Chile, Globalization and Poverty
Abstract
Benchmark economic theory suggests that free trade between
economic agents produces the best possible result for both agents
involved, and is the basis for globalization. This paper investigates
the validity of this theory through the extensive use of a simulated
dynamic Mundell-Fleming model calibrated to Social Accounting
Matrices (SAMs) for a base year of 1972. The end result is that if any
of the agents are not fully prepared structurally to accommodate
globalization, there will always be a loss of utility on the part of the
less prepared agent. (not generally true) Such results are the basis
for claims that developing countries would be better off had they
not engaged in free trade, forming the foundation for the analysis
used throughout. Using Chile as a case study, this paper will ask if
Chile might have been better off without liberalization by projecting
previous trends from 1973-1993. The analysis suggests that Chile is in
fact better off by integrating themselves in the global economy.
John Doe1
I.
Introduction
Strictly defined, globalization is simply the removal of barriers to the flow of
international goods, services and capital. Given to us more than 200
years ago by Adam Smith and David Ricardo, the theory states that all
parties involved, and thus society, are better off as a result. This theory is
strongly advocated even today and is the underlying basis for making the
Washington Consensus the preferred policy for all countries, developed
and developing. More than a decade has passed since the ascendancy
of the Washington Consensus and critics charge that the gains from trade
University of Vermont and State Agricultural College, Burlington VT 05405; xxx@uvm.edu.
I would like to thank Professor William Gibson, whose support and infinite patience have
proved to be crucial inputs.
1
have been distributed in a lopsided fashion. This begs the very important
question of whether countries that benefit less would be better off under
autarky.
It is this question that creates the motivation for the analysis in this
paper. Chile is frequently cited as an example of a successful
development strategy based on current and capital account
liberalization.(Cite source.) Using a simulated Computable General
Equilibrium (CGE) model based on the Mundell-Fleming IS-LM-BP
framework, this paper compares a counterfactual for Chile under the
assumption of continued relative autarky of the 1980s. The paper
demonstrates that, had the country not opened its borders in the way
they did, Chile would have been worse off economically.
This paper is separated into six parts. The second section is
concerned with the theory of globalization and what should happen
when the terms of trade are favorable to poor countries and thus
implemented correctly. Section three gives a brief outline of Chile’s
economic history prior to the opening of its markets, while the fourth
section presents the empirical results and analyzes them with respect to
Chile’s history and the theory presented in the second section. Section
five discusses the dynamic Mundell-Fleming model and shows how it how
it was calibrated to match pre-liberalization data and gives basic
forecasts based on the trajectory pattern presented in section four as well
as policy recommendations. The sixth and final section concludes that
Chile would have been better off without implementing globalization on
such a large scale than it has been with it.
II.
Theory
Based on the theory given to us by Ricardo more than 200 years ago,
Repetitive. Comparative Advantage states that two nations, in the case
2
of no input factor mobility, should specialize in the good in which they can
produce relatively more efficiently. There are of course a number of other
assumptions at work in this simplified theory, but as a point of reference it is
necessary. For all of its significance, however, comparative advantage
says nothing of the distribution of post-trade utility, which is where the
present discussion begins. In the event of two countries (one rich, one
poor) engaging in free exchange, and the poor country, as a result of the
exchange, realizes strong economic growth from there on, then the terms
of trade were favorable to the poor country and they have experienced
“pro-poor growth.” According to certain experts (Bhalla, 2002), this type
of growth has been the norm since the early 1980s, and is what will be
investigated in this paper, in the example of Chile
III.
Chilean Economic History, 1972-1993
The best place to begin discussion of relevant Chilean economic history is
with Salvatore Allende. Elected president in 1970, Allende is the man
whose Marxist Socialist economic policies contributed the basis for Chile’s
later economic frustrations. Grounded in the popular dependency
theory, Allende’s policy package assumed economic growth was
constrained by domestic demand (Schatan, 2001). As a result, subsidies
were given to agriculture and industry as well as tax and tariff incentives
to promote growth. In line with the theory of import substitution
industrialization, policies were enacted, however, with the intent of
minimizing imports rather than
3
increasing exports. The export sector was based on a few commodities,
mainly copper (Schatan, 2001, p. 61). Furthermore, when the Chamber of
Deputies refused to pass legislation raising taxes, the Allende government
borrowed from the Central Bank; when inflation accelerated, the
government simply fixed prices for staple goods (Schatan, 2001, p. 60).
This combined with a multiple exchange-rate system, dampened
incentives to produce for the formal market and thus a black currency
and thus exchange market were spawned (Schatan, 2001). The end
result, of course, was that, in terms of dollars, the marginal cost of
producing these staple goods rose above their prices, thus creating spot
shortages (Schatan, 2001). Expectations were widely frustrated and
Dornbusch and Edwards (1991) later described the process as
TABLE 3.I
Real GDP Composition, 1965-1983
Year GDP Consumption Investment Government Exports Imports
1965
1966
1967
1968
1969
1970
1971
1972
1973
1974
1975
1976
1977
1978
1979
1980
1981
1982
1983
17.78
19.56
20.27
21.03
21.76
22.22
24.23
24.03
22.84
23.41
20.75
21.46
23.32
25.06
27.24
29.46
30.86
27.67
26.62
12.50
13.47
14.04
14.62
15.05
15.06
16.70
17.55
17.93
14.52
15.09
14.71
16.89
17.72
19.17
20.82
22.98
20.83
19.51
3.25
3.70
3.80
3.99
3.87
4.27
4.17
3.53
2.39
5.82
3.52
3.37
4.05
5.27
5.74
6.19
7.00
3.12
2.62
1.86
2.17
2.20
2.25
2.35
2.77
3.60
3.77
2.93
3.68
3.25
3.00
3.40
3.62
3.89
3.67
4.06
4.24
3.78
Source: World Bank (2004)
Note: Tens of million Chilean pesos of 1965..
4
2.42
2.90
2.89
2.94
3.58
3.25
2.67
2.36
3.12
4.77
5.28
5.39
4.81
5.16
6.34
6.72
5.07
5.36
6.39
2.23
2.68
2.66
2.77
3.09
3.12
2.91
3.18
3.53
4.61
5.69
4.46
5.23
6.00
7.11
7.95
8.26
5.88
5.68
“macroeconomic populism.’’ Some macroeconomic data from the
period are shown by Table 3.1, the gains made by the Allende regime
were less than impressive, to say the least. Language too informal for an
academic paper. The latter part needs further explaination. As shown in
the table, the growth of GDP and its components were slow, as they grew
by an nine percent after Allende’s first year, but negatively in the next two
years, respectively. Nonetheless, Allende was overthrown by a military
during September of 1973 and Augosto Pinochet became President.
TABLE 3.2: Real
GDP Composition by Percentage, 1965-1983
Year Consumption Investment Government Exports Imports
1965
1966
1967
1968
1969
1970
1971
1972
1973
1974
1975
1976
1977
1978
1979
1980
1981
1982
1983
70.00
68.86
69.26
69.52
69.14
67.76
68.94
73.02
78.50
62.02
72.72
68.56
72.42
70.72
70.37
70.68
74.49
75.29
73.27
18.26
18.92
18.75
18.99
17.80
19.20
17.20
14.70
10.47
24.84
16.97
15.69
17.35
21.03
21.06
21.02
22.70
11.28
9.85
10.47
11.11
10.84
10.69
10.78
12.44
14.86
15.69
12.84
15.73
15.67
13.98
14.57
14.43
14.30
12.45
13.15
15.32
14.19
13.61
14.81
14.27
13.98
16.46
14.61
11.03
9.82
13.65
20.38
25.44
25.12
20.62
20.58
23.28
22.82
16.42
19.37
24.01
12.56
13.70
13.13
13.16
14.19
14.02
12.02
13.23
15.47
19.71
27.41
20.80
22.42
23.93
26.11
26.98
26.75
21.25
21.32
Source: World Bank (2004) and author's calculations
Convinced by “Los Chicagoboys” and their mentors, Pinochet decided to
make Chile free of “the stigma of statism,” and thus a free market
economy, which would require a significant amount of changes.(Cite
5
source.) The first of these was freeing the price system of the controls
imposed by the previous regime and slashing government spending
(Collins, 1995, p. 26). After price controls are lifted, the economy falls prey
to repressed or pent-up inflation created below controls. Thus the prices
of domestic goods rose by nearly 375 percent annually, clearly
outstripping wage growth (Collins, 1995, p. 27). Furthermore, despite the
cuts in spending, the budget deficit approached nearly 32 percent of
GDP (Collins, 1995, p.?).
The next step in the Chicago reform package was to increase
efficiency through privatization. In short, the Commanding Heights, as
well as the financial and transportation sectors were privatized, resulting in
nearly 15 percent unemployment (Collins, 1995, p.?). These reforms,
however, still failed to produce the predicted results, as by 1975 Chile
found itself in a deep recession with real output shrinking by eleven
percent, per annum. Soon thereafter, Milton Friedman was brought in to
give Pinochet a “one-hour course” on proper economic planning,
resulting in an additional 20 percent decline in Government expenditure
(Collins, 1995, p.). This is reflected in Table 3.2, which shows the
composition of GDP in percentage terms. What the table also shows is
the volatility of investment as a result of such policies, falling 32 percent in
1973, only to increase by more than 140 percent in 1974 and fall by 39
percent the following year. The changes continued throughout, as import
tariffs were further decreased, thus resulting in increased openness2,
shown in Figure 3.1.
As the chart clearly shows, the influence of neoliberal economic
philosophy
Here openness is defined as the sum of export and imports as a percentage of GDP:
(X+M)/Y.
2
6
continued as import tariffs fell and thus trade as a percentage of overall
GDP, increasing Chilean dependency on foreign goods. What the graph
also shows is the break between the Allende era and that of the Chicagoschool dominated Pinochet regime. From 1977-81 the Chilean economy
grew rapidly, prompting further efforts to reduce government borrowing,,
most notably the privatization of the social security and health care
system. Chile also enacting a new labor code that severely reduced
workers’ rights and undermined their position at the bargaining table
(Collins, 1995, p. 30). Unemployment rose to nearly 25% of the workforce.
Starting in November 1981, a number of major banks and businesses
began to fail, partially as a result of the poor performance of the US
economy. GDP in the following year fell by ten percent, and
unemployment rising to nearly thirty three percent (Collins 1995, p. 33).
The recession deepend, despite efforts by the government to issued\ a
series of bailout loans to the private sector. The public sector absorbed
the massive debts accumulated in the financial sector and in many
businesses (Collins, 1995, p.10).
7
Figure 3.1: Chilean Openness, 1965-1998
0.8
0.7
Openness (% of GDP)
0.6
0.5
0.4
0.3
0.2
0.1
0
1960
1965
1970
1975
1980
1985
1990
1995
2000
Year
Source: World Bank (2003) and author’s calculations.
Not long after, Chile found itself faced with serious balance of
payments deficits, for which they ultimate had to seek support from the
World Bank and the International Monetary Fund (IMF) (Schatan, 2001, p.
62). To qualify for the stand-by facility, Chile was required to submit to
“stabilization package” that called for:
1. Liberalization of foreign exchange and import controls
2. Increased Hospitality to Foreign Investment
3. Anti-Inflationary programs such as higher interest rates and
control of credit, as well as salary increases (Collins, 1995, p.).
The results of Chile’s “choice3” to follow the Washington Consensus,
(this is not the WC) surprisingly, were very solid ones. Openness clearly
increased, as shown by Figure I, while GDP grew by a steady pace,
averaging about seven percent annually from 1985-1998. The major
The argument here is that there is not exactly much choice for these developing
countries, considering the state that they are in. For more on this, see Stiglitz (2001).
3
8
components of GDP also experienced steady growth throughout the rest
of the surveyed period. However, though growth is good for the overall
economy it may not necessarily be good for all of its participants and thus
to arrive at an appraisal of Chilean economic performance, it is
imperative that we examine such growth, post and pre-liberalization, in
terms of poverty and inequality.
IV. Poverty and Inequality
There are a number of methodological concerns surrounding the
measurement of poverty and inequality, mainly the lack of credible
data.(Cite source.) Four measures are used concerning these two
economic variables. They are the poverty headcount, the poverty gap,
squared poverty gap and the Gini coefficient, all of which are used
throughout the literature. (Cite Lipton and Ravallion) The simplest and
most widely used is the headcount, which is merely the percentage of
individuals with incomes below the poverty line. The second is the poverty
gap, an aggregate of the difference between the poor and the poverty
line divided by the population size. This index is used to illustrate the depth
to which poverty extends. The fourth index is the Gini coefficient, which is
the difference between complete equality and the current level of
income inequality. These are the four main measurements in which the
trends in poverty and inequality will be discussed.
During the period 1973-1976, the Chilean economy, on average,
shrank by three percent annually.Repetitive. Much of this could be
attributed to the adjustment to the policy prescription of Friedman and
company.Repetitive. The effects of such poor performance were felt,
nonetheless, as they present a bleak picture for its income distribution as
well as poverty. Noting a lack of data on Chilean Income Distribution in
1973, the Gini coefficient rose from 0.468 to 0.543 between 1974 and 1976,
9
as shown by Figure 4.1 (Mesa-Lago, 2000). A good portion of this could be
explained by the fact that, as a result of government prohibition of unions,
strikes and collective bargaining, and a 12.7 percent average rate of
unemployment, the real wage fell by 7.4 percentage points (Mesa-Lago,
2000, p. 43). Here the relationship should be clear: in the event of falling
wages, other things constant, inequality will increase. Furthermore, the
poor performance of the economy resulted in an average decline of 4.43
percent in per capita (Italicize all Latin, indeed, foreign words) income
(Mesa-Lago, 2000). The effects of this trend as well as that of real wages
were felt by workers—namely the poor, with the end result being a 39.9
percentage point increase in the poverty headcount between 1970 and
1976 and a 22 percent increase in indigence (Mesa-Lago, 2000).
Figure 4.1: Gini Coefficient, Selected Years (1974-1993)
0.580
0.560
0.540
0.520
0.500
0.480
0.460
1970
1975
1980
1985
Source: Mesa-Lago (2000).
10
1990
1995
Following the crisis of 1975, from 1976-81, the Chilean economy was
characterized by strong economic growth (otherwise known as “The
Chilean Economic Miracle”), rapidly falling deficits (that eventually
became a surplus), rates of unemployment, rising real wages and
significant growth in the export sector (Mesa-Lago, 2000, p.58). In 1976,
GDP grew by three and a half percent, and by eight percent during the
period 1977-81. Furthermore, per capita income rose by an average of
1.5 percent and the average wage rose to 38 percent above its 1976
level and the minimum wage rose 48 percentage points (Mesa-Lago,
2000). Part of these wage gains could be attributed to the seven percent
decrease in unemployment, as it fell from a fifth of the total labor force to
about 15 percent (Mesa-Lago, 2000). Such impressive gains were
instrumental in decreasing the poverty headcount from 57 to 44 percent
and indigence falling by 13 percentage points (Mesa-Lago, 2000, p. 62).
In addition, the Gini coefficient fell from 0.543 to 0.531, as shown by Figure
4.1.
Despite such impressive growth during the previous period, there
were signs that such an expansion was coming to an end. One was that
during the year 1981, the growth of the industrial sector fell from 7 percent
during 1977-81 to 2.6 percent, with an eight percent decline in total
production (Mesa-Lago, 2000, p. 58). Furthermore, the peso became
overvalued, the trade surplus became a growing deficit and external
debt doubled (Mesa-Lago, 2000). Rather than change course, the
Chicago policy prescription was pushed even further. This lack of
foresight on the part of policymakers contributed to Chile experiencing
the worst recession since the 1930s. GDP fell by an average of 7.3 percent
between 1981 and 1983. Such a drastic reduction in income had an
adverse affect on employment, as the unemployment rate rose from 11
to nearly 20 percent of the labor force (Mesa-Lago, 2000 p. 76). Most of
11
this was felt in industry, as employment in this sector fell by 23 percent
(Mesa-Lago, 2000). Furthermore, half of these unemployed were from the
lowest income quintile, which resulted in an increasing Gini coefficient
from 0.521 to 0.542 (Mesa-Lago, 2000, p. 77). According to government
surveys (namely ECLAC), poverty incidence fell 14 percentage points
during this time; but these numbers are questionable, considering a 17
percent decline in per capita consumption and a nearly 9 percent drop
in per capita income (Mesa-Lago, 2000).
The economy recovered quite
impressively in 1984-85 and continued with
sustained growth from 1986-89. During this
period, GDP grew by 6.3 percent from 1984-85,
and continued the upward trend to a peak of
9.9 percent in 1989 (Mesa-Lago, 2000, p. 93).
Real wages declined between 1984 and 1987,
Table 4.1
Wage Share, 1987-1993
Year
Wage Share
1987
31.92%
1988
30.88%
1989
32.20%
1990
33.78%
1991
34.17%
1992
35.27%
1993
36.62%
Source: Penn World Tables
(2004)
but grew thereafter (Mesa-Lago, 2000). Additionally, the number of
unionized workers increased by 22 percent (Mesa-Lago, 2000 p. 90). Such
gains indicate a macroeconomic climate more favorable towards
workers, shown by the fall in the unemployment rate from 14.6 percent in
1983 to 5.9 percent in 1989 and the continued growth of the wage share,
shown in Table 4.1 (Mesa-Lago, 2000). Such growth continued in the
period 1990-93, as GDP and Per Capita GDP grew by an average of 5.8
and 5.3 percent annually, considerably higher than the growth rates for
1974-77 (-4.4), and 1982-83 (-9%) and 1984-89 (4.6%). Such a strong
expansion was partially due to an improvement in the state of the labor
market during the period, as there was a 3.1% annual rate of employment
creation as a result of the government creating new training programs
that emphasized skilled labor and productivity (Mesa-Lago, 2000, p. 124).
This resulted in 75% of the 600,000 individuals trained finding jobs, 50%
12
above the minimum wage (Mesa-Lago, 2000). This was reflected in the
share in agriculture falling 2.8 percentage points (Mesa-Lago, 2000).
Income distribution worsened during this period, as the Gini
coefficient increased slightly from 0.556 to 0.562 (Table 4.1). However, the
ratio of the highest quintile to lowest income quintile fell from twenty three
to eighteen, closer to its pre-liberalization levels. The poverty headcount
fell from 0.4945 in 1990 to 0.4891 in 1992 (World Bank, 2001). Interpreted in
the context of households rather than individuals, the headcount fell from
48 to 24 percent during the period (Mesa-Lago, 2000, p. 125). A good
portion of such gains were due to the unemployment rate of the lower
income sector falling by nearly ten percentage points (Mesa-Lago, 2000).
These country specific trends of poverty and inequality are for the
most part inconsistent with the aggregate trends in greater Latin America,
as during the seventies, Latin America’s Gini coefficient fell consistently,
while Chile’s faced a continuously faced positive growth rate (Londono
and Szekely, 2000). However, the two trends would move together during
the 1980s, with Latin America’s Gini index (58.3) rising past Chile’s 55.6 in
1990 (Londono and Szekely, 2000). In terms of poverty, incidence in Latin
America as a whole fell during the 1970s while that of Chile rose
considerably. During the eighties the headcount fell in Chile, while it rose
sharply for Latin America. For Latin America, this trend continued on
through the 1990s, while the headcount in Chile continued to fall.
V. Simulations
The simulations discussed investigate the path of Chile’s growth and
development under relative autarky. As noted above, they are done in a
simulated dynamic Mundell-Fleming model calibrated to a Social
Accounting Matrix (SAM) for a base year of 1972. It is a one sector model,
with two income classes (rich and poor) and three variables that adjust to
excess demand, according to the the Walrasian adjustment process: the
13
interest rate, exchange rate, and the wage rate. The Mundell-Fleming
model can be best described statically with an IS-LM-BP diagram which
gives the reader a flavor of exactly how the model works. Since it is a
dynamic model, the only “state” variable the model accounts for is the
capital stock as it changes from period to period according to investment
and depreciation in the standard stock-flow analysis.
Based on these simulations, we will have a more concrete tool to
analyze whether or not Chile would have been better off under autarky.
This analysis will primarily be done based on the Gini coefficient, Poverty
Headcount, Poverty Gap and the Squared Poverty Gap, all of which are
calibrated to match the actual data at the year of liberalization (taken
here as 1983) and projected relative to the trend produced by the
counterfactual. These variables have no direct feedback into the model
and are thus calculated exogenously. (They obviously have indirect
feedback in the sense that they depend on wages and employment
which does feed back.)( Anybody sophisticated enough to read this
paper will already know what is deleted.)
Figure 1 shows the counterfactual (i.e., relative autarky) versus the
actual of Chile’s Net exports during the surveyed period. As shown in the
figure, Chile is at a small trade deficit in the base year, where the two are
equal. As shown in the figure, despite the initial trade deficit, for every
period during the twenty one years surveyed, Chile’s trade balance is
steadily improving at a rate of fifteen percent annually, reaching a high of
15.7.
14
Figure 5.1: Net Exports, 1972-1993
30.00
20.00
10.00
0.00
1970
1975
1980
1985
1990
1995
Counterfactual
Actual
-10.00
-20.00
-30.00
-40.00
put the legend and source statement on the graph.
Source: World Bank (2003) and author’s calculations.
This is significantly better than the trend that Chile faced under the
actual case of rapid liberalization. Based on the figure above, we can
confidently deduce that Chile’s trade balance would have definitely
fared better under relative autarky. It is worth noting that even in the
base year of 1972 Chile’s import share was 13.23, significantly different
from zero (Table 2.2).
Figure 5.2 shows the trend of consumption during the twenty one
year period. As is the case with Figure 5.1, the counterfactual is
calibrated to the actual.
Figure 5.2: Household Final Consumption, 1972-1993
15
400.0
350.0
300.0
250.0
Counterfactual
200.0
Actual
Linear (Actual)
150.0
100.0
50.0
0.0
1970
1975
1980
1985
1990
1995
Source: World Bank (2003) and author’s calculations.
Based on the figure above, we can see that there is also a stark
difference between the consumption levels under autarky and
liberalization. This is really based on volatility; the pink line is better
because it is less volatile. As can be expected, the counterfactual follows
a more stable growth pattern while the actual fluctuates a bit. However,
since in this case we are modeling consumption, the actual is still relatively
stable, based on consumption usually being the largest and most stable
component of aggregate demand. Even with levels produced by the
counterfactual being stable as the marginal propensity to consume rises
by a respectable one percent annually, the upward trend in consumption
since 1983 (the year of liberalization), culminates with the actual
surpassing that of the counterfactual in the final period, allowing us to
conclude that since liberalization has taken place, the growth of the
actual is considerably more striking than that produced by the
16
counterfactual and thus liberalization has had a positive effect on
consumption levels, meaning that there has been significant enough
demand to merit high levels of investment in Chile, post-liberalization. This
is shown by Figure 5.3.
Figure 5.3: Gross Private Investment, 1972-1993
160.0
140.0
120.0
100.0
Counterfactual
Actual
80.0
Linear (Actual)
60.0
40.0
20.0
0.0
1970
1975
1980
1985
1990
1995
Source: World Bank (2003) and author’s calculations.
As predicted, the actual trend in Figure 5.3 is one of almost uninterrupted
positive growth. There is of course more than one reason why investment
has followed such a progressive path over the final ten years of the
surveyed period (falling interest rates are also a large factor), but the
influence of demand cannot be discounted. Such positive results for
investment would obviously push GDP growth significantly, which is the
case in Figure 5.4.
Figure 5.4: Real GDP, 1972-1993
17
600.0
500.0
400.0
Counterfactual
Actual
300.0
Linear (Actual)
200.0
100.0
0.0
1970
1975
1980
1985
1990
1995
Source: World Bank (2003) and author’s calculations.
Looking at figures 5.3 and 5.4 one is able to fully see the effects that
globalization has had on Chile’s macroeconomic climate. While not only
attracting considerable amounts of foreign direct investment (FDI), which
has grown from 3.2 to 33.2 percent of GDP between 1980 and 1990,
globalization has also had a significant impact on poverty and inequality
(UNCTAD, 2004).
Figure 5.5 shows the Gini coefficient for Chile over the surveyed
period. As noted above, in the year of liberalization, the counterfactual is
calibrated to the actual data for the four measures presented. As the
actual trend shows, Chile was a country of rising inequality from the 1970s
forward. With liberalization, such inequality has continued to rise,
reaching its peak 1989. In the simulated model, this measure was
performed by subtracting share of income from share of population.
18
Figure 5.5: Gini Coefficient, 1972-1993
0.7000
0.6000
0.5000
0.4000
Counterfactual
0.3000
Actual
0.2000
0.1000
0.0000
1970
1975
1980
1985
1990
1995
Year
Source: World Bank (2004), Mesa-Lago (2000) and author’s calculations.
Given 1983 as the year of liberalization, there is a very clear
divergence of the counterfactual from the actual, as the former falls
considerably while the latter somewhat tapers off. Income inequality, in
the era of liberalization is a great deal lower for the counterfactual.
Shown by the distance between the actual and counterfactual, the
distribution of the gains to trade have had a negative impact on income
inequality are in fact .
Figure 5.6: Poverty Headcount, 1972-1993
19
0.70000
0.60000
0.50000
0.40000
Counterf actual
0.30000
Actual
0.20000
0.10000
0.00000
1970
1975
1980
1985
1990
1995
Source: World Bank (2003) and author’s calculations
In terms of poverty incidence, the opposite is true: globalization
has lifted a greater percentage of the population up out of poverty than
would have been under autarky (see Figure 5.6). However, the poverty
gap, which essentially measures the depth of poverty, is lower under
autarky, meaning that by not liberalizing, the depth of poverty in Chile
would have been comparably less. This is corroborated by Figure 5.7
below. Interesting.
Figure 5.7: Poverty Gap, 1972-1993
0.80000
0.70000
0.60000
0.50000
Counterfactual
0.40000
Actual
0.30000
0.20000
0.10000
0.00000
1970
1975
1980
1985
1990
Source: World Bank (2003) and author’s calculations
20
1995
Finally, we have the squared poverty gap which measures the
incidence of extreme poverty. This is depicted in Figure 5.8. As the figure
clearly shows, the case of extreme poverty is one that looks significantly
different from the other poverty measures, based on the u-shaped curve
that is produced by the counterfactual. What this tells us is that under
autarky, the proportion of individuals living in extreme poverty would have
fallen pre-liberalization and risen post-liberalization. What is most
significant about Figure 5.8 is that after 1986, the level predicted by the
counterfactual is greater than the actual trend.
Overall, the results of the simulation corroborate the case made by
classical trade theory: that in the long run the welfare of a given society’s
people are better off with trade, also giving weight to Ricardian growth
theory’s argument that inequality is a prerequisite for growth. However,
the results of the simulation do not support Ravallion’s (1997) claim that
the rate of poverty reduction is lower in countries with higher inequality
because the growth elasticity of poverty reduction with respect to growth
declines as the distribution worsens.
Figure 5.8: Squared Poverty Gap, 1972-1993
14.00000
12.00000
10.00000
8.00000
Counterfactual
6.00000
Actual
4.00000
2.00000
0.00000
1970
1975
1980
1985
1990
-2.00000
Source: World Bank (2003) and author’s calculations.
21
1995
Income inequality in Chile is still very high by international standards, as it
has the fifth highest Gini coefficient in Latin America during the 1990s
(Londono and Szekely, 2000). Conversely, its headcount index is in fact
the fifth lowest in Latin America (Londono and Szekely, 2000). Using the
growth elasticity of income inequality, and based on the results of this
simulation, I found Ravallion’s argument only to be the case up until 1984.
Show some details; the is the change in the poverty level, HC, gap or gapsquared, with respect to growth. Not surprisingly, the trend of the growth
elasticity of the poverty gap continued to increase with every subsequent
period—even after 1984! These results are shown in the attached model.
Cannot do this. The result have to be in this paper.
VI. Policy Options
The simulations presented in this paper have demonstrated that, in the
case of liberalization, Chile has experienced a rate of growth in not only
GDP but its components as well, that is much greater than that implied by
the continuation of autarky. Therefore, it does not seem that decreasing
their level of openness through creating trade barriers would be a very
plausible solution. However, though Chile is better off now, her economy
did in fact go through two major shocks during the twenty one year
period surveyed. Good! In order to avoid such shocks, a slower transition
would have to take place between the decision to liberalize and the
actual opening up of the economy even further. After all, shock therapy,
like all theories, has its limits as well. This really should have been the
theme of the paper from the very beginning. It is much more convincing
than lib/no lib in the case of Chile.
In terms of poverty reduction, my recommendations are in line with
those of the World Bank, that Chile continuously find a way to allow the
22
poor to invest in human capital (as they have done in the past), and to
find a way to allow them to use their greatest economic asset: labor.
(World Bank, 2001) It is worth noting that in the final period of the
simulation, the level of capacity utilization was more than 95 percent,
which is excellent; but there does exist the possibility that the economy
could overheat due to lack of excess capacity on the part of the private
sector. So I recommend that the government continue to subsidize
training programs, allowing the economy to continue rapid expansion.
Finally, acknowledging the many dangers of rapid capital flight, I
recommend that, as a means of ensuring that the amount of hot money
entering and leaving the country stays relatively stable, the central bank
place a somewhat modest tax on speculative funds leaving the country—
similar to an exit tax discussed by Collazo (2003).
VII. Conclusion
The simulations presented in this paper have given much weight to the
claims that developing countries are slow to develop because they are
slow to integrate themselves into the global economy. When examined in
the context of economic growth, Chile has proven to be a definite
success story; but on the other side of the story, there have indeed been
casualties: namely, increased inequality and less than stellar progress in
reducing the depths to which poverty extends, allowing us to conclude
that such growth has not been as pro-poor as it could have been. These
simulations, however, do show that, despite the impressive growth
experienced post-liberalization, there were many setbacks to the Chilean
economy. These setbacks were of course the result of rapidly liberalizing
the current and capital accounts of a country that is economically
immature. While this is no longer the case, it should be noted that if Chile is
to continue on the successful growth path that she is on currently, there
23
must be continued expansion with less volatile investment and consistently
low levels of unemployment coupled with high levels of job growth.
References
1. Collazo, F., “Capital Mobility in a Dynamic Structuralist CGE.” University
of Vermont (available at www.uvm.edu/~wgibson).
2. Collins, J. and , J Lear., 1995, Chile’s Free Market Miracle: A Second
Look. Monroe, OR: Institute for Food and Development Policy.
3. Litchfield, J., 2001, “Updated Income Distribution and Poverty
Measures for Chile: 1987-1998.” Background Paper #1 in Chile: Poverty
and Income Distribution in a High-Growth Economy – The case of 19871998. Report No. 22037-CH (Volume II), August 30, Washington, D.C.
4. Londono, J., and M. Szekely., 2000,“Persistent Poverty and Excess
Inequality: Latin America, 1970-1995.” The Journal of Applied Economics
3(1): 93-134.
5. Mesa-Lago, C., 2000, Market, Socialist, & Mixed Economies:
Comparative Policy and Performance, Chile, Cuba and Costa Rica.
Baltimore, MD: Johns Hopkins University Press.
6. Ravallion, M., 1997,“Can High-Inequality Developing Countries Escape
Absolute Poverty?” Policy Research Working Paper #1775. World Bank.
Washington, D.C.
7. Schatan, J., 2001,“Poverty and Inequality in Chile: Offspring of 25 Years
of Neoliberalism.” Development and Society. 30 (2): 57-77.
8. Stiglitz, J., 2001, Globalization and Its Discontents. New York, NY: W.W.
Norton.
9. United Nations Conference on Trade and Development,
Investment Report, 2004. (available at www.unctad.org)
2004. World
10. World Bank. 2001,Chile: Poverty and Income Distribution in a HighGrowth Economy – The case of 1987-1998. Report No. 22037-CH (Volume
I), August 30, Washington, D.C.
11. World Bank, 2004, World Development Indicators CD-ROM.
24
12. World Bank, 2001, World Development Report: Attacking Poverty.
Washington, D.C.
VIII. Appendix
Figure 8.1: Growth Elasticity of Poverty Gap
0.00000
1970
-0.05000
1975
1980
1985
1990
-0.10000
-0.15000
-0.20000
-0.25000
-0.30000
-0.35000
-0.40000
Source: World Bank (2003) and author’s calculations.
25
1995