Augusto Pinochet in 1973, in his message to the nation, stated, “The aim is to make Chile not a nation of proletarians, but a nation of entrepreneurs.” And now, here’s a fun fact:A report by the Global Entrepreneurship Monitor i.e. GEM(2019) shows that Chile has a total entrepreneurship activity rate of 25.1%, positioning her at third place, globally. The data compiled by the study shows that Chile is one of the economies where entrepreneurship has grown the most. Surprising, isn’t it?  Witnessing a plan actually coming into action. But wasn’t Chile always an entrepreneurially strong nation? Hasn’t Chile’s economic performance and the resulting welfare improvement always been recognized internationally? One might be tempted to think so but the road wasn’t always this smooth. It is after the reorientation of the Chilean economy in the 1980s, more commonly referred toas “The Miracle of Chile”, that it actually started flourishing. Yes, you read it right. There was a time when Chile’s inflation was at 150% which further reached 375% in 1974 (the highest rate in the world) under Pinochet’s rule, who was the then President of the Government Junta of Chile. The inflation was so high that the price of basic goods doubled every two months. For e.g., a family that used to buy 5 gallons of milk could now afford to buy just 1 gallon. There was a steep decline in wages and family allowances. The budgets for health, housing and education had dropped by 20% on average. Around 48% of Chileans lived below the poverty line. The factors responsible for the inflation included protectionism i.e. restricting imports from other countries, expropriation or using the privately-owned property by the government for public good against the will of private owners, and last but not the least increase in money supply by the Central Bank to finance the increasing government deficit. To deepen the inflation, the US government presented an unfavorable economic policy towards Chile because it was under Salvador Allende’s rule (1970-1973) when he apparently nationalized its copper industry. Does that remind you too of the Venezuela Crisis where Chavez, Venezuelan President, began to nationalize industries (oil, gold, etc.) at the great national expense, all funded by high oil prices and unchecked borrowing? Venezuela became overburdened with high levels of debt. Well, let’s not get carried away. So, as I was saying,mining is a very important sector of the Chilean economy. For many years, copper has been their main export and the nationalization of copper industry gave the state, ownership of “greater copper mining”. As a result, US firms declined the export of machinery and transport equipments to Chile due to which the transport sector of Chile could not operate because of a lack of tires or spare parts. This meant that in many industries, no new machineries were installed, no new firms were started, fewer new jobs were created, which further lead to unemployment. This economic policy by the US government was meant to weaken the Chilean economy by depriving it of the resources necessary to function. This is also known as “economic warfare” wherein a nation uses measures to incapacitate the economy of another state. Followed by the economic warfare in 1973, Salvadore’s civil government was succeeded by Pinochet’s Junta/military government. Before Pinochet assumed power, he was made aware of a confidential economic plan that had been prepared by the economists, more popularly known as Chicago Boys, having studied at the University of Chicago. This plan included a set of reforms like liberalization, privatization, removal of state regulation or deregulation and stabilization of inflation. It was after Pinochet assumed power in 1974, that a radical transformation took place. Before 1974, Chile had been one of the most protectionist economies in the world. He implemented the reforms laid out in the plan in three phases 1974-1983, 1985 and 1990. The copper industry which was nationalized remained in the hands of the government, however, the private sector was encouraged to develop new mines. There was a dramatic increase in public expenditure during that period.Between 1970 and 1980, public expenditure inChile had peaked at 44.9 percent of GDP.The annual growth rate between 1975 and 1981 was around 8%. In 1980 Chile ran a “surplus”of 3.1 percent of its national income. Controlling inflation(refer to fig 1.1) was one of the achievements that the Pinochet administration was the mostproud of. While other South American nations were experiencing high debt-to-service ratios, Chile had very little access to international credit. In 1980, Chile did not see an increase in external borrowings at all because Chile’s government was running a surplus which it could use to finance projects. By 1980, Chile had every reason to believe that the great economic transformation has begun and that Chicago Boys had worked their miracle.If things were going as planned, why did the recession take place in 1982? Didn’t Pinochet implement the reforms and bring about a complete reorientation? These are some questions that you might have come across because taking all of these factors into consideration, one must be inclined to agree with the economists who insisted that reorientation of the economy had taken place and that there could not be any debt crisis. But then, what happened? How did it get so bad?  

(Fig 1.1) Inflation Rate of Chile

It was in 1975, Milton Friedman, an American economist, in his letter to Pinochet laid out what he thought Chile’s economic policies should be. To stabilize inflation, he suggested reduction of government deficit and a commitment by the government, that it will no longer finance government spending by creating money, which was taken care of, thanks to Chicago Boys & Pinochet. Also, he suggested free-floating exchange rates but Pinochet government in 1979 decided to peg the exchange rate at 39 pesos to the US dollar because Pinochet administration was more committed to anti-inflation policy and this somewhat anti-free market decision placed an effective ceiling on any inflation Chile was to suffer and also provided the benefit of a stable currency in the minds of foreign investors who were considering sending their funds to Chile. It was a win-win situation. But what happened was completely unanticipated.As a result of peso being pegged to the US dollar,the economy had to witness a serious balance of payments problem. Before 1979, the peso was devalued three times a month. This intense supervision and adjustment of the nominal exchange rate was out of constant fear of inflation. By 1979, thanks to constant supervision, Chile was seeing an inflation rate of 38.9% - definitely lower than the ridiculously high rates of 5 years earlier but it was still not acceptable to the Pinochet government, hence the decision to peg the currency. In the1970s, the US dollar was rapidly declining in value and was considered weak relative to the appreciating Peso. With the exchange rate 39 pesos to the weak US dollars, it did not take long for international investors to see the bargain. Soon, Chile was flooded with the dollars of investors buying up the strong pesos. As per the report by the New York Times, the interest rate on pesos deposits rose above that of US dollar deposits. The Chilean buying power of foreign goods started increasing drastically. But in the 1980s, when the Presidential elections took place in the US, the dollar started regaining its strong position in the world market because of better enforcement of the monetary policy. Now, it was one strong dollar for 39 weak pesos. As a result, capital investments that skyrocketed in the 1970s when the peso was strong started disappearing. Net inflows that accounted for 15% of GDP during 1979-81 fell down to 5% in 1982. In actuality, this inflow of capital was merely speculative capital which proved disastrous for the Chilean banking sector because it did not enter the country with the goal of building enterprises and was, therefore, certainly not intended to remain in the country for long. As soon as the advantage of holding pesos disappeared, speculators withdrew their investments and when that happened, it left behind many problems with which Chile had to deal. Chile had to buy up the immense amount of foreign currency to defend its fixed exchange rate for which the Pinochet government injected 70 billion pesos into the nation’s money supply. During periods of expected inflation, a large increase in the demand for loans is observed. This is exactly what happened, consumers and businesses alike started borrowing money in the hope of paying it back in the future when the currency would actually worth less than when they were borrowed. Due to an increase in borrowings, interest rates started rising once again. And as expected, inflation did follow and rose from 9% in 1982 to 25% in 1983. As a result, there was a steep decline in savings from about 16% in 1975 to 12.4% in 1981 and a rapid increase in lending as a result of which banks started turning bankrupt. By the end of 1981, Chile announced that its financial institutions were $2.5 billion in debt more than twice the capital possessed by them.And even after listening to the cries of Chilean businessmen, farmers & others suffering from the loss of competitiveness in the international market, Pinochet refused to devalue because he had confidence in the fact that Chile would be out of the crisis by 1983. William Faulkner, one of my favorite authors, once said, “confidence has the tendency to turn into stubbornness when things start to fall apart.” That is exactly what happened in Chile when its entire banking sector had to pay because of Pinochet’s stubbornness. As a result of which, the Central Bank of Chile was forced to absorb the debt of the private banking system.It is ironic how one decision to curb inflation eventually resulted in an inflationary situation. Many economists are of the view that had Chile’s exchange rate policy been handled differently, the recession may not have been completely avoided but at the very least would have been less painful.At this point one might think, could the recession of the early 1980s possibly throw overboard the efforts of all those years? Well, no. In 1983, Pinochet under pressure from IMF which considered Chile to be in deep trouble, decided to devalue. After the crisis, theIMF and World Bank stepped in to set Chile on the road to financial recovery. The World Bank granted loans to Chile to fund 4 targeted projects aimed to rebuild the economy. First, it was observed that Chile needed intervention to deal with matters relating to medium term and long-term financing.The World Bank thusresponded with the Industrial Finance Restructuring Program (IFRP) whereby a loan amount of $100 million was provided. Its principal objective was the overall financial strengthening of large industrial firms. The 2^nd project conceived at the same time was Small & Medium Industry Project (SMIP), whereby a loan of $40 million was provided with the motive of assisting small & medium companies with the hope of generating jobs, thus, reducing unemployment. The next two projects were Industrial Finance Project (IFP) and Financial Markets Loan (FML). IFP was designed to provide loans worth $75 million to provide investment opportunities to industries, particularly medium-sized industries. FML, on the other hand, was distinct from the other 3 projects. It aimed to provide $100 million to the Chilean government mainly to deepen the “securities market”. In 1989, firms that had received loans out of the IFRP were witnessing an increase in revenues by more than 50% per year and around 1700 firms benefitted from SMIP, as the newly created investments funded by it turned out to be profitable.FML was considered a great success as it contributed to the rapid growth of Chilean pension funds, life insurance corporations and the security exchange. This recovery and subsequent growth took place only after Pinochet left office as it was after he left the office that banks that were nationalized during the crisis were decided by the new government to be eventually “re-privatized”. In 1985, Patricio Aylwin assumed office. He was the first President of Chile after dictator Pinochet, and his election marked the transition to democracy.  His government was more focused on financial solvency and economic growth. Under his regime, exports grew rapidly and unemployment went down. There was a program “growth and equity” emphasizing both economic liberalization and poverty reduction which was completely ignored under Pinochet’s regime as economic inequality increased massively under his rule. The Aylwin government also introduced a tax reform which boosted tax revenue and enabled the administration to increase government spending on social programs. In addition to improving the income of companies and people, the Aylwin government strengthened the capital market by allowing a large group of people to own stocks. It is indeed surprising to see how Chile’s banking system, and in fact, its entire financial sector, was turned around from near bankruptcy to success. Today, Chile is in a much better situation than its neighbors. GDP Growth rate is positive, inflation is low and the budget is almost balanced. In contrast, other Latin American nations like Argentina are experiencing high levels of inflation and economic upheaval which can be illustrated in the following diagrams. And it couldn’t have been possible without Pinochet’s administration because they did bring about a complete transformation in the country and would’ve achieved the desired results had they decided to go with a free and floating system of exchange. Also, Pinochet’s dictatorship couldn’t ensure social welfare because of his utter commitment towards economic good, which is always a shortcoming in a dictatorship. There was a need for democracy or free society to ensure both social and economic welfare and the irony is, that the return of democracy in Chile was the result of free-market reforms introduced under Pinochet’s regime. To quote Milton Friedman, “the real miracle is that a military junta was replaced by a democratic society and that free markets worked their way in making it possible”.

Inflation Rate