Current Legal Issues Affecting Central Banks, Volume III.
Chapter

Chapter 9 Legal Aspects of Economic Reform in Latin America: The Case of Chile

Author(s):
Robert Effros
Published Date:
August 1995
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Author(s)
HERNÁN FELIPE ERRÁZURIZ

What has happened in Chile is quite different from what is happening in Eastern Europe because Eastern Europe has to build a new economic system while Chile has had to rebuild and modernize one. However, the goal is the same: to create a market-oriented economy. In Chile, achieving that goal has taken 20 years, and the process is still incomplete. During these 20 years, comprehensive changes have been made. Almost every piece of legislation has been changed, as well as many important regulations and even the Constitution.

Chile’s Economic History

The Chilean case is similar to that of many Latin American countries. From the Great Depression in the 1930s until the early 1970s, Chile had a very centralized economy. At one point, almost 90 percent of the mining companies, almost every utility, and approximately 95 percent of the financial institutions belonged to the state.1 State-owned companies were the most important part of the economy.

Structural changes had to be made through privatization. Changes had to be made in the social security system, the labor market, and almost every area of the economy. The effects of those changes have proved that this was the right way to deal with the country’s economic problems. Since the mid-1980s, Chile has had sustained growth at an annual rate of 6 percent.2 Although Chile’s economy is medium sized in the context of Latin America (being 16 times smaller than Brazil, 3 times smaller than Argentina, and 2 times smaller than Venezuela or Colombia in terms of GNP),3 Chile has been able to enjoy one of the highest per capita incomes in the region. One must recall, however, that in the early 1970s Chile’s economy spiraled to a point of almost total collapse.

Chile was similar to most Latin American countries in that it was poorly advised by the UN Economic Commission for Latin America to maintain a policy of import substitution and government interference.4 Following amendments to the Constitution in 1962, 1967, and 1971 that allowed expropriation without prior and fair compensation,5 the Government embarked on a course of expropriating property without sufficient payments. The payment period was up to 30 years,6 and approximately only half of the payment was indexed despite very high inflation.7 Large enterprises were nationalized, and almost every foreign company ultimately came into the hands of the Government.

During this period, Chile adopted overwhelming governmental regulation that limited the scope of the private sector, introduced price controls, and operated government monopolies. The official requirements tended to limit competition. Chile had state-owned monopolies with special regulations in each sector. Special laws allowed only a few drugstores in every neighborhood. Competition through exchange and trade barriers was restricted. The average trade tax was in the range of 90 or 100 percent. In addition to very high duties, government permits practically prohibited the importation of most merchandise that was needed. Licenses were allocated in a very discretionary way by the Government.

Chile had restrictions on foreign investment. It was a member of the Andean Pact, which had a membership including Bolivia, Colombia, Ecuador, Peru, and Venezuela.8 The members heavily restricted foreign investment in their countries. Foreign investors could not acquire interests in public utilities and were unable to control a local company.9 Remittances of profits were restricted, so foreign investors had to wait several years before they could send their profits home.10

The effect of these restrictions was to impinge upon the role of the central bank, because fiscal imbalances are accentuated in countries with inefficient public enterprises. Since the Government had such huge responsibilities, it went to the central bank, and the central bank, which at that time was not independent, lent all the monies that the Government needed. As a result, there was inflation, no investment, and no growth in the country. That was the situation for almost 20 years. At the end, the situation became critical as a result of increasing interference by the Government.

Liberalization in Chile

In the early 1970s, Chile began to liberalize the economy. The main goal was to create an efficient private sector. The first step was to establish confidence and certainty by enacting important legal amendments.

A new constitution in 1980 introduced new principles.11 The first principle was that the state is subsidiary to the private sector. It followed that if the Government wanted to expand its activities or to create a new state-owned company, it would have to go to the Congress. Bureaucrats could no longer create new enterprises.12 The second important principle was to guarantee property rights through protection against and compensation for expropriation.13 Compensation must now be adequate, prompt, and effective. In order to implement the guaranty, individuals were authorized to bring a writ before the Superior Court for any threats and damages to their property rights. A third principle was set out in a statute that made the central bank independent and prohibited it from financing the Government and state-owned enterprises.14 Furthermore, as a fourth principle, the imposition of taxes and duties was no longer left to administrative discretion.15 In the past, duties and tariffs could be imposed by the central bank, with the approval of the President. Now, they had to be approved by Congress.

A transition to a market-oriented economy from a centralized economy must be accompanied by the transfer of property and assets held by the Government. The process of privatization in Chile took several stages. First, the industrial companies were transferred, then the financial institutions, and finally the public utilities. This process was complex because the economy was in poor shape. When an economy is very weak, wealth needs to be created because local savings are not enough. Foreign investors had to be attracted, so a new foreign investment statute was adopted.16

In a market-oriented country, a foreign investment statute is not necessary. The best principle is to treat foreigners and nationals the same way. That is the principle of Chile’s foreign investment statute, with some minor differences that are related to exchange regulations.17 One of Chile’s biggest problems has been that it has not been able to integrate its financial system fully into that of the rest of the world. It did not have a free flow of capital. Chile retained some reserve requirements, and some authorization continued to be necessary from the central bank to meet the flows of capital.18 The central bank was reluctant to open completely the capital account even after 15 years of the liberalization process, although it is hoped that steps will be taken in that direction in the near future.

Another important aspect has been the deregulation process. While in some areas it is easy to lift price controls, where utilities are concerned the issue is complex. Consumers need protection, but at the same time investors need to be attracted to those utilities. In the past, in Chile, as in many other countries, utilities had a guaranteed safe return on their assets, which was fixed by the Government and subsidized. Major changes had to be made, and the political implications had to be considered. Utilities have a lot of power and a great impact on the people.

There was a similar situation in the labor markets. To change the labor laws is not easy. Even more difficult is to change the social security system, which in Chile’s case has been a key element in promoting the growth of the country. Chile made these changes in 1980, and since then more than 50 percent of the GNP is represented by the savings of private pension funds. Each worker in Chile has his or her own savings account that is managed through a private investment company, and most of these savings are invested in the private financial markets. This has been one of the most important elements behind the creation of a strong private sector.

All of these changes, which were made by a military government, have survived, been approved by, and, to some extent, been extended by the successor government. The mentality of Chileans has changed from that in 1970, when almost every foreign investment was expropriated with approval by the Congress, to today’s, when one of the main goals of the Chilean Government is to enter into a free trade agreement with the United States and Chile’s neighbors.19 A similar change in thinking is also occurring in many other Latin American countries.

During this process, important reforms were made in the supervising state agencies and the central bank. The central bank now has a different role and organization. The Chairman and the other four Board members are now appointed by the Government, but they cannot be removed during their ten-year terms.20 They must be approved by the Congress in their nomination.21 They have full authority to run the bank,22 and the Finance Minister has veto power only for some exchange control regulations and trade restrictions.23 In other cases, the Minister only has the right to postpone a decision to the next Board meeting.24

In its new role, the central bank is not allowed, as in the past, to make regulatory decisions on a case-by-case basis; it can only regulate in a general way.25 It is not allowed to fix duties and tariffs, as in the past. Only exceptionally can it enact some exchange controls and trade restrictions and then only for a certain period of time.26 Significantly, the central bank is not allowed to finance the Government or private companies.27 This new role of the central bank has made the Government balance the budget. The Government no longer has ready access to central bank financing. Article 98 of the Constitution makes this clear.28

The process of opening the economy has meant that Chile’s exports have increased over the past decade.29 Chile’s ratio of GNP to exports is one of the highest in Latin America. Besides an increase in the quantity of exports, there has been diversification in the types of exports. In the past, 90 percent of Chile’s exports was copper.30 Today, copper represents only 40 percent of exports.31 The remainder comprises nontraditional exports, whose rates of growth are increasing every year.

This process of opening and liberalizing the economy takes time. After 20 years, Chile still has public utilities in the hands of the Government. The biggest company in the country, the CODELCO copper company, remains state owned.32 The port authority is also in the hands of the Government. The Government has a monopoly in gas and oil refineries and in several other industries.33 This has to change. Chile’s neighbors are quickly progressing, so it cannot maintain this situation.

There has not been a unanimity of views on reform, and several areas in particular have generated much political discussion. One area involves the transparency of the transfer of public property. Everyone believes that the public assets are very valuable. Nevertheless, there has been criticism concerning the prices at which many public utilities were sold. The second controversial area concerns the social programs of the Government. Chile not only privatized its productive economy; it also privatized social services traditionally provided by the Government, including health, education, welfare, and urban development. Financing for education, especially for the universities, has been a popular issue of public debate.34 In the past, universities were free of charge. A change was made, however, and now scholarships are given only to the best students, with the others given a credit or voucher from the Government, which is not sufficient to pay all the costs of study. Similarly, in housing, the amount of subsidy has been insufficient. The system is not under discussion, but the amount of government subsidy is. Finally, government ownership of TV stations and some newspapers is a focus of discussion. The Government of Chile still owns the national TV system, although there are three or four private cable networks of lesser importance.

Conclusion

At the beginning of a comprehensive economic reform, there is a tendency on the part of some policymakers to think that they can solve every problem by copying laws from other countries and that, accordingly, they do not need advice. Eventually, they realize that other people have to understand what they are doing. Chile benefited by working in many of these areas with the IMF staff, especially with regard to the central bank statute. It also welcomed good advice from U.S. agencies in the areas of antitrust, stock market regulations, electrical power, transportation, and telecommunications.

This process cannot stop. It is always evolving. A public company may be privatized or sold, regulations may be changed, but still many regulations remain and still bureaucrats are tempted to create new state-owned companies. Each step in the reform must be defended; the process of deregulating the economy must continue.

It is very important to involve the people and to have good lines of communication to them through the press and universities. The benefits of deregulation must be explained, because at the beginning there is much reluctance to change. For example, when there is free education, it is difficult to explain why there needs to be a change to require people to pay for their education. However, if it is explained to the public that, if they pay, there will be more resources for better education, there will be greater support for the change. If the public is told that they are going to have to pay more for telephone calls, they will oppose the changes. However, if it is explained that there will be more telephones, better service, and the fees and tariffs of telephone calls are going to be fair, there will be more support for the change. Still, all of this has to be explained to the population. For that purpose, the attention of the media, academia, and entrepreneurs must be captured. Entrepreneurs in these countries favor subsidies and interference, and it is sometimes difficult to change their minds.

There are projections of the outcome of this process. Chile’s projections are not based on dreams but on the reality of the past decade. The GNP of Chile is expected to grow at an annual rate of 7 to 8 percent. Inflation is expected to continue to decrease. This is possible because Chile has a well-financed government and a stable exchange system. Investment has been high in recent years. Chile is going to make additional extensive changes in favor of the market. The role of government will be diminished further. Chile’s trade barriers with the rest of the world will be dismantled entirely. Comparing Chile’s trade barriers of 10–20 years ago, which were in the range of 100 percent, with today’s trade barriers of approximately 11 percent, it is not difficult to appreciate how this goal is within grasp.

Finally, Chile needs to improve its social indicators. Its per capita income is not what it needs to be to meet the challenges of the new century. Accordingly, Chile needs to invest heavily in education, develop its educational resources, and encourage transfers of technology to facilitate these goals.

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