The Chilean economy: Institutional buildup and perspectives Vittorio Corbo Governor 1
Outline 1. Introduction 2. Chile s economic reforms and institutional buildup 3. Performance of the Chilean economy 4. Conclusions 2
1. Introduction 3
Introduction Chile has shown outstanding economic performance during the past twenty years. Average growth in the last two decades was 5.9% and projections for 2007 range between 5%-6%. Inflation has declined steadily, approaching developedcountry levels. These results have been achieved within an economic model based on macroeconomic stability, strong institutional settings, robust financial sector, competitive open markets and a comprehensive social network. 4
2. Chile s economic reforms and institutional buildup 5
Period up to the 1970s In the early 1970s, the Chilean economy was closed to international trade, suffered from widespread price controls, a high degree of state intervention and severe macroeconomic imbalances: Fiscal deficit around 30% of GDP; Annual inflation rate above 500%; Average import tariff of 105% (with great dispersion), multiple exchange rates and many other restrictions to international trade (e.g., quotas); Price and interest-rate controls. 6
The 1970s In the 1970s, Chile initiated its economic transformation that continues to this day. First-generation reforms included: Fiscal adjustment: VAT was introduced in 1975 and fiscal surplus reached in 1976; Trade reform: non-tariff barriers were lifted and tariffs cut unilaterally to a flat 10% in 1979; Privatization: State-owned enterprises and banks were privatized or returned to previous owners. 7
Furthermore Previously controlled prices and interest rates were liberalized; Capital account restrictions were partly lifted while exchange rates were unified; Restrictions to banks and other intermediaries began to be removed. In 1981, Chile carried out a major reform to the social security system. 8
1982-83 crisis Stabilizing and market-oriented policies allowed quick growth. However, some weaknesses emerged. The fixed exchange rate combined with weak regulatory and supervisory frameworks of the banking system exacerbated moral hazard and fragility in the banking industry. The sharp external shock (i.e. the increase in world interest rates and the dollar appreciation of the early 1980s) was all it took to unleash a profound macroeconomic and financial crisis. 9
Reforms 10 The 1982-83 crisis uncovered major regulatory shortcomings and triggered in 1986 a revision of several institutions. In particular, second-generation reforms included: New banking and bankruptcy laws; The Central Bank being granted full autonomy and precluded by law from financing the government (1989). In 1989, a successful transition to democracy began, maintaining and strengthening the already thriving market economy model. Since then, additional weight has been given to social policies as a way to build social cohesion and accelerating poverty alleviation.
The 1990s In the 1990s, the reform process continued: Private sector involved in infrastructure development through BOT concessions (1991-92); Competition in telecommunications (multi-carrier system, 1994); Deeper integration into the world economy through unilateral tariff reductions (1991 and 1998) and FTAs: Canada (1996), Mexico (1998) and Central America (1999). Anti-trust rules (1994); Upgrading of banking regulation (1997); Gradual adoption of inflation-targeting regime (1991-99); Abolition of the exchange rate band (1999). 11
In the recent years Chile has continued strengthening its macroeconomic and institutional framework: Structural fiscal surplus equivalent to 1% of GDP was adopted by a fiscal rule (2001); All capital controls were abolished, completing the opening of the capital account (2001); Capital market reform (2001); FTAs continued and were signed with major trade partners: European Union (2002), EFTA (2003), United States (2003), South Korea (2003), China (2005) and P4 (2005); Competition Tribunals were created (2003). 12
3. Performance of the Chilean economy 13
Economic performance With the reforms, Chile acquired solid macro fundamentals together with modern and robust institutions, all necessary elements for attaining high and sustainable growth rates. During the 1990s, Chile was one of the fastest-growing economies in the world, largely due to efficiency gains. Closed its per capita income gap with developed countries by 30% in twenty years; Sharp contrast with the experience of other economies in Latin America, however still modest when compared to Asian developing countries. Gradual decline in inflation and inflation volatility, approaching industrial-country levels. 14
Successful monetary policy The inflation target, maintaining inflation most of the time around 3% with a tolerance range of +/- 1 percentage point, has been reached successfully: From Jan 2000-Dec 2006: Inflation averaged 2.9%; As a percentage of time (months), annual inflation has fallen: below 2% between 2% and 4% 15.5% 73.8% over 4% 10.7% Among 19 inflation-targeting countries, Chile ranks first in terms of smaller deviation from target and first in global inflation-targeting success (magnitude, persistence and frequency of deviation episodes). 15
Commercial and financial integration Due to the continuing process of commercial integration, Chile experienced a notably trade performance. Trade openness is higher compared to other Latin American countries and to world average. Chile s financial integration has increased remarkably since the 1990s. Financial openness is considerably higher than in other emerging countries, achieving developed-market levels. 16
Social indicators The fast expansion of this period allowed Chile to improve social indicators substantially: Incidence of poverty was cut in half in fifteen years; Mortality rate and life expectancy have also improved sharply. 17
Main strengths As a result of all of the above, Chile is today better prepared than in the past (and compared to other emerging economies) to accommodate shocks. Chile s main strengths include: A proved macroeconomic framework; Solid fiscal situation and very low public debt (a negative consolidated net public sector debt); Robust financial system; Strong institutions (e.g., rule of law, independent central bank). 18
Good international evaluation Chile is today one of the most competitive emerging market economies; Country risk is among the lowest; Moreover, the World Bank report on the ease of doing business ranks Chile 28 th among 175 countries in 2006. Chile is top of the list in the region. 19
Attractive tax system Chile s tax system is attractive to investors: Tax burden is low according to per capita income; Corporate tax is among the lowest (17%); Tax system is efficient: Based on a VAT complementing the income tax that includes several exemptions to eliminate distortions to saving. Integrated tax system: corporate tax is discounted from personal income taxes. 20
4. Conclusions 21
Conclusions The new economic model built over the last three decades is the main rationale for Chile s outstanding economic performance of the past twenty years. Chile s experience shows that there are some key elements in achieving sustainable economic growth: Macroeconomic stability with autonomous central bank and solvent fiscal sector; Robust and sound financial sector; Strong and stable institutional setting; Competitive open-market economy; Comprehensive social network. 22
Conclusions The solid macro fundamentals and robust institutions, together with the good prospects for the world economy, allow us to look at the future with optimism. GDP growth for 2007 is projected to be in the range of 5%- 6%. But economic development is a continuous process, and Chile still faces important challenges: Education, especially regarding quality; Technological innovation. 23
The Chilean economy: Institutional buildup and perspectives Vittorio Corbo Governor 24
Economic growth during the nineties (% per year) China Vietnam Malays ia Ireland Chile South Korea India Costa Rica Thailand Dom. Rep. Indonesia Argentina Bolivia Mexico Uruguay Peru United States Colombia Philippines Venezuela Canada Germany Ecuador United Kigdom Brazil Sweden Japan Italy 0 2 4 6 8 10 12 25 Developed countries Latin American countries Other emerging countries Source: IMF.
Solow s decomposition of economic growth: Chile 6% 5% 4% 3% 2% 1% 0% -1% -2% 1960-73 1974-89 1990-05 Capital Labor TFP 26 Source: Fuentes, Larraín and Schmidt Hebbel (2004).
Relative per capita output (per capita GDP over per capita GDP of G-7, PPP; 1980=1) 5 China 4 3 2 Asian developing countries 1 Chile 0 1980 1985 1990 1995 2000 2005 Asia 4 (*) United States Latin American countries (*) Asian 4: Malaysia, Indonesia, Thailand and Philippines. Source: Own calculations. 27
Inflation rate (1975-2006) 40 35 Inflation 1975: 343% 1976: 199% 1977: 84% 30 25 20 15 10 5 0 1975 1978 1981 1984 1987 1990 1993 1996 1999 2002 2005 Chile (Dec-Dec, %) Developed countries (anual % change) 28 Note: For developed countries, data 2006 based on forecast World Economic Outlook (September 2006). Sources: Central Bank of Chile and IMF.
Inflation volatility (standard deviation of rolling five-year window) 40 35 30 25 20 15 10 5 0 1980 1983 1986 1989 1992 1995 1998 2001 2004 Chile Developed countries Sources: Central Bank of Chile and IMF. 29
Inflation target and inflation rate (monthly average, annual percent change) 32 29 26 23 20 17 14 11 8 5 2-1 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 Source: Central Bank of Chile. 30
Relative deviations to the year 2004 (%) 1.0 0.88 0.8 0.6 0.43 0.44 0.44 0.46 0.47 0.47 0.50 0.54 0.54 0.62 0.66 0.73 0.4 0.2 0.16 0.20 0.22 0.28 0.32 0.0 Chile Colombia Mexico England Peru Canada Norway Note: Considers the starting period of an inflation-targeting scheme to the year 2004. The initial period of an inflation-targeting scheme varies across countries. Source: Albagli and Schmidt-Hebbel (2005). South Korea Poland Israel Switzerland Sweden Australia Czech Rep. South Africa Thailand New Zealand Brazil 31
Aggregate performance index 20 18.4 15 12 12.2 12.6 13.4 15 15.3 10 7.5 7.9 8.8 9.3 9.5 9.7 9.8 10.1 5.9 5 3.5 3.5 3.9 32 0 Chile Switzerland England Norway Mexico Canada Peru South Korea Sweden Note: The index considers inflation rate deviation with respect to the target in countries with inflation-targeting schemes, since the start of inflation targeting through December 2004. Source: Albagli and Schmidt-Hebbel (2005). Colombia Israel Iceland Australia Czech Rep. South Africa Thailand New Zealand Poland Brazil
Trade openness (% GDP, 1970-2005) 120 100 Asian emerging countries 80 Chile 60 40 20 World Developed countries Latin American countries 0 1970 1975 1980 1985 1990 1995 2000 2005 33 Note: Measured as the sum of exports and imports in percent of GDP. Sources: World Bank and IMF.
Financial openness (% GDP, 1970-2004) 140 120 Chile 100 80 Developed countries 60 40 Latin American countries Other emerging countries 20 0 Asian emerging countries 1970 1975 1980 1985 1990 1995 2000 34 Note: Measured as the sum of the stocks of external assets and liabilities of foreign direct investment and portfolio investment in percent of GDP. Sources: Lane, Philip and Gian Maria Milesi-Ferretti (2006) and IMF.
Poverty rate (%, population below poverty line) Mexico Peru Colombia Brazil Ecuador Chile Poland Hungary Philippines Malaysia China 6 12 13 15 17 19 23 24 30 33 36 36 39 41 48 48 47 48 48 51 56 62 35 0 10 20 30 40 50 60 70 Early 1990s Present Note: Present stands for 2005 in Mexico, Colombia, Brazil and Ecuador; for 2004 in Malaysia and Peru; for 2003 in Chile, Poland, Hungary, China and Philippines. Sources: ECLAC (2006), MIDEPLAN (2005), Asia Development Bank and Eurostat.
Infant mortality (per 1000 live births) Mexico Peru Colombia Brazil Ecuador Chile Poland Hungary Philippines Malaysia China 0 20 40 60 80 100 120 140 1970 1980 1990 2004 36 Source: World Development Indicators 2006, World Bank.
Life expectancy at birth (total years) Mexico Peru Colombia Brazil Ecuador Chile Poland Hungary Philippines Malaysia China 50 55 60 65 70 75 80 1970 1980 1990 2004 37 Source: World Development Indicators 2006, World Bank.
Competitiveness (ranking, 2006) 38 Switzerland Finland Sweden Denmark Singapore United States Japan Germany UK Hong Kong Israel Canada Australia New Zealand South Korea Malaysia Chile Czech Republic Thailand Hungary India South Africa Poland Indonesia China Mexico Russia Colombia Brazil Argentina Uruguay Peru Venezuela Ecuador Bolivia Paraguay 1 2 3 4 5 6 7 8 10 11 15 16 19 23 24 26 27 29 35 41 43 45 48 50 Note: The competitiveness index measures country s ability to achieve high and sustainable per capita GDP growth. The number beside each bar represents the place in the ranking. Source: World Economic Forum (September 2006). 54 0 10 20 30 40 50 60 70 80 90 100 110 Developed countries Other emerging countries Latin American countries 58 62 65 66 69 73 74 88 90 97 106
Country risk (basis points) 200 160 120 80 40 0 Argentina Brazil Colombia Peru Mexico Chile China Poland Hungary Bulgaria Malaysia South Africa Russia Latin American countries Other emerging countries 39 Note: As of January 19, 2007. Source: JP Morgan Chase.
Ease of doing business (ranking, 2006) 40 Singapore New Zealand USA Canada UK Australia Japan Sweden Finland Thailand Germany South Korea Malaysia Chile France Spain Portugal Mexico Uruguay Peru Hungary Poland Colombia Italy China Russia Argentina Paraguay Brazil Ecuador Bolivia India Indonesia Venezuela 1 2 3 4 6 8 11 13 14 18 21 23 25 28 35 39 40 43 64 65 66 75 79 82 131 134 135 Note: The ranking on ease of doing business averages country indicators across ten topics: starting a business, dealing with licenses, hiring and firing workers, registering property, getting credit, protecting investors, paying taxes, trading across borders, enforcing contracts, closing a business. The number beside each bar represents the place in the ranking. Source: World Bank (2006). 93 96 0 50 100 150 200 Developed countries Other emerging countries Latin American countries 101 112 121 123 164
Macroeconomic management (ranking, 2006) Algeria Kuwait Qatar United Arab Emirates Norway China Chile Singapore Finland South Korea Sweden Ecuador Australia Spain New Zealand Venezuela Thailand Malaysia Canada Russia United Kingdom Peru Argentina Mexico Indonesia Germany Colombia United States Poland Bolivia India Paraguay Japan Hungary Uruguay Brazil 1 2 3 4 5 6 7 8 12 13 15 21 23 24 25 26 28 31 32 33 48 49 51 54 57 63 65 69 70 77 88 90 91 98 109 114 41 0 20 40 60 80 100 120 Developed countries Other emerging countries Latin American countries Note: The number beside each bar represents the place in the ranking. Source: World Economic Forum (September 2006).
42 10 8 6 4 2 0 Contribution of monetary policy to macroeconomic performance (ranking, 2006) 2 3 4 5 6 7 8 9 11 12 14 20 21 23 24 26 29 30 34 36 38 44 47 51 52 54 55 56 Note: It is quantified in a scale from 1 to 9. The number over each bar represents the place in the ranking. Source: Institute for Management Development (2006). Chile Denmark Australia Singapore Colombia Norway United States India Malaysia Israel Switzerland Canada Japan Thailand Mexico China Finland England Sweden Spain Germany Poland South Korea Indonesia Russia Argentina New Zealand Italy Hungary Brazil Venezuela 1 60 61
Fiscal balance (% GDP, average 1995-2005) 2 1 0-1 -2-3 -4-5 -6 Argentina Brazil Colombia Peru Mexico Chile China Malaysia Philippines Poland Hungary Latin American countries Other emerging countries Sources: Moody s and Chile s Ministry of Finance. 43
Public debt (1) (% GDP, 2005) Japan Israel Bolivia Philippines Brazil Argentina Germany Unites States Hungary Colombia Malaysia United Kingdom Poland Peru South Africa Czech Rep. Thailand Mexico China Chile (2) 0 30 60 90 120 150 180 Developed countries Other emerging countries Latin American countries 44 (1) General government debt. (2) As of September 2006. Sources: Moody s and Chile s Ministry of Finance.
Banking system strength (index, 2006) Canada United States UK France New Zealand Australia Chile Ireland Germany South Africa Hungary Czech Rep. Mexico Malaysia Poland Japan South Korea Peru Brazil Thailand Philippines China Russia Indonesia Argentina Venezuela 0 2 4 6 8 10 12 Developed countries Other emerging countries Latin American countries Note: It is quantified in a scale from 1 to 13. Source: Central Bank of Chile, based on Moody s Financial Strength Ranking (December 2006). 45
Quality of institutions (index, 2005) Finland New Zealand Switzerland Netherlands Canada Australia Singapore Germany UK United States Chile France Spain Hungary South Korea Italy Uruguay Poland South Africa Malaysia Thailand Brazil Mexico Argentina Peru Colombia China Bolivia Russia Ecuador Paraguay Venezuela -1.5-1 -0.5 0 0.5 1 1.5 2 46 Developed countries Other emerging countries Latin American countries Note: Average of six indexes: rule of law, corruption control, political stability, quality of regulations, government effectiveness, and accountability. Source: World Bank (September 2006).
Rule of law (index, 2005) Switzerland Finland New Zealand Singapore Canada Australia Netherlands Germany UK United States France Chile Spain South Korea Hungary Malaysia Italy Uruguay Poland South Africa Thailand Brazil China Mexico Argentina Colombia Peru Bolivia Ecuador Russia Paraguay Venezuela -1.5-1 -0.5 0 0.5 1 1.5 2 2.5 Developed countries Other emerging countries Latin American countries 47 Note: Index measures protection of individuals and property against violence or theft, independent and effective judges, and contract enforcement. Source: World Bank (September 2006).
Tax burden and per capita income (2006) 45 Corporate tax rate (%) 40 35 30 25 20 LAC and other emerging countries Other OECD countries G7 15 Chile 10 0 5,000 10,000 15,000 20,000 25,000 30,000 35,000 40,000 45,000 GDP per capita 2005 (US dollars, PPP) 48 Sources: PricewaterhouseCoopers and IMF.
Corporate tax rate (%, 2006) Ireland Hungary Chile Singapore Russia Czech Rep. Ecuador Bolivia South Korea Aus tria Finland Portugal Malaysia Sweden Denmark Mexico Greece Peru Uruguay Thailand Australia United Kingdom Israel New Zealand Italy France Belgium Argentina Spain Colombia Canada Germany 13 16 17 20 24 24 25 25 25 25 26 27.5 28 28 28 29 29 30 30 30 30 30 31 33 33 33.3 34 35 35 35 36 0 5 10 15 20 25 30 35 40 45 Developed countries Other emerging countries Latin American countries 38 49 Source: PricewaterhouseCoopers.
Economic indicators Chile (2000-2005) 2000 2001 2002 2003 2004 2005 Real GDP growth (yoy %) 4.5 3.4 2.2 3.9 Real GDP (PPP, US$ billions) 140.4 148.6 154.5 163.5 178.0 193.2 Real GDP per capita (PPP, US$ mm) 9.229 9.648 9.911 10.379 11.166 11.937 Gross fixed capital (% GDP) Domestic savings (% GDP) Inflation ( yoy %) Unemployment (%) 6.2 20.7 21.7 21.3 21.1 20.2 22.1 20.6 20.7 23.0 Fiscal balance (% GDP) -0.6-0.5-1.2-0.4 2.2 4.7 Exports (US$ billions) 3.8 9.2 19.2 20.6 3.6 9.2 18.3 1.1 8.8 32.2 Imports (US$ billions) 17.1 16.4 15.8 18.0 23.0 30.4 External debt (% GDP) 49.4 56.2 60.2 58.7 46.2 39.5 Current account (% GDP) -1.2-1.6-0.9-1.3 1.7 0.6 2.5 9.0 18.2 20.7 2.8 8.5 21.7 6.3 23.6 3.1 8.1 40.6 50 Source: Central Bank of Chile.