FREE ESSAY ON CHILEAN ECONOMIC SHOCK THERAPY

CHILEAN ECONOMIC SHOCK THERAPY

Chile is seen to be the quintessential model of liberal restructuring in Latin America in
the late twentieth century. After the overthrow of the socialist regime of Salvador
Allende in 1973, Chile's government has implemented an authoritative economic
restructuring program that replaced state intervention with market incentives and opened
Chile to the global economy. This four-phase process transformed the economy from highly
protective industrialized to an open free market economy based on agricultural exports.
The process by which the Chilean economy was stabilized was termed "shock therapy." Like
other dramatic economic policy changes, the "therapy" caused the underlying social
problems of Chile to immediately surface. Real wages were cut in half, and public
spending in preventive health care, primary education, and public housing were
drastically cut. Unemployment, "soared to an average of 17.6 percent of the workforce,
and hyperinflation averaged 350 percent." (Sheahan 1997, 12) While in its inception C
growth, it also exacted a tremendous toll on Chilean workers, peasants, and sections of
the middle-class, worsening poverty and inequality. It took the process four-phases to
mediate the economy's growth to equilibrium, unlike Russia which is still feeling the
affects of their radical economic policies.
The "shock therapy" process entailed the rapid and efficient liberalization of capital
markets and prices and the elimination of most restrictions on trade. Tariffs were cut to
a uniformed percentage, and the exchange system was consolidated. The government
implemented a "crash privatization" process under which "more than 300 firms with a value
of $1 billion were returned to private ownership by the end of 1984."
( Bosworth 1994, 5) The budget deficit was cut sharply from 25 percent of the GDP to 1
percent, and labor market relations were restructured by labor union suppression. The
unions were severely weakened by legislation and then allowed to operate under new
confining labor laws. These laws included limited means to negotiate over wages,
collective bargaining and other issues regarding the working class.
The effects of the anti-labor union laws were far reaching indeed. Chile faced a severe
economic crisis that saw the GDP fall by more than 14 percent. However, by 1986 the
second phase of the "shock therapy" began a process of sustained recovery under a much
more flexible economic construction. The new policy orientation proved successful in
terms of generating the "Chilean miracle". This was an average annual growth rate of 7.4
percent from 1986-1990. However, while the growth generated sustained increases in
exports, and reduced unemployment, "the miracle" failed to reduce socioeconomic
inequalities and poverty. For example, "health expenditures alone fell by nearly 30
percent." ( Scully 1996, 401) Workers lacked access to social security and other basic
benefits. The first two phases, lasting 17 years did promote economic growth, but without
fair distribution; Chile had become a society where a large percent of the population
were left without seeing the actual benefits of this "miracle".
The third and most important phase of the "shock therapy" was not economic but political.
This restructuring was not intended by the existing regime and proved to be the Chilean
economy's greatest improvement, seeing how politics and economics are interrelated. The
center-left democratic opposition bloc made up of seventeen parties, the Concertacion de
Partidos por la Democracia (the Concert of Parties for Democracy) headed by Alywin
defeated the Pinochet regime, forming a democratic coalition government. The Aylwin
administration recognized that mitigating the problem of inequality and poverty and
advancing the needs of the popular sector. The new democratic government immediately
embarked on a plan to resolve the social deficit. 
In six short years Alywin and his successor, the current President Eduardo Frei enacted
and implemented a wide-range of "equity-enhancing reforms" without breaking from the
instituted liberal economic model. These reforms entail the last phase of the "shock
therapy" program. Saying that high growth rates would not cover the badly needed
increases in social spending, the government introduced a direct taxation. This placed a
higher personal income tax burden on the upper middle class, eliminated tax privileges
for the rich, and raised corporate profit tax. 
The Aylwin/Frei administrations increased fiscal spending on social and welfare programs.
The government raised family allowances for the poor by 50 percent and introduced
subsidies to support nutritional supplements for the lowest income households. Enhancing
school feeding and mother-child nutrition programs did this most successfully. Drives to
improve the quality of public education and vocational training for the unemployed
foreshadow the spread of enterprises and small businesses in the Chilean economy. 
Chile's labor movement expected and demanded much more power and economic benefits than
the democratic regime could ever deliver. For example, the right to strike and an end of
strike time limitation, and the right to collective bargaining were recently re-instated.
Legislation has also benefited from legislation enhancing pension funds, longer periods
over coverage for severance and increases in minimum wage. In the period between 1991 and
2000 the incidence of poverty has dropped by almost 40 percent while absolute poverty has
dropped by more than half. By any measure these are remarkable achievements for the newly
established democracy, and thereby ending the four-phase "shock therapy" program.
Why did Chile's abrupt economic change work as opposed to that of Russia? The answer is
based in Chile's democratic structure, in accord with its drive to grow on a
microeconomic scale. That is, the organizational, administrative, and political skills of
the latter governments and their ability to create efficient, coherent coalitions allowed
them to combine a free market policy with equitable development. There is no doubt that
the government's ability to develop and strengthen itself by developing an underlying
political culture of coalitions was its greatest assets. Therefore, the democratic
leadership has made every effort to seek consensus on economic policy, build a cohesive
"encompassing organization", in sharp contrast to the authoritarian government of Russia.
The Concertacion party crafted tacit agreements amongst the public, adhering to their
preferences. The labor, peasant, middle-class constituencies, and the business classes
all developed in the "social capital", developing power against the m
ilitary oligarchy. This slows the proliferation of black markets, and institutional
corruption, two problems plagued by most newly developed democratic states. 
Hence, rather than submit to the orthodox view that dismantling the state through sharp
economic reforms that profit the rich, the Chilean democratic government reconstructed
the state. This gave it not only macroeconomic development, but also in promoting human
development via investment in human capital, and management of social programs. These
ended the "shock therapy" treatment that in its inception worsened the problems facing
the Chilean economy and people. Chile's present program stresses that responsive and
relatively well-institutionalized political parties with strong links to civil
organizations are necessary to building a "developmental state." Other democratizing
Latin American countries like Brazil, Peru, or Argentina have only been able to elect
popular presidents who have broad executive, if not authoritarian powers. These countries
as with Russia will only demonstrate a limited capacity to make the necessary reforms
because of their lack of internal cohesiveness.
Bibliography
Bosworth, Barry, Rudiger Dornbusch, and Raul Laban. 1994. The Chilean Economy: Policy
Lessons and Challenges. Washington, D.C.:Brookings Institution.
Collins, Joseph, and John Lear. 1995. Chile's Free-Market Miracle: A Second Look.
Oakland, Cal:.Food First.
Hojman, David. 1999. The Political Economy of Development and Democracy in the 1990's.
Pittsburgh, Pa.: University of Pittsburgh Press.
Scully, Timothy. 1996. Constructing Democratic Governance: South America in the 1990's.
Baltimore.: The John Hopkins University Press.
Sheahen, John. 1987. Patterns of Development in Latin America: Poverty, Repression, and
Economic Strategy. Princeton, N.J. Princeton University Press.
Weyland, Kurt. 1997. "Growth with Equity in Chile's New Democracy,"Latin American
Research Review, vol. 32 no. 1.