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Chilean Economic Shock Therapy
Chile is seen to be the quintessential model of liberal restructuring in Latin America in the late twentieth century. After the overthrow of the socialist regime of Salvador Allende in 1973, Chile’s government has implemented an authoritative economic restructuring program that replaced state intervention with market incentives and opened Chile to the global economy. This four-phase process transformed the economy from highly protective industrialized to an open free market economy based on agricultural exports. The process by which the Chilean economy was stabilized was termed “shock therapy.” Like other dramatic economic policy changes, the “therapy” caused the underlying social problems of Chile to immediately surface. Real wages were cut in half, and public spending in preventive health care, primary education, and public housing were drastically cut. Unemployment, “soared to an average of 17.6 percent of the workforce, and hyperinflation averaged 350 percent.” (Sheahan 1997, 12) While in its inception C
growth, it also exacted a tremendous toll on Chilean workers, peasants, and sections of the middle-class, worsening poverty and inequality. It took the process four-phases to mediate the economy’s growth to equilibrium, unlike Russia which is still feeling the affects of their radical economic policies.
The “shock therapy” process entailed the rapid and efficient liberalization of capital markets and prices and the elimination of most restrictions on trade. Tariffs were cut to a uniformed percentage, and the exchange system was consolidated. The government implemented a “crash privatization” process under which “more than 300 firms with a value of $1 billion were returned to private ownership by the end of 1984.”
( Bosworth 1994, 5) The budget deficit was cut sharply from 25 percent of the GDP to 1 percent, and labor market relations were restructured by labor union suppression. The unions were severely weakened by legislation and then allowed to operate under new confining labor laws. These laws included limited means to negotiate over wages, collective bargaining and other issues regarding the working class.
The effects of the anti-labor union laws were far reaching indeed. Chile faced a severe economic crisis that saw the GDP fall by more than 14 percent. However, by 1986 the second phase of the “shock therapy” began a process of sustained recovery under a much more flexible economic construction. The new policy orientation proved successful in terms of generating the “Chilean miracle”. This was an average annual growth rate of 7.4 percent from 1986-1990. However, while the growth generated sustained increases in exports, and reduced unemployment, “the miracle” failed to reduce socioeconomic inequalities and poverty. For example, “health expenditures alone fell by nearly 30 percent.” ( Scully 1996, 401) Workers lacked access to social security and other basic benefits. The first two phases, lasting 17 years did promote economic growth, but without fair distribution; Chile had become a society where a large percent of the population were left without seeing the actual benefits of this “miracle”.
The third and most important phase of the “shock therapy” was not economic but political. This restructuring was not intended by the existing regime and proved to be the Chilean economy’s greatest improvement, seeing how politics and economics are interrelated. The center-left democratic opposition bloc made up of seventeen parties, the Concertacion de Partidos por la Democracia (the Concert of Parties for Democracy) headed by Alywin defeated the Pinochet regime, forming a democratic coalition government. The Aylwin administration recognized that mitigating the problem of inequality and poverty and advancing the needs of the popular sector. The new democratic government immediately embarked on a plan to resolve the social deficit.
In six short years Alywin and his successor, the current President Eduardo Frei enacted and implemented a wide-range of “equity-enhancing reforms” without breaking from the instituted liberal economic model. These reforms entail the last phase of the “shock therapy” program. Saying that high growth rates would not cover the badly needed increases in social spending, the government introduced a direct taxation. This placed a higher personal income tax burden on the upper middle class, eliminated tax privileges for the rich, and raised corporate profit tax.
The Aylwin/Frei administrations increased fiscal spending on social and welfare programs. The government raised family allowances for the poor by 50 percent and introduced subsidies to support nutritional supplements for the lowest income households. Enhancing school feeding and mother-child nutrition programs did this most successfully. Drives to improve the quality of public education and vocational training for the unemployed foreshadow the spread of enterprises and small businesses in the Chilean economy.
Chile’s labor movement expected and demanded much more power and economic benefits than the democratic regime could ever deliver. For example, the right to strike and an end of strike time limitation, and the right to collective bargaining were recently re-instated. Legislation has also benefited from legislation enhancing pension funds, longer periods over coverage for severance and increases in minimum wage. In the period between 1991 and 2000 the incidence of poverty has dropped by almost 40 percent while absolute poverty has dropped by more than half. By any measure these are remarkable achievements for the newly established democracy, and thereby ending the four-phase “shock therapy” program.
Why did Chile’s abrupt economic change work as opposed to that of Russia? The answer is based in Chile’s democratic structure, in accord with its drive to grow on a microeconomic scale. That is, the organizational, administrative, and political skills of the latter governments and their ability to create efficient, coherent coalitions allowed them to combine a free market policy with equitable development. There is no doubt that the government’s ability to develop and strengthen itself by developing an underlying political culture of coalitions was its greatest assets. Therefore, the democratic leadership has made every effort to seek consensus on economic policy, build a cohesive “encompassing organization”, in sharp contrast to the authoritarian government of Russia. The Concertacion party crafted tacit agreements amongst the public, adhering to their preferences. The labor, peasant, middle-class constituencies, and the business classes all developed in the “social capital”, developing power against the m
ilitary oligarchy. This slows the proliferation of black markets, and institutional corruption, two problems plagued by most newly developed democratic states.
Hence, rather than submit to the orthodox view that dismantling the state through sharp economic reforms that profit the rich, the Chilean democratic government reconstructed the state. This gave it not only macroeconomic development, but also in promoting human development via investment in human capital, and management of social programs. These ended the “shock therapy” treatment that in its inception worsened the problems facing the Chilean economy and people. Chile’s present program stresses that responsive and relatively well-institutionalized political parties with strong links to civil organizations are necessary to building a “developmental state.” Other democratizing Latin American countries like Brazil, Peru, or Argentina have only been able to elect popular presidents who have broad executive, if not authoritarian powers. These countries as with Russia will only demonstrate a limited capacity to make the necessary reforms because of their lack of internal cohesiveness.
Bibliography
Bosworth, Barry, Rudiger Dornbusch, and Raul Laban. 1994. The Chilean Economy: Policy Lessons and Challenges. Washington, D.C.:Brookings Institution.
Collins, Joseph, and John Lear. 1995. Chile’s Free-Market Miracle: A Second Look. Oakland, Cal:.Food First.
Hojman, David. 1999. The Political Economy of Development and Democracy in the 1990’s. Pittsburgh, Pa.: University of Pittsburgh Press.
Scully, Timothy. 1996. Constructing Democratic Governance: South America in the 1990’s. Baltimore.: The John Hopkins University Press.
Sheahen, John. 1987. Patterns of Development in Latin America: Poverty, Repression, and Economic Strategy. Princeton, N.J. Princeton University Press.
Weyland, Kurt. 1997. “Growth with Equity in Chile’s New Democracy,”Latin American Research Review, vol. 32 no. 1.
Word Count: 1166
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