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Home Opinion Chile reaps the rewards of prudence

Chile reaps the rewards of prudence

Francisco Javier Díaz - 11 January 2012

The Chilean left withstood the temptation to spend its copper bounty and worked hard to build national consensus for fiscal responsibility

For much of the twentieth century, Latin America was home to frequent economic crises, and Chile is no exception. Time and again, the country suffered from unstable exchange rates, high inflation, elevated fiscal deficits and external debt. These weaknesses were caused in large measure by Chile’s strong dependence on commodity exports, especially copper, whose price was prone to fluctuations on the world market. Macroeconomic instability affected public spending, social spending in particular. The result was the inability to maintain many important public policies over time, provoking public disenchantment and reinforcing public demands.

The last century was marked by political certainties; it was the political economy of black and white. The centre-left was viewed as pushing for public spending while the right was seen as pushing for fiscal restraint. The centre-left was in favour of social benefits which would produce an unsustainable fiscal burden, produce disequilibrium in the economy and lead to inflation. The right was allegedly against these things.

For all concerned, this was a vicious circle, and someone had to stop it. By the 1990s, in different parts of the world and in different historical contexts, the centre-left began to understand that its commitment to social protection was meaningless without corresponding and long-term financing for the programmes that were required to ensure this commitment. Upon coming to power with the recuperation of democracy, the centre-left in Chile understood that fiscal discipline would have to be an important part of its government programme. It was no longer a world of black and white. White became the new black.

Centre-left governments were able to create the institutions required for implementing a policy of structural equilibrium, while maintaining commitments to transparency and effectiveness. In fact, many of the underlying principles behind this new combination of social protection and fiscal discipline were established in laws that Keynes himself would have been proud of, laying the foundations for fiscal restraint during period of economic growth, allowing for stimulus spending during more challenging periods. Chile followed the example of others, such as Norway, in saving a percentage of its commodity revenues in foreign sovereign funds. In 2006, an institutional mechanism was established in order to assure transparency and accountability in the administration of these funds.

The timing could not have been better. In 2008 the world faced a major financial crisis, and in 2010 Chile was hit by the fifth strongest earthquake ever recorded, but Chile’s solid fiscal position helped it face these shocks without too much difficulty.

For example, in the wake of the international financial crisis, in January of 2009, the Bachelet government was able to introduce a fiscal stimulus package worth some $4 billion, representing, as a percentage of GDP, the world’s fifth largest such plan. Summing up the heterodox approach of the government of the day, the plan consisted of five main instruments: an investment of $700 million in public and social infrastructure; capitalisation worth some $1 thousand million in CODELCO, the country’s largest publicly owned company; a $100 million injection into the country’s development agency aimed at strengthening credit guarantees; internal demand stimulus and direct cash transfers for 1.8m lower income families; specific and temporary tax reductions aimed at encouraging investment; special subsidies for the training and hiring of youth, as well as for the forestry industry.

At the same time, Chile’s budget in 2008 and 2009 was not reduced nor were funds reassigned. Social spending was kept along the trajectory of previous years, including pensions and unemployment insurance, policies which had been recently implemented by the centre-left government and which the crisis was now putting to the test.

The result was that Chileans could observe first hand the way in which the country was facing this crisis, which was very different from similar experiences in 1998 (Asian crisis) or 1982 (Latin America’s debt crisis). This time around there were social protection mechanisms directed at those most affected, and the government had the resources necessary to carry out the fiscal stimulus, leading to a quick recovery. Neither the February 2010 earthquake, nor the change in government one month later, affected this strategy for recovery.

The main lesson of the Chilean experience has been that a national consensus for fiscal responsibility is necessary. A genuinely Keynesian policy suggests not only that one must spend more when there is less, but that one must also spend less when there is more. For governments, this is not easy. Pressures for increased spending in times of bounty – in the Chilean case, due to the high international price of copper – are often too great for governments to withstand. Most explanations of the importance of fiscal restraint fall short. Yet doing so is indispensable if countries wish to be prepared for turbulent times, and everything indicates that there are more turbulent times ahead. For political leaders to explain how white is the new black requires perseverance, courage, and leadership.

Francisco Javier Díaz is a senior fellow at CIEPLAN

This article forms part of a series of international responses to Policy Network's discussion paper In the black Labour: Why fiscal conservatism and social justice go hand-in-hand

Related articles:
Cut to the chase: 15 political truths for the centre-left by Andrés Velasco & Francisco Diaz

This is a contribution to Policy Network's work on Globalisation and Governance.

Tags: Francisco Javier Díaz , Chile , In the black labour , fiscal conservatism , Bachelet

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