Document ofThe World Bank

FOR OFFICIAL USE ONLY

Report No. 12903-CH

CIILE

ECONOMIC UPDATE, 1990-93

December 29, 1994

Country Department ICountry Operations DivisionLatin America and the Caribbean Region Office

This document has a restricted distribution and may be used by recipients only in the performance of theirofficial duties. Its contents may not otherwise be disclosed without World Bank authorization.

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CURRENCY EQUIVALENTS

Currency Unit = Chilean Peso (Ch$)

Exchange Rate

(Year-Average, Observed)

1987 Ch$219.41 = US$11988 Ch$245.01 = US$11989 Ch$266.95 = US$11990 Ch$304.90 = US$11991 Ch$349.22 = US$11992 Ch$362.58 = US$11993 Ch$404.17 = US$1

WEIGHTS AND MEASURES

Metric System

FISCAL YEAR

January 1 - December 31

FOR OFFICIAL USE ONLY

GLOSSARY OF ACRONYMS

ADRs American Depository ReceiptsAFPs Administradores de Fondos de Pensiones (Pension Funds

Administration)AMEX American Stock ExchangeAPEC Asia Pacific Economic CooperationBID Banco Interamericano de Desarrollo (Inter-American

Development Bank)CASEN The National Socio-Economic Characterization StudyCD Christian DemocratsCDs Certificate of DepositsCODELCO Corporaci6n del Cobre (State Copper Corporation)CORFO Corporaci6n de Fomento de la Producci6n (State Development

Corporation)COTRISA Comercializadora de Trigo S.A.CPC Confederaci6n de la Producci6n y del Comercio (Confederation of

Production and Commerce)CPI Consumer Price IndexCSF Copper Stabilization FundCTC Compafiia de Telefonos de Chile (Telephone Company of Chile)CUBOS Cupones de Bonificaci6n (Cupon Bond)CUT Central Unitaria de Trabajadores (Central Labor Union)DL Decree LawEdelnor Empresa Electrica de Norte (Electric company)EEC European Economic CommunityEFE Empresa de Ferrocariles del Estado (State Railways Enterprise)EMPREMAR S.A. Empresa Maritima del Estado S.A. (State Maritime Enterprise)EMPORCHI Empresa Portuaria de Chile (Port Enterprise of Chile)ENAMI Empresa Nacional de Mineria (National Mining Enterprise)ENAP Empresa Nacional de Petr6leo (National Petroleum Enterprise)FONASA Fondo Nacional de Salud (National Health Funds)FONDEC Fondo Nacional de Desarrollo Cientifico TecnolJgico (Scientific and

Technological Development Fund)FONDECYT Fondo Nacional de Investigaci6n Cientifica y Tecnol6gica (Science and

Technology Research Development Fund)FONTEC Fondo Nacional de Desarrollo Tecnol6gico y Productivo (the National

Technology and Productive Development Fund)FOSIS Fondo de Solidaridad y Inversi6n Social (Solidarity and Social

Development Fund)FTA Free Trade AgreementGDP Gross Domestic ProductIFC International Finance CorporationIGPA Indice General de Precios de Acciones (General Index of Stock Prices)IMIF International Monetary FundINE Instituto Nacional de Estadistica (Institute of National Statistic)

This document has a restricted distribution and may be used by recipients only in the performanceof their official duties. Its contents may not otherwise be disclosed without World Bank authorization.

IPSA Indice de Precios Seleccionados de Acciones (Selected Index of StockPrices)

ISAPRES Instituciones de Salud Previsional (Private Health Insurance Institutions)LIBOR London Inter-Bank Offer RateMIRA Multi-Year Rescheduling AgreementMIDEPLAN Ministerio de Planificaci6n y Cooperaci6n (Ministry of Planning and

Cooperation)NAFTA North American Free Trade AgreementNASDAQ National Association of Securities Dealers Automated QuotationNICs New Industrialized CountriesNYSE New York Stock ExchangePASIS Pensiones Asistenciales (Pensioner Assistances)POLLA S.A. Polla Chilena de Beneficencia S.A.PPD Partido por la Democracia (Party for Democracy)PPSF Petroleum Price Stabilization FundPDBC Pagares Descontables Banco Central (Index Promissory Notes

Discountable)PRBC Pagares Reajustables Banco Central (Index Promissory Notes

of the Central Bank)PR Partido RadicalPRC Pagares Reajustables Pago Cupones (Indexed Promissory Notes)PTF Pagares Tasa Flotante (Floating Promissory Notes)SACOR LTDA. Sociedad Agricola SACOR Ltda.SASIPA LTDA. Sociedad Agricola y Servicios Isla de Pascua Ltda.SENCE Servicio Nacional de Capacitaci6n y Empleo (National

Training and Employment Service)SNSS Sistema Nacional de Servicios Salud (National Health Services System)SOFOFA Sociedad de Fomento Fabril (Chile's Manufacturing Association)SUAF Subsidio Asistencia Financiera (Financial Assistance Subsidy)SUF Subsidio Unico Familiar (Family Subsidy)UF Unidad de Fomento (Development Unit)Zofri Zona Franca Iquique

CHILE

ECONOMIC UPDATE. 1990-93

Table of Contents

Page

COUNTRY DATA

EXECUTIVE SUMMARY .......

1. Background and Introduction ................................ 1

2. Output and Demand ...................................... 2

3. The Labor Market .............. 8

4. Inflation, Monetary Policy and Exchange Rate Management .... ........ 11

5. Fiscal Policy ......................................... 15

6. Social Expenditure and Poverty ............................. 20Social Expenditures . ................................. 21Poverty .......................................... 23

7. Medium-Term Prospects . ................................. 24

CITATIONS ........................................... 27

The initial draft mas prepared by J. Charoenwtana (LAlCO) on the basis of a mission to Chile inJanuary 1994 under the general guidance of Danny Leipziger (Lead Economist, LAIDR). Discussionswith the Govermnent took place in June 1994. Comments were incorporated by Claudio Sapelli(LAlCO) who prepared the present version of the report. As revised, this report is an extendedbackground volume for Report 13405-CH, "Issues for Chile's Future: A Policy Note."

STATISTICAL APPENDIX

Table Al: GDP Classified by Expenditures and Economic SectorsTable A2: Balance of PaymentsTable A3: Trade CompositionTable A4 Diversification of Chilean Export MarketsTable A5: International Comparison of Savings and InvestmentTable A6: Employment and UnemploymentTable A7: Wage Indices, Minimum Wages, and Public Sector WagesTable A8: Labor Productivity by Economic ActivityTable A9 Precentage Changes in Price IndicesTable AlO: Public FinanceTable Al1: Public Enterprises' Equity Classified by SectorsTable A12: CODELCOTable A 13: Infrastructure InvestmentTable A14: Social ExpenditureTable A15: Income DistributionTable Al6: Evolution of Poverty, 1987-92

CHILE

COUNTRY DATA SHEET

AREA: 756.95 thou. sq. km. POPULATION (1993): 13.5 mill. DENSITY (per sq. km.): 17.8Rate of Growth: 1.7%

POPULATION CHARACTERISTICS (1992) HEALTH (1991)

Crude birth rate (per 1,000): 23 Infant mortality (per 1,000): 17Crude death rate (per 1,000): 7 Population per physician: 2,152Total fertility rate: 2.7 Population per hospital bed: 318Life expectancy at birth (years): 73

INCOME DISTRIBUTION (1992) ACCESS TO POTABLE WATER(share in total income) (% of population, 1991)

Highest 20%: 51.8% Urban: 95.2Lowest 20%: 6.5% Rural: 73.3

NUTRMON (1990) EDUCATION (1991)

Per capita calorie intake (cal/day): 2584 Enrollment Rate:Per capita protein intake (gms/day): 65 Primary: 98

Secondary: 72Adult Illiteracy Rate: 8

GNP PER CAPITA (USS 1,992): 2,726

GROSS NATIONAL PRODUCT (1993)

Annual Growth Rate of GNP (% p.a., constant prices)

US$M % of GNP 1981-86 1986-1991 1992 1993

GNP at Market Prices 42,143 100.0 -0.8 7.7 10.8 7.6

Gross Domestic lInvestment 11,446 27.2 -4.6 12.9 23.8 15.7

Gross National Savings 9,299 22.1 6.4 26.6 7.7 -4.2

Current Account Balance -2,092 -4.9 ..

Exports of Goods and NFS 12,157 28.8 5.5 10.2 16.8 4.4

Imports of Goods and NFS 13,142 31.2 -7.3 12.7 22.5 11.5

OUTPUT, EMPLOYMENT. AND PRODUCTIVITY (1993)

Value Added (1986 prices) Labor Force V-A per Wo,rkel

Bill. ChS % of GDP Thousand % of Total 19X6= I(",persons

Agriculture & Fisheries 432.9 7.9 825.3 16.6 143.5

Industry 949.2 17.3 835.3 16.7 98.8

Services 3,142.4 57.2 2,803.1 56.2 135.4

Total/Average 5,498.3 100.0 4,985.7 100.0 125.7

CENTRAL GOVERNMENT FINANCE

Billion of ChS Percent of GDP

1990 1991 1992 1993 1990 1991 1992 1993

Current Receipts 1,901 2.685 3.486 4,169 20.6 22.5 23.3 23.6

Current Expenditures 1,671 2.260 2,718 3,268 18.2 18.8 18.1 18.5

Savings 230 425 768 901 2.4 3.7 5.2 5.1

Capital Expenditures 157 259 423 548 1.6 2.1 2.9 3.1

Overall Surplus 73 166 345 353 0.8 1.6 2.3 2.0

MONEY, CREDIT AND PRICES

1990 1991 1992 1993

Billions of Ch$, end of period

Money Supply (Ml) 407.1 581.6 706.8 792.7

Bank Credit to Private Sector 4,996 6,290 8,246 9,906

Percentage or Index Number

Money as ¶f of GDP 4.4 4.9 4.7 4.5

General Price Index (1989=100) 132.6 161.5 186.4 210.2

Annual percentage changes in:

General Price Index (end of period) 27.3 18.7 12.7 12.2

Bank Credit to Private Sector 26.0 25.9 31.1 20.1

BALANCE OF PAYMENTS (Million of US$)

1990 1991 1992 1993 Exports of Goods (US$M) 1990-(Average) 93

Exports of GNFS 10,379 11,189 12,417 11,837 Mining, of which 4,420.7

Imports of GNFS 9,364 9,577 11,732 12,810 Copper 3,636.5

Resource Balance 1,015 1,612 685 -973 Agriculture 1,149.8

Net Factor Payments -1,811 -1,810 -1,860 -1,503 Industrial, of which 3,536.5

Interest Payments 1,832 1,646 1,492 1,137 Fishmeal 436.6

Foreign Transfer 199 340 431 385 Cellulose & Paper 397.8

Current Account Balance -598 143 -743 -2092 Total Merchandise Exports 9,106.9

Foreign Investment 941 449 653 1,153

Net MLT Borrowing 692 -83 290 519 External Debt, end of 1992 USSM

ST Capital 1,435 447 1,940 1,091 Public & Publicly Guaranteed 9,578

Errors & Omissions -103 282 359 -94 Private Non-Guaranteed 5,347

Changes in Net Reserves 2,368 1,238 2,498 578 Total Debt Stock 19.360

Stock of Reserves 5,358 6,641 9,009 9,759 Debt Service Indicators (1992) (%)

TDS/XGNFS 20.9

TDS/GDP 7.1

ECONOMIC UPDATE, 1990-93

EXECUTIVE SUMMARY

Chile's first democratic government following the WP regime,presided over by President Aylwin, ended its term in March 1994. Sincecoming to power in 1990, the Aylwin Government had committed itself tomarket-oriented policies and improving the quality of life of the poor.Through prudent macroeconomic management, Chile sustained economicgrowth with equity and stability, further liberalized foreign trade and capitalmarkets, and successfully regained access to international capital markets.During the 1990-93 period, Chile became one of the Latin Americancountries that successfully consolidated economic reforms. On the domesticfront, GDP averaged 6.4% annual growth; after continuously declining,inflation reached an annual rate of 12.2%; and unemployment fell to 4.5% inDecember 1993, the lowest rate since 1975.

The period is characterized by continued but cyclical growth drivenby the external environment and domestic policy. Export growth waspositively influenced by diversification from traditional to non-traditionalexports and market expansion. Nevertheless, fluctuations in export growthwere strongly affected by external price shocks as the structure of Chile'sexports still depends on primary and natural resource based manufacturingexports. Terms of trade fell by approximately 15 percent during 1990-93.Domestic policy used the interest rate on indexed financial instruments to"fine tune" the economy so as to prevent unsustainable growth rates orcurrent account deficits. Investment cycles, possibly driven by the changesin real interest rates, paralleled GDP cycles. Investment contributed togrowth through higher volume, due partly to increased savings, and improvedtotal factor productivity.

While economic management has in general been excellent, structurallimitations still render the economy quite vulnerable. The report examinesfactors affecting Chile's international competitiveness, especially realwages, labor productivity, and the real exchange rate. Despite an increase inlabor productivity, Chile's international competitiveness deteriorated in 1990-93 because of an increase in real wages and continued real exchange rateappreciation. A continuation of such trends, including further real exchangerate appreciation and increases in real wages relative to productivity, willsignificantly retard Chile's international competitiveness in the future. Theissue of competitiveness would be particularly problematic if the substantialappreciation of some other Latin American currencies is reversed.

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Although inflation, which was one of the major concerns of theAylwin Government, declined during this period, it is still above desiredlevels. Government policy may have given less importance to disinflationthan to preventing a substantial appreciation of the exchange rate. Thispolicy has included using the real interest rate as the monetary instrumentand foregoing the use of a nominal anchor, such as the money supply or theexchange rate. Chile's widespread indexation, however, may be anotherreason for the slow progress in reducing inflation. Attempts to reduceaggregate demand growth and inflation by raising the real interest rates on90-day Central Bank notes generated significant capital inflows. Until 1992,the Central Bank sterilized the expansionary effect of capital inflows as thereal exchange rate moved away from the target level. Widening of theexchange rate band to 10% in both directions, initiated in 1992, providedmore scope for the Central Bank to conduct independent monetary policy tofurther restrain domestic expenditure. However, when the lower limit of theband is binding, Chile moves from a floating exchange rate to essentially acrawling peg, with ensuing limitations on the conduct of monetary policy.Moreover, since the rate of the crawl is determined by past inflation, thesystem lacks a nominal anchor to drive inflation down. On the other hand,indexation of wages and financial contracts contributed to inflation inertia asit translated real and nominal shocks into actual price increases. The currentdebate in Chile is centered around the relative weights one should give to theobjectives of preventing a large exchange rate appreciation or reducinginflation, and around how quickly the Government should press to deindexthe economy.

The overall public sector surplus remained roughly constant duringthe 1990-93 period, despite a decline in copper revenues and an increase ingovernment expenditure on social sectors and infrastructure . The reasonbehind this achievement lies in both the 1991 tax reform that increasedrevenues and the significant savings achieved because of the drop ininternational interest rates. The planned tax reduction for the next threeyears implies the need for active fiscal policy to aid monetary policy inreducing inflation. The active role of fiscal policy requires the governmentto control the growth of government expenditure, strengthen revenues, andreduce central bank losses.

Progress in poverty alleviation was significant during this period asthe number of people living in poverty substantially declined. This wasachieved through continued economic growth, employment generation, andincreased social expenditure targeted on the most vulnerable groups.Continued growth contributed to increased employment and income of thepoor. Increased social expenditure, especially social subsidies, supplementedincomes of target groups. While scope remains for improving the targetingand effectiveness of social expenditure, especially those of social safety net(education and health) for vulnerable groups, further progress may depend onreforms in labor markets and human capital improvements.

1. BACKGROUTND AND INTRODUCTION

1.1 Chile's first democratic government following the ainties regime,presided over by President Aylwin, ended its term in March 1994. Sincecoming to power in 1990, the Aylwin Government had committed itself tomarket-oriented policies and improving the quality of life of the poor.Through prudent macroeconomic management, Chile sustained economicgrowth with equity and stability, further liberalized foreign trade and capitalmarkets, and successfully regained access to international capital markets.Since 1984, Chile registered steady and uninterrupted growth, controlled theoverall public sector balance, and maintained a positive external balance.Over the period, both inflation and unemployment declined.

1.2 Mr. Eduardo Frei of the Concertaci6n por la Democracia (a coalitionof parties) won Chile's latest presidential election held on December 11,1993, with 58 percent of the votes. The new Government was inauguratedon March 11, 1994. The Concertaci6n won a majority in the House ofDeputies. For the Senate, the Concertaci6n and the opposition elected anequal number of senators. Hence, the "designated" senators (appointed bythe democracy regime) hold the balance of power in the Senate. AsCongress approved the six-year presidential term in December 1993, the Freiadministration will end its term in the year 2000.

1.3 During the 1990-93 period, Chile became one of the Latin Americancountries that successfully consolidated economic reforms. On the domesticfront, GDP averaged 6.4% annual growth; after continuously declining,inflation reached an annual rate of 12.2%; and unemployment fell to 4.5% inDecember 1993, the lowest rate since 1975. Although the public sectorbalance weakened on account of falling copper revenues and increases insocial and capital expenditures, it continued to register a surplus. On theexternal front, the current account deficit averaged 2.1 % of GDP for theperiod, largely due to falling export prices in 1993. The balance of paymentscontinued to register a surplus due to inflows of long-term capital and directforeign investment. As a consequence, the Central Bank accumulated amplereserves of up to US$9.8 billion (equivalent to ten months of merchandiseimports) by the end of 1993.

1.4 This report discusses selected developments in Chile during the 1990-93 period. Five themes are highlighted: (i) the influence of external shockson the economy; (ii) the importance of competitiveness; (iii) the need toreduce inflation; (iv) the importance of continued fiscal discipline; and (v) thedesirability of steady progress in poverty alleviation.

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2. OUTPUT AND DEMAND

2.1 Domestic Output. During 1990-93, real output grew by an annualaverage of 6.4%. The period was marked by two cycles. After growing by10.2% in 1989, output growth fell to 3% the following year. Growthaccelerated to 6.1 % in 1991, then reached 10.3% in 1992, the highest rate inthe past 26 years. In 1993, output growth decelerated to 6% (see Table Al).There are two important issues being discussed in Chile regarding outputgrowth. The first refers to the high average growth, its sustainability on theone hand, and the possibility/desirability of achieving East-Asian (i.e.,higher) rates, on the other. The second refers to the marked cycles, theircauses and possible remedies.

2.2 With respect to the high GDP growth achieved in the period, there isa consensus that it has been predominantly export driven and that the furthertrade liberalization and market diversification accomplished in the periodwere key achievements (as described below). In this respect thesustainability of high rates of growth would depend on the futurecompetitiveness of the Chilean economy. The discussion would centeraround the issues of productivity growth, the labor market, and exchange ratemanagement (see chapters 3 and 4). On the other hand, government officialshave been concerned that a rate of growth above 6 percent is not sustainableunless gross fixed investment as a share of GDP jumps from the range of 20-25 % (where it has been lately) to 25-30%, and that East-Asian rates will notbe achievable until savings increase to East-Asian levels of 30-35 % (seeTable A5). In the next paragraphs the evolution of output and demand isdescribed.

2.3 The positive growth pattern during this period was driven by strongexport performance and by a significant increase in investment (see Figure1). Chile's successful export diversification from traditional to non-traditional exports reduced the vulnerability of the economy to fluctuations inthe price of copper, currently accounting for about 36% of total exports(43% in 1987). Export growth, especially non-copper exports (fruits,fisheries, and cellulose products), increased substantially (with the exceptionof 1993) due to strong demand in foreign markets, favorable export prices,and an increase in domestic production. Gross fixed investment increasedsignificantly because of the private sector's confidence in governmenteconomic policy, the dynamism of the Chilean economy, an increase inpublic investment, and lower real interest rates.

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GDP, Investment, and Export Growth

30.0

25.0

20.0

15.0

0.0co co co co a) _I cs 1

az ax a) a) a)< ( a

-5.0 --

-|-- GDP Investment Exports

Figure 1

2.4 Sectoral expansion has been broad based, with average (1990-93) highgrowth rates (of between 7 and 12 percent) in some non-tradable sectors,such as utilities, transport and communication, commerce, construction, andfinancial services (See Table Al). Growth of tradable sectors (agriculture,fisheries, mining and manufacturing which produce export goods) laggedbehind that of non-tradable sectors.

2.5 The manufacturing sector, which grew on average by 5.2% during1990-93, lagged average GDP growth (6.4%). In 1992 it accounted for 21 %of GDP, 40% of total exports, and generated 17% of total employment.Most manufacturing industries are based on natural resources, principallyconcentrated in food and beverages, fishmeal, paper and pulp, cellulose,metallurgy, and chemical products. Because manufacturing exports arepredominantly based on natural resources, the economy is susceptible toterms of trade deterioration, as was the case when export prices of celluloseand fishmeal fell in 1993.

2.6 Exports. Export growth suffered cyclical variations as a result ofchanging external conditions. Export growth fell from 15.9 percent in 1989to 8.8 percent during the 1990 slowdown and again from 16.8 percent in1992 to 4.4 percent during the 1993 slowdown. Overall, exports grew at anaverage rate of 10 percent during 1990-93. Growth was precipitated by thegrowth of non-copper exports, especially fruits and fruit products, andmanufacturing (fishmeal, cellulose, and paper products). Export performance

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during the 1990-92 period was exceptional due to strong foreign demand,new export markets, and an increase in the productivity of export sectors.Non-copper exports registered a two-digit growth rate despite the peso'sappreciation, while the growth rate of copper exports fell due to a reductionin Chile's copper output and a steady decline in copper prices since 1988.Export performance in 1993, however, was a disappointment. Exports grewby only 4.4% due to significant reductions in all principal exports (copper,fresh fruit, fishmeal and cellulose), due to increased protectionism in theEEC market, a reduction in foreign demand and a decline in the price ofcopper. However, non-traditional exports continued to grow strongly in

1993, at a rate of 11.8 percent in volume.

2.7 The gradual shift in the structure of Chilean exports from primarygoods to manufactures contributed to the remarkable export growth. Despite

the increasing share of manufacturing in total exports (from 28% in 1989 to43% in 1993), scope remains for further diversification.

2.8 These events affected the balance of payments. After significant gainsin the balance of payments over the 1990-92 period, the current accountdeficit widened to 4.8% of GDP in 1993. The capital account continued toregister a surplus because foreign investment, and long-term and short-termcapital inflows remained strong. Importantly, the share of short-term capitalinflows was relatively small in comparison to long-term capital inflows. Thestock of foreign reserves increased, reaching US$9.8 billion by the end of1993 (equivalent to about 10 months of merchandise imports; see Table 2. 1).Chile's openness, as measured by the ratio of exports and imports over GNP,was high (more than 60% over the period 1990-93) and rose over the past 5years.

TAble 2.1Balance of Payments, 1990-93

(% of GDP)1990 1991 1992 1993

Merchandise Trade 4.2 4.6 1.8 -2.2Exports 27.5 26.3 24.2 21.1Imports 23.3 21.6 22.4 23.3

Non-Factor Services (net) -0.9 0.1 -0.2 0.0Financial Services (net) -6.0 -5.3 -4.5 -3.4Transfers 0.7 1.0 1.0 0.9Current Account Balance -2.0 0.4 -1.8 -4.8Capital Account Balance 10.2 2.4 7.0 6.3Errors and Omissions -0.3 0.8 0.9 -0.2Overall Balance 7.8 3.6 6.1 1.3Stock of Foreign Reserves (net) 17.8 19.5 21.8 22.3

Source: The Central Bank of Chile.

2.9 Services. Non-factor services registered a small surplus in 1991 and1993, benefitting from an increase in export services and tourism. Theincrease in export services was associated with penetration into foreignmarkets by Chilean utilities, supermarket chains, pension funds, and softwaredevelopers. The number of tourists visiting Chile also increased over thisperiod, especially those from Argentina, given the appreciation of theArgentine peso.

2.10 Market Diversification. Chile has succeeded in not only increasingits market shares in traditional markets, especially in Latin America, but alsoin opening new export markets in Asia (see Table A4). 'Traditional exportmarkets continued to be the US, EEC, Japan, and Latin America (especiallyArgentina and Brazil). During the 1990-93 period, exports to the US, EEC,and Japan (fresh and dried fruits, fisheries, fishmeal, copper, and cellulose)declined significantly from 71.3% of total exports in 1989 to 59.2% in 1993.Exports to Latin American countries (Argentina, Brazil, Peru, and Bolivia),concentrated mainly in manufacturing products (cellulose, paper and pulp,chemicals, and forestry products), increased by nearly 50% over the sameperiod. Besides Japan, its largest trade partner in Asia, Chile also openednew export markets in China, Thailand, and Malaysia and increased exportsto existing markets such as Korea and Taiwan. Although exports to thesenew markets remain relatively small, they may increase in future if their higheconomic growth is sustained.

Table 2.2Diversification of Export Markets

(% of Total Exports)

1989 1993

United States 17.8 17.6

Latin America 12.2 19.8

EEC 36.0 26.0

Asia, of which: 25.5 30.8

Japan 13.7 16.0

Middle East 1.1 0.8

Africa 1.2 0.4

Total 100.0 100.0

Source: Central Bank of Chile

2.11 Trade Liberalization. Over the period, Chile generally continued tomaintain its open trade regime. In June 1991 import tariffs were loweredfrom 15 % to 11 %. In addition, the government concluded bilateral free

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trade agreements that provided for gradual elimination of tariffs with Mexicoin 1992, and with Venezuela in April 1993. More limited trade agreementswere signed with Argentina in 1991, and Bolivia in April 1993. Chile alsosigned a bilateral trade agreement with Colombia, granting zero tariffs to along list of items from January 1994, including 40% of the productscurrently exported to Colombia. Most products will benefit from zero tariffsin 1997.

2.12 After the conclusion of NAFTA between the US and Mexico inDecember 1993, Chile could be the next Latin American country to joinNAFTA. Trade negotiations will likely cover removal of non-tariff barriers,agreements on services, investment protection, intellectual property, disputesettlement, labor, and environment. Chile also joined the Asia PacificEconomic Cooperation group (APEC) in 1994.1 Currently, APEC countriesaccount for nearly half of Chile's trade, with Asia being its largest market.

2.13 Investment. Both public and private domestic investment remainedstrong. In 1992, real gross fixed investment grew impressively, reaching arate of 23.8%, before falling to 15% in 1993. The gross fixed investmentlevel rose to 26.5% of GDP by 1993 from 24.7% of GDP in 1990. Theincrease in public investment (general government and public enterprises),which sought to alleviate infrastructure bottlenecks, was an important sourceof the sharp increase in total investment. To complement private investment,government projects concentrated on sanitary services and infrastructureprojects, including highway construction and rehabilitation, urban transport,and air and marine transport. Public enterprises, especially CODELCO andENAMI, also increased their investments. Private investment increasedsignificantly, primarily in 1992, because of increases in real estateconstruction, investment in mining, transport and communication, commerce,and manufacturing.

2.14 Recent increases emphasized purchases of new capital goods,especially machinery and equipment imports rather than construction.Chile's physical capital is estimated to have increased to Ch$1,496.9 billionin 1993 (in constant 1977 prices), compared to Ch$1,275.7 billion in 1990.This makes capital stock per employed worker close to Ch$0.31 million,compared to Ch$0.29 million in 1990.2

1. This group is an inter-government forum created in 1990. Currently, it includes theUSA, Japan, Canada, Australia, New Zealand, Brunei, Philippines, Hong Kong,Indonesia, Malaysia, Papua New Guinea, Taiwan, and Thailand.

2. E. Haindl estimated Chile's physical capital stock for the 1960-88 period. SeeHaindl, E, "Estimacion del Stock de Capital en Chile: 1960-88," Mimeo, 1989.Jorge Kaufman used the empirical work to project the capital stock series. SeeJorge Kaufman, "Inversion y Crecimiento en Chile: Proyecciones de Largo Plazopara el Periodo, 1991-2000," Mimeo, The World Bank, August 1989. The CentralBank revised the National Accounts in 1993, and changed the base to 1986. Thenew investment series is uniformly above the old one by 10/12%. Hence the

(continued...)

2.15 Savings. The increase in gross domestic investment was principallyfinanced by an increase in national savings. Chile's national savings rategrew slowly, to a constant rate of 22/23% of GDP over the 1990-93 period.A major impetus for the increase in national savings was greater publicsavings spurred by improved tax administration and the 1990 tax reform.Private savings, however, increased only slightly as consumption accelerated.Nevertheless, Chile's average national savings rate was the highest nationalsavings rate among major Latin American countries (Argentina, Mexico andBrazil, See Table A5).

2.16 Consumption. Spurred by increases in income and confidence instable economic growth, total consumption (on average) grew 6.5 % perannum. Real private consumption growth for the 1990-93 period averaged7.0% annually. Private consumption was mostly spent on non-tradablegoods, as indicated by the significant growth in these sectors. Real publicconsumption increased steadily by 3.3% annually during the period mainlydue to increased salaries of government employees.

2.17 Output Cycles. Although in general the averages achieved by theChilean economy during 1990-1993 have been impressive, the two sharpcycles that occurred during the period create some concerns. In the twoinstances, the Government decided that the economy was overheated and therates of growth were unsustainable; consequently the authorities adoptedmeasures to cool the economy. In both cases it was done through atightening of monetary policy. The guidelines that the authorities have beenfollowing to judge the sustainability of trends have been that presentinvestment rates do not sustain a GDP growth rate beyond 6 percent and thatthe objective of not increasing the debt to GDP ratio does not permit asustained current account deficit of more than 4 percent of GDP. This policycould face problems because: a) the use of ICORs to translate investmentrates to rates of growth is misleading; b) the authorities can't control theshort term evolution of the economy; and c) attempts to "fine tune" theeconomy usually do more harm than good. The issue lies in whether cyclesare driven by demand shocks or supply shocks. The authorities take theposition that cycles are driven by demand shocks and attempt to controlaggregate demand. But it is not clear if supply shocks are not thepredominant factors and hence there is no point in trying to target a certaingrowth rate3.

2.18 There is also an issue regarding the importance of external shocks anddomestic policy in determining cycles. If cycles have been mostly driven by

2.(. . .continued)estimates quoted here would increase by a similar amount, but the general evolutionof the capital stock would remain the same.

3. These supply shocks could be policy driven. An increase in the rate of growth ofproductivity would increase the rate of growth of GDP without overheating theeconomy. However, this would require productivity enhancing measures.

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external shocks, and domestic policy has not had much incidence, the abovediscussion would be mostly irrelevant. As evidence in favor of this, wecould mention the close pattern followed by export and GDP growth (seeFigure 1). Moreover, the increasing openness of the economy has loweredthe ability of domestic policy to influence outcomes. In this line of thoughtpolicy should center on how to deal with external shocks. In this area, theChilean economy appears well suited to absorb such shocks, with its prudentdebt management, its BOP surplus, its fiscal surplus, and the existence ofStabilization Funds for copper and oil, the two main export and importproducts, respectively.

3. THE LABOR MARKET

3.1 Chile's long-run prospects are closely linked to the country'scompetitiveness. Exchange rate management issues are examined in thefollowing chapter. This chapter centers in a description of events in the areaof real wage growth, productivity growth and the evolution of real unit laborcosts. Since in the long term it is to be expected that real wages will rise,the key to competitiveness lies in the ability to increase productivity. Toachieve this, the country will require a flexible labor market and an effectiveeducation system.

3.2 Although Chile's labor market has been liberalized, there remains aninformal wage indexation system enforced by trade unions, minimum wagelegislation, rigidities in labor contracts (in particular in the public sector),and the increase in severance payments due to the 1991 labor code reform.While there has been no mandatory indexation since 1982, a substantialpercentage of private wage contracts are indexed to past inflation and arerevised to account for changes in market conditions. The minimum wageand public sector wages are important indicators for private sector wagesetting.

3.3 The 1991 labor code reform was designed to enhance workers'bargaining power and reintroduced optional industry-wide collectivebargaining. It made redundancies more difficult and expensive for employersbecause they were required to substantiate why redundancies were made,reasons that employees can challenge in the labor courts. The maximumredundancy payment (severance pay) was raised from 5 months' to 11months' pay, while the minimum was kept to one month's wages per yearworked.

3.4 Labor mobility across firms or industries is said to be small.Unfortunately, there are no official statistics on the turnover rate of workers.Labor officials believed that the low turnover rate is attributed to the limitedscope and dubious success of labor training (especially retraining programswhich would allow workers to move from declining industries to growing

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industries). Currently, there is only a reconversion program administered bythe Ministry of Labor to retrain workers in the coal mining sector, which hasnot been very successful. This area deserves attention to increase flexibilityin the reallocation of resources in response to relative price changes.

3.5 Employment. Uninterrupted economic growth significantly increasedthe overall level of employment. The non-tradable sectors registered higheremployment growth levels than did the tradable sectors (see Table A6).Despite the slowdown in economic growth in 1993, the economy stilloperated at close to full employment, as unemployment continued to fall andhidden unemployment was minimal. The average unemployment rate fellfrom 5.7% in 1990 to 4.5% in December 1993, the lowest rate since 1975.

3.6 Higher employment has exacerbated the shortage in skilled labor, andhas led to significant increases in real wages in such industries asconstruction and manufacturing. Currently, there are several trainingprograms administered by the National Training and Employment Service (ElServicio Nacional de Capacitacion y Empleo, or SENCE), a governmentorganization taking the lead on industrial training. The training program foryouth (Programa de Capacitacion Laboral de Jovenes) financed by IDB isconsidered successful. Other SENCE programs, those that offered taxrebates to firms that trained their workers and provided apprenticeships andscholarships for the unemployed and low income self-employed, are generallyconsidered less successful because blue-collar workers were excluded fromthe programs and only large companies (especially in commerce, mining, andservices) used the tax rebate incentives.

3.7 Wage Developments. Real wages increased an average 3.6% yearlyover the 1990-93 period and lagged economic growth. After increasing byonly 1.9% p.a. during 1989 and 1990, real wages accelerated in thefollowing three years in response to an overall increase in the demand forlabor, which resulted from economic expansion and a shortage of skilledlabor (Table A7). The increases in real wages generally weredisproportionate across sectors and professions. As expected, it increasedrapidly in sectors where there was scarcity of skilled labor (such asconstruction and manufacturing), while it increased only gradually in suchsectors as personal services. Similarly, real wages for skilled workers tendedto rise faster than real wages for unskilled workers. There is no reliableproductivity data by sector, although the GDP/worker ratio rose 10.9%,compared to an accumulated increase in real wages of 15.6% over the sameperiod.

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Real Wage, Real Exchange Rate, and Terms ofTrade

130

120

O 110

90

80to t- co D CD - C'C CD CD CD am CD 0s 0)

--+ReaIWaqe -_-RER TOOT

Figure 2

3.8 The Government raised the minimum wage continuously over theperiod. There were four consecutive annual increases in the minimum wagetotalling 155%, and the monthly minimum wage rose to Ch$46,000 (US$110)in May 1993, compared to Ch$18,000 (US$59) in 1990. The largestincrease took place in 1990 when it jumped by 118 % over that of 1989. Itwas accepted that the 1989 minimum wage was not binding in the labormarket, but there is some controversy on whether the increased minimumwage has generated problems for younger workers.

3.9 Public employees wages were also informally linked to inflation andlabor productivity. In 1990, public sector wages increased less than annualinflation. In 1991, the Government delayed wage adjustments to reducepressure on the budget until December of that year. Public wages thenincreased by 18% and were complemented by a Christmas bonus. In 1992,the Government increased the wages of public employees by 15% andchanged the wage rule by linking nominal wages to projected inflation ratherthan past inflation. In 1993, public sector wages were increased by 15%,above that of projected inflation (11 %) at a time when a tighter fiscal policywas being called for by some public officials.

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3.10 Labor Productivity. A simple estimate of labor productivity--the ratioof sectoral GDP to employment--illustrates that Chile's labor productivityincreased during 1990-93 but that the rate of increase was slower than theincrease in real wages (see Table 3.1). Slower growth in average laborproductivity is explained by a decline in labor productivity in major sectorsincluding mining and construction (see Table A8). The increase in real unitlabor costs (RULC) was especially marked in 1993, principally due to asharp slowdown in productivity growth. The increase in RULC by 3.1percent during the 1991-93 period has aggravated the loss of competitivenessbrought about by the appreciation of the exchange rate (of 9 percent) duringthe same period. However, there are dramatic sectoral differences inproductivity growth and hence in loss of competitiveness.

Table 3.1Changes in Labor Productivity and Real Wages

(Percent)

Productivity Real Wages RULC

1989 6.1 1.9 -4.2

1990 2.2 1.8 -0.4

1991 4.2 4.9 0.7

1992 4.9 4.6 -0.3

1993 1.5 4.2 2.7

Source: Institute of National Statistics.Notes: Labor Productivity = GDP/EmploymentRULC = Real Unit labor cost which is calculated as real wage increase

minus real productivity increase.

4. IN4FLATION, MONETARY POLICY ANDEXCHANGE RATE MANAGEMENT

4.1 Exchange rate management in Latin America during the nineties hasrepresented a challenge. Countries have had to deal with large inflows ofcapital that have appreciated the real exchange rate and both threatenedcompetitiveness and complicated the management of monetary policy. Inmany cases, countries have been faced with a trade-off between handlingexchange rate/monetary policy to maintain a certain real exchange rate or tokeep inflation under control. With an unorthodox combination of policies (anexchange rate band, short-term capital inflow taxes, employment of the realinterest rate as the monetary instrument), Chile has managed to prevent amajor real exchange rate appreciation and, because of an offsetting growth inproductivity, has preserved export growth (as shown by the high rates of

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growth of non-traditional exports) and at the same time has managed toreduce inflation by half. However, there is some discussion whether currentpolicies would be able to achieve a reduction of inflation to single digitlevels.

4.2 Exchange Rate System. Chile's exchange rate system was modifiedin the mid-1980s from a crawling peg system to that of a "managed float".Chile maintains two exchange rate markets: one is formal, the other informalbut legally recognized. The exchange rate in the legal formal market, knownas the "dolar acuerdo," is pegged to a basket of currencies (50% to the USdollar, 30% to the German mark, and 20% to the Japanese yen) and isallowed to vary within a range of 10% around the "dolar acuerdo," which isadjusted daily by the difference between domestic and international inflationrelevant for Chile.4 The formal market covers transactions linked to theproceeds of exports of goods and services, loans or contributions of capitalpayments for imports of goods and services, debt service, and repatriation ofdividends and capital. The exchange rate in the informal market, whichcovers other transactions, is freely determined by demand and supply, buthas not diverged significantly from the observed rate.

4.3 Exchange Rate Trends. The exchange rate movements during 1990-92 were influenced by a significant increase in capital inflows. The CentralBank's intervention in the foreign exchange market kept the nominalexchange rate against the floor of the band, except when the band waswidened to 10% in both directions in May 1992. The real exchange rate,however, appreciated by 13% over this period despite a large sterilization ofcapital inflows. The Central Bank's net foreign exchange purchasesincreased significantly during the period, especially in 1990, when netpurchases of foreign exchange increased by US$ 378.5 million, compared toUS$ 146.6 and US$ 211.5 million, respectively, in the following years. InJanuary 1992, the central bank revalued the peso by 5%, and subsequently inMay it widened the band to 10% in both directions.

4.4 Exchange rate movements in 1993 were affected by the terms of tradeshocks and capital inflows. The observed exchange rate prevailed above thefloor of the band throughout the year. The nominal exchange ratedepreciated by 12%, compared to 4% in 1992. This resulted in a realdepreciation of the peso by 5% during January and May 1993, before turninginto a real appreciation throughout the year. The real exchange rate endedup appreciating by less than 1% in 1993, compared to 8 % in 1992 (seeFigure 2). The emerging trade deficit combined with a decline in capitalinflows contributed to a significant reduction in the Central Bank's average

4. Before June 1992, the peso was pegged to the U.S. dollar and was depreciated by amonthly preannounced rate equivalent to the difference between domestic andforeign inflation in the previous month. The central bank intervened in the foreignexchange market (purchase/sale of foreign exchange), forcing the exchange rate tofluctuate within the target zone.

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net purchases of foreign exchange to only US$ 9.7 million in 1993,compared to US$ 211.5 million in 1992.

4.5 The real -exchange rate appreciation did affect Chile's exportcompetitiveness; even though it was offset by productivity gains in someexport sectors (fresh fruits, fisheries, and manufacture). Exports continuedto increase during the 1990-93 period despite a 14% accumulatedappreciation of the real exchange rate (against Chile's partners). Empiricalevidence shows that some sectors were more sensitive to the real appreciationthan others. For example, fresh fruit and fishmeal were more sensitive toworld economic activity rather than the real exchange rate appreciation.Exports of small and medium size mines were more sensitive to the realappreciation than CODELCO's exports. Canned fruit exports were highlysensitive to the real exchange rate appreciation.5

4.6 As a consequence of the real appreciation since 1990, the ratio oftradable output (agriculture, fisheries, mining, and manufacture) to GDP fellfrom 35.5% in 1990 to 32.9% in 1993, while the share of non-tradableoutput rose from 64.5% in 1990 to 67.1 % in 1993. In the agriculturesector, resources were reallocated from traditional crops (basically importcompeting goods), to fruit, wine grape production, and fisheries (exportgoods).

4.7 Inflation. Inflation declined steadily over the 1990-93 period. CPIincreases declined to an annual rate of 12.2% in 1993, compared to 27.3% in1990, clearly a major accomplishment since at the time the economy wasgrowing at high rates. Wholesale price inflation fell sharply, reaching 6.7%in 1993 (single-digit inflation was last attained in 1988), compared to 25.7%in 1990. Export prices fell continuously, faster than falling import prices(See Table A9).

4.8 Management Issues. Recent experience in Latin America withexchange rate management has raised the issue of whether greater fixity orcontinued flexibility should be the policy course. The issue has beencomplicated by the need to preserve competitiveness in the face of largecapital inflows while at the same time reducing inflation. Some observers,such as Corbo and Fischer (1994), favor a form of nominal anchor to bringinflation down to international levels. Such a system would provide ananchor for price expectations but could put a strong damper on growth,particularly if indexation retains a significant amount of inflation in thesystem.6

5. Felipe G. Morande, "Real Peso Appreciation and the Real Sector Response: SomePreliminary Results," The World Bank, Mimeo, September 1992.

6. For a discussion of the link between indexation, inflation inertia, and exchange ratesin Chile, see S. Edwards (1993).

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4.9 While the ultimate goal of driving inflation out of the system is widelyshared, the Government is concerned with the cost in terms of probablelower growth through greater exchange fixity. Much of the appeal ofnominal anchors is in the limits they place on governments which lackcredibility (see Edwards, 1993); however, this is not the major issue inChile. The success of any policy to reduce inflation to single digits in Chilemay not only require aggregate demand management, but also micro levelreforms in the indexation system, especially for wages.' Thus, the issue forChilean policy makers to assess is whether progress can be made in reducingthe current double-digit level of inflation by traditional fiscal measures,coupled with gradual institutional reforms in indexed factors markets, orwhether a more drastic exchange rate policy stance is required, with itsattendant costs. In the final analysis, the effectiveness of any rule-basedexchange rate system depends on its credibility,' and few would believe thatan all-out attack on inflation via the exchange rate is in the offing if the costwere a major slowdown in growth.

4.10 The two factors contributing to continued double-digit inflation inChile are believed to be (i) the lack of a nominal anchor, and (ii) theindexation system, which has been widely used throughout the economy overthe last two decades.9 The Central Bank's policy has been to raise short-term real interest rates on its 90-day liabilities to encourage purchases ofPRBCs, and thereby curb domestic expenditures, under the understandingthat the reduction of the expenditure/output gap will lower inflation. Theincrease in the real interest rate produced some unwanted consequences, suchas increasing capital inflows. To prevent the real exchange rate from movingfrom the target level as capital inflows increased, the Central Bank purchaseddollars, and increased reserve requirements on short term capital inflows. Inthis system, the money supply is endogenous and is used by the Central Bankmore as an indicator of the state of the economy than as an instrument.

7. Edwards (1993) shows that inflation inertia can be affected by greater exchange ratefixity, but that its success will depend on both the credibility of the nominal anchorand the degree to which markets are de-indexed.

8. In a recent paper, Kiguel and Liviatan (1994) argue in assessing the slowconvergence of the Chilean inflation rate and the rate of devaluation in the late1970s that the key factor was the inherent lack of credibility of the program,especially in the face of external shocks.

9. In Chile, both wages and financial contracts are indexed to inflation. Currently,private wage contracts are only informally indexed to expected inflation. Financialcontracts, including deposits and central bank domestic financial liabilities, areindexed to the Adjustable Development Unit (Unidad de Fomento, UF), a dailyindex produced by the central bank. The UF was created by Supreme Decree No.40 of January 2, 1967. The method used to determine the value of UF isdetermined by law and is as fbllows:

UF(n+ I) = UF(n) x CPI(n-1)/CPI(n-2)I UF = Ch$9.873 in 1993 (average).

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However, in a system where the center of the band around which the pesofloats is adjusted according to a backward looking indexation formula (i.e.,the "dolar acuerdo" follows a passive crawling-peg), indexation iswidespread, and money supply can validate expectations of continuinginflation, there is no force (no automatic mechanism) driving inflation down.Indexation, moreover, contributes to inflation inertia as it translates nominaland real shocks to an increase in actual prices.

4.11 The Government has gradually reduced the scope of indexation tofacilitate a faster reduction in inflation. Beginning in 1993, the Governmentlinked public wage increases to projected inflation rather than past inflation.The exchange rate system was made more flexible through widening of theexchange rate band, thus increasing control of the Central Bank overmonetary policy. In June 1992, the peso was pegged to a basket ofcurrencies rather than the US dollar to reduce exchange rate volatility.Although there has been much discussion about deindexing financial paper,the Central Bank's position has been that de-indexation will have to followsingle-digit inflation, since only then will indexation not be demanded by thepublic.

4.12 In any event, reducing inflation to the level existing in industrialcountries will remain a major concern of the authorities. So far the CentralBank has relied primarily on monetary policy to curb inflation by targettingaggregate expenditure through changes in its own 30-90 day paper realinterest rate. In broad terms, this policy has been successful. Now, tocontinue to bring inflation down further, the issue centers around the outputloss that would be required to reduce inflation significantly within thisframework. Some of the alternatives are: i) float the peso, while keepingmoney supply growth low; ii) fix the peso (or go to an active crawl); and iii)de-index the economy more aggressively. Vittorio Corbo and StanleyFischer argue in favor of adopting an active crawling-peg exchange rate, withthe central reference rate crawling at a gradually declining rate, and with awide band on either side of the target rate. The rate would be adjustedapproximately on an annual basis, and the central parity could be adjusted aswell.'.

5. FISCAL POLICY

5.1 The management of fiscal policy has been of fundamental importancein the achievement of Chile's macroeconomic stability. During the periodthe consolidated public sector had a sustained surplus. The continuation of

10. See Vittorio Corbo and Stanley Fischer, "Lessons from the Chilean Stabilization andRecovery," edited by B.P. Bosworth, R. Dornbusch, and R. Laban, in The ChileanEconomy: Policy Lessons and Challenges. Washington, D.C.: The BrookingsInstitution, 1994, pp. 29-80.

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such surplus will be very important if Chile is going to achieve single digitinflation in the next few years. This chapter describes the evolution of fiscalvariables during the period.

A. Fiscal Developments

5.2 The overall public sector surplus (including the Central Bank)remained roughly constant (within a band of 1.0-1.9 percent of GDP) overthe 1990-93 period, after a sharp drop in 1990. Within the CentralGovernment, rapid growth of government expenditure on infrastructure andsocial sectors and a decline in copper revenues were compensated by anincrease in tax revenues and a decrease in interest payments. The CentralBank losses (cash basis) fell during the period despite sterilization of capitalinflows, especially during 1990-92 (see Table 5.1), mainly due to asubstantial improvement in the term structure of the debt. The publicenterprises' overall surplus deteriorated substantially over the period (seeTable 5. 1) due mainly to the drop in copper prices.

5.3 To facilitate a rapid fall in inflation, the Government could activelyuse fiscal policy to support monetary policy in its attempt to diminish theexpenditure/output gap. This could be achieved through strengtheninggovernment revenues, controlling public expenditure growth, reducing centralbank losses, and reforming public enterprises, especially CODELCO.

5.4 General Government. The overall balance of the general governmentregistered a surplus over the period 1990-93. Total revenues relative to GDProse slowly from 22% of GDP in 1990 to 23.8% in 1993 mainly due to anincrease in national income and the 1990 tax reform, which generated anincrease in tax revenue from 14.5% of GDP in 1990 to about 17.4% in1993. This increase in revenue was sufficient to cover not only an increasein social and capital expenditures and amortization of public debt, but also tocompensate for reductions in revenues from CODELCO. Capital revenuesfrom sales of government assets declined, reflecting a winding down inpublic enterprises privatization (see Table AIO).

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Table 5.1Public Finance, 1990-93

(% of GDP)1990 1991 1992 1993

Central Government Surplus 0.8 1.6 2.3 2.0Total Revenues 22.1 23.7 24.4 24.6Total Expenditures 21.3 22.1 22.1 22.6

Public Enterprises Surplus 2.7 0.5 0.7 -0.1Non-Financial Public Sector Surplus 3.5 2.1 3.0 1.9Central Bank Losses (cash basis) -2.0 -0.7 -1.1 -0.9Consolidated Public Sector Surplus 1.5 1.4 1.9 1.0Memorandum:

Deposits in Copper Stabilization Fund 2.3 0.7 0.3 -0.2Use of Petroleum Stabilization Fund 0 0.2 0 -0.1

Source: Ministry of Finance, the Central Bank of Chile, and IMF.

* Preliminary.

5.5 The 1990 tax reform was intended to support increased socialexpenditures during 1990-93, and it provided for a partial return of the taxregime to the status quo ante beginning in January 1994. In September 1993,Congress approved an extension of the tax reform for another four years tostrengthen the fiscal position, subject to the following changes: (i) alowering of the value-added tax from 18% to 17% in 1997-98; and (ii)reducing the top marginal bracket in two stages--from the present rate of50% to 47% in 1994 and then 45% in 1995. This rate is likely to fall to40% in 1997. This built-in tax reduction generates an expansionary bias tofiscal policy, when most observers believe it should be mildly contractionary,contributing to increase the country's savings.

5.6 Reductions in domestic and foreign public debt have benefited largelyfrom the government's overall surplus. The stock of domestic and foreignpublic debt declined to 16% and 10.2% of GDP, respectively, in 1993.Most government domestic debt held by the Central Bank originated from thefinancial system bail out stemming from the 1982 crisis, during which thegovernment issued treasury bills in exchange for central bank credit. TheGovernment used these surpluses to repay the central bank; as aconsequence, the stock of treasury bills declined. Central governmentforeign debt declined significantly.

5.7 Public Enterprises. The role of the state in productive sectors hasdiminished, reflecting reductions in the number of enterprises in theproductive sectors and reductions in the ratio of public enterprise value addedto GDP from 11% in 1990 to 6.7% in 1993. Forty-four remaining publicenterprises had a combined equity of US$7.6 billion and an asset value ofUS$12 billion. Their participation in productive sectors relative to total

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equity of public enterprises is diversified as follows: mining (40.5%),transport (19.2%), sanitation (13.8%), energy (12.7%), finance (5.9%),communication and others (1.5 %). CORFO (the state holding company) andCODELCO (the state copper company) hold, respectively, 33.7% and 29.9%of total public enterprise equity (see Table Al 1).

5.8 Despite a decline in the operational surplus of public enterprises, theAlywin Government maintained its participation in public enterprises,particularly those with monopoly power, strategic sectors, and essentialpublic services. Its attempts to expand the private sector took differentroutes, other than privatization. For example, in the second half of 1991, theGovernment allowed concessions of public works to the private sector;concession contracts were awarded to private companies to construct andmanage a tunnel and a large water supply project. In May 1992, theGovernment authorized CODELCO to form a joint venture with private firmsin exploring new mining deposits."

5.9 The accumulated deficit of public enterprises under the control ofCORFO must be self-financed (without recourse to the central government).If CORFO's affiliates require new investment, the Government recommendedthat: (i) enterprises grant concessions or subconcessions to the private sector;(ii) the private sector increase its participation in CORFO enterprises; and(iii) public enterprises improve their management. To reduce CORFO'sparticipation in large public enterprises, during 1990-93 CORFO completelyprivatized LAN-Chile and sold shares of public enterprises under its control,including 25 % of Zofri, 51 % of Edelnor, and 5 % of Colbun.

5.10 Currently, public enterprises, especially CODELCO, contributesignificantly to the central government budget. Government revenues frompublic enterprises, including indirect taxes and dividends, accounted for about20% of total government revenues during 1990-93. However, contributionshave recently declined to 17% in 1993, compared to 32.6% of totalgovernment revenues in 1990, mainly reflecting a fall in copper prices andCODELCO's output, the peso's revaluation, and a reduction in the numberof public enterprises.

5. 11 CODELCO. CODELCO's net income declined steadily principallybecause of a fall in copper prices, but also because of reductions in output,

11. To strengthen its position as the wvrld's largest copper production company and todiversify its portfolio investment, the government passed the new CODELCO Lawin May 1992. The law authorized CODELCO to establish joint ventures withprivate or public entities, domestic and fbreign, for the exploration of CODELCOmines that have not yet been exploited. CODELCO could sell off surplus miningproperty (it owns a third of all registered mining property). The new law alsoenabled CODELCO to exploit 30% of Chile's mining deposits currently in the handsof CODELCO and to overcome difficulties in obtaining financial resources. Theprime candidate for development under the joint venture option will be El Abra, acopper deposit located some 501an north of Chuquicamata, which will require aninvestment of $250 million to build a mine capable of producing 150,000 tons/year.v

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the peso revaluation, and low productivity. During 1989-93, the copperprice fell by 32% to US$0.87 per pound in 1993, compared to US$1.29 in1989. Due to technical and geological problems, declining ore concentration(at Chuquicamata), over-exploitation of mines (El Teniente), and labordisputes, CODELCO's total output fell by 10 percent to 1.14 million tons in1993, compared to 1.24 million tons in 1989. This led to lower productivitylevels that together with the traditional problems CODELCO has faced forsome time now -- high absenteeism, overstaffing, and high wages -- elevatedoperating costs of copper production to nearly 60 cents per pound in 1993(compared to 38 cents per pound in 1985; see Table A12). In light of thedecline in net income combined with CODELCO's significant losses in futuremarket operations in the amount of US$206 million (equivalent to 0.5% ofGDP) in 1993, the Frei administration is now considering a restructuringplan to improve efficiency and increase competitiveness.

5.12 The Central Bank. The Central Bank deficit (cash basis) graduallydeclined to about 1 % of GDP in 1993 (from 2% of GDP in 1990) due to areduction in sterilization of capital inflows and increased interest revenuesderived from better management of international reserves, especially in 1993.In addition, reductions in Central Bank liabilities due to improvements in thestructure of the debt and repurchases of subordinated debt by commercialbanks also contributed to a decline in the deficit.

5.13 Elimination of the Central Bank deficit will enhance the effectivenessof monetary policy, thereby reducing inflationary pressures. This requiresaccelerated retirement of Central Bank paper and greater repurchases ofsubordinated debt by commercial banks. The Government may need togenerate a substantial surplus to retire the bonds held by the Central Bank inthe amount of US$7 billion (equivalent to 16% of GDP). As of 1989 theGovernment used Ch$ 453.7 billion (US$1.7 billion) of the CopperStabilization Fund accumulation to repay Central Bank debt.12Correspondingly, commercial banks need to increase their portfoliorepurchases. Recently, the Government proposed legislation to Congress toeliminate the accumulated stock of commercial bank subordinated debt within40 years.

5.14 Infrastructure Investment. Over the past 20 years, infrastructure inChile deteriorated considerably, especially in roads, ports, railways, watersupply/sanitation, and irrigation. Low pavement ratio, poor conditions, anddeficiency of road networks, especially feeder roads, increase transportationcosts, product losses, and impair accessibility and safety. Congestion ofports increases ship waiting time, and thus, results in monetary losses ofagricultural exports in the future. Railway infrastructure, which providesaccess to a large number of ports, deteriorates and relies on old technology.Investment in waste water treatments is relatively low despite extensive sewer

12. The World Bank, Chile: Current Macroeconomic Situation and Prospects, ReportNo. 9851-CH, Country Operations Department IV, Latin America and theCaribbean Region, March 1992.

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connections. There are deficiencies of conveyance and distributioninfrastructure in rural irrigation.

5.15 The Aylwin Government strongly committed itself to promoting adynamic role for the private sector. It tried not to compete in productivesectors, particularly where private investment was considered viable. Publicenterprises, which operated in traditional sectors were authorized to grantconcessions to the private sector. Concessions were already carried out inthe areas of water and sanitation and infrastructure projects (El MelonTunnel), thereby allowing public enterprises to overcome financial constraintsin large investment projects.

5.16 Nevertheless, to ensure economic growth and to satisfy basic needs,the Government increased its own capital expenditures during the 1990-93period, and concentrated on roads, transportation infrastructure, and sanitaryworks in rural and urban areas. The Government based its programs onthree criteria: (i) seeking private assistance in investing through policies ofconcessions; (ii) ensuring social equity by developing a system whereby userswill pay for the cost of construction works; and (iii) elaborating anddesigning evaluation methods to avoid or reduce the impact of buildinginfrastructure on environment.

5.17 Infrastructure investment increased on average by 20% in real termsas a consequence of an increase in road construction, transportation, waterand sanitation and regional/municipal investment. During the 1990-93period, the public sector remained the major financier of infrastructureinvestment, while private sector investment was negligible, accounting foronly 4.1 % of the total. Highway construction took priority because pastunderinvestment in roads had caused a low pavement ratio and poor roadquality. Average investment in the road sector by the public sector duringthe 1990-93 period accounted for 47.4% of total infrastructure investment(only 0.3% of the total invested by the private sector). Investment intransportation, especially, airports, ports, and railways (public and privatesector) took second priority, and accounted for about 8.6% of totalinfrastructure. Water and sanitation investment (combined public and privatesector) accounted for 15.2% of the total. Other infrastructure investment(metro, public buildings, irrigation, and others) were financed entirely by thepublic sector (see Table A13).

6. SOCIAL EXPENDITURE AND POVERTY

6.1 During the period 1987-1992 Chile achieved substantial progress inreducing poverty. Probably the most dramatic statistic is the reduction of thepoverty gap (that measures the distance between the poverty line and themean income of the poor -- i.e. the intensity of poverty, or how poor thepoor are) from 15.2% to 9.7%. A more intuitive interpretation of the

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poverty gap is the percentage of national income needed to eliminate poverty(to provide income for all the poor to reach the poverty line). The cost ofeliminating poverty was reduced from 2.46 percent of GDP in 1987 to 0.94percent of GDP. in 1992. Larraniaga has separated the reduction in povertyinto a growth effect and a distribution effect.13 The first effect tells uswhat percentage of the reduction in poverty would have been achieved if thedistribution of income would have remained unchanged and all incomeswould have grown at the average rate. The second effect tells us the effectof improvement/deterioration in income distribution. The growth effectexplains 78 % of the reduction in the number of poor and 77% of the

14reduction in the intensity of poverty

A. Social Expenditure

6.2 Social expenditure accounted for about 60% of total governmentexpenditure and ranked first in the expenditure priority of the Aylwinadministration. Following several years of reductions since 1985, socialexpenditure as a share of GDP increased to 15.3% in 1993 from 13.9% in1990. The increase was financed entirely by the 1990 tax reform.Expenditure on education, which accounted for about 20% of socialexpenditure and 3 % of GDP, increased by 33 % in real terms over theperiod. Health expenditure, accounting for 17% of social expenditure and2.5 % of GDP, increased by 55 % in real terms. Housing expenditure,accounting for 8.6% of social expenditure and 1.3% of GDP, rose by 43% inreal terms. Social security, which accounted for nearly 40% of socialexpenditure and 6.7% of GDP, increased by 22% in real terms due to thegrowing number of retired workers. Finally, subsidies, which accounted for8.6% of social expenditure and 1.3% of GDP, increased by 50% in realterms (see Table A14).

13. 0. Larrafiaga: "Pobreza, crecimiento y desigualdad. Chile 1987-92". Documento deInvestigaci6n 77. Programa de Postgrado en Economia Ilades/Georgetown, 1994.

14. Larrafiaga also estimated the effect of increasing the rate of growth of GDP from anaverage 5% to 7% in the period 1992-99. By 1999 the number of poor would bereduced to 20.4 % with an average rate of growth of 5% and to 16.4 % with 7%(assuming a constant income distribution). The four points represent approximatelyhalf a million persons, and would be a minimum if one takes into account thatfurther growth would imply more revenues and potentially more expenditure onsocial programs, enabling to reduce income disparity.

- 22 -

Table 6.1

Social Expenditure

1990 1991 1992 1993

% of Social Expenditure

Education 19.5 20.0 20.7 19.5

Health 15.3 16.4 17.4 17.8

Housing 8.1 8.8 8.7 8.7

Social Security 49.0 46.6 44.7 44.8

Subsidies and Others 8.2 8.3 8.5 9.2

Source: Ministry of Finance, Budget Department, 1990-93.

6.3 Priorities. Social expenditure concentrated on education, health, andhousing, and the combined expenditure of the three sectors accounted for27% of total government spending during the 1990-93 period. Educationexpenditure ranks first as the government's role remains significant inproviding and subsidizing education since the implementation of educationreform in the early eighties. Chile's education system is based ondecentralization of public education to municipalities and direct subsidies toeducation centers on a per-student basis. The Government was especiallyconcerned about secondary education and skill training, to enhance theproductivity of Chile's human capital. The health sector reform carried outin early 1980s diminished the Government's role in health sector as itincluded privatization of health insurance system (currently operated byISAPRES) and improved government targeting of basic health care services(SNS) to the poor. The health of the average Chilean has improvedsubstantially (as reflected by an increase in life expectancy to 73 years andlowered infant mortality); however, problems remain in the area of qualityand efficiency of resources employed by health services at all levels of thesystem-- primary, secondary, and tertiary. The housing sector has the lowestpriority among the three sectors because good private markets exist formortgages, particularly for middle and upper-income borrowers. Becausegovernment housing programs generated financial problems due to the non-collectability of loans, public housing programs (which included up-frontsubsidies) were limited to lower income groups.

6.4 Targetting. Social expenditures, especially monetary subsidies, werewell targetted to the most vulnerable priority groups, including youngsters,women with scarce resources, children, elderly, and people with handicaps.Since the 1980s, the Government systematically decentralized the deliveryand financing of programs in the social sectors, with the objective of

- 23 -

effective targeting the services to communities' extensive needs, followingyears of underinvestment. The Government mobilized and channelledresources towards community-based poverty alleviation programs via a SocialSolidarity Fund (FOSIS) and Servicio Nacional de Menores (SERNAM)under the Ministry of Justice. Other types of social expenditures, includingbasic social services, social investment and social administration, are nottargetted to the poor, since these programs usually grant equal access to allChileans to guarantee equal opportunity.

6.5 The foregoing discussion indicates that some scope remains forimproving social expenditure targets, especially in education and health. Ineducation, secondary education enrollment of the lowest two quintilesremained unchanged; about 50% of the rural population is not enrolled. Inhealth, although total health benefits received by the poorest have improved,especially through National Health Services System (Sistema Nacional deServicios Salud, SNSS), the targeting of some health programs (such asFONASA, the maternity subsidy, and others) could be improved so that thepoorest group can benefit more from them.

6.6 Income Distribution. The CASEN studies during the 1990-92 periodshow a slight improvement in income equality as the share of total incomereceived by the poorest 20% increased (from 6% in 1990 to 6.5% in 1992)and the share of total income received by the top richest 20% declined (from52.2% to 51.8%). This improved income distribution was attributed to anincrease in the share of individual income and monetary subsidies received bythe poorest 20%, while its share of income from the social net (education,health and housing) fell slightly (see Table A15). However, Chile's Ginicoefficient, at around 0.5, continues to be high.

B. Poverty

6.7 GNP per capita registered US$2,726 (1992) and placed Chile as alower middle income country; however, its social development performancehas been impressive. According to the 1993 UNDP Human DevelopmentReport, Chile's GNP per capita ranked 75, while its UNDP's HumanDevelopment Index (HDI) ranked 36 among 173 developing countries.'5

Key social indicators (for example, average life expectancy at birth, infantmortality rate, the prevalence of malnutrition, educational attainment, andoverall adult literacy) are similar to those in many developed countries. Thepoverty indicators, in particular the number of indigents and poor, show thatpoverty in Chile declined over this period (see Thble 6.2).

15. The Human Development Index (HDI) measures human development progress bycombining indicators of real purchasing power, education and health. Thismeasurement of development, which was introduced by UNDP in 1990, offers muchmore comprehensive than GNP per capita alone. For Chile, its HDI value in 1990is equivalent to 0.864.

- 24 -

Table 6.2

Poverty Indicators

1987 1990 1992

Per Capita GNP (US$) 1,445 2,144 2,726

Gini Coefficient 51.1% 50.7% 50.4%

Indigent (% of total) 16.8% 13.8% 9.0%

Poor, including Indigent (% of 44.6% 40.1 % 32.7%total)

Source: CASEN 1987, 1990, and 1992.

Note: Gini coefficient, based on monetary income (including subsidies), iscalculated by the program POVCAL.

6.8 As a consequence of uninterrupted economic growth and increasedsocial expenditure, poverty in Chile been has alleviated as indicated by areduction in the number of Chileans living in poverty. According to 1992CASEN data (The National Socioeconomic Characterization Study), thenumber of people no longer living in poverty per percentage of GDP growthincreased from 14,300 persons during 1987-89 to 49,000 persons during1990-92. The number of Chileans living in poverty dropped by 833,000persons. This, in turn, lowered the national poverty rate from 45 % to 33 %during the period. The total number of poor Chileans now stands at 4.37million. Per capita income of individuals living under the poverty line is lessthan two times the cost of a basket of basic diet goods. The number ofdestitute poor, whose per capita income is less than the cost of one basket,fell by 600,000 since 1990 (see Table A16), or from 16.8% to 9% of thepopulation.

7. MEDIUM-TERM PROSPECTS

7.1 The administration of President Frei finds itself in the enviableposition of inheriting an economy which in recent years has enjoyed stronggrowth and declining inflation. Chile finds itself in a privileged position interms of economic achievements and social progress. An added advantage isthe considerable consensus on the basic thrust of Chilean policies.Nevertheless, the country must continue to improve its economic efficiency

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to compete internationally, gain greater benefits from its allocation of publicresources, and pursue policies conducive to high sustained rates of growth.Chile faces major challenges, of the sort normally faced by countries at ahigher stage of development. Some of these challenges and areas for furtherpolicy action are mentioned below. A consensus on these may prove harderto achieve. The World Bank remains ready to assist Chile in examining theadvantages and disadvantages of different policy options.

7.2 Chile faces two related challenges: strengthening exportcompetitiveness and sustaining long-term economic growth. To strengtheninternational competitiveness, Chile needs to increase the productivity of itsexport sectors (mining, fruit, and fisheries), which are intensive in naturalresources and labor, through improving the efficiency of factor markets(labor and capital), maintaining a competitive exchange rate policy andeliminating infrastructure bottlenecks. At the same time, Chile shoulddiversify exports toward higher value-added manufacturing products, thuslowering Chile's dependence on primary exports. This can be aided byimproving the skill base of the labor force, productivity-increasing researchand development, and technological innovation. Finally, the key to sustainedlong-run economic growth requires a high rate of investment, lower inflation,and continued prudent macroeconomic management.

7.3 To attain and sustain high rates of economic growth, actions arerequired in a number of areas. Among them, the Bank would like tohighlight the following priority areas: (i) education policy and labor marketissues; (ii) health system reform; (ii) infrastructure; (iv) internationalcompetitiveness; (vi) environmental issues; (vii) rural poverty; and (vii)further reform of the government. In all these areas the Bank has recentlyperformed some work. However, there are areas where policy actions arerequired where the Bank has not done any work recently. They include: (i)CODELCO; (ii) the internal organization of the government; and (iii) tradeintegration options.

7.4 Of the latter three issues, probably the most pressing is the challengepresented by the formation of new trade blocks. At the moment, Chile doesnot belong to any of them, and the advantages and disadvantages of differentstrategies vis-a-vis both NAFTA and MERCOSUR have been the subject of aheated debate lately. To this has been added the possibility of a newunilateral reduction of tariffs to 5 % flat, as a reaction to the huge flow ofcapital. The subject is dominated by the need for detailed empirical analysis.However, careful consideration of the alternatives is sometimes preempted bythe speed with which events unfold. Hopefully, Chile will keep as itspriority in its dealing with these blocks, the maintenance of its very opencommercial policy.

7.5 Clearly a number of exogenous factors, such as the price of copperand other international commodities, global interest rates and growthdevelopments, and regional trade prospects, will shape the frontier againstwhich Chile will be pushing. Nevertheless, the economy's ability to compete

- 26 -

internationally and to break away from other upper middle-income aspirantswill largely depend on the pace of micro-economic reforms inside Chile.The faster the economy can enhance the efficiency of its factor markets, theproductivity of its workers, the competitiveness of its industries, and thedrive of its entrepreneurs, the more likely will be that success. If labor, theprivate sector, and government together harness their energies, medium-termgrowth of 6-7% per annum is possible.

- 27 -

CITATIONS

Banco Central de Chile. Boletin Mensual. Santiago, Chile, 1990-93.

Banco Central de Chile. Informe Econ6mico y Financiero. Santiago, Chile,1990-93

Banco Central de Chile. Indicadores de Comercio Exterior. Santiago, Chile,1990-93.

Banco Central de Chile. Cuentas Nacional de Chile 1985-1992. Santiago,Chile, 1993.

Corbo, Vittorio and Stanley Fischer. "Lessons from the Chilean Stabilizationand Recovery." In The Chilean Economy: Policy Lessons andChallenges. Edited by B. P. Bosworth, R. Dornbusch, and R. Laban,Washington, D.C.: The Brookings Institution, 1994 (pp. 29-80).

Dahlman, Carl. "Background and Analysis of Competitiveness," The WorldBank, Mimeo, February 1994.

Edwards, Sebastian. "Exchange Rates as Nominal Anchors,"Weltwirtschaftliches Archiv, Vol.129, No. 1, pp. 1-32.

Haindl, E. "Estimaci6n del Stock de Capital en Chile: 1960-88," Mimeo,The World Bank 1989.

Informe Gemines, "Analisis de la Coyuntura Econ6mica," various issues,1990-93, Santiago, Chile.

International Financial Corporation. Emerging Stock Markets Factbook,1993, Washington D.C.

Kaufman, Jorge. "Inversion y Crecimiento en Chile: Proyecciones de LargoPlazo para el Periodo, 1991-2000," Mimeo, The World Bank, August1989.

Kiguel, Miguel and Nissan Liviatan. "Exchange Rate Based Stabilizations inArgentina and Chile: A Fresh Look," Mimeo, 1994.

Lopez, Ram6n and Luis Riveros. "Macroeconomic Adjustment and the LaborMarket in Four Latin American Countries," The World Bank, PolicyResearch Working Papers, WPS 335, December 1989.

MIDEPLAN. "El Sistema Nacional de Inversiones y el Banco Integrado deProyectos," Santiago, Chile.

- 28 -

MIDEPLAN. "Avanzando en Equidad: Un Proceso de Integraci6n alDesarrollo, 1990-92," Santiago, Chile.

Ministerio de Hacienda. Estadisticas de Las Finanzas Publicas. 1989-92,Santiago, Chile, June 1993.

Morande, Felipe. "Real Peso Appreciation and the Real Sector Response:Some Preliminary Results," Mimeo, The World Bank, September1992.

Rojas, Patricio. "El Dinero Como un Objetivo Intermedio de PoliticaMonetaria en Chile: Un Analisis Empirico," Cuadernos de Economia,Afno 30, No. 90, pp. 139-178 (Agosto 1993).

Solimano, Andres. "How Private Investment Reacts to ChangingMacroeconomic Conditions: The Case of Chile in the 1980s," PolicyPlanning and Research, Working Papers, WPS 212, December 1989,The World Bank.

Stone, Andrew, Brian Levy and Ricardo Paredes. "Public Institution andPrivate Transactions: The Legal and Regulatory Environment forBusiness Transaction in Brazil and Chile," The World Bank, PolicyResearch Working Papers, WPS 891, April 1992.

Superintendencia de Bancos y Instituciones Financieras. Informaci6nFinanciera, 1990-93, Santiago, Chile.

TASC. "Pequenia y Mediana Empresa: Acceso al Mercado del Credito,"Trabajo de Asesoria Econ6mica al Congreso Nacional, No. 31,Febrero de 1992.

The World Bank. CHILE: Current Macroeconomic Situation and Prospects,Report No. 9851-CH, March 3, 1992, Country Operation DepartmentIV, Latin America and the Caribbean Region.

The World Bank. "Chile Transition Brief: Infrastructure Development,"Mimeo, January 1994.

United Nations Development Program. Human Development Report,UNDP, Oxford University Press, 1993, New York-Oxford.

STATISTICAL APPENDIX

Table Al

GDP Classified by Expenditures and Economic Sectors(% Changes in Real Terms)

1989 1990 1981 1992 1993

GDP 10.2 3.0 S.1 10.3 6.0

ConsumptionPublic 2.4 -1.3 4.1 5.2 5.0Private 10.5 2.8 7.5 10.1 7.7

Fixed Capital Formation 26.4 6.1 -3.8 23.8 15.7Construction 16.8 3.9 2.3 11.7Machinery and Equipments 36.4 8.1 -9.0 35.6

Exports 15.9 8.8 10.0 16.8 4.4Imports 24.5 2.0 6.3 22.5 11.5

Sectoral Growth: 1/Tradable Sector:

Agriculture and Livestocks 2.6 8.5 2.3 4.0 1.0Fisheries 12.2 -5.1 9.5 10.5 1.5Mining 9.8 -1.9 5.3 1.5 0.6Manufacturing 10.9 0.5 5.7 11.0 3.6

Non-Tradable Sector:Electricity, Gas, and Water -2.8 -1.7 24.1 22.6 5.2Construction 17.2 4.5 3.8 12.8 14.0Commerce, Hotels and Restaurants 12.6 5.1 6.2 14.0 8.7Transport and Communication 13.5 6.4 9.6 14.2 7.9Financial Services 13.9 3.4 8.4 11.1 7.1Real Estate 1.7 2.6 2.0 1.6 2.5Personal Services 3.5 3.0 3.5 3.7 4.0Public Administration -0.3 1.4 1.4 3.0 1.5Less: Banks' Imputed Charges 13.5 1.8 7.2 10.4 6.1Plus: Net Value Added Taxes 12.2 3.3 6.6 10.7 8.1

Import Duties 32.1 1.7 8.5 26.9 12.6

Source: The Central Bank of Chile.

Table A2

Balance of Payments(Millions of US Dollars)

1989 1990 1991 1992 1993*

Merchandise Trade Balance 1578 1273 1576 749 -978Exports 8080 8310 8929 9986 9202Imports 6502 7037 7353 9237 10181

Non-Factor Services -634 -259 36 -63 5Credit 1537 2069 2260 2431 2635Debit 2171 2327 2224 2495 2629

Financial Services -1926 -1811 -1810 -1860 -1503Credit 237 354 470 398Debit 2163 2165 2279 2258

of which Interest Payments 1780 1832 1646 1492

Transfer 216 199 340 431 385

Current Account Balance -767 -598 143 -743 -2092

Capital Account 1278 3068 813 2883 2763Foreign Investment 1366 941 449 653 1153

From Abroad 1376 949 547 1031 1674To Abroad 10 8 98 378 521

Medium and Long-term Capital -1305 692 -83 290 519Short-term Capital 1/ 1217 1435 447 1940 1091

Errors and Omissions -74 -103 282 359 -94

Overall Balance 437 2368 1238 2498 578

Memo:Current Account Balance (% of GDP) -2.8% -2.0% 0.4% -1.8% -4.8%Stock of Foreign Reserves (Net) 2948 5358 6641 9009 9759

Source: The Central Bank of Chile.

Preliminary.Note: Short-term capital in 1991 accounted for repayments of short-term debt by CODELCO and banks

in the amount of US$975 million.

Table A3

Trade Conpoildon

1980 1986a 1989| 1990 1991 1992 1993

Millions of USt

Export F.O.B. 4705 3804 8080 8310 8929 99se 9202Copper 2125 1789 4021 3795 3817 3886 3248Non-Copper 2580 2015 4059 4515 5312 6100 5954

Agriculture end Fishing 340 515 786 979 1221 1230 1170Fresh Fruits 35s 544 704 949 941 844

Industrial 1705 1078 2475 2741 331e 4033 4056Foodstuffs 376 406 1134 1158 1466 1758 1651Beverages and Tobacco 21 15 62 72 119 163 167Forest and Wood Furniture. 286 112 292 370 428 420 487Cellulose, Papor, Cardboard, and Others 297 210 423 423 446 684 617Chemical Products 163 96 263 311 351 355 400Iron and Steel Basic Industries 425 189 80 93 102 115 83Metallic, Electrical and Transport Products 136 49 92 153 181 289 373Other Industrial Products 0 0 130 161 224 250 278

Imports C.l.F. 6145 3268 7144 7678 8094 10129 11125Consumer Goods 2071 751 1054 1042 1392 1904 2068Intermrdiate Goods 2801 1887 4111 4313 4ee2 5439 5829

Petroleum and others 963 564 814 1129 1034 1114 1109Capital Goods 1274 650 1980 2322 2041 2786 3228

As a Ratio of Total

Export F.OB. 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0%Copper 45.2% 47.0% 49.8% 45.7% 40.5% 38.9% 35.3%Non-Copper 54.8% 53.0% 50.2% 54.3% 59.5% 61.1% 64.7%

Agriculture of which; 7.2% 13.5% 9.7% 11.8% 13.7% 12.3% 12.7%Fresh Fruits 0.0% 9.4% 6.7% 8.5% 10.6% 9.4% 9.2%

Industrial 36.2% 28.3% 30.6% 33.0% 37.1% 40.4% 44.1%Foodstuffs 8.0% 10.7% 14.0% 13.9% 16.4% 17.6% 17.9%Beverages and Tobacco 0.5% 0.4% 0.8% 0.9% 1.3% 1.6% 1.8%Forest and Wood Furnitures 6.1% 2.9% 3.6% 4.5% 4.8% 4.2% 5.3%Cellulose, Paper, Cardboard, and 0thers 8.3% 5.5% 5.2% 5.1% 5.0% 6.9% 6.7%Chemical Products 3.5% 2.5% 3.3% 3.7% 3.9% 3.8% 4.3%Iron and Steel Basic Industries 9.0% 5.0% 1.0% 1.1% 1.1% 1.1% 0.9%Metallic, Electrical and Transport Products 2.9% 1.3% 1.1% 1.8% 2.0% 2.9% 4.1%Other Industrial Products 0.0% 0.0% 1.8% 1.9% 2.5% 2.5% 3.0%

Imports C.IF. 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0%Consumer Goods 33.7% 23.0% 14.8% 13.6% 17.2% 18.8% 18.6%Intermediate Goods 45.a% 57.1% 57.5% 58.2% 57.8% 53.7% 52.4%

Petroleum and Petroleum Products 15.7% 17.3% 11.4% 14.7% 12.8% 11.0% 10.0%Capital Goods 20.7% 19.9% 27.7% 30.2% 25.2% 27.5% 29.0%

Source: The Central Bank of Chile.

Table A4

Diversifioation of Chilean Export Markets

1990 1 986 1989 1990 1991 J 1992 1993

Millions of US$

Total Exports 4670.7 3823.0 8192.7 8580.3 9048.0 10125.5 9416.2U.S.A. 588.9 870.7 1456.0 1469.2 1596.3 1849.4 1655.2Latin America 1138.4 554.8 996.1 1074.8 1303.0 1701.7 1859.9

Argentina 280.6 84.5 110.1 113.5 257.4 461.6 588.9Brazil 448.6 209.7 522.6 487.4 447.6 450.9 407.1

Europe 1912.6 1459.7 3262.5 3394.2 3092.3 3214.5 2640.2of which EEC - 2945.4 3203.1 2881.3 2931.7 2443.9

Asia - 2091.4 2245.9 2639.6 3147.1 2901.1Japan 506.6 392.5 1120.5 1388.2 1644.0 1707.3 1502.3Teiwen . . 399.8 279.8 395.3 490.9 407.7South Korea . . 257.5 259.3 263.0 242.8 413.4

Middle East . 84.6 94.4 75.5 87.2 77.5Africa 98.9 92.5 98.4 85.5 41.8Other Countries - 203.2 219.3 242.9 240.1 240.5

Ratio to Total Exports

Total Exports 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0%U.S.A. 12.6% 22.8% 17.8% 17.1% 17.6% 16.3% 17.6%Letin America, of which 24.4% 14.5% 12.2% 12.5% 14.4% 16.8% 19.8%

Argentine 6.0% 2.2% 1.3% 1.3% 2.8% 4.6% 6.3%

Brazil 9.6% 5.5% 6.4% 5.7% 4.9% 4.5% 4.3%EEC - 36.0% 37.3% 31.8% 29.0% 26.0%Asia. of which - - 25.5% 26.2% 29.2% 31.1% 30.8%

Japan 10.8% 10.3% 13.7% 16.2% 18.2% 16.9% 16.0%Taiwan - - 4.9% 3.3% 4.4% 4.8% 4.3%South Korea . 3.1% 3.0% 2.9% 2.4% 4.4%

Middle East 1.0% 1.0% 0.8% 0.9% 0.8%Africa 1.2% 1.1% 1.1 % 0.8% 0.4%Other Countries 14.0% 14.9% 15.2% 14.6% 14.5%

Source: The Central Bank of Chile.

Table A5

Intemational Comparison of Savings and Investment/% of GDP)

Investmnt National Savings Foreign Savings

1990 Argentina 14.0 15.5 -1.5Chile 24.7 22.0 2.7Mexico 21.9 19.0 2.9Brazil 21.5 20.6 0.9Korea 37.0 35.5 1.5Malaysia 32.1 28.2 3.9Thailand 36.8 30.0 6.8Indonesia 36.6 32.2 4.4

1991 Argentina 14.6 13.2 1.4Chile 22.2 22.6 -0.4Mexico 22.4 17.7 4.7

Brazil 18.9 18.3 0.6Korea 30.0 35.9 3.1Malaysia 36.3 28.0 8.3Thailand 38.9 30.2 8.9Indonesia 35.1 30.1 4.1

1992 Argentina 16.7 13.0 3.7Chile 23.7 22.3 1.4Mexico 23.7 16.3 6.9Brazil 17.5 18.7 -1.2Korea 35.9 34.5 1.4Malaysia 33.8 30.9 2.9Thailand 37.9 32.6 5.3Indonesia 36.3 35.8 0.5

Sources: The World Bank and International Financial Statistica.

Table AS

Employment and UnemploymentIMillions of Persons)

1999 1990 1991 1992 1993

Total Population 12.7 12.9 13.1 13.3 13.5Labor Forces 4.7 4.7 4.8 5.0 5.2Employment 4.4 4.5 4.5 4.8 5.0Total Participation (%) 52.5% 52.3% 52.8%

of which Female Participation (%) 31.0% 30.7% 31.8%Unemployment 0.2 0.3 0.3 0.2 0.2Unemployment Rate 5.3% 5.7% 5.3% 4.4% 4.5%

Percent of Total EmploymentEmployment by Economic ActivityAgriculture and Fishing 19.4% 19.2% 19.1% 18.0% 16.6%Mining and Quarries 2.3% 2.3% 2.1% 1.8% 1.8%Industry 16.8% 16.0% 16.6% 17.0% 16.7%Construction 6.7% 6.4% 7.1% 7.1% 8.1%Electricity, Gas, and Water 0.5% 0.5% 0.5% 0.5% 0.5%Trade 17.1% 17.7% 17.0% 17.8% 18.6%Financial Services 4.3% 4.5% 5.0% 5.1% 5.8%Personal, Communal and Social Services 26.0% 26.4% 25.8% 25.6% 24.7%Transport and Communications 6.8% 6.9% 6.8% 7.0% 7.1%

Source: National Bureau of Statistics.

Note: Based on the Survey Period during October - December of each year.

Table A7

Wage Indices, Minimum Wages, and Public Sector Wages

PublicMinimum Pubic Sector Salaries and

Wage Indices Wage Wage Wage IndexatlonNominal Real Ch* per month Ch$ %

(1982-100) 11) (2) (3)

1988 290.0 100.6 10863 10810 10%1989 345.8 102.5 11950 13318 22%1990 443.8 104.4 26000 16648 25%1991 566.8 109.5 33000 19645 18%1992 684.0 114.5 38600 22395 14%

1993 (Jan-Apr) 761.7 118.5 46000 25754 15%

Source: The Central Bank of Chile.

Notes: (1) Effective December of each year.(2) Public wage for grade 31.

(3) Effective June 30, 1988. The rest is effective December 31 of each year.

Table AS

Labor Productivity by Economic Activity

Sectors 1986 11887 1988 1989 1990 1991 1992 1993-

Agriculture and Fishing 100.0 104.9 113.2 118.6 126.2 129.1 136.2 143.5Mining 100.0 102.9 103.4 96.6 96.1 105.4 119.6 113.6Manufacture 100.0 92.1 90.8 90.5 94.8 95.3 98.0 98.8Utilities 100.0 104.2 108.6 113.4 121.9 152.8 158.6 153.1Construction 100.0 96.4 79.2 85.7 93.6 86.4 92.4 88.5Commerce and Tourism 100.0 104.5 103.8 113.1 114.0 123.2 128.1 127.7Transport and Communication 100.0 99.8 100.0 103.5 107.2 118.0 123.8 126.2Financial Services 100.0 95.3 101.1 109.2 107.1 103.2 106.7 96.7

GDP 100.0 103.5 104.5 110.9 113.3 118.1 123.9 125.7

Sources: Institute of National Statistics and the Central Bank of Chile.

I Preliminary.Note: Productivity = GDP/Labor

Table A9

Percentage Changes In Price Indicles

CPI WPI GDP Export Import Terms ofIDec. to Dec.J Deflator Trade

1985 26.4% 30.3% - -7.8% -0.7% -7.2%1986 17.4% 18.2-% 22.1% 2.5% -7.8% 11.2%1987 21.5% 17.1% 24.6% 14.6% 9.9% 4.3%1988 12.7% 3.3% 21.5% 28.7% 6.2% 21.2%1989 21.4% 22.8% 15.1% 4.2% 5.6% -1.4%1990 27.3% 25.7% 19.1% -6.1% 4.8% -10.4%1991 18.7% 16.5% 21.6% -1.4% -8.7% -0.6%1992 12.7% 8.9% 14.1% -2.0% -1.1% -1.0%1993 * 12.2% 6.7% 11.4% -2.6%

Source: The Central Bank of Chile.

* Preliminary

Table AlO

Public FinanceM% of ODP)

1989 1990 1991 1992 1993*

Central GovernmentTotal Revenues 23.6 22.1 23.7 24.4 24.6

Current 21.2 20.6 22.5 23.3 23.6Tax Revenues 14.8 14.6 16.9 17.5 18.4Copper Revenues (net) 1.9 1.6 1.1 1.3 0.7Others 4.5 4.4 4.5 4.5 4.5

Capital 2.4 1.5 1.2 1.1 1.0Total Expenditures 21.8 21.3 22.1 22.1 22.6

Current 18.2 18.2 18.8 18.1 18.5Capital 3.6 3.1 3.3 4.0 4.1

Savings 3.0 2.4 3.7 5.2 5.1Overall Surplus 1.8 0.8 1.6 2.3 2.0

Public Enterprises 3.5 2.7 0.5 0.7 -0.1Overall Surplus

Non-financial Public Sector 5.3 3.5 2.1 3.0 1.9Overall Surplus

The Central BankOperational Deficit (Cash Basis) -1.8 -2.0 -0.7 -1.1 -0.9

Consolidated Public SectorThe Overall Surplus 3.5 1.5 1.4 1.9 1.0

Sources: Ministry of Finance, the Central Bank of Chile, and the IMF.

Preliminary.

Table Al l

Public Enterprises' Equity Classified by Sectors(Percent of Total Equity)

Mining 40.5CODELCO 29.9ENAMI 3ENAP 7.6

Transport 19.2

CORFO 33.7

Finance 6.3

Others 0.3

Source: Informe Gemines, "Analisis de as Coyuntura Economia," No.155/Agosto 1993.

Tabl A1 2

CODELCO

1995 1989 1990 1991 1992 1s93

Production (Millions of Metric tons) 1.0767 1.2434 1.1954 1.1255 1.156 1.144

Labor Force (Number of Full-time Employees) 25,111 25,932 26,609 26,841

Investment (Million USS) 369.5 410.2 330.6 345.5 425.1 446

Operating Costs (US$ per pound) 0.37 0.46 0.51 0.s6 0.54 0.60

Total Costs (US$ per pound) 0.44 0.51 0.57 6.62 0.63 .

Operating Surplus (Billion Ch$) 126.1 593.0 514.7 330.1 350.1 225.5

(Before Tax and transfers)

Overall Surplus/Deficit (-) 12.5 42.3 17.1 18.6 ..

Sources: Felipe Morande, "Real Peso Appreciation, and the Real Sector Response: Some Preliminary Results" 1992, andAlejandro Jara W. , 'Projecto Gran Mineria 2001 Secundo Informe y Final: Hacis Una Corporacion Publicade Desarrollo Minero Para CODELCO, 1994.

Table A13

Infrastructure Investment(% of Total)

1991 1992 1993 Total

Public Infrastructure Investment (% of total ) 95.7 95.2 96.0 95.6As % of Public Infrastructure InvestmentHighways 53.3 48.4 39.9 46.0Transportation 21.3 24.3 24.4 23.6

Air 1.9 4.3 5.3 4.1Maritime 5.9 5.6 4.7 5.3Urban 13.1 14.2 14.0 13.8Railway 0.4 0.2 0.4 0.4

Sanitary Services 18.4 19.4 18.4 18.7Metro 0.5 0.6 9.4 4.3Irrigation 3.7 5.8 6.4 5.5Public Buildings 2.4 1.1 0.7 1.3Others 0.4 0.4 0.8 0.6

Total 100.0 100.0 100.0 100.0

Private Infrastructure Investment: I% of total infrastructure investment)Water and Sanitation 1.9 1.5 1.9 1.8Ports 2.5 3.3 1.1 2.2Roads .. .. 1.0 0.4Railways . .Airports .. .. . _. _ ._.

Sources: Ministry of Finance, "Estadisticas de las Finanzas Publicas 1989-92'and Ministry of Public Works.

Table Al 4

Social Expenditure

Bllions of peso at 1992 prices

Education 340.6 325.6 364.4 418.2 432.1Health 267.2 255.0 300.4 351.1 396.4Housing 135.0 134.9 160.2 176.1 192.9Social Security 803.4 818.0 850.4 902.2 994.3Subsidies and Others 139.3 136.9 1 50.8 172.1 205.2

TOTAL 1685.4 1670.4 1826.2 2019.7 2220.9

Sectoral Composition

Education 20.2 19.5 20.0 20.7 19.5Health 15.9 15.3 16.4 17.4 17.8Housing 8.0 8.1 8.8 8.7 8.7Social Security 47.7 49.0 46.6 44.7 44.8Subsidies and Others 8.3 8.2 8.3 8.5 9.2

TOTAL 100.1 100.1 100.1 100.0 100.0

% of GOP

Education 2.8 2.7 2.9 3.0 3.0Health 2.2 2.1 2.4 2.6 2.7Housing 1.1 1.1 1.3 1.3 1.3Social Security 6.7 6.9 8.7 6.6 6.9Subsidies and Others 1.2 1.1 1.2 1.3 1.4

TOTAL 14.0 13.9 14.5 14.8 15.3

Source: Ministry of Finance, Department of Budget, 1993.

0 Budget.

Table A15

Income Distribution1%)

luirntlh of inoomoTotal Income 1 2 3 4 5

1990 1992 1990 1992 1990 1992 1990 1992 1990 1992

I. Individual Income 3.8 4.1 8.5 8.6 12.8 12.7 19.1 18.9 55.8 55.7

Income from work 3.9 4.3 9 9.1 13.2 13.1 1 8.8 1 8.6 55.3 54.8

Other individual income 3.2 3.1 6.2 6.3 11.3 10.8 21.1 20.0 58.2 59.9

Retirement & Pensions 3.7 3.9 8.4 8.9 14.8 14.8 24.9 24.0 48.1 48.4

Capital Income 0.3 0.s 0.4 1 3.3 3.9 13.4 13.5 82.5 81

Others 16.9 10.1 15.1 11.2 16.6 12.8 19.5 20.6 31.9 45.3

II. Monetary Subsidies 29.1 32.3 21.4 23.6 18 18.5 14.5 13.9 16.9 11.7

1 Welfare Subsidies 46.9 50.8 24 24.6 17.9 14.1 8.7 8.1 2.5 2.4

PASIS 45.5 48.3 22.2 24.5 19.4 15 10 9.3 2.9 2.9

SUF 50.8 58.9 29.3 24.9 13.6 11.2 4.8 4.3 1.5 0.7

2 Labor Subsidies 16.3 17.7 19.6 22.8 18.1 22 18.7 18.5 27.3 19.1Family Allowances 21.6 23 25.7 28.3 21.2 22.7 17.6 16.3 13.9 9.7

Maternal Subsidies 1.8 3.1 4.9 7.2 11.1 19.9 19.7 19.2 62.6 50.6

Pension Subsidies 5.1 6.1 12.8 15.2 17.3 23.1 23.7 27.3 41.1 28.3

Other 1 57.2 47.3 28.3 32 7.7 12.6 4.5 6.4 2.3 1.7

Ill. TotalMonatarylnoome 4.2 4.6 8.8 8.8 12.9 12.8 1s 18.8 55.1 55.0

IV. Social Safety Net 36.4 36.3 28.3 27.2 19.8 20.1 12.2 12.4 3.4 4.0

Health 49.5 49.3 35.2 33.4 21.2 23.5 6.4 4.1 -12.2 -10.3

Education 34.2 34.6 26.6 26.1 18.6 18.4 13.0 13.6 7.5 7.3

Housing 20.6 21.5 23.2 21.4 23.7 21.0 19,9 21.3 12.6 14.8

V Total Ill + IV) 6.0 6.5 9.8 10.0 13.3 13.2 18,6 18.4 52.2 51.8

Souroe: MIDEPLAN, CASEN Surveys, 1990 and 1992.

Note: PASIS - Subsidy for elderly and disabled persons not receiving any other pension and being in situation of extreme poor.

SUF - Family subsidy

Table Al S

Evolution of Poverty 1987-92

1987 1990 1992Thousands % Thousands % Thousands %

Indigent 1/ 2073.5 16.8 1790.4 13.8 1199.9 9Poor but not Indigent 3424.4 27.8 3412.6 26.3 3169.7 23.7

Total Poor 2/ 5497.9 44.6 5203 40.1 4369.6 32.7

Source: MIDEPLAN. Departmento de Planificacion y Estudios Sociales and Encuesta CASEN 1987, 1990 y 1992.

Notes:1/ Those who live below poverty line and have no sufficient per capita income to buy

a basket of basic food.2/ Below poverty line with no sufficient per capita income to satisfy basic needs.