Chile’s economy: The way forward

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Reforms that instil greater coherence in social and economic policies would help Chile build on its successes and get the economy back on to a stronger growth path.

In a region known for its turbulence, Chile stands out as a particularly stable and resilient economy. Already building a global reputation for some of its produce, like fresh fruits, salmon and fine wines, Chile has also set itself up as a benchmark for other emerging markets engaged in structural reforms, with its sound fiscal and monetary policies, relatively well-developed financial system and up-to-date institutions.

Reforms started early. In the 1970s, Chile was the first Latin American country to implement far-reaching trade and market liberalisation, and it was a pioneer in competition law and policy. In the early 1980s, it privatised its pension system, health care and education.

All very well, except that these deep reforms were imposed by an authoritarian regime (1973-89) and had an uneven social impact. So, with the return to democracy in 1989, their legitimacy was questioned. And while successive governments stuck with a market-oriented approach in pushing on with reforms in infrastructure, trade and capital markets, they focused on improving equity. Social spending increased, particularly in education and health care, and workers’ rights were re-established.

The results of reforms speak for themselves. Chile’s economy has surged, with GDP per capita increasing by over 5% per year between 1986 and 1997 (see graph). This was the fastest rate in Latin America and pushed current GDP per capita above US$9,000 (in purchasing power parities). The Chilean economy, including its policy framework, also resisted the external shocks that floored many emerging markets after 1997. In particular, risk spreads for international credits have remained much lower than in neighbouring countries.

But this good story has recently lost a little of its gloss. Since 1998, GDP growth has slowed sharply from the 6-7% highs to a modest 2-3%. A sluggish global economy is partly to blame, but there are distinct domestic causes too. One is that the gains from previous market-oriented reforms may simply have been exhausted. Moreover, the government’s strategy to tackle income inequality depended on continued fast growth. Not only did this growth fail to materialise, but also the labour market legislation became more rigid at a time when the economy was already sluggish, and this probably weighed down further on the business climate. Not that there has to be a trade-off between growth and equity – indeed both goals can be mutually reinforcing – but in the case of Chile, the nature of these linkages was perhaps not properly taken into account.

Formulating policy more coherently will be essential to meet some of the challenges ahead. Take ageing and the pension system. Despite the fact that Chile has a fully funded defined-contribution pension system, only around 60% of workers contribute to it, and among those who are affiliated to pension funds, on average only 40% contribute regularly during their working lives. These suggest a very low income-replacement rate for many, typically below 30% of average wages.

Privatisation of pensions has worked well, but it will not be enough to solve the problem of ageing, which will affect Chile, just as most OECD countries. The upshot is mounting pressure on public spending through minimum-income schemes for retirees, as these are financed out of general taxes. If the private-funded system is to deliver and fiscal stability be maintained, then further reforms will be needed.

The place to start is in the pension market itself where high administrative costs should be reduced by fostering competition among pension funds. To improve returns on investment, the capital markets need more liquidity and financial instruments. For example, benefiting from the large size of the pension market, Chilean pension funds could further diversify their portfolios by investing more in enterprise creation (risk capital) and in ventures abroad.

But the main key for solving the low density of social contributions is probably to be found in the labour market, where employers are dissuaded from offering good jobs due to high severance payments and cumbersome rules of dismissal. Moreover, between 1998 and 2000 the salario minimo (minimum wage) rose faster than either average wages or typical pay of unskilled workers. Nor is training to acquire skills encouraged as much as it should be. With these obstacles in place, informal job markets and other forms of precarious jobs for low-skilled workers are spreading.

Instead of trying to enforce rigid regulations, a more effective policy response to this would be to increase the public support of the unemployed, including moving towards fully-fledged unemployment insurance, so as to reduce the maximum severance benefit. The minimum wage should also be made to evolve more in line with other wages, in particular those of the unskilled, though this would require some tough bargaining. At the same time, there is room to develop the scope of the formal labour market.

As with many countries, including in the OECD, Chile must aim to raise the labour force participation rate of young people and women in particular. Easier said than done, of course, since their employment activity is currently very low, at 26% and 35%, respectively. Bringing in more flexible working arrangements would encourage more women into the market for jobs, as would reinforcing child-care and pre-school facilities. The reward would be a better functioning labour market and a more dynamic business sector, as well as more funding for pensions and public finances.

As for other social policies, Chile has made great strides in education and health, particularly since 1990. Life expectancy and child mortality rates are now similar to OECD countries, while primary and secondary school are almost universal. Still, important problems remain. First is cost, and in particular, those large spending increases in the 1990s aimed mainly at boosting real incomes of teachers and doctors. Second, until recently, insufficient attention has been paid to improve the actual performance of social services. This is illustrated in education by poor scores of 15-year old students on the international OECD PISA+ tests, in public health care by long waiting lists, and in the private health sector by insufficient insurance coverage, adverse selection against the elderly and excessive supplementary payments.

The government is tackling these equity and quality issues, such as by moving from half-day to full-day education and by introducing universal health care to guard against specific diseases, like cardiovascular diseases, some types of cancer and some chronic conditions. But it must be careful to introduce these reforms gradually to limit any tax increases needed to fund the additional spending.

Social and labour markets are not the only areas where reform is required: improvements in product and financial markets, as well as administrative changes, would all help strengthen Chile’s economic framework. Ultimately, more coherent policies will help underpin the growth needed to tackle issues like equity. After all, during the period of high-growth of the 1990s, Chile’s poverty rate fell from above 40% to below 20% of the population.

Chileans have good reason to be proud of their progress in the world economy, and they have a valuable opportunity to build on reforms. With coherent policies to link its economic and social strategies, Chile’s long-term prospects would be bright indeed.


OECD (2003), Economic Survey: Chile, Paris.

Oliveira Martins, J. and Price, T. (2001), “Brazil: more than just potential”, in OECD Observer No 228, September.

©OECD Observer No 240/241, December 2003

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