The Washington Post
Wednesday, January 21, 2004; Page E01

A Smoother Road To Free Markets

Chile's Success Makes the Case For State Involvement in Economy

By Jon Jeter
Washington Post Foreign Service

PUERTO MONTT, Chile -- A midmorning mist settles on this fishing hamlet with the arrival of the first shift at the Patagonia Salmon Farming. Water tanks spit gunmetal-gray fish onto a silver table where Jorge Almonacid and his eldest son, Jose, stand waiting for them on either side, slicing their gills with one smooth stroke from their fillet knives before sending them on their way.

"I've worked here for nine years," said Almonacid, 46. "My son started three months ago. He's not as good with the knife as the old man but he's not bad," he said with a grin. "This is a good job. The company takes care of you. Before the factories opened you either made a living off the land or not at all. The best thing to happen to this part of the country was the salmon industry. We'd be lost without it."

Salmon illustrates why this country is Latin America's most successful convert to globalization. While neighboring countries sputter, crash and protest against their stumbling economies, Chile is selling more fish, fruit, wine and other goods abroad than ever before, fueling the longest period of economic growth in the nation's history.

No other country in this part of the world has grown more since 1990, inspiring Wall Street, the White House, economists and other gurus of unregulated capitalism to praise this nation of 15 million people as a shining example of what developing countries can accomplish if they tear down their walled-off economies and faithfully follow Washington's blueprint for prosperity.

But the arc of Chile's salmon industry also illustrates how this country assembled Latin America's most dynamic economy by doing quite a bit more than simply stepping out of the way of the free market.

It was the Chilean government that in the mid-1980s began developing the technology for salmon cultivation for wide-scale commercial use. When the project became commercially viable, the government's nonprofit research arm, the Chile Foundation, sold its stake to Japanese investors in 1989. Today, salmon is Chile's second-largest export after copper, bringing annual revenue of nearly $1 billion and providing jobs for more than 100,000 people.

While many Latin American countries have whittled government's role in business affairs, Chile has gone largely in the other direction. Not only has it wielded influence in getting to market its key exports, from table grapes to goat cheese to sofas, but it also has used more legislation, regulation and taxes to tame a feral free-market system that failed to deliver in the 1970s and '80s.

Argentina and Brazil loosened restrictions on foreign cash flowing in and out of their countries, but Chile slapped restrictions on it. While countries such as Bolivia and Uruguay put the brakes on public spending in the 1990s, the Chileans have more than doubled public expenditures on health and education since 1990.

Other countries cut taxes; Chile nearly doubled the taxes on corporations over the past decade. While Argentina in the 1990s was watering down its labor laws to lower costs and make it easier for employers to hire and fire workers, Chile was strengthening its labor legislation, doubling its minimum wage and requiring that employers extend jobless benefits to unemployed workers.

Brazil and Argentina fixed the value of their currencies -- guaranteeing that the central bank would exchange local tender for dollars at a fixed rate -- to combat inflation. By contrast, Chile devalued its currency and kept it on a tight leash to protect local industries from foreign goods that gained a price advantage against an overvalued local currency.

The difference between Chile and the rest of the continent can be stark. When Bolivian demonstrators in October forced their president to flee the country in violent protests against globalization's unevenness, the first Starbucks was opening in Chile. Nearly half of all Brazilian workers do not have a job contract; for Chile the figure is 1 in 5. The number of Argentines living in poverty has quadrupled since 1989; over that same period, Chile has reduced the ranks of its poor by half.

"What makes Chile different from the rest of Latin America," said Manuel Riesco, an economist with the Center for National Studies of Alternative Development in Santiago, "is not that we embraced the free market more than our neighbors. What we realized is that the free market is like a car. There is no doubt that it is the best way to get you from point A to point B. But you have to steer. If you take your hands off the wheel, you will end up face-down in a ditch."

Said Dani Rodrik, professor of international economics at Harvard University: "The myth is that Chile's success is purely the result of fundamentalist free-market policies. But the truth is quite a bit messier than that. Government activism and management in Chile did not stifle the power of the free market. It unleashed the power of the free market."

An Economy in Meltdown

In September 1973, as troops stormed the presidential palace, the 500-page economic plan of the military junta leading the coup against President Salvador Allende's socialist regime was being printed in the basement of a Santiago publishing house.

Convinced that he was rescuing Chile from a communist menace, Gen. Augusto Pinochet put his faith in a coterie of young Chilean advisers who had trained at the University of Chicago's School of Economics, the academic vanguard of conservative, free-market economics. Restricting dissidents and union activity, Pinochet's repressive regime handed the "Chicago Boys" -- as they came to be known -- a blank check to remake Allende's nationalized economy.

Nearly 15 years before economists coined the phrase "Washington consensus" to describe the deregulatory policies promoted by the U.S. Treasury Department, the World Bank and the International Monetary Fund, Chile had installed Latin America's first post-Cold-War template for a wide-open economy.

Pinochet slashed duties on imports, from an average tariff rate of 94 percent in 1973 to 10 percent by 1979. He privatized all but two dozen of Chile's 300 state-owned banks, as well as utilities and entitlements such as social security. By 1979, he had cut public spending almost in half and public investment by nearly 14 percent. He lowered taxes, restricted union activities and returned more than a third of the land seized under Allende's land reform program.

Monetary policy was liberalized on two important fronts. First, Pinochet allowed "hot money" -- speculation on the currency market -- to flow in and out of the country without obstacle. And in 1979 he fixed the exchange rate for Chile's peso, requiring the central bank to keep $1 in reserve for every 39 pesos printed. This kept the bank from merely printing money to pay bills and curbed an inflation rate that had soared to nearly 400 percent annually under Allende.

With a recession in 1975, Chile's economy contracted by 13 percent -- its greatest decline since the Great Depression. The recovery that followed was fueled largely by foreign cash, which poured into the country as investors gobbled up utilities and stashed money in Chile's currency markets. The prices of imports fell sharply; between 1975 and 1982, the number of foreign cars sold in Chile tripled. Domestic manufacturing shriveled by 30 percent. Domestic savings plummeted. Wages fell, and the income gap between rich and poor widened by a factor of 50.

By 1982, Chile had accumulated $16 billion in foreign debt -- the highest in Latin America -- and foreign investment represented a quarter of the country's gross domestic product. The money flowing into the country flowed out just as easily, to pay debts and bills for imported goods and through capital flight as investors soured on Chile's currency market. The economy had overheated and was now in a meltdown.

"I don't think there is any question that Chile did not have the right policy mix in those days," said Hernan Somerville, president of the Chilean Banking Association and one of Pinochet's advisers at the time. "The government wasn't as diligent as it needed to effectively manage the markets and the economy. We needed a system with more balance."

With a third of the workforce unemployed and unrest growing, by 1984 Pinochet began to "reform the reforms," said Ricardo French-Davis, an economics professor at the University of Chile.

He allowed the peso to float and reinstated restrictions on the movement of capital in and out of the country. He introduced banking legislation, and ratcheted up spending on research and development efforts through the Chile Foundation and other collaborations between the public and private sectors.

Finding a Balance

In the 1990s, after Pinochet allowed a plebiscite that returned democracy to Chile, the new government accelerated the reforms, said French-Davis and others. Between 1990 and 1992, Chile doubled government spending on health and education, and introduced tax incentives to businesses that provide job training, helping to increase the percentage of Chileans with higher education from 9 percent in 1992 to 16.4 percent last year. The number of professionals in the country expanded 124 percent over that period.

Successive governments led first by Chile's conservatives then by its socialist party worked to restore worker rights eroded by Pinochet's regime. Government strengthened trade unions' ability to negotiate collective bargaining agreements, introduced the broadest unemployment insurance plan on the continent and reduced from six months to one month the period of time employees can work without a contract. Between 1990 and 1998, Chilean lawmakers increased the minimum wage by 87 percent, making it the highest in Latin America, said Yerko Ljubetic, Chile's undersecretary of labor.

"You can probably find cheaper labor in other Latin American countries," said Jose Luis Charpentier, the manager at the Patagonia Salmon farm. "But you can't find better workers than we have here in Chile. Their productivity more than makes up for the difference in costs."

Chile pressed ahead with privatizations, even selling its cash cow -- the copper mines that are Chile's top export earner -- without charging the royalties that are typically charged in transactions extending mineral rights. But Chile's regulations generally surpassed anything attempted by its neighbors, said Ricardo Paredes, an economics professor at the University of Chile.

Preoccupied with fostering competition, Chile requires that telecommunications and natural gas firms connect their lines with other providers and Chilean regulatory agencies set the price for those interconnections. That has resulted in the lowest-priced long-distance prices in the region; a phone call from Chile to New York City is actually less expensive than one in the other direction.

The low prices have attracted new businesses. Delta Airlines, for example, two years ago opened a $4 million international call center in Santiago, employing 70 workers.

Since 1990, Chile's gross domestic product has grown by an annual average of 5.9 percent, the fastest on the continent and nearly twice that of Argentina and Brazil. When Mexico's sharp devaluation of its currency in 1995 plunged both Brazil and Argentina into mild recessions, Chile's economy was unscathed. With money unable to leave at a moment's notice, it grew 6 percent that year.

"What we learned from the '70s and '80s," said French-Davis, "is that you don't want too much foreign investment coming into the country. You want money coming into the country to go towards the development of technology, roads, job training, those things that will improve productivity. That's where government comes in. We limited the influx of hot money and encouraged domestic savings that we can use as a building block just as easily as foreign savings."

Chile's domestic savings rate is the highest in Latin America.

While Chile's economy improved steadily over the 1990s, its neighbor to the east, Argentina, endured cycles of boom and bust that culminated in a default on more than $140 billion in foreign loans in 2001, the largest sovereign default in history. Between 1989 and 2001, Argentina's unemployment rate nearly quadrupled, to 22 percent, in a chain of events that largely mirrored what happened in Chile 20 years earlier.

"What happened to Argentina in the late '90s and into 2000, 2001," French-Davis said, "is almost identical to what happened to Chile in the late '70s and '80s. When people say that developing countries should do what Chile did, I always wish they would clarify what time period they're referring to. We've tried some very different things over the last 30 years."

Chilean lawmakers in 1999 abandoned restrictions on capital controls, saying they were no longer necessary. This year, they have introduced legislation to scale back workplace protections for workers under 21, and trade union officials and others have criticized those efforts as missteps that may begin to return the country to the unregulated Pinochet days.

Here in Puerto Montt, Patagonia Salmon is anticipating record-breaking sales this year of packaged fillets and steaks to the United States. It remains unclear whether the industry's sales will be affected by recent health warnings about the levels of PCBs, or polychlorinated biphenyls, in farm-raised salmon around the world.

"I think the sky is the limit," said Charpentier, the factory manager. "You know, our economy has been a little like the three little bears. First we were too cold, then we were too hot. Now, I think Chile has gotten it just right."

© 2004