Economically speaking, Chile’s new government could hardly have had a better start. President Michelle Bachelet, who took office in March heading the fourth term of the centre-left coalition that has governed since 1990, inherited an economy riding high on a tide of 6% annual growth.
That strong growth would, the government anticipated, allow it to finance new social programmes worth $6 billion over the four-year administration, without increasing taxes or breaching a structural surplus fiscal rule in place since 2000. Under this counter-cyclical policy, government spending is capped at a level that would give a budget surplus of 1% of GDP if the economy were growing in line with its medium-term potential and if the price of copper, Chile’s main export, were at its expected average for the next 10 years.
But since March, copper prices have climbed to well over $3 per pound, doubling last year’s average. That has boosted the earnings of Codelco, Chile’s state copper producer, and tax revenue from private mining companies, and by June the budget surplus had already reached 4.2% of annual GDP.
The catch is that, with per capita income still reaching only $7,000 and very unequally distributed, the copper boom has whetted the appetite of Chileans for a bigger slice of the national pie. “In a country like Chile, it’s far more difficult to administer prosperity than to manage poverty,” says Leonardo Suarez, senior economist at Larrain Vial, a local investment bank.
The risk, he says, is that Chile’s hallmark fiscal prudence could succumb to political pressure for higher spending. The new government’s shaky start has helped to fuel this fear.
In May, it only fumbled through three weeks of demonstrations and sit-ins by secondary school children, protesting against the poor quality of state education and demanding that some of the country’s copper riches be invested in their future. State health workers, civil service employees and Codelco miners are now also gearing up to join the queue.
Standing firm
But finance minister Andres Velasco – on leave from Harvard University, where he is a professor of international finance and development – has promised to stand firm on the fiscal rule, announcing a plan to save most of the government’s copper windfall. Under a law approved recently by Congress, two new investment funds will be created to provide for long-term pension liabilities and to set against future economic downturns.
Still, the government will be able to increase its spending by nearly $2 billion next year, representing a real increase of around 9%. “The budget will be perfectly compatible with macroeconomic stability,” assures Velasco, pointing to Chile’s current account surplus and the fact that, despite the higher cost of imported oil, inflation is within the central bank’s 2-4% medium-term target range.
“The composition of the budget also matters, and we’ll be emphasizing non-recurrent expenditure and, in particular, investment,” says Velasco in an Emerging Markets interview. In a bid to cushion the exchange rate against the pressure of high copper prices and protect the competitiveness of non-copper exports, the government will also be looking to channel as much public investment as possible into imported goods and services.
Spending on schools
But one of its main spending priorities next year will be education. Under a bill currently before Congress, the government plans to increase funding for state primary schools that receive children from families defined as vulnerable. The scheme will be introduced gradually over several years but, once in full operation, will have an annual cost of $300 million, estimates Velasco.
Other social priorities include increased access to nursery school education, which is particularly low among poor families – this will, as well as its educational impact, help to increase the low workforce participation of Chilean women, notes Velasco – and improvements in the quality of state-subsidized housing.
But during her election campaign, President Bachelet promised that her government’s flagship achievement would be a reform of the private pension system created in the early 1980s by general Augusto Pinochet’s dictatorship. The system, which has served as a model for pension reform in many other countries, has achieved healthy investment returns and promises to provide those Chileans, who contribute regularly throughout their working lives, with a decent retirement income.
However, it has failed to incorporate the self-employed – for whom contribution is voluntary but may now become obligatory – and many more workers, particularly women, have important gaps in their contributions. Moreover, the government would like to increase competition in the industry, which is dominated by six large players, so as to reduce administration charges.
Prior to presenting a reform bill to Congress later this year, the government has already increased state pensions by 10% and, under the reform, may further increase support for the elderly. It estimates that, as its historic liabilities under the former pay-as-you-go system are gradually extinguished, this will not mean a net increase in fiscal spending.
Business worries
However, there is some unease in business circles. One of the complaints is that, despite the government’s commitment to fiscal discipline, it is putting too much emphasis on redistribution.
“Increasing pensions is perfectly legitimate, but the political emphasis seems to be on redistribution, rather than growth,” says Suarez. In one worrying sign, he points to a sharp drop in the expansion of investment, which rose by only 2.8% in the second quarter, after expanding by almost 25% last year.
The drop has, Velasco admits, been rather more abrupt than anticipated, but he denies that it reflects a wavering of business confidence. “Let’s look at the facts – investment has grown this year; true, at a slower rate, but last year it expanded at a completely unsustainable rate, due to a bunch of very big investment projects,” he argues.
Critics also point out that, despite record copper prices, Chile’s growth rate is slowing and will reach only just over 5% this year, down from 6.3% last year. But, according to Velasco, that is also unsurprising.
One of the objectives of Chile’s fiscal policy and its inflation-targeted monetary policy is to reduce the economy’s volatility in the face of swings in the price of its commodity exports, and to keep growth in line with its medium-term potential rate, which is currently estimated to be around 5.3%. “In other words, we’re roughly on trend,” insists Velasco.
“What this shows is that Chile, unlike many other emerging markets, is managing to insulate its economy from external shocks – not fully, but at least partly so,” he says. That is an important achievement. The question now is whether the government’s economic virtue will stand the political test of convincing Chileans that it is in their best interest.