a lost opportunity.