1 Chile: The archetypal success story Source: IMF, own calculations Note: all magnitudes in nominal terms (not adjusted for infllation); Chile’s real growth rate 92-97: 6.5% (5% per capita) 1. Successful application of the « Washington Consensus » Macroeconomic stabilization State rollback: privatization & deregulation Trade and financial liberalization Good governance 2. Successful integration in world markets (« globalizer » country) 3. Higher growth performance than rest of LA

2 The Allende experiment: Populism and its consequences

3 Macroeconomic stabilization Source: IMF, own calculations

4 Trade liberalization Source: IMF, own calculations Note: all magnitudes in nominal terms (not adjusted for infllation); Chile’s real growth rate 92-97: 6.5% (5% per capita)

5 Source: IMF, own calculations And yet... Such a bumpy road

6 Why volatility’s bad: changing trajectories Traj. 1 Traj. 2 Traj. 3 Real GDP level Real growth rate

7 Stabilization and price competitiveness Tight money grinds down inflation to zero… But price competitiveness deteriorates …but price competitiveness deteriorates… …and so does the trade balance, with trade measures following with a lag

8 How macro stabilization can interfere with trade policy Objective 1: Liberalization Objective 2: Stabilization Opening up of trade & capital accounts High real interest rates Capital inflowFixed exchange rate Loss of price competitiveness (real exch. rate appreciat.) Trade deficit prevents reserve depletion financed by Temptation to use trade remedies

9 Sources : First graph: J.P. Morgan, unpublished data a =100 (arbitrary) Second graph: IMF, International Financial Statistics, August 2005 Index value a A key danger signal: the real exchange rate growth slowly choked

10 Budget stabilization Monetary stabilization Establishment of a competition policy Establishment of an independent Central Bank Trade liberalization Prudent exchange-rate policy Capital account liberalization Establishment of strong banking oversight body & rules Internal financial liberalization P HASE 1 P HASE 2 P HASE 3 Privatization The sequencing of reforms

11 Selling reforms: political line-up of interest groups Adapted from Lederman 2005

12 Selling reforms: compensation mechanisms Adapted from Lederman 2005

13 Overall lessons from a quarter-century of Chilean history 1.In the mid-seventies, Chile took the right direction in terms of economic policy 2.Lots of costly mistakes were made along the way. How surprising is this? All the key choices that Chile made over those years look obvious now. They weren’t then. In particular, there was no experience to draw on about the sequencing of reforms. Thin markets made privatizations difficult (resulting in concentrated ownership--- reinforced the economy’s conglomerate structure) The international environment was rough: two oil shocks ( and ), the « Latin American debt crisis » ( ).

14 So where do we stand today? Source: IMF, own calculations Note: all magnitudes in nominal terms (not adjusted for infllation); Chile’s real growth rate 92-97: 6.5% (5% per capita)

15 Does Chile have a problem today? Primary products Copper Other minerals18158n.a. Timber124n.a. Semi-finished products Products of the sea287n.a. Agricultural products5118n.a. Cellulose448n.a. Manufactured products Wood products334n.a. Food products459n.a. Beverage and tobacco011n.a. Chemical products323n.a. Other manufactured products113n.a. Export composition: Percent of total Source: COMTRADE database, own calculations. Discrepancies between individual items and totals due to rounding

16 Foreign investment: reinforcing existing patterns (of production and exports) or fostering change? Source: Central Bank of Chile, Foreign Investment Committee, 2005, own calculations Average only

17 How Intel boosted Costa-Rica’s growth Source: Central Bank of Costa Rica, cited in F. Larrain, Luis F. Lopez-Calva, and Andres Rodriguez-Clare, “Intel: A Case Study of Foreign Direct Investment in Central America”.

18 All manufacturing Estimatet-statistic Comparative-advantage variables Labor costs a Infrastructure b Market size c Agglomeration variables Existing FDI stock Industrialization d Policy variables No war risk e Corporate taxation f Political risk g (reverse scale) Openness h Dependent variable: Log inward FDI flows from US Observations: 255 R-square: 0.71 Method: OLS Notes a) Average hourly wage in manufacturing b) Quality of transport, communications and energy infrastructure (survey data) c) GDP d) Manufacturing & mining as percent of GDP e) Survey data (expatriates assessment) f) Assumes no tax holiday, $1 million profit, 50% remitted abroad (BI data) g) Composite of 13 variables; most closely associated with corruption (correlation coefficient of 0.88) h) Composite of 9 variables; most closely associated with local-content requirements (0.84), controls on the repatriation of profits (0.83), and import restrictions (0.82) Panel of 42 countries, 23 of which are developing ones;  FDI attracts FDI Source: Moody and Wheeler, JIE 1992

19 Cutting deficits... but by cutting on infrastructure? Source: Cesar Calderon, William Easterly, and Luis Serven, “Infrastructure Compression and Public Sector Solvency in Latin America”, Banco Central de Chile, Documento de Trabajo 187, 2002.

20 Estimatet-statistic Convergence variables log per capita GDP log per capita GDP squared Accumulation variables log fertility rate Investment rate Schooling years TFPG variables Govt consumption/GDP Rule-of-law index Democracy index Democracy index squared Inflation rate Terms-of-trade growth Dependent variable: log per capita GDP growth Observations: 87 R-square: 0.67 method: OLS Schooling: average years of school attainment at secondary and higher levels for males aged 25 and above. Female education levels have no significant effect (presumably because of lower participation rates). Rule of law: seven-level index computed by Political Risk Services. Democracy: seven-level index of electoral rights computed by Freedom House. Fueling growth: education matters

21 Education efficiency: math test scores compared Source: Doug Harris, « Diminishing Returns to Scale: Addressing some Basic Unanswered Questions about the Production of Education, mimeo, Florida State University, 2004; GDP per capita figures from World Bank (2004), regression line from own calculations.

22 Business environment quality: cost of living Source: UBS, own calculations Buenos Aires Santiago Seoul Frankfurt Miami Hong Kong NYTokyo Bangkok SP Mexico

23 Business environment quality: various indicators Source: World Bank 2004 (data based on executive surveys)

24 Business environment quality: various indicators Source: World Bank 2004 (data based on executive surveys) smaller diamond means better performance