Over the past decade, Chile’s economic performance has been distinguished by strong growth and increasing diversification. However, copper has long been a chief determinant of the country’s fortunes and still plays a significant role in the economy. In the 1990s, the mining sector and the rest of the economy each grew at an average annual rate of 8 percent—the result of two distinct impetuses: massive capital inflows, which fueled a rapid expansion of production in the mining sector, and profound structural reforms and a stable macroeconomic environment, which spurred growth in the remainder of the economy.
In Copper and the Chilean Economy, 1960-98, Antonio Spilimbergo examines the dynamic relationships between world copper price cycles and the Chilean business cycle. His study finds that copper prices influenced short-term fluctuations in the country and may also have had an impact on longer-term growth. With copper likely to remain an important element in the Chilean economy, correlations between copper price cycles and Chilean business cycles may have important implications for the country’s policymakers.
Copper’s role in the economy
Copper has played—and seems likely to continue to play—a significant role in Chile’s exports and GDP, and to a lesser extent in its fiscal revenues. In 1997, for example, copper accounted for 42 percent of Chile’s exports, with the mining sector, dominated by copper, accounting for at least 8 percent of GDP. (Since copper-related industrial activity is not included in this estimate, the true impact of copper in the economy is likely to be underestimated in this figure.) CODELCO, the state copper company, contributed 3.6 percentage points to GDP in 1997 and accounted for more than 10 percent of the national government’s revenues. Earlier analytical studies, which considered the long-term effects of the mining sector on real exchange rates, wages, fiscal revenues, growth, economic cycles, and inflation, all concluded that copper “has played a crucial role in the Chilean economy.”
Impact: Short and long term
To determine the degree to which the copper price cycle is correlated with the Chilean business cycle, Spilimbergo examined the behavior of Chile’s GDP and compared the evolution of the main components of GDP with copper price cycles.
For all three major copper cycles over the 1987-97 period, GDP growth in Chile peaked three to six months after the peak of copper prices. All the components of GDP proved to be procyclical, but each component exhibited a somewhat different pattern around the cycle.
Investment, Spilimbergo notes, is the most consistent with, and sensitive to, the copper price cycle. In all cases, it peaks one quarter after the copper price peaks. On average, fixed investment grew by more than 30 percent on a four-quarter basis at the peak of the cycle. “In particular,” he stresses, “investment in machinery, which is mostly imported, surged at virtually the same rate in both cases for which the data are available.” Imports, which are highly correlated to investment and the consumption of durable goods, show a pattern similar to that of investment.
For exchange rates, the effects of copper cycles on exchange rates are also strong and correlated with the copper cycle. In each cycle during this period, the nominal exchange rate appreciated (or depreciated less) during the booms and depreciated (or appreciated less) when copper prices declined. On average, the turning point corresponded to the peak in the price of copper and preceded by one or two quarters the peak of the business cycle. Foreign currency inflows increased in the early phase of the copper cycle—a direct result of higher copper revenues and an indirect effect of increased foreign investment. Both factors put upward pressure on the exchange rate, which appreciated until copper prices peaked. When copper prices declined, the appreciation of the real exchange rate slowed until it stabilized about one year after the peak of the cycle.
The exchange rate pattern also helped shape the inflation rate behavior. When the real exchange rate appreciated during the first phase of the cycle, inflation declined rapidly. When copper prices fell and the rate of appreciation slowed, inflation stopped declining in two cases and rose sharply in one case in 1989. Inflation always declined when copper prices increased, but inflation did not rise when copper prices dropped. This asymmetric behavior, Spilimbergo suggests, may reflect an asymmetric response of monetary policy to the copper cycle.
Real wages exhibited a quickening of the rate of growth as copper prices increased, which may reflect, Spilimbergo theorizes, both an increase in nominal wages and a slowing down in inflation, given the use of a backward-looking indexation mechanism. Real wages typically slowed after copper prices peaked. The rise in real wages during the first phase of the cycle may also explain the increase in private consumption that is observable one or two quarters after the copper cycle peak.
In terms of the longer-term implications of the copper price cycle for Chilean growth, Spilimbergo’s data suggest that exports may affect long-run growth, particularly through investment (which in turn affects imports). While private consumption is little changed by copper price trends over the long run, Chile’s fiscal position has historically improved sharply when copper revenues swelled. In the 1990s, however, Chile’s extensive structural reforms have tended to diminish the dependency of the country’s fiscal accounts on copper.
How copper influences the business cycle
After finding strong evidence of a correlation between copper cycles and Chile’s business cycle, Spilimbergo tested the means by which this effect could be transmitted. He found that
• There is no evidence of long-term changes in consumption growth due to changes in copper export growth, thus ruling out a wealth effect. By contrast, real wages did increase when copper prices rose—a product either of the correlation between a rise in the price of copper and a decline in inflation or of the availability of greater public sector resources during copper booms and higher nominal wage increases.
• New investment is attracted when higher copper prices are, or are perceived to be, permanent. Foreign direct investment in Chile surged during copper cycle peaks and was concentrated in the mining sector.
• Chile, aided by prudent macroeconomic policies throughout the 1990s, wisely administered copper export revenues and avoided the rent-seeking behavior that was a widely experienced consequence of high commodity prices and surging capital inflows in other countries.
• The monetary effects of the copper price cycle tended to bolster Chile’s efforts in the 1990s to limit the size of the current account deficit. Monetary policy was more expansive in the first phase of the copper cycle, when the current account improved, the exchange rate appreciated, and inflation declined. By contrast, monetary policy grew more restrictive in the later phase when copper prices declined, the current account position worsened, the exchange rate depreciated, and inflation did not go down.
• Copper cycles have also been very relevant for the fiscal balance, even though their importance has been decreasing thanks to the development of alternative sources of revenue and the introduction of the Copper Stability Fund.
Fixed investment in machinery, fourth-quarter growth
Distance from copper price peak
Data: IMF, Copper and the Chilean Economy, 1960–98.
Copper mining in Chile
In 1971, Chile nationalized its large copper mines, which at the time were owned chiefly by U.S. multinationals. By the end of the 1970s, Chilean government-owned mines accounted for 85 percent of national copper production.
In 1974, however, Chile created a legal framework for foreign investment in the mining sector and in 1980 readmitted foreign investment in large new mines. It also adopted a fiscal regime that provided incentives for foreign investment in the mining sector (foreign investors are subject to no royalty payments and are eligible for reduction in their tax burden through accelerated depreciation).
Between 1974 and 1989, foreign investment in the mining sector grew by an annual average of $90 million. By 1990, the annual growth in foreign investment in the mining sector was $803 million. With more than half of all the foreign investment in Chile between 1989 and 1995 going into the mining sector, the share of large private mines in total output rose to 54 percent in 1996 from 6 percent in 1980. By contrast, the share of CODELCO, the state copper company, in total output shrank to 39 percent from 84 percent over the same period.
Fourth-quarter GDP growth
and real copper price
In constant terms.
Data: IMF, Copper and the Chilean Economy, 1960–98.
Copper still matters
Ultimately, Spilimbergo concludes, copper prices have important implications for short-term fluctuations in the Chilean economy and also are likely to exert an influence on long-term growth. Among the many mechanisms through which copper prices affect the economy, investment appears to play the most significant role. The exchange rate appreciation that high copper prices have triggered has also favored the central bank’s policy of progressive disinflation. According to the study, the fastest gains in the disinflation policy have been obtained when the copper price was increasing. The central bank tended to use periods of decreasing copper prices to consolidate gains in disinflation. Also on the positive side, there is little evidence of a correlation between the copper price cycles and booms in either consumption or share prices.
Copper has played, and is likely to continue to play, a key role in the Chilean economy. But Spilimbergo emphasizes that the reasons for Chile’s success in the 1990s are many and go well beyond the development of the copper sector. Increased macroeconomic stability and diversification have served Chile well and have been the product of sound policies and sustained and far-reaching structural reforms.
Almost half of the world’s known reserves of copper are concentrated in two countries: Chile (28 percent) and the United States (17 percent), according to the 1998 U.S. Geological Survey. Copper production is even more highly concentrated, with Chile accounting for 34 percent of production, and the United States accounting for 17 percent. The long-term prospects for copper production are expected to be good, although copper faces increased competition from optic fibers in the telecommunication industry and from aluminum in the construction and automotive industries.
Ian S. McDonald
Senior Editorial Assistant
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Copies of IMF Working Paper No. 99/57, Copper and the Chilean Economy, 1960–98, by Antonio Spilimbergo, are available for $7.00 each from IMF Publication Services. See page 180 for ordering information. The text of this and other IMF Working Papers can also be found on the IMF’s website, http://www.imf.org.