This paper examines the sources of growth in Chile and compares Chile’s experience with that of other countries. Two alternative measures of the sources of growth for Chile are presented to facilitate comparisons with other studies. The first measure adjusts factor inputs for the degree of utilization (using the unemployment rate), and the second measure introduces an index of the quality of factor inputs. The paper presents estimates of potential output of Chile for 1971–95, and also discusses the projections of potential output growth for Chile over the medium term.

Abstract

This paper examines the sources of growth in Chile and compares Chile’s experience with that of other countries. Two alternative measures of the sources of growth for Chile are presented to facilitate comparisons with other studies. The first measure adjusts factor inputs for the degree of utilization (using the unemployment rate), and the second measure introduces an index of the quality of factor inputs. The paper presents estimates of potential output of Chile for 1971–95, and also discusses the projections of potential output growth for Chile over the medium term.

Basic Data

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Includes central bank losses.

Medium- and long-term public and publicly guaranteed debt over total current account credits.

Excludes reduction of debt through debt conversions.

Changes as percent of liabilities to the private sector at the beginning of the period. Flows based on constant end-of-period exchange rates.

Includes prepayment of debt through purchases abroad of Chilean external debt at a discount.

Gold valued at US$42.22 per ounce.

Includes publicly guaranteed private debt.

I. Potential Output Growth

The concept of potential output is central to the analysis of cyclical developments and medium-term growth prospects and plays an important role in the assessment of the stance of macroeconomic policies. The discussion of the sources of growth and the estimates of potential output growth for Chile presented in this chapter are based on a production function approach. Section 1 examines the sources of growth in Chile and compares Chile’s experience with that of other countries. Section 2 presents estimates of potential output of Chile for the period 1971-95, and Section 3 discusses the projections of potential output growth for Chile over the medium term.

1. Sources of growth

Growth accounting is a useful framework for assessing alternative explanations of a country’s growth experience and provides a basis for medium-term projections. However, the measurement of the contribution of various factors of production to growth is quite sensitive, inter alia, to adjustments to factor inputs for utilization and quality and to assumptions on the share of capital. In this section two alternative measures of the sources of growth for Chile are presented to facilitate comparisons with other studies. The first measure adjusts factor inputs for the degree of utilization (using the unemployment rate), while the second one introduces an index of the quality of factor inputs.

a. Chile’s experience

The basic growth accounting framework starts from a neoclassical production function, which defines GDP (Y) as a function of total factor productivity (A) and factor inputs (capital, K, and labor, L):

Yt=AtKtαLt1α(1)

Data on the total capital stock were provided by the Central Bank of Chile and were adjusted for utilization, using series of unemployment from the National Bureau of Statistics (INE). Data on employment from the INE and the University of Chile were used as a proxy for the labor input. The share of capital in GDP (a) used in this study is 0.44, the coefficient on capital of an estimated production function (see Roldós, 1996).

The Chilean economy grew at an average annual rate of 3.7 percent in real terms in 1971-95 (Table 1, Panel A). During that period labor and capital contributed in about equal amounts (1.3 and 1.6 percent) to the growth rate of GDP while total factor productivity (TFP) growth contributed with 0.8 percent (or about 22 percent of the total). 1/ More recently, in the period 1986-90 factor inputs and TFP contributed about equally to the growth process, with an important contribution coming from labor. In contrast, during 1991-95 capital formation and TFP growth had a dominant role.

Table 1.

Chile: Sources of Growth

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Sources: Central Bank of Chile; National Statistics Institute; and staff estimates.

Date on employment were used for the labor input. The capital stock data were adjusted using the actual unemployment rate.

The contribution of the labor input to growth in the second half of the 1980s--a result of the reduction in unemployment from 18.9 percent in 1982 to 4.6 percent in 1993--was stressed by Marfán and Bosworth (1994). These authors also concluded that the more recent acceleration of TFP growth was largely due to cyclical factors, in contrast with Dornbusch and Edwards (1994) and De Gregorio (1994) who attribute the recent gains in productivity to the process of structural reform and consider them to be of a more permanent nature.

To improve the estimates for TFP, the present study allowed for quality change in factor inputs by using indices that reflect changes in the composition of the capital stock and the labor force that make aggregate inputs more productive (see Harberger (1990) and Barro and Sala-i-Martin (1995)). The production function can be redefined as:

Yt=At(Ktzt)α(Ltht)1α(2)

where z and h are the indices of quality of capital and labor respectively. The index of quality of labor is defined as a weighted average of labor with different levels of education-where the weights are relative wages--and was estimated by Jadresic and Sanhueza (1992). The index of quality of capital is a weighted average of machinery and equipment, on the one hand, and of buildings and structures on the other--where the weights are relative rental rates.

The index of labor quality displays clearly an upward trend, possibly reflecting improvements in human capital and a shift to higher-skill jobs. The quality of capital index shows a more uneven pattern (Chart 1), mainly reflecting the changes in the share of machinery and equipment in the capital stock that drops slightly over most of the 1970s before rising from less than 20 percent in the late 1970s to 31 percent in 1995. It should be noted that these indices do not account for the differential productivity of capital and labor of different “vintages”--which remains to be captured in the residual TFP.

CHART 1
CHART 1

CHILE: CAPITAL AND LABOR QUALITY INDICES

Citation: IMF Staff Country Reports 1996, 089; 10.5089/9781451807455.002.A001

Sources: Central Bank of Chile; and Fund staff estimates.

Introducing quality change in factor inputs brings into a sharper focus the relative roles of these inputs on the growth experience of the last decade (see Table 1, Panel B). In particular, in 1986-90 the quality-adjusted labor variable explains close to 60 percent of the growth rate of GDP, compared to 30 percent explained by the unadjusted labor variable, as the effect of the increase in the share of skilled labor in total employment--now captured by the labor quality index--is superimposed on the fall in unemployment. In 1991-95 the accumulation of capital is the main engine of growth, explaining 55 percent of output growth owing to the increase in the investment rate as well as the rising share of machinery and equipment in total capital. With these changes, TFP growth is reduced significantly compared with the unadjusted figures. For the period 1986-90, it falls from 2.2 percent (without adjustment) to 0.9 percent, while in the period 1991-95 estimated TFP growth falls from 3.3 percent to 1.4 percent.

b. International comparison

Chile’s sources of growth also could be assessed by examining the experience of other countries with comparable phases of growth acceleration. Table 2 summarizes the results of two studies using comparable methodologies that also adjust for quality change in factor inputs. The first study focuses on a sample of OECD countries in the postwar period up to the 1973 oil shock (Christensen, Cummings and Jorgenson, 1980), and the second one concentrates on Korea and Taiwan Province of China (Young, 1995). The results show that the rapid growth in the East Asian countries is largely explained by the accumulation of quality-adjusted inputs, and that TFP accounted for only one fifth of the GDP growth rate. They also show a relatively large contribution of the labor input in East Asia, a result of an increase in participation rates. For the OECD countries, the increase in participation rates is much slower than in Southeast Asia and it is sometimes outweighed by a decline in average hours worked.

Table 2.

Sources of Growth—International Comparison 1/

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Sources: Panel A: Christensen, Cummings, and Jorgenson (1980); Panel B: A. Young (1995).

Capital and labor inputs adjusted for quality.

The recent Chilean experience shares some of the features of the East Asian economies. In particular, Garcia (1995) shows that the participation rate has increased by more than four percentage points between 1986 and 1994, largely as a result of an increase in female participation. Although investment rates have not reached the levels of some Asian countries, they have increased substantially—from around 20 percent of GDP in the late 1980s to 27 percent in 1995. Chile and the East Asian countries also share relatively low contributions of TFP compared with OECD countries.

2. Potential output estimates

The analysis of the sources of growth presented in the previous section was based on actual GDP and factor utilization series adjusted for quality. In order to estimate potential GDP the cyclical components of TFP and the labor input need to be removed. The smoothed series for TFP and the full utilization levels of labor and capital are combined according to equation (2) to produce the potential output estimates.

To this end, the series on TFP was smoothed using the Hodrick-Prescott (HP) filter. The smoothed series displays a negative trend until 1985, when it begins trending upward (Chart 2). 1/ This seems to be broadly in line with studies on Chile’s growth experience during the 1970s and 1980s (Marfán and Bosworth, 1994, Jadresic and Sanhueza, 1992), which found a fairly flat or even negative trend for TFP attributed to the deep recessions of 1975 and 1982 and the initial impact of the structural reforms undertaken in the period under study. This trend appears to be reversed in the late 1980s and the first half of the 1990s with the consolidation of the process of stabilization and structural change.

CHART 2
CHART 2

CHILE: POTENTIAL OUTPUT, 1970–95

Citation: IMF Staff Country Reports 1996, 089; 10.5089/9781451807455.002.A001

Sources: Central Bank of Chile; and Fund staff estimates.1/ Assuming a natural rate of unemployment of 5.5 percent.2/ Natural rate of unemployment estimated using a Hodrick-Prescott filter.

Two approaches were used to remove the cyclical component of employment. The first one, followed by Jadresic and Sanhueza (1992), assumes the natural rate of unemployment (NRU) at 5.5 percent (the average of the actual unemployment rate in 1990-95, when the economy appeared to have attained full employment) and replaces the actual unemployment rate with that figure. 1/ The second one smooths the labor input by applying the Hodrick-Prescott filter to the actual employment figures. This permits to capture a possible increase in the natural rate of unemployment in the late 1970s related to the initial frictional costs of structural reforms, in particular those derived from trade liberalization (see Chart 2). 2/ It also allows to capture the trend component in labor force participation, which according to García (1995), was accompanied by a large cyclical component.

Estimates of potential output using the labor input that results from the two approaches to calculate the natural rate of unemployment and the smoothed TFP series show a similar pattern (see Chart 2, bottom panels), especially for the last decade. In particular, both estimates show a positive output gap in the years when the economy was deemed to be overheated (1989 and 1992-93), leading the Central Bank to tighten monetary policy. The results also show that after a slowdown in 1994, the resumption of output growth in 1995 left the economy slightly above potential. Finally, assuming real GDP growth of 7.4 percent for 1996 would leave the level of output somewhat more than 2 percent beyond its potential providing support for a tightening of financial policy. 3/

3. Potential output projections

Based on the adjustments explained in the previous section, a baseline projection for potential output was made as an extrapolation of the trends of the last five years for each of the components in equation (2). The average growth rate of real GDP for the period 1995-2000 in this baseline projection was 6.9 percent. This baseline projection was supplemented with estimates of high and low bounds for potential output growth. Under the assumptions on factor inputs and TFP growth described below, the projections using equation (2) yielded 6.4 percent for the average low growth rate and 7.5 percent for the average high growth rate.

Population growth was estimated at 1.7 percent a year during 1996-2000 (from the United Nation’s Economic Commission for Latin America). The participation rate in Chile, which is still fairly low compared to other countries, was assumed to increase from the current level of 54.7 percent to 56.7 percent by the year 2000 in the high growth scenario, and to 56.2 percent in the low growth scenario. The unemployment rate was assumed to remain at about 5 percent in the low growth scenario and to fall to 4.2 percent by the year 2000 in the high growth scenario.

The index of quality of labor in Chile rose at an average annual rate of 1.7 percent in the period 1985-95, but slowed down to 0.9 percent in the last five years. A comparable measure of labor quality for Korea and Taiwan Province of China during 1966-90 shows average growth rates of 1 percent and 0.3 percent respectively (Young, 1995), reflecting a structural shift toward higher skill jobs in the composition of the labor force. Taking into account these elements and the Government’s commitment to step up investment in human capital, the projections for Chile assume that the quality of labor would grow at 0.8 percent a year through 2000 in the high growth scenario, and at 0.6 percent a year in the low growth scenario.

The recent acceleration of physical capital accumulation was assumed to continue in the high growth scenario, albeit at a slower pace with gross fixed capital formation rising from the current level of 27 percent of GDP to 29 percent by the year 2000. In the low growth scenario fixed capital formation was assumed to return gradually to 24 percent of GDP (the level prevailing at the beginning of the 1990s). The index of quality of capital was assumed to remain unchanged in the low growth scenario, and to grow by 0.5 percent a year in the high growth scenario.

Despite its recent acceleration, TFP growth in Chile has been slower than in other countries. Looking ahead, it is reasonable to expect an increase in TFP growth because of the recent investment in equipment (suggesting a larger share of more productive “vintages” of capital) and the large fraction of mat equipment that is imported, which has proven to be a vehicle for knowledge spillovers (Coe, Helpman and Hoffmaister, 1996). On that basis, the low growth scenario assumes a TFP growth rate of 1.9 percent and the high growth scenario one of 2.4 percent, compared to an average rate of 1.4 percent in the last five years.

References

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1/

The low contribution of TFP for this period may be associated with weaknesses in the data. For example, data on hours worked are not available and the series on employment that were used may underestimate the fall in utilization of inputs in the deep recessions of 1973-75 and 1982-83.

1/

The estimation of a cointegrating regression between GDP and factor inputs confirms the existence of a negative deterministic trend as well as a positive break in the trend from 1985 onwards (see Roldós, 1996).

1/

The natural rate of unemployment measures that fraction of the labor force that is unemployed due to normal frictions in the process of job separations and findings (Barro, 1984). It is hence consistent with the concept of full employment of resources and potential output.

2/

The average unemployment rate in 1976-80 was 13 percent despite average real GDP growth of 6.8 percent.

3/

The size of the output gap in 1996 would be similar to that of 1989 but smaller than the 3.7 percent of 1992.

Chile: Recent Economic Developments
Author: International Monetary Fund