CCHILE INITIAL CONDITIONSHILE INITIAL CONDITIONS,, 1990 1990 17 17 Years Military Rule.Years Military Rule. Over Heated EconomyOver Heated Economy

– Rate of Inflation Rate of Inflation 30% 30%

– Annualized Import Growth Annualized Import Growth 30%30% 40 % of Population Below Poverty Line. 40 % of Population Below Poverty Line. General Perception of Unfairness, Too Much General Perception of Unfairness, Too Much

Inequality Inequality Private Sector Private Sector

– Fear of Populism Fear of Populism – Low Confidence and Expectations on New Low Confidence and Expectations on New

Economic Team.Economic Team.

A NEW APPROACH: A NEW APPROACH: GROWTH WITH EQUITY GROWTH WITH EQUITY

Break Populist Cycle of Center Left Break Populist Cycle of Center Left Governments.Governments.

Commitment to Budget Surplus.Commitment to Budget Surplus. Pre-Pre-PPay Public Debt.ay Public Debt. Tax Reform & the Fight Against Poverty Tax Reform & the Fight Against Poverty Labor Legislation Reform.Labor Legislation Reform. Tripartite AgreementsTripartite Agreements.. External Tariffs Reduction and Open External Tariffs Reduction and Open

Regionalism Regionalism .. Deepening the Capital MarketDeepening the Capital Market..

Table 1 Table 1

Chile´s Economic Perfomance Chile´s Economic Perfomance 1990- 19931990- 1993

Annual Rate of GrowthAnnual Rate of Growth 7.8 7.8 Domestic Saving Over GdpDomestic Saving Over Gdp 22.022.0 B of P Deficit in Current Acc.B of P Deficit in Current Acc. 2.5 2.5 Total Investment Over GTotal Investment Over GDP (real)DP (real) 227.87.8 Productivity Increase Productivity Increase pper er yyearear 4.1 4.1 ReaReal wage l wage IIncrease, per year ncrease, per year 4.64.6 Employment, annual rate of growth Employment, annual rate of growth 3.53.5 Government Savings over GDPGovernment Savings over GDP 4.34.3 Budget Surplus over GDPBudget Surplus over GDP 1.71.7

Source: Banco Central de Chile (2001) “Indicadores Económicos y Sociales de Chile 1960-2000”. Source: Banco Central de Chile (2001) “Indicadores Económicos y Sociales de Chile 1960-2000”.

Table 2 Table 2

Social Expenditures Social Expenditures 1990- 19931990- 1993

Government Social Expenditure, (*) 48Government Social Expenditure, (*) 48

Govt. Expenditures in Public Health (*) 62Govt. Expenditures in Public Health (*) 62

Govt. Expenditures in Education (*) Govt. Expenditures in Education (*) 24 24

(*) Accumulated Growth 1990 – 1993(*) Accumulated Growth 1990 – 1993

Source:Source: C. Pizarro,et al (1996)”Social and Economic Policies en Chile´s C. Pizarro,et al (1996)”Social and Economic Policies en Chile´s Tradition Tradition to Democracy”, a book piblished by UNICEF-CIEPLAN. to Democracy”, a book piblished by UNICEF-CIEPLAN.

Table 3Table 3 Trayectory of Trayectory of MMain ain EEconomic conomic IIndicators ndicators DDuring uring

the Aylwin the Aylwin AAdministrationdministration 1990 1990 1991 1991 11992 992 11993993

Growth Rate Growth Rate 3.7 8.0 12 7.03.7 8.0 12 7.0

InflationInflation 27.3 18.7 12.7 12.2 27.3 18.7 12.7 12.2

Rate of Unemployment 7.8 8.2 6.7 6.5Rate of Unemployment 7.8 8.2 6.7 6.5

Poverty Rate, % 39 Poverty Rate, % 39  28 28 oof Populationf Population

Extreme Poverty, % 12.9 7.6Extreme Poverty, % 12.9 7.6 oof Population f Population

Budget Surplus Budget Surplus 0.8 1.6 2.3 2.00.8 1.6 2.3 2.0

Public Debt Over GDP 43.0 37.4 30.9 Public Debt Over GDP 43.0 37.4 30.9 228.78.7

Source: Banco Central de Chile (2001) “Indicadores Económicos y Sociales de Chile 1960-2000”. Source: Banco Central de Chile (2001) “Indicadores Económicos y Sociales de Chile 1960-2000”.

THE POLITICAL ECONOMY OF THE POLITICAL ECONOMY OF REFORMREFORM

Consensus Politics. Consensus Politics.

Ad- Hoc Coalition Building for Each Ad- Hoc Coalition Building for Each Policy Package. Policy Package.

Weakening of Opposition to Policies.Weakening of Opposition to Policies.

THREE CASE STUDIESTHREE CASE STUDIES : :

1.1. Deciding When To Spend Political Capital: Deciding When To Spend Political Capital: The Key Reform UThe Key Reform Upfpfront ront

First 100 Days : Focus On Most DifFirst 100 Days : Focus On Most Diffficult Key Reform icult Key Reform Only. Only.

Tax Increase: Tax Increase: – Solidarity in Economic PolicySolidarity in Economic Policy– Legitimize Economic ModelLegitimize Economic Model– Continuity and Change: Continuity and Change:

Opportunity for CompromiseOpportunity for Compromise

Tie Tax Increase to Specific Social Expenditures. Tie Tax Increase to Specific Social Expenditures.

RESPONSE TO UNNEXPECTED SHOCKS: RESPONSE TO UNNEXPECTED SHOCKS: The Gulf War and The Price of Oil.The Gulf War and The Price of Oil.

Policy PackagePolicy Package Increase Domestic PriceIncrease Domestic Price.. Petroleum StabilizationPetroleum Stabilization..

FundFund.. Reduce Government Reduce Government

ExpendituresExpenditures.. Reduce Military Reduce Military

Expenditures: Share Expenditures: Share SacrificeSacrifice..

Labor Unions Agreement Labor Unions Agreement to Lower Real Wagesto Lower Real Wages..

Lower Interest RateLower Interest Rate.. EEnergynergy Saving Measures Saving Measures..

Constituents in FavorConstituents in Favor Financial Markets Financial Markets .. ConsumersConsumers

Private SectorPrivate Sector

Civilian Population Civilian Population Labor Unions Labor Unions

Business Business

Private SectorPrivate Sector.. EnvironmentalistEnvironmentalist..

GOOD USE OF CHANGING GOOD USE OF CHANGING OPPORTUNITIES: CAPITAL INFLOW OPPORTUNITIES: CAPITAL INFLOW

AND “ENCAJE”AND “ENCAJE”

Policy PackagePolicy Package Lower External Tariffs Lower External Tariffs Tax Capital InflowsTax Capital Inflows Open Capital Open Capital

Outflows Outflows Fiscal Compensation : Fiscal Compensation :

Tax on Gasoline Tax on Gasoline

ConstituentsConstituents in Favor in Favor CoConnsumers sumers Export Sector Export Sector Financial InstitutionsFinancial Institutions

Private Sector, Private Sector, environmentalists environmentalists

Passed in 48 hoursPassed in 48 hours..

SUCESS AND FAILURE: CHILESUCESS AND FAILURE: CHILE

Shock Absorption Capacity: Reaction to Shock Absorption Capacity: Reaction to Volatility in Capital Flows. Volatility in Capital Flows. – Policy ResponsePolicy Response::

Reduce Public DebtReduce Public Debt Structural Budget Surplus Structural Budget Surplus Flexible Exchange Rate Flexible Exchange Rate Inflation Inflation TargettingTargetting Restriction to Capital InflowsRestriction to Capital Inflows Unilateral Opening to Trade Unilateral Opening to Trade Free Trade AgreementsFree Trade Agreements

ROLE OF INSTITUTIONS.ROLE OF INSTITUTIONS. Upgrade Quality of Institutions: RULESUpgrade Quality of Institutions: RULES..

» Autonomy Central Bank Autonomy Central Bank » Independent, Non- Corrupt Judiciary Independent, Non- Corrupt Judiciary » Congress: Rules for Government ExpeCongress: Rules for Government Expendndiittures ures

TranTranssparencyparency» Corruption: T.I. Index Corruption: T.I. Index » CampaiCampaiggn Finance n Finance » Civil Service ModernizationCivil Service Modernization

Conclusion: Modernization of the State Conclusion: Modernization of the State Upfront, Within Upfront, Within FFiirsrst Generation Ot Generation Off Reforms Reforms. .

3º GENERATION REFORMS: 3º GENERATION REFORMS: INNOVATION CAPACITY INNOVATION CAPACITY

World Bank Study: Chile Performance Below World Bank Study: Chile Performance Below Average in Innovation. Average in Innovation.

– Firms Doing More of the SameFirms Doing More of the Same– Underinvestment in Research and Development. Underinvestment in Research and Development. – No Technological Adaptation No Technological Adaptation – Venture Capital: No ProjectsVenture Capital: No Projects– Industrial Policies Trauma Industrial Policies Trauma – Dispersion in Government Programs Dispersion in Government Programs – No Strategic Dialogues No Strategic Dialogues – No Clusters No Clusters

DEVELOPMENT LESSONS DEVELOPMENT LESSONS

Rules of Thumb for Shock AbsorptionRules of Thumb for Shock Absorption – Public SavingsPublic Savings– Low Public DebtLow Public Debt– Budget SuBudget Surrplus plus – Flexible Exchange Rate Flexible Exchange Rate – Inflation TargettingInflation Targetting– Local &Local & Regional Govt. Expenditures Regional Govt. Expenditures – Budget Budget Rules Rules

Sequencing of Reforms Sequencing of Reforms

Growth With Equity, Not Just Growth Growth With Equity, Not Just Growth

DEVELOPMENT LESSONSDEVELOPMENT LESSONS

Institutional Change: First Generation Institutional Change: First Generation ReformReform

Crisis: Opportunities for Additional Crisis: Opportunities for Additional ReformsReforms

Invest in Cooperation With the OppositionInvest in Cooperation With the Opposition Art of Packaging Art of Packaging Policy Decisions: ad-hoc coalitionsPolicy Decisions: ad-hoc coalitions Innovation : How to Achieve Continuous Innovation : How to Achieve Continuous

and Endogenous Increases in Productivityand Endogenous Increases in Productivity..